You must have heard about bitcoin before. But what is it? How does it work? And why do people care?
Bitcoin is a new type of currency to the internet.
A currency is an agreed-upon means of exchange that can be used for purchasing goods and services. Its value is determined by the market. This ensures its credibility by recognizing balances maintained with other currencies. When you buy something with a currency, you are given that currency's value in return. To be considered a legitimate currency, the money must not be debased or diluted through inflation. It must have a stable value over time. The current standard unit of account in many countries is the US dollar.
One type of currency not yet widely accepted as legal tender is bitcoin, an online payment system that was first introduced in 2009 by pseudonymous developer Satoshi Nakamoto. Unlike many other digital payments systems, bitcoin transactions are instantaneous. Bitcoin is also free from third-party fees and restrictions on availability or quantity (such as those imposed by banks).
Transactions are peer-to-peer and are verified using cryptography.
Peer-to-peer simply means that there is no central authority which processes transactions. Instead, the network is made up of connected computers, called nodes. These nodes are able to send and receive transaction information to each other.
Cryptography is a field of computer science which deals with encrypting messages so that only the intended recipient can read it. Cryptography can be used to verify the authenticity of a message, or prove that it was sent by someone who has access to a specific key.
The Bitcoin network relies on cryptography in order to process transactions. Nodes are able to verify whether transactions are valid through the use of cryptography, without needing a central authority such as a bank in order to do so.
Transaction records are open to anyone and cannot be changed.
Let me give you an example of how the blockchain works. When you make a purchase with bitcoin, your transaction gets stored on the blockchain. The data is encrypted, but if you have someone's private key, you can decrypt it. A private key is like a password that's very long and extremely hard to guess correctly.
Each transaction is called a block and each block is linked to each one that came before it in the ledger (blockchain). There are specialized computer programs that work together on this task. It's actually very complicated, but at its core the blockchain is simply a public record of who made which transactions and when they were made.
Transaction costs are minimal.
Like any payment service, the use of Bitcoin entails processing costs. Services necessary for the operation of currently widespread monetary systems, such as banks, credit cards, and armored vehicles, also use a lot of energy. Although unlike Bitcoin, their total energy consumption is not transparent and cannot be as easily measured.
Bitcoin transactions are almost free compared to credit card payments or even PayPal transactions. No fees for exchanging currencies and no chargebacks. This means that you can send or receive bitcoins at any time without worrying about some middleman or bank denying your transaction because it hasn't been confirmed within their pre-defined timeframe (which could take days if they want it to!).
Bitcoin is not backed by a government or central bank.
Bitcoin isn't backed by a government or central bank.
There's no regulatory agency like the Federal Reserve. There are people who are in charge, but they're not government employees and they don't have any official authority to make decisions for the currency.
And bitcoin is decentralized — it exists on a network of computers that anyone can access. The computers work together to verify transactions, log them in a public record of sorts and keep track of how many bitcoins each person owns without needing an official third party to check on their balances or confirm that they made their payments. People who own bitcoin actually control the network instead of having the big banks do it. This is kind of important because if you get rid of the middleman you get rid of some costs and other problems like fraud that come with having one entity in charge.
But if bitcoin isn't backed by any central authority, then how does it have value? Well, things only have value because people are willing to trade for them or believe they're valuable enough to pay money for them. And right now there is faith in bitcoin because enough people feel like it's valuable and are willing to buy more than just a few slices of pizza with it.
The worth of bitcoins
The value of bitcoins is determined by the market. This means that if there are more people buying and storing bitcoins as assets, then the price increases. If there are more people selling their bitcoins, then the price decreases. Bitcoins have no intrinsic value, so the value (or price) is entirely determined by supply and demand.
Bitcoin is a type of money that requires just the internet
A Bitcoin can be thought of as pure internet money. It's like an email, but instead of being a message from one person to another, it's a token that can be given from one person to another.
Unlike paper money which requires the backing of a nation's central bank, or gold that requires people to dig up and haul around heavy bars, Bitcoins exist simply because they were created by software. It's all done by computers talking to each other over the net. Since there is no central bank or government issuing Bitcoins, it's impossible for any authority to confiscate them. This means that you can use Bitcoins to buy things anonymously. No one will know who you are (unless you tell them) and no one can spy on your financial transactions.