Digital giants Amazon and Netflix enjoyed an outstanding year in the 2017 stock market. But last year’s best financial investment may have been in bitcoin, a digital cryptocurrency owned by everyone and no one at all.
The frenzy over bitcoin has prompted several institutions of higher education to offer courses on “blockchain” technology. This spring, Nitin Kale, an associate professor in the Information Technology Program at the USC Viterbi School of Engineering is teaching “Blockchain,” the university’s second offering on the subject. Kale taught the first USC course on the peer-to-peer technology last fall.
Kale explained that classes are so popular that, due to limited space, students are turned away in droves.
“2017 was the year of bitcoin,” Kale said. “The students are very, very excited.”
During 2017, the value of 1 bitcoin crested at around $19,000 — a figure that created overnight millionaires and elevated the cryptocurrency to asset-class fortunes. Bitcoin’s value has many people, from curious neophytes to established investors, trying to understand how blockchain technology works.
How does bitcoin work?
Bitcoin’s origin story is peculiar. The technology was originally described in a 2008 white paper by a person with the pseudonym Satoshi Nakamoto. Kale said that no one knows Nakamoto’s true identity, gender, nationality, whereabouts or even whether he/she is one person or a group of people. Nakamoto, who many believe is identified through his cryptographic name or “seed” in the ledger’s history, mysteriously dropped off the platform in 2010.
Bitcoin is a decentralized, open-source software platform that is free and available to everyone on the internet.
Being decentralized takes the system away from a central location or a central point of failure or attack.
“Being decentralized takes the system away from a central location or a central point of failure or attack and makes it really thin and distributed,” Kale said. “It’s everywhere, so in order to attack, you have to do so in many different places.”
Bitcoin has special participants around the world called “miners” who opt in voluntarily and use computing power to solve a math puzzle called the “proof of work.” Excessive computing resources are hurled at the puzzle in order to solve it, an approach Kale calls “brute force.”
The first miner to verify the block, or ledger of transaction data, and accurately solve the “proof of work” is rewarded with 12.5 newly minted bitcoins and all transaction fees within that ledger. Then a new block of transactions begins — hence, the term “blockchain.”
Lower transaction fees
Bitcoin users also benefit when making everyday purchases because they don’t pay high commissions to third parties. Kale explained that Bitcoin users can send payments with much lower transaction fees compared to an intermediary like Western Union or PayPal. Bitcoin’s public ledger of transactions also discourages fraud.
“In this way, the technology can be disruptive because it may change how people do business — the first possibility being the financial banking industry itself,” Kale said. “It creates trust in a trustless system.”
But if bitcoin sounds too good to be true, there’s the rub.
Bitcoin’s worth is highly volatile. In January, the value of one coin dropped to less than $10,000, losing between 40 and 50 percent of its peak value.
The sharp decline is likely due to the South Korean government’s threat to regulate the cryptocurrency, Kale said. Even hints at federal regulation create panic in bitcoin’s users, spurring them to sell their coins.
Because bitcoin is open sourced, the software code is freely available to the public and can be tweaked slightly, then reintroduced as a different cryptocurrency — a practice that has spawned a rash of other blockchain cryptocurrencies, most of which have minimal to no value.
The second-most valuable cryptocurrency is Ether, available from an open-source blockchain platform called Ethereum. At the time of this writing, one ETH (the name for an Ether coin) was worth approximately $957.
Another drawback: The excessive amount of computing power required to fuel bitcoin’s technology is cost-prohibitive. Mining is increasingly concentrated in countries like China where electricity is cheaper.
Bitcoin mining has become more and more difficult, which means that miners have to expend a tremendous amount of computing resources to mine the next coins.
“Bitcoin mining has become more and more difficult, which means that miners have to expend a tremendous amount of computing resources to mine the next coins,” Kale said.
A limited horizon for new coins
Since bitcoin has a limited supply, a day will come when there are no more new coins on the market. So far, 17 million of the available 21 million coins have been mined.
Even though the end seems nigh, Kale said that miners can still reap transaction fees by solving the math puzzle in each new block of Bitcoin transactions. For that reason, bitcoin could live on indefinitely, Kale noted.
Kale added that blockchain technology itself could impact the non-financial sector, creating disruption in government, banking, contracting and identity management, all through its fraud-proof mechanism.
But time will tell since the blockchain revolution has only just begun.