One of the advantages and greatest assets of Bitcoins lies in how they are sourced. Their quantity is limited in that the more are mined, the more difficult it is to obtain them. It really is not much different from gold, oil, or any other precious resource.
Think gold rush: Those who arrived first found the biggest chunks of gold. Those who joined the rush too late struggled to reap the benefits for their endeavors and saw their dreams of being millionaires go up in the dust they hoped would hold their treasure.
The mining of Bitcoins has reached a similar point. Striking lucky has become very difficult.
In fact, the idea of being an adventurous explorer is what first drew me to the mining of Bitcoins. Just that it was physically much safer than mining gold and that it required no heavy machinery. Although the thought of meeting up with your peers in a salon after a day of manual labor does sound somehow romantic.
In essence, Bitcoins are mined through solving mathematical problems. But rather than trying to dig up some hidden nugget, Bitcoin mining is based on keeping track of transactions between people in a specific time period and putting them into, what is called, a block. A block is just like a folder holding all the transactions between different parties.
The Bitcoin miner is in fact more of a problem solver than a tough guy in jeans shuffling tons of sand. With every newly added folder, the shelf becomes larger. In Bitcoin mining this shelf of ever increasing folders is called the blockchain, a constantly expanding chain of folders of transactions.
Bitcoin Mining Problematic
The actual mining process takes place when a block is complete and needs to be sealed to protect the information contained inside. Bitcoin mining is in fact a mathematical process turning the block and all its information into a hash, a sequence of letters and numbers (just like the ones you will need when unlocking your phone, for instance).
For every newly created hash the miner receives a set number of Bitcoins (currently 25). However, the difficulty lies in the fact that a hash has to look a certain way to be accepted by the Bitcoin protocol – the digital control mechanism if you will. Only if the protocol accepts the created hash are the Bitcoins awarded.
But what was once easy and accomplishable with one computer has now become a task impossible to solve on a single computer. Every computer requires electricity to run and with the increasing complexity to find the right hash, the necessary power is far extending the reward. It is for that reason that there are now groups of people working in unity to calculate a hash.
So if mining has become to difficult, how about trading it? Many of the original platforms are no longer. When the dollar prices for Bitcoins plummeted, several trading companies, such as Mt. Gox, closed their doors for good. Others have since popped up and are moving into serious territory. New York has just, for the first time, awarded a banking license to a Bitcoin exchange, itBit. In fact, New York has opened the possibility of being granted a banking license to other digital currency companies. So if you are in for a new venture, why not just open a Bitcoin exchange and apply for a license in New York?
The fact that New York has gone this route is a testament to the increasing importance of Bitcoins as a currency.
But how would you go about if you wanted to trade them? The answer is very simple: you trade them just as if you were trading another currency or commodity. You pay a certain amount of euros or dollars and in return receive a Bitcoin. If you were to sell it, you trade the Bitcoin for euros or dollars, or whatever other currency.
And just like trading currency, commodities, bonds, or shares, you open an account with a trading platform and buy or sell Bitcoins for money. And just as your regular broker, most trading platforms will charge you a transaction fee.
One very important aspect to not forget is the fact that it is not backed by a government nor are Bitcoins based on anything of substance. Different to shares, for instance, Bitcoins do not represent the value of a company, its products or services. It is merely based on algorithmic calculations executed by computers.
Would I trade Bitcoins?
Simple answer: No.
I love the idea of an alternative digital currency. This is why some years ago I looked into Bitcoins as an investment alternative. If Bitcoins were to be the digital currency to become just that, a lasting serious alternative to regular currencies, it would indeed be a positive development.
Bitcoins are well thought out in their basic form: they are difficult to mine and as such fulfill the criterion of scarcity – similar to gold. But for Bitcoins to be a real contender, their reach in terms of acceptance by retailers and companies needs to expand.
For these reasons I would not trade them, yet. Once they are more widely accepted, have a track record that is evidence to them being not merely a hype will they become a real alternative. For the moment Bitcoins are still in their infancy and do not possess the substance I seek in investments to put real money in them. Currently, the volatility – the fluctuation in the price of a Bitcoin – is still too substantial for it to be an investment alternative.
But with an ever expanding reach and a longer track record, Bitcoins may very well become a real investment opportunity. And this is when - although no longer a tough tea sipping miner - I would be more than happy to trade Bitcoins.
Read in Part 1: What are Bitcoins?