Editor's note: Since this article was published, China has banned Bitcoin exchanges such as BTCC. But Bobby Lee's explanation of what Bitcoin is and how it works remains valid.
Bobby Lee, founder of BTCC, the first Bitcoin exchange in China, says the Bitcoin network will prevail. “The reason is, because it will,” he said.
He acknowledges Bitcoin is difficult to understand because it is complex. “It’s many things to many people,” he said, speaking at a Finnovasia event in Hong Kong in December, 2016.
Bitcoin and other crypto-currencies are gaining traction because digital information offers advantages. Transactions are nearly instant and can occur without intermediaries, which brings costs way down.
An email message today costs virtually nothing to send. The internet economy is based on this free and instant sharing of digital information, which works by making an instant copy across computers.
For example, when I send you an email, there is a copy of the message in my outbox and in your inbox.
This has transformed business and society. Although a technology is morally neutral, Lee argues that the internet – a network for digital information – has been a great thing for humanity, a view shared by many.
Lee takes this to the next step: “What’s even better than digital information is digital assets.”
What’s a digital asset?
We are habituated to conceiving of assets as physical things: cars, homes, clothes, machines. Until recently, nothing online was like this. Whatever images or messages we stored on our smartphones, or whatever we transacted online, were not assets. They were transactions that ultimately involved paper money being exchanged for a physical good or service.
But with Bitcoin, the first crypto-currency, you can send real value, instantly, Lee says.
“By copying or sending Bitcoin to anyone in the world over wi-fi or an email, you can transfer values of any amount, instantly, with no third party involved,” he said.
Digital currencies mean information now has a defined and transferable value. “Until Bitcoin, digital information was never transferable in the true sense of giving and taking,” Lee said. Sending an email or sharing a photo didn’t involve giving something away: the information remains in the sender’s outbox or on her smartphone.
But with digital currency, once I give you a bitcoin, it’s yours to keep or to give to someone else, just like a physical object. “This is a big deal,” Lee said.
How big? In Hong Kong, the number of ATMs transacting in Bitcoin have shrunk and there’s hardly any retail merchants who accept it.
“It hasn’t impacted your life yet,” Lee said. “But neither did the internet 20 years ago. In 1996, the internet was just the ‘information superhighway’. Now, though, through our mobile phones, it’s part of life.”
Digital assets will follow suit, and it won’t take 20 years, he predicts.
There are many crypto-currencies out there. Most of them are iterations of Bitcoin. Bitcoin’s specific features include: it is global; it has a fixed supply (no more than 21 million bitcoins will ever be issued – assuming the system is never hacked); it is decentralized (like gold, it doesn’t depend on a central bank or other authority to impact supply and demand); and it’s very inexpensive to transact.
Of these, scarcity is perhaps the most interesting feature. The creators of the algorithm defining Bitcoin ensured a process in which no more than 21 million bitcoins can be issued. A physical coin represents 1/1000th of a bit. If you own 21 bitcoins (or BTC21), you own one-millionth of global supply.
(Bitcoin, with a capital B, refers to the entire Bitcoin network and ecosystem; bitcoin, lower-case b, refers to specific units of value. I own BTC1 or one bitcoin; I am writing about Bitcoin.)
That’s all fine and dandy, but what makes Bitcoin a thing of value? Because it can’t be used in payments or to trade if there’s no value.
Mining for value
Essentially Bitcoin has value because people who make it and use it say it has value, just like ancient rulers imbued value in a shiny rock. Nor is this too different from people today accepting paper money issued by a central bank, which is based on faith in the government ultimately meeting claims on that cash. Governments, even indebted ones, can always resort to taxation, but they are ultimately relying on confidence. Bitcoin can’t tax anyone but it too relies on confidence, which is generated in the manner of its creation.
When Bitcoin was created by “Satoshi Nakamoto” in 2008, anyone in the world with a computer could participate in the generation of units. Satoshi Nakamoto developed a system that’s basically a lottery. Every ten minutes, his software releases what is essentially a lottery ticket to win 50 bitcoins. To get a ticket, your computer must solve a math puzzle.
This quickly led to an arms race of computing power as people added servers to race to break these equations and snag more lottery tickets. Faster computing power meant more lottery tickets and more chances to win bitcoins.
This process, called mining – and it’s no coincidence that the terminology replicates digging for gold – gravitated to China, which is now the world’s biggest Bitcoin market, for both mining and trading.
“You need time and have to want to make money” to mine for bitcoins, Lee said. “People in China have access to great computing equipment, fast assembly, and cheap electricity.”
Anyone in the world can join in if they have a computer to run Satoshi Nakamoto’s equations. “But in China, they’re generating trillions of lottery tickets,” Lee said, “by stealing machines and using free electricity.”
Once bitcoins are created, it resides as money in the cloud (cloud computing being the mass sharing of computer processing resources and data, that enables on-demand access, from any linked device).
In the cloud, each bit is assigned a unique identity and password. Although holders of bitcoins may be anonymous, every single transaction is visible. But anyone with a smartphone can trade bitcoins.
There are also physical bitcoins. Lee says these exist mainly as marketing devices, to generate familiarity with it as a currency. What makes a coin a bitcoin is the QR code on the back of a sticker, which embeds the same unique information about value and passwords to a corresponding account in the cloud. (Don’t peel the sticker: it will negate your ability to transfer the value to someone else.)
Some people use Bitcoin to invest; Lee says because of Bitcoin’s baked-in scarcity, holding it in the cloud as fiat currencies depreciate makes it “the ultimate hard money”.
Many people, however, use it to speculate – a time-honored tradition in the world of stocks or real estate.
Bitcoin has generated controversy and skepticism. Could the aggregation of supply in China allow the Chinese government to effectively nationalize the currency?
Bitcoin exchanges such as Mt. Gox in Japan and Bitfinex in Hong Kong have been subjects of, or enabled, fraud. Is Bitcoin safe or just a new way for punters to lose their money?
Bitcoin has been used by criminals such as the narcotics syndicate Silk Road to move assets. Is its anonymous nature giving criminals and terrorists a new way to operate?
Lee can address some of these, but not all of them.
Hacks and attacks on the infrastructure around Bitcoin have been a problem, Lee says, but exchanges such as BTCC have survived and continue to improve their technology. There will always be criminals finding ways to steal money, but Lee argues these episodes can be minimized through best practices. That leaves a lot of questions.
He’s on firmer ground when he notes that Bitcoin is just money, and bad guys launder it in any form. The system’s users may be difficult to identify, but transactions are made in public.
As for China’s preponderance, Lee says people in other countries are free to address this concern by upping their own mining activity. He is obviously keen to make the case that this is a private-sector activity, done by individuals, and to disregard a potential government hand.
If anything, Beijing is keeping a wary eye on Bitcoin. It allows citizens to mine and trade it, but doesn’t let banks transact in it. This minimizes capital flight using crypto-currency.
Lee, who is based in Shanghai, says Bitcoin is not a practical tool for evading capital controls. He argues there are already other, easier loopholes in China to get around Beijing’s desire to control capital flows.
Bitcoin and other digital currencies will not replace fiat money. But Lee says future generations will hold some of their assets in digital form, along with physical ones. As a major player in Bitcoin, he’s betting it will retain its edge over other types of crypto-currencies because of its market size, early start and ability to set the standard.