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Bitcoin: What you need to know

Wednesday, 10th May 2017

For the last few months Iíve attended several conferences discussing various aspects of the financial services sector from product innovation to financial inclusion. The one thing that has carried over from country to country and topic to topic is the inevitable moment when the coolest person in the room will mention that theyíre currently reading up on the next big thing. Bitcoin and Blockchain. This technology is going to change everything. It will upturn business models and the internet will finally be leveraged for change and life will be all rainbows and ice-cream-gluten free at that.

You might also have read the warning to the public that Bank of Uganda (BOU) recently sent out saying that anyone that had dealings with Bitcoin or other cryptocurrencies did so at their own risk. These services are not licensed by the Financial Institutions Act, 2004 under which BOU can exercise control and regulation. The Central bank wanted people to only deal with financially regulated institutions.

Despite and arguably aided by this rather ominous announcement, interest in Bitcoin has been piqued in the minds of several business and lay people in East Africa They cryptocurrencies had grown enough to merit recognition from the central bank. So I, too, begun dropping the word at events to appear clued in on the new thing. However, the deep dark secret was, though I seemed to know the basics, all the right words, -cryptocurrencies, decentralised and distributed ledger, computing nodes etc, but if anyone were to ask me how this really worked, Iíd probably run out of jargon and regurgitated examples. Iíd quickly be out of my depth.

I know Iím not alone in this and so I did what Iíve always done since graduate school-I decided to commit myself to writing two articles tackling these concepts because thatís the surest way to get a good grasp of things. And maybe these articles can help you sound smarter in front of your friend seated next to you at your next dinner party.

We start with Bitcoin : This is the most famous and popular cryptocurrency1 in existence. Itís basically a libertariansí dream. A currency which is encrypted and whose creation is controlled by a community of peers and can be transferred from one person to another without the need for a middle man or third party to act as an authority.  By using cash, we all agree that the paper currency and coins we hand each other in exchange for goods and services has value because the government has declared it legal tender. With bitcoin, the value of the currency is determined by other people like you on the network.

For this to work, Bitcoin relies on a network of peers who take turned in validating transactions and keeps records of every transaction a unit of bitcoin has gone through from the time it was created. The Peer to peer mechanism, the public ledger of transactions (blockchain) and the means for validation (Consensus mechanism) together form thunder lying technology of bitcoin. I shall go into more detail of these three in my next piece.

But how is Bitcoin created you might be asking? Well, peers on the network of computers using the software for bitcoin are randomly given the chance to solve complex mathematical problems. Think of it like a math problem your high school teacher wrote on the blackboard, inviting people to solve. And the reward for the person solving this? Well they get the right to validate transactions and authenticate exchanges of bitcoin between people on the network, and get bitcoin in exchange which adds to the amount of bitcoin in circulation so to speak. 

As such, Bitcoin and one of its key underlying technologies, Block chain, has been hailed as the dawn of a new age. One with great implications for business as we know it. We already see with companies like BitPesa in Kenya, Tanzania and Uganda, the immediate use case for doing international remittances is clear. One could purchase Bitcoins and send them to another user anywhere in the world. But if this person needs cash-letís say youíre in England and ending money to someone in Uganda. You could spend a lot in transaction fees having banks do the transaction for you, but with Bitpesa, you could buy Bitcoin and have this bitcoin transferred to your relative who can then cash out the money from their mobile money wallet in the local Ugandan shilling at a much lower rate than the banks would offer.  Itís also much faster taking minutes to hours.

To get a chance to participate in this, one need only obtain a virtual wallet (Assuming you donít want to get the special hardware to mien bitcoin yourself!) which is like a bank account number in that itís a unique string of text but different in that itís not connected to any identifying information about you. You remain totally anonymous.

Thatís where some of the darker aspects of the idea of cryptocurrencies come into play. Various illegal activities from drug dealing, illicit material purchases and even the hiring of hitmen have been facilitated by Bitcoin and by the online black markets, such as the now closed Silk road, which was a platform on the darknet (the part of the internet you canít find by searching through your web browser). Transactions are recorded but the people behind the transactions are difficult to trace because of anonymity. This makes bitcoin of huge interest and concern for governments that want to maintain law and order.

Much like money we know today, Bitcoin is a store of value and a means of exchange but one that relies on the trust of people in this peer network and who want no central authority for the movement of their finances. This means the elimination of centralized authorities which could mean easier transferences and payments for services in East Africa but it could also worsen the lack of transparency the government always complains about by having its citizens engaging in services with no trails.


By Joel Muhumuza, Partner Support Specialist, FSD Uganda 

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