The Nature of Bitcoin (Not crypto currency in general, but just Bitcoins):
To understand the nature of cryptocurrencies, one needs to understand the history and the context of how they came into being. It all started with a person called Satoshi Nakamoto, who circulated a white paper which proposed the foundation of a global unregulated currency. The aim was to create a currency that would not be affected by the decisions of central banks or senior politicians. Money had to be free. This concept appealed to the internet renegades, and knowledgeable people got together to make this dream of his a reality. (The white paper was very detailed, with mathematical depictions of the problems that I just explained, but we do not need to go into that)
Bitcoin Simplified: The Desi Way
We will get the explanation in 2 parts:
1. Why do we need it?
2. What is the mechanism behind it?
Why do we need it?
In short: Because no process of online money transfer in the world is reversible.
Why does that bother you? It doesn’t, actually most of the people in the world are consumers rather than merchants. Bitcoin is a system that puts onus on the customer to verify the details of the merchant rather than the other way round.
For Example see 2 scenarios:
1. You being a fraud yourself, send money to a merchant, and when you see that your item is shipped, you just call your credit card company, and declare that you had no knowledge of this transaction, and hence, you want to cancel/reverse it.
AND here is the catch, since most of us don’t do such things, we don’t know the magnitude of the problem (neither did I) but apparently, it’s a huge problem. But if we think about it, it makes sense. As a merchant, I have less venues to verify a customer than vice versa. I am a simple person selling lamps on amazon. If a customer orders I ship, it’s that simple. The customer doesn’t have reviews, and I being a businessman will try to sell giving the benefit of doubt.
2. You paid money online to buy something from a merchant and your account gets debited. But then the merchant turns out to be a fraud and he doesn’t send you anything or damaged goods.
This is a sad scenario, but you had reviews, you had options to verify the merchant, yet you got scammed. Well, thin line between accident and foolishness.
Up until now, merchants had relied on middle parties like banks to ensure that money is transferred, and banks had inevitably sided with consumers during disputes of this kind. Putting merchants at a disadvantage.
Now coming to Bitcoin, these are irreversible, if you send it to the merchant, it’s sent, end of story, nothing
more to say. It aint coming back. So why will consumers accept such a risky proposition?
Well they won’t, but what if you really needed something, what if that thing was worth risking it for? What if you needed drugs? :O
Yes so, if you put your minds to it, we can understand why Bitcoin initially gained notoriety as the choice of currency for underworld transactions.
But then again, these problems have been fixed. So we have services like Bitcoin escrow:
But then doesn’t it undermine the very purpose of bitcoin, afterall we are using mediators! Aren’t we trying to get rid of those pesky banks? Well this is different, imagine if you are using a bank to do the transaction, you just pay and the bank does not know the identity of the seller or the customer, so if a matter of dispute arises, the bank has to believe what the customer says. On the other hand, if you and the merchant are mutually agreeing on a third party for a transaction, the third party knows that both of you are intending to make this deal. So if one party backs out, the mediator can extend a verdict rightfully.
Problem of Double Spending:
Now this concept is fairly easy to grasp. What is it that makes transactions with physical cash so popular, it is because it is double spending. Consider the following scenario.
You go to a dhaba, you pay for an ice cream, and place the money on the counter. The guy gives you the ice cream, lets your money stay lying on the counter, and goes to take a piss. Meanwhile another guy comes to take his place, you point to the same money lying on the counter, and tell him that you want a Coke, (Not Pepsi, a coke, because Pepsi is horrible). The guy considers the previous money left on the counter as new money and accepts it and gives you a coke. You take your stuff and run away. And that is how you double spent your money.
Now a more sophisticated example:
J has INR 100.00
At the same time from two different tabs of your net banking portal, you transfer INR 50.00 to two different people. What goes on in the back end? The bank ensures that they timestamp each transaction, so try as you might you cannot do 2 transactions simultaneously.
But what would have happened if that were not possible?
You could have taken advantage of the situation like this:
1. You send INR 50.00 to K
You know that there is a time lag between the time when you actually spend, and the point of time when the said change is reflected in the system. So in that lag, you send that same money again to someone else. Now in essence, you paid the same amount of money to two people.
Bitcoin solves this problem as well.
Now in both these problems, you needed a third party, one in case of reversibility you needed a bank to transfer the money to a seller, and for double spending you needed the system adopted by the bank to ensure the money in your account is being used in an honest manner. These problems are fairly common, and although we don’t have exact numbers we can always guestimate.
If there is 1 in a million transactions that get affected by such problems. And say the cost for the bank to deal with such problems each time is say:
1. INR 100.00 considering the employee that is getting paid to do this job of ensuring security
2. INR 10.00 mn Infosys charges you for maintaining the software that you use to monitor this and say this comes to INR 100.00 per issue
3. The power costs at lumpsum
The global ecommerce sales is USD 1.9 trillion. Now considering an average cart size of USD 50.00 per customer, there are 38.00 bn transactions.
No of transactions that have issues will be 38 bn / 1 mn = 38 mn
For each transaction you are spending INR (100.00 + 100.00). So that comes to INR (200*38) mn or INR 7600 mn which is equal to INR 76,000.00 Crores. This cost is borne by us. And that is what we spend availing these services. Lot of money eh?
Bitcoin tried to fix this.
Now we established a few reasons as to why we needed a centralized system. I mean hey, who loves banks anyway, we all hate those suited booted Dalal Street/ Wall Street players, apparently they take your money and give it to Vijay Mallya, and poor people get squeezed.
Well, before I go any further, I just wanted to clarify that I am one of them. And no we are not bad, because the amount you deposited with us, you will always get it back. No matter how much we take losses because of people like Mallya. No one has to worry.