Northern Alberta Institute of Technology

5 things to know about bitcoin

Bitcoin's economic impact, the block chain, the currency's possible flaw, and more

Digital currencies are like green-haired punks sauntering into the blazered, shiny-shoed world of institutional finance. Nobody quite knows what business they have being there but, curious or worried or both, nobody outright dismisses them. Those punks are reinventing money, after all – the basis of the modern economic system.

No virtual currency (of which there are hundreds) has challenged that system more than Bitcoin. When the first transaction happened in 2009 shortly after the currency’s mysterious creation, it was worth a fraction of a cent. By early October 2017, it was valued at more than $5,200 CDN, with one analyst projecting $7,500 US by next year and $50,000 by 2027.

But its rising value isn’t the most interesting thing about bitcoin, says JR Shaw School of Business instructor Max Varela. “It enables you to transfer money without an intermediary, and that’s the real revolutionary thing about Bitcoin,” he says. That is, it requires no banks.

So, how does it work? Why is the value skyrocketing? What could it mean to the way the economy functions? And what’s all this talk of “mining” money? Nobody mines money.

They do now, says Varela. Here, he explains why, how and what it all means to those of us still content to hear the jingle of cold, hard loonies in our pockets.

1. It’s economic democracy in action

Conventional, physical money is regulated by the government to influence economic growth. Regulating the amount in circulation can help keep inflation in check, and manipulating interest rates on borrowing can bitcoin mining pickaxeaffect spending. Then these factors and more interact with the near-cosmic complexity that helps keep instructors like Varela gainfully employed.

“Bitcoin is very democratic.”

In contrast, “Bitcoin is very democratic,” says Varela. It was created by users, is regulated by users and is made by users who trade it unimpeded by banks or other institutions. “There’s no central authority.”

2. “Mining” and the block chain

Every bitcoin transaction is logged in what’s known as the block chain. This is a fully transparent and ever-growing public record. With more than 16 million bitcoins in circulation as of September 2017, it is almost unimaginably complex, and the accounting requires specially designed, high-performance computers.

In Varela’s eyes, the extraordinary innovation is how the block chain has incentivized users to regulate the system themselves. The “mining” is the number crunching. “Once you run the calculation, you get rewarded with bitcoin,” says Varela.

Other industries are now looking at the block chain as a cheaper and possibly more effective alternative to conventional, centralized accounting and recordkeeping.

3. Why bitcoin is worth so much

“Things are valuable because we think they are,” says Varela. “Everything is worth what we’re willing to pay for it.”

He feels the same applies to bitcoin – the supply of which has been capped at 21 million by its creators. While that built-in scarcity is a contributing factor, Varela attributes the currency’s meteoric rise in value largely to bitcoin miningspeculation, or investors betting on a big return despite significant risk. “You have to ask yourself, ‘What is driving the increase?’ I don’t think anything is.”

“You have to ask yourself, ‘What is driving the increase?’ I don’t think anything is.”

That said, does he see a bitcoin bubble? “You never know. You only know once it’s popped.” In any case, he doesn’t plan to get a special bitcoin wallet and start investing.

4. Bitcoin’s possible flaw

Thinking about bitcoin as a functioning currency, Varela sees its 21-million cap as a problem. “Having the supply fixed means that prices have to go down.”

In general, he explains, the supply of money in the economy has to keep up with an ever-increasing amount of goods and services. Limit the supply and there’s not enough money available to buy them all, so their prices must drop; a recession follows.

But wouldn’t the increased value of each bitcoin compensate, you ask? (Or I did, at least.) No – in fact, Varela still foresees recession as a result. If people know their money will be worth more tomorrow, and therefore will have more purchasing power, they’ll wait to get a deal.

“No one will spend money,” he says. “You’ll always be in a deflation spiral.”

5. Bitcoin has benefits

bitcoin miningAt heart, bitcoin is an experiment in disruption. “It was created to show that it could be done,” says Varela. And it worked. Hundreds of thousands of retail locations around the world accept it; in Japan, it’s a legal form of payment. Varela sees value in that shift.

“It’s a challenge to the order of finance.”

“It’s a challenge to the order of finance,” he says, and therefore to a system that shapes the life of nearly every person on Earth. But that’s not a bad thing, says the instructor. The punks may not have been invited to the party, but that shouldn’t stop them from crashing it.

“It’s human development,” says Varela. “That’s what drives innovation.”

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