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5 Things to Know About Bitcoin

The future may run on cryptocurrency, so it’s important to understand how it works.

Bitcoin is the most widely used digital currency in the world, supported by a network whose computing power is 100,000 times greater than that of its nearest competitor. It dominates its market and shows little sign of slowing down. But what exactly is bitcoin? And is it a fad or the future of payment systems?

YPO members had a chance to hear the answers to those and other questions during a global conference call hosted by the YPO Technology Network, featuring Stephen Pair, Co-founder, President and CEO of BitPay, the world’s largest bitcoin payment processor. Given the expanding footprint of Bitcoin and its impact on the way individuals and businesses transfer value, an understanding of its possibilities and its drawbacks is a good addition to your knowledge base.

Here are five facts about bitcoin that will help you get started.

It is both like and unlike other financial assets

In Pair’s view, bitcoin is similar to highly speculative growth stock. Its price reflects its current and possible future utility and adoption. The more people who use the platform, the more the price rises. It trades like stocks, driven by supply and demand and based on what buyers are willing to pay.

For those living in the United States, be aware that the U.S. Internal Revenue Service considers bitcoin to be property. In other words, Pair cautions, “You pay capital gains.”

On the flip side, however, bitcoin’s value is not correlated with other assets. Stocks and bonds tend to trade in unison, which exposes the investor to the ups and downs of the financial system. Bitcoin is independent of that and can, therefore, diversify an investment portfolio.

It depends on miners

Although “miners” is, in Pair’s words, a “fun term,” the reality of what they do is quite serious. They secure the blockchain, which is the technology that enables Bitcoin, making it infeasible to alter past transactions or double-spend the same bitcoins. In exchange, they can create new bitcoins, hence the reference to mining.

It saves energy and money

Although the mining processes use a great deal of energy, Bitcoin enables more energy savings than it uses. For example, because it is powered by a community, there is no need to build large, energy-devouring data centers. No currency has to be printed. No large bank buildings have to be constructed and powered. And, because Bitcoin enables near-real-time reconciliation, there are minimal transaction delays, thus avoiding missed opportunity costs.

It operates under no central governing entity, which is both a strength and a threat

Bitcoin is “governed” by the community itself, which means that problems are immediately addressed by those who have a vested interest in solving them.

However, when the community becomes divided over an issue, there is no “higher court” to which to appeal. For example, the community is now debating how to increase scalability. Because bitcoin has hit its capacity limit, in terms of mining power, transaction fees have increased. One faction is concerned that increased fees will inhibit adoption and recommends that fees be lowered, thus placing more emphasis on adoption than on revenue. The other faction is concerned that increased scalability will lead to centralization, with the possible outcome that smaller users will be crowded out, and Bitcoin will become a corporate realm. Such debates can affect the market value of bitcoins.

The technology supporting it has considerable potential for nonfinancial use

Blockchain is being adapted for other, nonfinancial applications, such as identity verification. Every transaction that uses bitcoin is authenticated by the owner of the originating address by way of a “signature” created by a cryptographic key. If that key is stolen or compromised, the key is revoked, which makes it difficult to verify signatures made with the key before its revocation. However, blockchain’s time-stamping function verifies when the signature was applied, thus validating that it was made with the key before it was revoked, assuring the signer’s identity.

As bitcoin’s usage continues to increase, Pair says, look for it to affect nonfinancial uses, such as health care records, developing education programs and assigning land titles.

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