Breaking down Bitcoin

How does bitcoin work?
12 February 2018

Interview with 

Peter Cowley, Angel Investor




Digital currencies have been in the news a lot recently. Some banks have stopped customers using credit cards to buy cryptocurrencies, amid concerns they could run up too much debt. Last month, a family was held at gunpoint over a type called bitcoins. Our go-to Tech Guru and Angel Investor, Peter Cowley, was able to give Katie Haylor the lowdown. Starting with, what is a cryptocurrency?

Peter - A cryptocurrency, put simply, it’s a digital currency which doesn’t have banknotes or coins or a virtual currency, but it’s encrypted. That’s a very simplified version.

Katie - What is a bitcoin?

Peter - A bitcoin is the first cryptocurrency that was invented by a lady, chap, or group of people called Satoshi Nakamoto back in 2009. It was invented using blockchains which we’ll come to later. There are 1400 or so different cryptocurrencies available at the moment but bitcoin is by far the best known one. Bitcoins have been mined for about ten years and so they are in quite common usage.

Katie - Okay. We’re talking about what actually bitcoin is. Are we talking about data here - is a bitcoin a packet of data?

Peter - Yes. The point about the cryptocurrencies is they’re a public ledger so, basically, all transactions that have ever occured are in the public domains - anybody can see that. The bitcoin itself is a chunk of data within that chain, within that blockchain.

Katie - Right, okay. We’ll come onto what blockchains are. How does bitcoins work?

Peter - A bitcoin is a chunk of data which is associated with currency i.e. something that’s to do with money. There are blockchains used for many other purposes. Let’s take the example of you and I, if I want to pay for something you've done for me, maybe you’ve done some music or you’ve written a book or something, I can pay you with a cryptocurrency. So I transfer a chunk of data, which is not a whole bitcoin because they’re worth thousands of dollars, to you and then you will receive that, and then you can use that.

Katie - The difference here is that we’re cutting out the middle person right? So instead of a traditional bank transaction where you might give money to your bank, they give money to my bank, they give money to me, we’re passing money just between the two of us, so that’s the difference?

Peter - Exactly. It’s fully decentralised so that every single transaction that’s going on is available for everybody to see so we’re not relying on a middleman.

Katie - Where do bitcoins come from?

Peter - Bitcoins are mined; mined as in found by running through an algorithm - it takes a lot of energy. A bitcoin algorithm which was designed many years ago, but can be changed in the future, is actually set to mine no more than 21 million of them, which the current calculation is about 2140. Somebody has some computing power somewhere mining these bitcoins. Then they go into circulation. It costs, at them moment, probably a low number of thousands of dollars to mine it just using computing power - using electricity to drive computers.

Katie - So you can make bitcoins?

Peter - Correct.

Katie - Why bother to use them, this virtual currency, over conventional money?

Peter - Originally it’s because the founders didn’t believe, didn’t trust the banking system, so they wanted something that was decentralised, so it was effectively in the public domain where effectively it could be lost. It was always there. That’s why it was done originally. I imagine it was just done for interest initially rather than necessarily the fact that it’s grown so rapidly into a currency that’s used in a 100,000 places round the world.

Katie - This blockchain, this public ledger, this public account of where the data’s going between which users, that is blockchain? We here that bitcoin is associated with quite a lot of criminal activity, why is that? What makes it vulnerable to that?

Peter - The banking system doesn’t know about it, so obviously the banking system and the governments are worried that things could be happening that they don’t know about. If you were to obfuscate something, these transaction although it’s in the public domain, you would disassociate your wallet ID, which is how you get at this currency, from yourself, then it could mean that money is transferred around that is non-traceable. So that’s the concern and it does happen. There are a lot of criminal activities using this.

Katie - So even though this blockchain is a public ledger, you can make yourself or the transactions or who you’re transferring money to anonymous.

Peter - Yes. But you’ve got to compare it say with 100 dollar bills. There are trillions worth of 100 dollar bills around. Those aren't traced are they? They have numbers on them but people don’t write them down. So there are plenty of ways for criminals to transfer money around.

Katie - But the key point is that bitcoin isn’t regulated, is that the case?

Peter - It’s not regulated. It’s also very easy to transfer. If you’re moving large amounts of currency around it weighs something. This can be done with an electronic transaction.

Katie - I see, okay. Can bitcoin go from this digital medium to physical?

Peter - It has to really because, if you think about it, in the end people can transfer and buy services and products within bitcoin. But, at some point, you want to bring it out to say pay the rent, or to pay the food bill, or something like that. But there are ATMs, in fact there are about a hundred or so in the UK - there’s five or so here in Cambridge - where you can put in a £20 note and get some bitcoins out or visa versa. So they do translate into real or what we call fiat currencies.

Katie - Ah, okay. Finally, do you think this is something that will last?

Peter - I’m absolutely convinced. Being in the investment scene, there are plenty of companies that are proposing blockchain and, to some extent, cryptocurrencies. Blockchain I’m sure will do. There are a number of reasons why it’s better than having other ways of doing it. Cryptocurrencies? I’m not sure. Maybe I’ve got a bit too much grey hair to believe that enough trust will occur. I suspect it will do in time and there are signs that the Swiss government and other governments are starting to regulate in such a way that they will become the norm. I don’t know when though.


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