How are bitcoin, cryptowallets and blockchain related? Some jargon busted …
December 15, 2017 1.54pm GMT
When the bitcoin was first introduced eight years ago, it promised to change payments. People would be able to transact directly with each other, without needing to place their trust in banks – but that promise still hasn’t materialised and adoption of bitcoins is low.
We were first told in 2009 that many transactions would be verifiable and validated by the bitcoin protocol. However, as we argued in a recent study, a significant adoption barrier to bitcoin is the lack of usability.
Since the inception of cryptocurrency, developers and researchers have been using metaphors to explain bitcoin in a clear effort to help people feel more comfortable with the technology.
A secure application for holding bitcoins is dubbed a “cryptowallet”, the trading platforms where people can buy and sell bitcoins are called “exchanges”, and in several locations around the world, ATMs have emerged for bitcoin-based transactions. The production of bitcoins is described as “mining”, but the only similarity between this and mining for gold or valuable gems, is that both processes are very, very difficult to achieve. Finally, bitcoins are called “coins”, even though they are entirely digital.
Using metaphors to refer to these technologies helps people feel more familiar with the technology. But there is also a downside: people expect that the technology can be used as regular money.
One could easily believe that, in fact, such “coins” are stored in a “wallet”, which leads to further misinterpretations: if these are coins, what do they look like? if it’s real money, how do I get refunds for paying for stuff? and do I get change if I don’t have the exact amount? But the coins don’t exist. They are merely entries in a highly secure, very restricted database.
There are no wallets, crypto or otherwise. These are either software applications that may or may not connect to the internet, or hardware-based solutions (similar to USB sticks). ATMs can be used to buy and sell coins, but teller machines do not hold “coins”. And, in the bitcoin world, there are many transactions that can’t mimic how regular money works.
If I pay for something with pound notes and then regret my purchase, I can return the item to the shop and the shop may or may not issue a refund. But the bitcoin protocol doesn’t allow this. If a transfer of bitcoins has been broadcast to the network, by design that transaction is final. It means that, had I paid for that item with bitcoins, the shop can’t issue a refund but instead has to process a new payment, or a charge back – which incurs additional processing fees. This isn’t a refund – as some money would be deducted from the full amount I originally paid.
X marks the spot
To support the adoption of bitcoin as an alternative payment, we need to have a system that is cheaper, better and more desirable compared with other forms of payments, such as debit cards.
The bitcoin is cheaper, because – even when paying by debit or credit cards – there is always a fee involved for processing such transactions. Some merchants will pay the fee themselves, or roll this cost over to the consumer, as an extra charge for paying by card. Paying in bitcoins has zero cost or very low cost, subject to how much of a hurry the consumer is in.
Everyday transactions in bitcoins are fairly straightforward and security is robust: if I need to pay somebody in bitcoins, I can send the exact amount to that other person’s bitcoin address (a randomly generated sequence of characters, that changes every time there is a transaction) by confirming it with my unique PIN-like number. The rest is done by the miners (more about which later) who need to verify that the transaction is unique and genuine.
Despite these clear advantages, bitcoin’s desirability factor remains low. And there is little we can do (at least for now) to increase its uptake. Notably, adoption is also affected by trust perceptions. People are more likely to trust the technology if they have a better understanding of how the bitcoin protocol works. This can be achieved without forcing everybody to become an expert in cryptography.
Four essential facts about bitcoin
What is bitcoin? It’s one of many cryptocurrencies – but the only one that has grabbed the headlines. It is a type of digital currency, created and regulated by a network of thousands of computers (known as peers) using encryption techniques. Because of this, its production is independent from any authority, such as banks and sovereign states – and trust in the bitcoin is produced by the technology itself. How does this happen?
Meet the blockchain: Simply put, the blockchain is a very restricted database, whose entries are the bitcoin transactions. The blockchain operates as a digital ledger of transactions. Just like regular businesses that keep a record of money coming in and going out, users of the cryptocurrency need to record all bitcoin-based transactions. The difference is that the blockchain is a decentralised and distributed, open-access ledger whose records are permanent and verifiable by the network of peers. So everybody can view past transactions, but nobody can alter them without having the consent of the majority. This means that the blockchain doesn’t exhibit weaknesses associated with traditional ledgers. The blockchain technology is secure by design.
How are bitcoins produced? Through mining, which is undertaken by the peers of the network. The miners are people and organisations that connect their computers in the network to offer processing power, using special software to solve very difficult algorithms, while leveraging the power of advanced computers and graphic cards. In return for their services (creating new bitcoins, authenticating transactions, maintaining the blockchain), they get rewarded with new bitcoins.
Where are bitcoins stored? A cryptowallet – which is a software application that stores private keys (code that looks like a very long PIN) – is where all bitcoins are stored. These private keys are connected to public keys (code again, but the equivalent would be a bank account). The best way to understand how a cryptowallet works is to think of it, in similar terms, as a secure connection between a person’s PIN to their bank account, which then allows them to check balances and make payments.
Money makes the world go round
The bitcoin hasn’t become the alternative payment system for consumers that was promised eight years ago. Widespread adoption of the cryptocurrency is hobbled by a number of factors: its reputation is associated far too often with alleged bad boys, and talk of a bubble that’s about to pop persists even as bitcoin continues to surge. But, above all else, few people can cut through the jargon to understand how it actually works.
These perceptions can shift if bitcoin-based transactions become easier to comprehend in a way that will help people build trust in the technology. Instead of replicating old paradigms, bitcoin should be embraced as a fresh new way to pay for stuff.