Bitcoin Simplified

Bitcoin news has been creating jitters, as it becomes a subject of anticipation, uncertainty and fear in February.

Bitcoin ATMs were pulled down after declaring those as illegal sometime back, but a Supreme Court judgement overruled RBIs decision in the matter. Legal sanctity of bitcoin trading in the country was restored after the Apex Court’s intervention.

Now, the government proposes to introduce a Cryptocurrency Bill in the second part of Budget 2021 session, scheduled to be held from March 8, 2021. It will lay down the framework for digital currency being brought in by Reserve Bank of India, and the use of blockchain.

Speculation abounds on the subject that all private cryptocurrency may be banned. The definition of ‘private’ is not yet clear. Will it include the topmost currencies like Bitcoin and Ethereal? Should it do so at a time, when Bitcoin is touching a new high?

WHAT IS BITCOIN MINING?

Let us understand the origin of this particular cryptocurrency, introduced by Satoshi Nakamoto, and put it in as simple a manner as possible.

The number of bitcoins in the system is finite – 21 million.

Mining of cryptocurrency is a computer program, to be run on expensive computing rigs, consuming a lot of electricity. The cost of running this program is huge, and may not be cost-effective for many miners.

Bitcoin miners first need to verify 1MB transactions. This sounds simple.

Next, the bitcoin miners need to solve a puzzle in the form of a ‘hash’.

The hash or problem statement is a 64-digit hexadecimal number.

Example:

0000000000000000057fcd708cfg0130d85e27c5919203e9f967aa57e4df598ee

The bitcoin miner has to guess this number or a number below that. So, it becomes a game of probability.

Decimal system

If you have to guess a number below 10, the probability of getting the right answer from 0-9  is 1 out of 10.

Hexadecimal system

Here , the probability is one out of 16, hence alphabets are included.

But a bitcoin miner doesn’t have to total up the value of the hash. Miners play the game by randomly generating as many nonces as possible, as quick as possible. 

Nonce = “number only used once.” 

The first miner whose nonce generates a hash, less than or equal to the target hash is awarded credit for completing that block and 6.25 BTC. There is a chance that one may not be rewarded with bitcoin, despite going through this exercise. The huge cost of transactions may not be recovered, and this raises question marks on viability of the whole exercise.

BITCOIN HALVING

The rewards have been reducing by half every four years. The reward was 

2009 – 50 BTC

2013 – 25 BTC

2017 – 12.5 BTC

2021 – 6.25 BTC

It will whittle down to 3.125 in 2025, and so on…

This ensures that all 21 million bitcoins do not get mined very soon.

The bitcoin price today hovers between INR 34,00,000 to 35,00,000/-. And this has shot up from Rs. 17 lakhs a few months ago. Bitcoin price  in USD is $47,348.70 on date of writing this blog.

Bitcoin price history in India is available on the following link

The level of difficulty in the game increases, as the number of bitcoin miners competing for the spoils increases.

The estimate is that all 21 million bitcoins will be mined by the year 2140.

As of now, about 18.5 million bitcoins have been mined.

There are many where owners have forgotten the crypto-keys, or owners who died have not passed on the key to survivors. 

MINING POOLS

The solution to the complexity of the process  and high cost is is to do the mining in pools. So, there are groups of miners performing the tasks on shared equipment, under huge cooling fans.

HOW DOES AN AVERAGE PERSON INVEST IN BITCOIN?

What if an average person does not wish to go through this rigmarole, or does not have the competence to do so. An investor may yet want to profit from this asset class.

An investor can buy bitcoins from a cryptocurrency exchange. CoinDCX is one such exchange in India.

Investors can trade in bitcoin, and use it to make certain payments.

Indian investors can pay for bitcoin, and receive proceeds of sales in their bank accounts. They are liable to pay tax on the capital gains made through such sale. Bank accounts hold KYC details  (such as PAN and Aadhar) of investors, and flow of money can be tracked.

What cannot be tracked is the spending of bitcoin, and items purchased through it. The prevalent fear in government circles is about 

  1. illegal or potentially harmful use of cryptocurrency by unethical entities, and
  2. Gradual flow of wealth in fiat currency to a form beyond the control of RBI

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