What the Heck is a Bitcoin?

by Emily Guy Birken · 8 comments

Imagine there was a currency that wasn’t tied to any particular country or government. It could be accepted any place in the world, without having to be exchanged into local currency. It could provide both anonymity and security in transactions, and only the free market would decide how much it was worth.

While such a currency may sound like the stuff of science fiction, it’s the reality for Bitcoin, the peer-to-peer digital currency.

While Bitcoin started as the province of extreme techies, it’s recently gotten the attention of the mainstream financial world. Here’s what you need to know about this unusual currency.

The Origin of Bitcoin

In 2008, an anonymous designer (or designers) using the pseudonym Satoshi Nakamoto published a paper describing the potential for Bitcoin. A year later, Nakamoto launched the Bitcoin network. Bitcoin is self-sustaining, which means that whoever is behind the Nakamoto pseudonym doesn’t need to maintain involvement in the program in order for it to continue.

How Bitcoin Works

The inherent problem with a digital currency is ensuring that money isn’t double spent. That is, how do you keep people from simply using the same piece of currency over and over again if the currency isn’t physically tied to something?

Bitcoin avoids this problem in an ingenious way. Each Bitcoin actually represents a unique number, and every transaction using Bitcoin is recorded so that the same unique number can only be used once by the same user.

This public record of transactions is called the blockchain — and it is this that keeps Bitcoin from being purely anonymous. Users of Bitcoin are anonymous, but the Bitcoins themselves can be traced. (This would be like if the U.S. Treasury traced the movement of all cash by scanning serial numbers with every cash transaction, thus ensuring that no counterfeit money was introduced.)

Bitcoin is like any currency in that it only has value because people agree that it does. Now that more merchants are accepting Bitcoin as payment, and more individuals are interested in having their money in decentralized currency, Bitcoin has gained value. As of this writing, one Bitcoin is worth nearly $200. However, because this currency is decentralized, it’s also incredibly volatile.

How to Get Bitcoins

There are two ways to get into the Bitcoin economy. The first is to become a “miner.” Since the currency is really just a series of numbers, there are formulas for generating (or mining) new numbers. People can use free software to turn their computer into a Bitcoin miner. Bitcoin is set up so that there are a diminishing number of Bitcoins that can be mined each year, with a cap of 21 million Bitcoins. There are currently about 11 million Bitcoins in circulation, and final Bitcoins will be mined in the year 2140.

Mining isn’t free, however, since running your computer isn’t free; and any casual PC user will find that it isn’t worth the money to run the program in order to earn Bitcoins.

That’s why it’s also possible to purchase Bitcoins from other users with various traditional currencies, including dollars. The main Bitcoin exchange marketplace is a Japanese website called Mt. Gox.

Is Bitcoin the Future of Money?

There’s a lot to be excited about with Bitcoin. It allows for a true free market and can solve many current problems with centralized currencies, such as conversion costs for international transactions.

However, the anonymous nature of Bitcoin means that it’s also very attractive for illicit activities, from money laundering to illegal purchases.

In addition, the volatile and finite nature of Bitcoin means that users may be rewarded for hoarding, which could potentially lead to a deflationary spiral if Bitcoin became more universally accepted.

Altogether, Bitcoin is a smart adaptation to the issues of the global economy. It will be interesting to watch how this experiment plays out.

Have you ever used Bitcoins? After reading this article, are you more or less inclined to do so?

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  • AG says:

    The idea of having universal currency is brilliant but it needs to be tangible. Our world is not there yet to accept a universal digital currency.
    Any type of currency needs to be owned by central authority like government, UN, etc. You give people the power, wrongdoings happen.

    • donttreadonme says:

      Seriously? Trying to avoid wrongdoing utilizing government or UN administration of bitcoins? I am trying to imagine any reality putting my mind at rest magnifying corruption with government intrusion. Just imagine our nation being run without the guidance of the Constitution. Never mind, what was I thinking…

  • It is such an interesting concept in economic terms. If Bitcoins increase in popularity it will have devastating effects on centralized currencies. I’m 28, and I wonder what currency I will be retiring with. I’m positive it will be some form of universal digital currency. (play: Jetsons theme song)

  • Byron says:

    I think it’s a great back up system right now and could become more. The great thing is that it takes government stupidity out of the equation (unless the government noses in to Bitcoins). So the massive spending we’ve seen from the government can’t cause deflation or inflation of Bitcoins. I have to think world governments, especially socialistic ones, will decide to intrude on the Bitcoin parade. But I hope not.

  • I think Bitcoins are a great idea and I am all for currencies competing with each other. The competition gives currency creators a incentive not to devalue their currency as much, and it give currency users options (don’t put all your eggs in one basket).

    Maybe one day we will be able to spend them at the grocery store!

  • MoneyNing says:

    I probably won’t invest or use bitcoins until they are EXTREMELY popular but I just read today that someone in Norway bought $25.43 worth of bitcoins in 2009 and they are worth $848k now.

    http://news.cnet.com/8301-17852_3-57609880-71/man-forgets-he-once-bought-$25-of-bitcoins-now-worth-$848k/

    Sometimes it’s better to be lucky than good!

    • Tim says:

      Yeah… I seriously regret selling off my mining earnings (which I got back when it was profitable and GPUs were the big, new, way to mine them) before the huge increase in valuation! Oh well, it could have just as easily gone the other way and they could be worthless these days.

      • MoneyNing says:

        You just never know what the future holds so you did the right thing by selling.

        Good for that guy though, who made a fortune. I hope he paid taxes, as it would surely be a blow if he gets audited because he agreed to an interview 🙂

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