The bitcoin bubble – Part I

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As published in Hawke's Bay Today. Canny View by Nick Stewart, Authorised Financial Adviser.

What if there is a technological advancement so powerful that it transforms the fundamental pillars of our society?

A technology that fundamentally influences the way our economy, governance systems and business functions, and could change our conceptual understandings of trade, ownership, and trust.

This kind of technology already exists, and it’s called bitcoins, also known as “cryptocurrency”.

Bitcoin is often seen as virtual money or an exchange of digital information that allows you to complete any transaction.

With the bitcoin price so volatile everyone is curious, especially investors. It is important to understand about bitcoin – to act or not act.

In a two-part series, I will give an overview of bitcoin in a nutshell, how the blockchain technology program works, the concept to circumvent the governance, bitcoin as an investment, regulatory risks and, finally, address frauds and security concerns.

Bitcoin, the category creator of blockchain technology, is the first decentralised payment network.

It is powered by its users with no central monetary authority, yet extremely complicated, and no one definition fully encapsulates it.

By analogy, it is like being able to send a gold coin via email, and you can purchase anything (goods or services) with bitcoin.

It is a consensus network that enables value to be transferred over communications channels without using any centralised service, like a bank or Paypal.

The bitcoin network is secured by individuals called “miners”.

Bitcoin miners are individuals who maintain the ledger and manage the bitcoin process flow by chronologically adding new transactions (or blocks) to the chain and keeping them in the queue.

Miners are rewarded with newly generated bitcoins as well as the fees paid by users for verifying transactions.

Bitcoin software enables a network of computers to maintain a collective bookkeeping via the internet.

This bookkeeping is neither closed nor in the control of one party; rather it is public and available in one digital ledger, which is fully distributed across the bitcoin user network. This is called the blockchain.

In the blockchain, all transactions are logged, including the information on the date, time, participants and amount of every single transaction from the beginning of the bitcoin time, which was 2009.

Each node in the network owns a full copy of the blockchain.

However, the blockchain doesn’t record the items that are purchased or sold and doesn’t include the identities of the users.

Miners can also generate new bitcoins by solving cryptographic issues. This provides a smart way to issue the new bitcoins and provides an incentive for people to mine.

The reward is agreed upon by everyone in the network but is generally 12.5 bitcoins.

To prevent inflation and to keep the system manageable, there can be no more than a fixed total number of 21 million bitcoins (or BTCs) in circulation by the year 2040, so the “puzzle” gets increasingly harder to solve.

There is no doubt that bitcoin and cryptocurrencies have caused a paradigm shift in our economy.

It is important to explore this new technology constructively and critically, and openly discuss the potential applications.

Next week, I’ll discuss if the bitcoin is the brave future of transactions, particularly for investors, and what people need to know about regulatory risks and frauds with bitcoin investment.

* Nick Stewart is an authorised financial adviser and executive director of Stewart Financial Group. Stewart Group is a Hawke’s Bay-owned and operated independent financial planning firm based in Hastings. This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to consider your investment objectives, financial situation, and individual needs. A disclosure statement can be obtained free of charge by calling 0800 878 961.