Bitcoin is everywhere and some say it can make you fabulously rich. We can certainly look at the fantastic prices a bitcoin demands and imagine all the things we could do with that money! But what is bitcoin and other so-called cryptocurrencies? Can they really make you rich? And why do people say it will change money forever?
What is bitcoin?
Bitcoin is a cryptocurrency, which Francois explains is not legal tender (as in a legally recognised currency, like the rand or dollar), but it’s legal to use.
‘Using bitcoin and cryptocurrencies is at your own risk, as the market is unregulated. You cannot pay your taxes in bitcoin, but you can use it to buy things from someone who accepts bitcoin as a method of payment.’
Regular currency is kept stable through institutions such as the Reserve Bank. Bitcoin is not quite the same as the cash in your wallet. Think of it more like owning something valuable that you’d like to sell in exchange for money. But one day bitcoin and other cryptocurrencies may become real money, because what they do is pretty cool.
How does it work?
Cryptocurrencies use a system called blockchain. This is a technology that distributes a ledger - the record of who owns what - across many different computers. Every time there is a change, all the machines reflect that change.
This makes it nearly impossible to forge a record, because the system always self-corrects. Since banks spend a lot of time and money verifying payments, this is big step forward in creating trust.
‘Blockchain technology allows money to move faster, cheaper and more securely than ever before, without even having to use a bank or trusted third party,’ says Francois. ‘If banks themselves use the technology, they will save billions in fees, and be much faster, having transactions settled in seconds or minutes, as opposed to days.’
Is this why cryptocurrencies are so expensive?
No. Even though there is a lot of excitement around cryptocurrencies, their explosion in value have more to do with people wanting them to be valuable.
Unlike normal currencies, which are pegged to financial systems, cryptocurrencies are still speculative. If everyone decided tomorrow that bitcoin is worth only a cent, the price would fall to reflect that. You can’t do that with a more traditional currency.
The prices of bitcoin and other cryptocurrencies are purely down to what people are willing to pay for them. Because of several factors, such as how tough it is to mine the currencies (mining is the way new cryptocurrencies are created and gets harder the more currency is produced), the price is very volatile.
Miners are members of the public who use their computers to help validate, verify and timestamp bitcoin transactions, ensuring there is no fraud. Once he's happy with a transaction, the miner adds it to the ledger. As an incentive, miners are rewarded for doing this by being ‘paid’ in cryptocurrency.
Can it make me rich?
In the 18th and 19th centuries, clipper ships raced from China to Europe to sell cargos of tea. These ships were incredibly fast, because the first to reach port could set the highest price for tea. Everyone else got less.
Even though bitcoin is showing huge price values, unless you already sit on a pile of coins you might not see much profit. Of course there is a chance that the price will go even higher, but that also means the price can go much lower. Traders will tell you to buy low and sell high, but at the moment bitcoin is already very expensive.
You could mine more bitcoins, but that becomes tougher per coin and will cost you a lot of electricity. You also have no guarantee that the value will hold. Like a prospector mining for gold, you could get lucky. But most don’t and many lose more than they put in.
‘Some people get rich from mining gold too,’ says Francois. ‘That doesn’t mean you should go and buy a spade and start trying to find gold in your garden. Mining cryptocurrencies can be profitable if the conditions are right. Many people who start mining do not ever get a return on their investment. There are many companies offering mining equipment for sale, but the profitability depends on your running costs, the current price of bitcoin, and the amount of bitcoin you can mine over time.’
So is it a fad?
No, quite the opposite. Cryptocurrencies are the future, and they have been a long time coming. They are also a much better way to handle money than traditional banking, says Francois.
‘Bitcoin and its blockchain are major breakthroughs in computer science. Bitcoin began in 2009 so will be a decade old next year in January. The blockchain technology bitcoin uses is one that builds on 20 years of research into cryptographic currency, and 40 years of research in cryptography by thousands of researchers around the world. It is not new technology at all - it’s just that bitcoin was the first time that technology was pieced together and set up to run in that manner and order.’
(Cryptography is the study of techniques for secure communication – your WhatsApp messages are encrypted, for example.)
One day, all money will use blockchain systems to keep things honest. But before that time arrives, a few things must happen. The technology needs to be adopted by the financial world and cryptocurrencies must prove their worth.
That is happening at the moment and maybe in the near future you'll be able to pay for your lunch with pieces of a bitcoin. But that is many years away, so don’t ditch your wallet just yet.