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Baffled by Bitcoin? How Cryptocurrency Works
From Bitcoin to Litecoin to Ethereum, we explain how cryptocurrency transactions work.
There’s Bitcoin. There’s Litecoin. There’s Ethereum. So just what is cryptocurrency, and how does it work? Essentially, it’s digital money that’s bought and sold online. There’s no bills or coins. It’s not based on another asset like gold. And it doesn’t go through traditional financial institutions like banks. Instead, these currencies operate in a completely decentralized system that uses so-called blockchain technology to track transactions. To see how this works, let’s look at how you’d buy something with cryptocurrency. Say that Alice wants to buy a bike from Dan using Bitcoin, her cryptocurrency of choice. Alice begins by logging into her Bitcoin wallet with a private key, a unique combination of letters and numbers. With a traditional financial transaction, the exchanges get sent to banks on each side who record the money being subtracted from one account and added to another. But remember, in this scenario, there are no banks or middlemen. Instead, Alice’s transaction is shared with everyone in the Bitcoin network. These networked computers add Alice’s transaction to a shared list of recent transactions, known as a block. Every 10 minutes, the newest block of transactions is added on, or chained, to all the previous blocks. That’s how you get a blockchain. To ensure that each block of transactions on the chain is verified, a subset of Bitcoin’s network joins a race to solve a difficult math puzzle. And if they solve it first, their record of the block of transactions becomes the official record. They’re rewarded with Bitcoins of their own, and the network gets a new block on the chain. This entire process is known as mining. But instead of chipping away at rock, you’re solving complex puzzles. The fact that many computers are competing to verify a block ensures that no single computer can monopolize the Bitcoin market. To ensure the competition stays fair and evenly timed, the puzzle becomes harder when more computers join in. The Bitcoin protocol says mining will continue until there are 21 million Bitcoins in existence. That’s set to happen around 2140 — if Bitcoin lasts that long.
By Nathaniel Popper
SAN FRANCISCO — A concentrated campaign of price manipulation may have accounted for at least half of the increase in the price of Bitcoin and other big cryptocurrencies last year, according to a paper released on Wednesday by an academic with a history of spotting fraud in financial markets.
The paper by John Griffin, a finance professor at the University of Texas, and Amin Shams, a graduate student, is likely to stoke a debate about how much of Bitcoin’s skyrocketing gain last year was caused by the covert actions of a few big players, rather than real demand from investors.
Many industry players expressed concern at the time that the prices were being pushed up at least partly by activity at Bitfinex, one of the largest and least regulated exchanges in the industry. The exchange, which is registered in the Caribbean with offices in Asia, was subpoenaed by American regulators shortly after articles about the concerns appeared in The New York Times and other publications.
Mr. Griffin looked at the flow of digital tokens going in and out of Bitfinex and identified several distinct patterns that suggest that someone or some people at the exchange successfully worked to push up prices when they sagged at other exchanges. To do that, the person or people used a secondary virtual currency, known as Tether, which was created and sold by the owners of Bitfinex, to buy up those other cryptocurrencies.
“There were obviously tremendous price increases last year, and this paper indicates that manipulation played a large part in those price increases,” Mr. Griffin said.
[Steve Bannon has a “good stake” in Bitcoin and floated the idea of creating a “deplorables coin.”]
Bitfinex executives have denied in the past that the exchange was involved in any manipulation. The company said on Wednesday that it had never engaged in “any sort” of market or price manipulation. “Tether issuances cannot be used to prop up the price of Bitcoin or any other coin/token on Bitfinex,” Jan Ludovicus van der Velde, Bitfinex’s chief executive, said in a statement.
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