This post continues on from the introduction to Bitcoin into the Bitcoin payment ecosystem. This article assumes that the reader understands the purpose and working of Bitcoin and expands on the different participants in the network.
To those in the banking and financial system Bitcoin may seem to defy conventional rules for accounting, lending, reserving, taxation and regulatory requirements but it must be stressed that Bitcoin is not designed to have any built-in financial and regulatory controls nor book-keeping.
Bitcoin is a peer to peer cashless (and trust less) system and by virtue of its stated objective is quite lean. It is also one of the riskiest payment systems as users are anonymous and the network does not have regulatory approval. Consumers who participate in Bitcoin transaction and speculation do so, completely at their own risk.
Bitcoin users also include investors who use exchanges to speculate and trade in bitcoins. These users not only have to accept all inherent risks involved with the fluctuations in bitcoin value but also that of unregulated exchanges losing or making off with their money. Bitcoin exchanges and banks are sometimes perceived as fiduciary investment platforms but it must be remembered that the system assigns no value to bitcoin.
Bitcoin users also include investors who use exchanges to speculate and trade in bitcoins. These users not only have to accept all inherent risks involved with the fluctuations in bitcoin value but also that of unregulated exchanges losing or making off with their money. Bitcoin exchanges and banks are sometimes perceived as fiduciary investment platforms but it must be remembered that the system assigns no value to bitcoin.
A conceptual view of the Bitcoin payments ecosystem is shown in the diagram below. There are four major components within the Bitcoin payments ecosystem - core, wallets, exchanges and marketplaces.
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A conceptual representation of the Bitcoin payment ecosystem. Bitcoins are transacted through user wallets while the core performs the consensus validation on the blockchain, which also creates new bitcoins. Exchanges act as interfaces to the real world. Users can also transact directly. |
Bitcoin Core
The Bitcoin Core is the program that runs the consensus rules and ensures the integrity of the blockchain. The Bitcoin core enables the decentralization of Bitcoin. It can be downloaded and run as a thick client by users on node computers which then can work as miners and maintain the distributed blockchain.
For all practical purposes, Bitcoin network can be run and operated exclusively by its users who can mine and exchange bitcoins on the network by installing Bitcoin core.
Computers that download the complete blockchain are called full nodes. Higher the number of nodes, the more reliable is the consensus and difficulty to tamper, exponentially higher. Full nodes all have the complete blockchain and verify new blocks. Six verifications can be treated as a consensus and the blockchain grows.
Core users have a number of incentives such as transaction privacy, faster tracking of their bitcoins, simplified interfaces and can use anonymity protocols to remove any IP identification.
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| A comparison on Bitcoin.org on privacy and security of transactions using Bitcoin Core versus platforms built on top. |
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| A global map of all bitcoin mining nodes on the Bitnodes website. Bitnodes is a service that tracks all reachable nodes on the network |
As proof of work difficulty increased, mining pools were formed to combine resources and split block rewards among members of a pool. Mining pools offer an interface to allow multiple users to sign-up and contribute resources (CPU power, electricity) to run the Bitcoin core in exchange for block rewards which are shared by miners.
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| A demo account dashboard from bitcoins.cz, one of the first mining service (also known as Slush's pool). |
Although the Bitcoin network does not require user identities, users expecting complete anonymity will find it difficult to do so outside the Bitcoin core.
Bitcoin Wallets
Bitcoin wallets are bitcoin address databases which have address keys of their respective owners. Bitcoin Core provides a wallet interface and has all the advantages of the core.
For consumers of the bitcoin currency, wallets are required to spend and receive bitcoins. Digital bitcoin wallets are also available in different forms such as mobile, desktop, web and hardware form. These are called lightweight wallets.
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Bitcoin wallets are available in a variety of forms such as desktop, web, mobile and hardware (USB) wallets. Users can download and install wallets like any other application. |
Wallet providers offer services such as mixing where coins are routed between different transactions so that it is difficult to associate a group of addresses with any one user. In this case, the wallet provider becomes an intermediary who will still know the source wallet. The bitcoin owner also has to trust that the wallet provider will not lose or spend their coins elsewhere.
Bitcoin Exchanges
Bitcoins can be traded against or exchanged with physical currency on bitcoin exchanges. Bitcoin exchanges operate online and have been set-up all over the world. Exchanges such as LocalBitcoins allow bitcoin buyers and sellers in a geographical location to contact one another and transact directly.
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| Coinbase, one of the largest bitcoin exchanges looks like any other trading platform. |
Bitcoin payments do not require user identification or information and settlements are made quickly (usually the next day).
However, exchanges will have access to user information especially where bank accounts for handling physical currencies come into the picture. Exchanges can also be registered as money trading businesses and providing identity and verification is required to transact on such exchanges.
Bitcoin Banks
Bitcoin banks have started opening that accept deposits primarily for investors in bitcoins as an asset class. They may make way for a bitcoin banking system although it is difficult to see what operations they can have apart from saving deposits at present. It will be very risky to make deposits expecting a long term return on investment (apart from speculation) or that bank reserves will be adequate or borrowers will be credit worthy.
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| The website of Bitcoin crypto bank, the world's first "real" bitcoin bank shows returns on investment |
Bitcoin Marketplaces
Bitcoins are accepted by businesses all over the world. Bitcoin transactions can be made by in bitcoins which in turn can be redeemed on exchanges. Another model that has emerged is an escrow type marketplace, where bitcoin owners can spend bitcoins where only traditional currency is accepted or traditional currency holders can buy goods valued in bitcoins. The marketplace operator acts as an intermediary converting bitcoins into physical value on behalf of the parties involved. Not all marketplaces provide an escrow mechanism for buyers, but providers such as Bitify offer automated escrow as an added incentive.
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Bitcoin marketplaces such as bitify and BitPremier show the proliferation of bitcoins in the economy. Note the buying power of bitcoins in the luxury segment. |
Bitcoin Platform Ecosystem
Apart from the payment ecosystem, a complete technology ecosystem forms the backbone of Bitcoin and is responsible for its growth. This includes information providers such as Blockchain.info and BitNodes who use Bitcoin’s open API to provide services such as blockchain transactions and reporting. As more consumers start using the network or speculating on Bitcoin, they will be dependent on the open source community and solution providers to maintain the scale and integrity of the block chain.
The Bitcoin platform ecosystem will be covered in a separate post.
The Bitcoin platform ecosystem will be covered in a separate post.
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