Understanding Bitcoin (2 of 5)

Bitcoin as a Virtual Currency

We touched on some characteristics on Bitcoin last time. This time let’s focus on one use of currency: exchange for goods or services and see how Bitcoin is compared with it.

Beside the legal currency we use today (say Hong Kong Dollar in Hong Kong), we see a lot of “virtual currencies” in our daily life, that is, something we can finally exchange for some goods or services, such as stamps issued by supermarkets, or mileage by airlines. Say you can get a pan after collecting 100 stamps, or redeem a flight to somewhere by 50,000 miles. You may not consider them as currencies. Nevertheless, they do have this capability to let you get back some goods or services.

Of course, these virtual currencies are not real currency, as their issuance always comes with terms like “non-negotiable”, “non-transferable”, etc. This is obviously different from the legal currency we are using today.

When we ask this question, we are in fact asking what the price of a stamp or a mileage is. From issuers’ perspective, as they have a promise to give the goods and services to those holding the virtual currencies, these goods and services certainly have a price tag. But as users, we usually overlook this.

Let’s imagine a situation: tomorrow is the deadline for stamp redemption, and I still lack 5 stamps before I can get that pan, and there is no way to get more new stamps. What can I do? I can “buy” stamps from others, if they have some unused ones. It can be free (well, nothing is really free) or at a price for these 5 stamps. Now we know that the stamp really has a price tag, and one is willing to exchange the stamp at a price. How much is the price? It is my judgment. Accept it or not? It is other’s call.

Some airlines already do this for you. They allow top-up in case you have not adequate mileage for a particular flight. Therefore mileage also has a price tag. But this time it is they deciding the price, not you.

Who is controlling these virtual currencies? Legal currency is governed and enforced by local government according to the law. Virtual currencies on the other hand are controlled by the issuers, which, in our examples, are supermarkets and airlines. They are the “creator” of these virtual currencies: they have the right to determine how to get them (how much money spent to get one stamp, one for one in miles), how to use them (how many stamps for what product, how many miles for this category of flights), expiry policy, or any promotional incentive (more stamps on weekends, 30% off for redemption on a particular category), etc.

There is difference between stamp and mileage: supermarkets in general only recognize the stamp itself, and do not care how the stamp is collected (e.g. obtained from someone else as far as it is real stamp). Therefore it is de-facto transferrable. Mileage is associated to individuals, and transferability is under certain restriction. Also mileage is not something tangible but a record kept in their database. We trust the airlines who always keep the integrity and reliability of such records.

Finally, and the most important part, these rules are subject to change, and to certain extent, you as users can only accept them. Airlines can change the expiry of mileages from life-long to three years. To the extreme, supermarkets and airlines have the right to cancel the plans completely. Well in reality whether they will do so is another story, but they really have this right.

Virtual currency appears much earlier than Bitcoin. Understanding some features of them helps us know more about Bitcoin. As a virtual currency, Bitcoin is also subject to some predefined rules, and how the rules are changed or updated. The difference is that Bitcoin is not owned by a company or by a government (decentralization). The current situation is that there is an agreed protocol, and participants like Bitcoin users and miners (we talk on this later) are executing this protocol.

Besides, the Bitcoin is not tangible. They are just transactions recorded in a distributed “database” (this is not a generic database, and we will talk on it later, which is called “blockchain”). The database is open to public, everyone can trace what it is, and it is almost impossible to modify the records.

Lastly, Bitcoin itself also have a price, but how much? Unlike those virtual currencies by issuers, the price of Bitcoin (vs. a legal currency such as US Dollar) is determined by market. A market is a place where participants are competing. When someone says USD20,000 is a bubble, someone says USD20,000 is underpriced. As this series is not about investment, I leave it to other experts do the prediction on something we have never seen before.

Next time we will see how a Bitcoin transaction works.

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Happy to share what I learn on blockchain. Visit http://www.ledgertech.biz/kcarticles.html for my works. or reach me on https://www.linkedin.com/in/ktam1/.

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