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Mystery money: A beginner’s lesson in cryptocurrency

Technology is both a blessing and a bane. While it’s wonderful to have the world at our fingertips, figuring out the latest versions of computer software and upgraded smartphones exhausts anyone who grew up using typewriters and landlines.

Even what once seemed a tangible national foundation—the monetary system established under the U.S. Department of the Treasury with physical dollars and coins—now faces competition in the cyber world.

Cryptocurrencies such as bitcoin are increasingly researched, debated, used for purchases and considered an investment option internationally. One universal surrounding cryptocurrencies is that most people struggle to understand them, as U.S. Sen. Thomas Carper from Delaware aptly surmised.

“Virtual currencies, perhaps most notably bitcoin, have captured the imagination of some, struck fear among others, and confused the heck out of the rest of us,” Carper said.

The basic definition is not helpful in bringing clarity. In the simplest of terms, cryptocurrencies are a virtual medium of exchange. Bitcoin—the most recognized from among more than a thousand cryptocurrencies and the first one created—began with Satoshi Nakamoto. The name is a pseudonym for a person or group that has never been identified.

“Bitcoin: A Peer-to-Peer Electronic Cash System” was written in 2008 by Nakamoto and is considered the currency’s launch. The article explains that Internet commerce relies on financial institutions, with fraud easily occurring.

“What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other,” the article states.

What that means, explains Information Technology Professor Glen Sagers, is that cryptocurrencies allow for purchases to be made anonymously using digital money and without involvement of a financial institution.

Check ledgers and credit card statements are no longer needed to verify expenditures. Evidence of any purchase or money transfer instead comes through a tracking system known as the blockchain, which Sagers explains is the strength of cryptocurrencies.

“Fraud protection is the best argument,” he said. “It’s a really good idea, and is what appeals to a lot of people. There is proof that a transaction has occurred.”

The blockchain has been described as the Internet, with a bitcoin analogous to an email. Sagers explains the blockchain as a database with no central administrator. Every transaction is time stamped and recorded, with multiple copies on millions of servers around the world.

“There is no way to fake the fact that a transaction has occurred, whereas a signature can be forged,” Sagers said. Any coin transfer is permanently recorded because data cannot be altered or erased from myriad computers scattered across countries.

This cryptocurrency feature attracts individuals eager to better protect their financial transactions. The need for improved safeguards overall resulted in creation of a cybersecurity degree program at ISU. Enrollment has grown to approximately 200 since its start last fall. Sagers, who helped launch the degree, understands people feeling leery as corporate credit card database breaches escalate.

He acknowledges that others are made equally nervous by the fact cryptocurrencies are not regulated and users are only known by a digital address. Circumventing the traditional financial sector leads many to contemplate if cryptocurrencies are tied to or encourage illegal acts.

“Virtual currencies have been linked to criminal activity in the past,” Sagers said. The anonymity may, for example, be an incentive for some to engage in illicit behavior that would be embarrassing if discovered in a way that names were exposed.

Another troubling aspect of no regulation is the fact that the currency fluctuates widely in value. “It is definitely the gambler’s market,” Sagers said, pointing to trends of rapid gain followed by huge collapse before another rally.

“Bitcoin could ruin the planet.”—James Jones

For example, one bitcoin equated to $2,900 in U.S. dollars in September of 2017, rose to $17,900 by December 2017, was $6,200 in February 2018 and up to $7,635 in June. This radical variation is just one reason cryptocurrencies are not deemed a good idea by scholars in the Department of Economics, according to Chair David Cleeton.

“Bitcoin markets are very poor alternatives to well-regulated banking and payment settlement systems. The exchange rate volatility of the bitcoin currency, the high fractional transaction costs and extremely low acceptability mean bitcoins are of no measurable influence in monetary systems,” Cleeton said.

There is limited research on the subject within the department because “economists rely on data to perform analysis of economic effects, and you simply can’t do any reliable data analysis.”

By comparison, scholarly interest is high within Sagers’ area of information technology. This is understandable given computers are needed to verify transactions by creating the blockchain, which is also how bitcoins are created.

Computers collect pending bitcoin transactions, which are turned into mathematical riddles. The first whiz to find the solution receives 12.5 bitcoins once the answer is verified by other miners. As of June 6, 17 million bitcoins existed. There is a global limit of 21 million total that will be created, with expectations that cap will be reached in 2140.

The race to create bitcoins does not guarantee financial gain, however, because of the energy required. Hundreds of thousands of computers are running around the clock globally to solve the equations, which then adds to the blockchain and results in the bitcoin award. As more mining is done, more computers are used. The math problems become harder to crack, meaning more energy is needed to power more computers.

“It could all go bust because nobody wants to mine and confirm transactions,” Sagers said. There are predictions that is inevitable, as mining has led to banks of computers in warehouse buildings that require enormous electricity to power.

Banks of thousands of computers, some filling warehouses, run continuously around the world to mine bitcoins.

Banks of thousands of computers, some filling warehouses, run continuously around the world to mine bitcoins.

“Bitcoin could ruin the planet,” said James Jones, executive director of the Center for Risk Management, Insurance, and Financial Services within the College of Business. “The crazy energy consumption by bitcoin miners is growing at a staggering rate, to the point it is greater than the energy consumption of some entire countries.”

In South Korea, for example, it takes approximately $26,000 in energy expenses to mine a single bitcoin. The cost is around $3,000 in Louisiana, which is the cheapest state for miners in the U.S.

Jones, who is focused on the ethical implications of cryptocurrencies, presents a solid argument both for and against bitcoin. Beyond the energy issue, he notes that the nation’s financial institutions could be destroyed.

“Central banks will lose control, overturning centuries of monetary policy,” Jones said. And while individual transactions may be more secure, cryptocurrencies can still be hacked. He points to $530 million lost when a cryptocurrency exchange in Japan was breached earlier this year.

There is the positive side of an investor potentially gaining significant profit, but Sagers cautions that bitcoin earnings are taxable under capital gains. The odds of a windfall are not great given the variability in value, yet Jones notes that there is a growing interest among students investing in bitcoin as a way to cover college expenses.

They could end up making money with such a payment plan, or they could spend exponentially more than the actual total cash bill for their degree depending on when the coins are bought and sold. There are online currency exchanges to do both, with the largest and most reputable being Kraken and Coinbase.

Both Jones and Sagers have invested minimally in bitcoins, in part to remain knowledgeable of the issues surrounding digital currency. They agree that the burden of finding ways to spend it is a huge deterrent limiting current use.

“But the underlying technology is a good thing, and it’s here to stay.”—Glen Sagers

“It is not widespread enough to be a cash or credit card replacement,” Sagers said, at least not yet. But there are, as Jones points out, plenty of experts across disciplines convinced a global currency will emerge. Neither he nor Sagers make such a prediction.

“It is too soon to know if it is the future,” Sagers said. “But the underlying technology is a good thing, and it’s here to stay.”

Bitcoin stats

Total bitcoins in circulation
17,078,675
Total bitcoins to ever be produced
21,000,000
Percentage of total bitcoins mined
81.33%
Total bitcoins left to mine
3,921,325
Total bitcoins left to mine until next blockhalf
1,296,325
Bitcoin price (USD)
$7,635.20
Market capitalization (USD)
$130,399,099,360
Bitcoins generated per day
1,800
Bitcoin inflation per day (USD)
$13,743,360

Stats from bitcoinblockhalf.com as of June 6, 2018

Susan Marquardt Blystone can be reached at sjblyst@IllinoisState.edu.

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