Personal Finance: Blockchain a test for using Bitcoin

Christopher Hopkins
Christopher Hopkins

Brother, can you spare a Bitcoin?

By now, most of us have at least heard of Bitcoin, but what is it exactly, and will it deliver on its promise to radically alter our lives by eliminating money issued by legitimate governments?

On the second question: no. National governments are unlikely to relinquish control of their various currencies any time soon, so disregard the hype.

As to the first question, what is Bitcoin, well that one takes a little longer to cover.

photo Christopher Hopkins

Bitcoin is the most familiar of many so-called "cryptocurrencies." It was designed to function like money but exists entirely in cyberspace. There are no physical Bitcoins, only digital entries on a vast collection of electronic records distributed among hundreds on computers.

Bitcoin represents one example of a computing protocol known as "blockchain." Unlike many geeky tech terms, blockchain is fairly descriptive. It is essentially an endless electronic ledger book that tracks every related transaction sequentially. In the case of Bitcoin, purchases, sales and transfers are compiled on a ledger page called a "block." Once a particular block is filled (currently about every 10 minutes in real time), the block is closed and a new block is opened. Each block is tied digitally to both the previous block and the new one, hence the term blockchain. It is a continuous, ineradicable and public record of every Bitcoin transaction.

The "crypto" part comes from the fact that the blocks utilize an encryption algorithm to ensure they are valid and to defeat attempts to falsify the record. But another fascinating twist renders fraudulent alteration of blockchain records virtually impossible.

Identical copies of the blockchain reside simultaneously on hundreds or even thousands of computers around the world. Referred to as "nodes," those host computers continually update the shared copy of the blockchain with each Bitcoin transaction. This makes corruption of the blockchain theoretically impossible. Owners of the powerful computers dedicated to hosting the nodes are rewarded periodically with additional Bitcoins.

Individuals purchase Bitcoins from exchanges or from other holders. They are stored electronically in a "Bitcoin wallet," from which payments may be initiated. So far, major companies that accept Bitcoin are few but include Microsoft, Expedia and Subway.

As a threat to the U.S. dollar or any other major currency, don't hold your breath. For starters, it is far too unstable. In fact, it is not money so much as gambling, given its extreme volatility. The cryptocurrency fluctuated by 10 percent just last Friday, and has risen from $567 to $4,050 over the past year. Imagine making an offer on a house and paying 20 percent more by the time you changed your dollars into Bitcoins.

Second, Bitcoin will never be big enough. There are currently 17 million of them, valued at around $68 billion, less than the money supply of Peru. And the total number is limited to 21 million, so the end is in sight and the future beyond is entirely undefined. Further, since Bitcoins are popular with extortionists and money launderers, many governments are reluctant to sanction their widespread use pending additional regulation.

So Bitcoin is no threat to conventional money. But blockchain technology already is in increasingly common usage to secure financial transactions. Some global banks are experimenting with the technology to secure wire transfers, and stock markets are prototyping immediate settlement of stock trades using the protocol. One day soon, voting at home on the internet will be possible with zero potential for voter fraud by using blockchain.

Think of Bitcoin as an early and impermanent testing ground for the more promising blockchain technology. And blockchain will be truly revolutionary.

Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga.

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