A guide to blockchain and Bitcoin

In an ever-evolving world, digital currencies are being accepted by some product and service providers as payment, but not yet by the major banks. Bitcoin is accepted at over 30,000 online websites through Payfast, one of South Africa’s payment providers and over 150,000 merchants worldwide.

While you can ‘mine’ Bitcoins and other digital currencies, you also have the option to purchase them. “There are already bitcoin exchanges such as bitx.co.za and ice3x.com where one can exchange Rands for Bitcoins. Money can also be sent from other countries to a Payfast account holder in South Africa and many ecommerce websites accept Bitcoin, as these transactions are less regulated than money. These digital currency services offer convenience, lower costs and greater security to consumers; it will become more widespread as an alternative to money,” revealed Peter Alkema, chief information officer for First National Bank (FNB) Business, and Farzam Ehsani, leader of RMB’s (Rand Merchant Bank) blockchain initiative.

 There are a number of digital currencies that make use of blockchain for exchange with physical products and services, according to Alkema and Ehsani.

“VCs (virtual currencies) are private sector systems that, in many cases, facilitate peer-to-peer exchange bypassing traditional central clearinghouses. VCs and their associated technologies (notably distributed ledgers based on blockchains) are rapidly evolving,” revealed the International Monetary Fund in ‘Virtual Currencies and Beyond: Initial Considerations’.

Alkema and Ehsani explain that blockchain a virtual ledger that stores Bitcoin transactions.

“The blockchain is a series of connected “blocks” of data containing records of transactions, the most common type in use at present is Bitcoin transactions. These interconnected blocks form a “chain” of data which is effectively a database that is decentralised, fully distributed and publicly visible, thus open for scrutiny and acts like a ledger. In a traditional non-blockchain transaction, usually there is a trusted third party such as a bank that independently verifies the transaction; with blockchain it is the network that verifies the transaction thus not requiring the third party,” said Alkema and Ehsani.

What is the difference between virtual and digital currencies?

There is a difference between virtual currencies and digital currencies. “There’s a lot of misunderstanding around the terms “virtual” and “digital,” and people often mistakenly use them interchangeably. The reality is that virtual currencies are a type of digital currency, meaning that all virtual currencies are digital, but the converse is incorrect. Cryptocurrencies like Bitcoin are another type of digital currency, but they are in a separate category from virtual ones. Other types of digital currency also exist, and understanding which is which can become confusing,” explains Bitcoin magazine in an article.

Bitcoin magazine clarified that almost all virtual currencies are centralised. This means that the control of the money is with the developers of the virtual environment where the currency exists.

In contrast, a digital currency is decentralised, which means that no one has central control over the currency. In addition, a digital currency, such as Bitcoin, can be exchanged for goods and/or services in the real world. Bitcoin magazine added: “Cryptocurrencies (e.g. Bitcoin) are designed to be capable of replacing cash, and there’s nothing virtual about that.”

Alkema and Ehsani noted that Bitcoin is a digital global currency that is not issued by any sovereign state. According to them, if digital currencies, such as Bitcoin, “become widely used it is likely to reduce the use of sovereign currency such as Rands and Dollars (actual cash).”

Bitcoins are mined at a mathematically controlled rate. The demand for Bitcoin is subject to free market demand. This is unlike centralised currencies where the developers of the virtual currency can exert an influence over the currency, thereby affect the availability, value etc.

As Bitcoins are subject to free market demand, they differ from traditional currencies, such as the Rand, which is controlled by the South African Reserve Bank (SARB). Furthermore, Bitcoin magazine revealed: “The cryptography inherent in cryptocurrency also makes it more anonymous than any real or virtual currencies, which are tracked by banks and developers, respectively.”

Alkema and Ehsani explained that Bitcoins are earned by validating other people’s Bitcoin transactions. “Validating other people’s bitcoin transactions is called Bitcoin mining and is the process by which transaction records are added to the blockchain, or the Bitcoin public ledger. Bitcoins are thus not actually created (or printed like cash), they are “discovered” when computers compete with each other to successfully add transactions to the blockchain.”

They added: “Computers compete through a process of trial and error (called “proof of work”) to find a particular number that satisfies an equation for a particular block, which is rewarded through the issuance of Bitcoin and transactional fees. The public scrutiny of a peer network of multiple computers using the same calculation for a series of interlinked blocks creates the tamper-proof integrity of the blockchain. The incentive to perform Bitcoin mining is that for every successfully created block, which contains a set of transactions, the miner receives 12.5 bitcoins (or R127, 000 at the current exchange rate).”

How safe are digital and virtual currencies?

Your data does not need to be stored in the blockchain, this depends on the nature and purpose of the transaction which is using it.

“With Bitcoin already in use in South Africa, its use of blockchain is not currently violating any South African data privacy laws. However, it is physically impossible to remove data from the blockchain if it is already part of a string of sealed blocks of transactions. Data in the blockchain can also be encrypted or limited to be just a timestamp of the transaction with a pointer to the restricted location of whatever customer data that needs to be kept private,” emphasised Alkema and Ehsani.

There are various Bitcoin wallets, which offer varying levels of security to consumers. As with other digital services, people are required to manage their own level of security, like passwords.

“Accounts (or “addresses”) on the Bitcoin blockchain act like pseudonyms so unless you tell someone what your address is, it is virtually impossible to deduce which address belongs to which person,” revealed Alkema and Ehsani.

According to Alkema and Ehsani, the tamper-proof nature of the blockchain means that it is impossible for prior transactions to be manipulated. However, security features are necessary where users interact with the Bitcoin network.

“A number of improved security features have developed to protect a user’s Bitcoin wallet and ensure good practices are in place to protect the value stored in the bitcoins they own. It is important to note that blockchain technology uses the advances in the field of cryptography to secure the network. As such, each address or account has a private key that gives the owner the right to the funds in a particular account. If that private key is compromised, so are the funds,” added Alkema and Ehsani.

The way of the future?

There are benefits to banks accepting digital and virtual currencies. “The central bank and consumer banks in a country could decide to include a digital currency such as Bitcoin as a legitimate form of exchange. A currency that uses blockchain technology has the potential to reduce costs in traditional banking infrastructure and also introduce new and different types of digital currency handling firms into the industry,” added Alkema and Ehsani.

But until banks decide to let us, the consumer, trade them we’ll have to purchase and sell them through those channels that currently accept them, while being vigilant and ensuring that we trade through reputable service providers.

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