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Why?

Techly Explains: What is Bitcoin and why is it worth so much?

The price of Bitcoin has seen a massive surge this year, with the price increasing roughly 1,600% to reach around AU$21,600 at the time of writing.

But what is it? And why is it worth so much?

Bitcoin is a type of digital cryptocurrency with no involvement from any government, bank or central authority.

Its underlying technology is the blockchain, which is a distributed, decentralised, immutable public ledger that keeps a record of all the transactions ever made in a cryptocurrency.

In this case that currency is Bitcoin, but there are plenty of others.

Conventional or “fiat” currency as it is also known was originally based on gold, but Bitcoin is based on mathematics.

When a Bitcoin transaction is made, it is added to the ledger (or chain of blocks) and becomes known to all the other computers on the peer-to-peer network.

It is distributed because multiple copies of the transaction exist, decentralised because transactions can take place without a central authority, immutable because coins cannot be “double spent” and public because all computers on the network know about it.

Bitcoins are “mined” through a sequence of complex mathematical computations. The anonymous creator of Bitcoin, known only as Satoshi Nakamoro, set a cap on the total amount of Bitcoins, 21 million.

To date, computers have mined around 16.5 million bitcoins, but as we mine them the calculations necessary to do so become more demanding.

At the current rate of mining, estimates for when the last coin will be mined range from 2140 to never. As time goes on it takes longer and more energy to mine them and people are already speculating that the process is using more energy than entire countries.

Bitcoins can be traded on markets or used to buy goods and services. In its early days, it saw use on the Silk Road and black market but it is becoming increasingly widespread as a form of payment.

Why is it worth so much?

Governments back fiat currencies, giving them their value. Bitcoin isn’t backed by anyone but can still be used as a store of value because people are willing to trade them.

This may sound silly, but part of the reason Bitcoin has value is because people believe it does.

This had led some to call Bitcoin a bubble, comparing it to other classic economic bubbles in history such as the Tulip Mania of the 17th century (in which the Dutch were trading tulips for 10 times the annual salary of a skilled worker) and the Dotcom bubble of the late 1990s.

Reserve Bank of Australia governor Philip Lowe concurred this week, calling Bitcoin “speculative mania”.

Lowe’s reasonsfor labelling it as such are that the price is “very volatile, the number of payments that can currently be handled is very low, there are governance problems, the transaction cost involved in making a payment with Bitcoin is very high and the estimates of the electricity used in the process of mining the coins are staggering”.

If Bitcoin does have value, it largely comes from its aforementioned scarcity.

While more governments print more cash every year to keep up with inflation, there will only ever be 21,000,000 Bitcoins. This means that if it does become a popular currency (and transaction speed does inhibit this), the value of one Bitcoin will increase over time. In other words, the 21 million cap prevents Bitcoin from devaluing through inflation.

This year, Wall Street took notice and is now trading Bitcoin futures. This has well and truly brought Bitcoin into the mainstream and exposed it to a whole bunch of new investors. Your grandma has probably even heard of it by now.

More people are thus buying it, further driving up the price.

We’re blazing a new trail here so it’s unclear how this will end. Those that are bullish on Bitcoin believe the value will continue to rise indefinitely despite speed bumps that may be encountered along the way.

Those that are bearish see it as a speculative bubble that will soon pop spectacularly, taking billions of dollars with it.

The truth is we don’t really know the true value of a Bitcoin just yet. What is clear is that blockchain technology is here to stay and will eventually revolutionise the way we buy, sell and ultimately live.

As the first application of this technology, Bitcoin will likely always hold a special place as “Digital Gold 2.0”.

Disclaimer: Caveat emptor.

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About the author

Stefan is an Adelaide-based freelance writer. In his spare time, he plays tennis badly, collects vinyl and brushes up on his Mandarin. Follow Stefan on Twitter

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