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Bitcoin: A Seemingly Rampant Elevator, or is Someone Pushing its Buttons?

A Case Study on Bitcoin’s Fluctuations in Price and Concept.

Written by O. Wandery

Paper category

Bachelor Thesis

Subject

Business Administration>Finance

Year

2014

Abstract

Bachelor Thesis: Bitcoin 2.3.1 The working principle of Bitcoin The working principle of Bitcoin is to assume that transaction costs are high, because fraudulent behavior stems from the problem of double payment. This problem gave birth to a trust-based transaction system, which relies on financial institutions to control and ensure safe transactions, and check that the transaction has not been spent twice. 110 If we look at the official Bitcoin document in 2008, it defines an electronic coin as a digital signature. These digital signatures are created through transactions. Every time someone transfers a bitcoin, the sender will sign all the previous owner's "hash" left by the previous transfer and the recipient's public key. Then add it to the end of the digital chain. 111 This proves chain ownership and makes the coin "unique". In fact, this is the first part of solving the double-spending problem. The second part involves creating a common log of all transfers. The log shows all the transfers that took place and the bitcoins involved. This is done by a so-called time stamp server, which gets the hashes of the different items to be sent and publicly announces these items so that they can be checked against previous transmissions. In turn, this control mechanism needs to be safe and not compromised. This is done by turning the control organization into a large node system that has an honest motivation (if most nodes in the control organization are dishonest, double spending may occur). These nodes consist of computing power, such as the CPU in a personal computer. In principle, a CPU (or a computing power) is a node, or a vote. 113 Therefore, the whole idea of ​​the proof system was built by a community of ordinary people running Bitcoin software on their PCs. The working principle of the node-based system is explained as follows (the following points are directly from Satoshi Nakamoto's official Bitcoin article): 1) New transactions are broadcast to all nodes. 2) Each node collects new transactions into a block. 3) Each node is committed to finding a difficult proof of work for its block. 4) When a node finds a proof of work, it will broadcast the block to all nodes. 5) Only when all transactions are valid in it and have not been spent. 6) Nodes express their acceptance of the block by creating the next block in the chain, using the hash of the accepted block as the previous hash. The incentive for each node to perform the third stage (search for proof of work) is the potential reward of Bitcoin. The effect of this incentive plan is twofold. This is both a way to keep people actively involved in making the system safe. But it is also a way of distributing bitcoin. 2.3.2 Bitcoin Criticism Brian P. Hanley wrote a critique of Bitcoin based on the basic economic concepts of currency and banking. He claimed that the premise of Bitcoin is based on a "house of cards". 115 His goal is to expose Bitcoin criticism in four main ways. First, he claimed that the upper limit of the total Bitcoin supply is untrustworthy. Bitcoin should reach the upper limit of 21 million BTC, which in turn can be divisible by 100 million, of which the smallest component is called satoshis (that is, 0,00000001 BTC is a satoshis), resulting in a total of 21 million satoshis. To illustrate that this is unreasonable, he used the 2012 GDP of the United Kingdom as an example. If we assume that all bitcoins are available and should be equivalent to transactions only in the UK, then the value of each bitcoin must be $116,100. Today one is worth about 438.116 US dollars, which means an appreciation of about 270 times, which is unattainable by other commodities. 117 And since it is only for the United Kingdom, it is conceivable that the price of global currencies will be higher. With this in mind, Hanley recommends that any reasonable person will not use their Bitcoin to make purchases. 118 If no one uses it for transactions, it is impossible for Bitcoin to achieve such a high price through commerce. This is a paradox. The second problem is based on the fact that Bitcoin cannot be used as the basis for loans. Subsequently, the creation of money or the increase in money supply cannot be created out of thin air like money can be created through commercial banks and loans-basically, there is no increase in welfare. 119 Then we have the problem of hoarding. Hanley believes that saving Bitcoin is like depositing money in Madras. Putting money on the mattress will not bring interest and value to the entire economy, and normal currency interest rates can be charged, and the money deposited in the bank can be used for reserve banking. But according to Hanley, Bitcoin can only be hoarded, spent or lost. 120 And because from a system perspective, there is no difference between lost Bitcoin and hoarded Bitcoin, so basically there are only two options to deal with digital coins: spending money 121 and finally a zero-sum game for investors. When Bitcoin reaches its upper limit, it cannot create more value. This means that when one person receives Bitcoin, the others must lose one. Therefore, investors have no incentive to make money through interest rates or creating value through loans. Read Less