What is a Bitcoin?

Friday 26 July 2013

You may often have heard people use the terms 'decentralised', 'peer-to-peer', 'open-source' or 'crypto-currency' when referring to bitcoin, or other such alternative, digital currencies.

They are digital because they are transacted online, over the Internet, using a computer or smart phone. They do not exist in a physical form, which for some, can prove a difficult concept to grasp.

So what are they? Where do they come from? How much are they worth? Well, here is our attempt to guide you through what bitcoin is, without giving you too much information overload or technical jargon, which is unnecessary for a basic understanding.

To start with, although you can get into minute technical detail about bitcoin, the easiest way to think of it is money. Bitcoin is money, just a different type of money. We like to think, a superioir type of money. Like the cash in your wallet and the money in your bank account, bitcoin can be exchanged, traded and spent. The difference is that the transactions are done over the Internet and you do not physically hold it.

With so many banking transactions done online these days or using a debit card, the idea of not holding your money, should no longer be a foreign one.

The difference is that bitcoin, instead of sitting in your bank account, is stored online in an electronic 'bitcoin wallet'. Each wallet has its own bitcoin address, just like a bank account number, and this is what you give to people to receive bitcoins, or what you need from them, to send them. 

The actual process of sending and receiving is also very simple and secure. Once you have a bitcoin wallet on your phone, if you are with the person, a face-to-face (or phone to phone) transaction can be done by simply scanning the bitcoin address, in the form of a QR code, on their phone with yours. If you are sending bitcoins to someone on the other side of the world, then it is a case of just typing in their bitcoin address and sending the money that way. It is instant, secure and so so easy. Oh - and, in most cases, free.

This is why bitcoin is 'peer-to-peer' because you transact directly with the person or people you are buying or selling with, there is no middle-man.' There are no banks taking a hefty slice of each transaction, or credit card companies taking a per centage every time you use it. The fees involved with bitcoin transactions are markedly lower, and in some cases, as mentioned, completely free.

On that note, bitcoin is also 'decentralised' because no governments, banks or central authorities control it or own it.  It is managed by a global network of computers, known as miners. Anyone can buy the software and become a 'miner', if they choose because the design and technology of bitcoin is available to everyone and anyone can participate (hence it is 'open source'). Miners are important for two reasons: one they help secure and validate every bitcoin transaction that takes place by keeping a record of each one and monitoring this electronic ledger of transactions (which as you can imagine is enormous). Two, they are constantly crunching numbers, decrypting special blocks of data, which release bitcoins into circulation. This is the technical bit and not actually critical to understand for a basic knowledge of bitcoin. (If you are interested in knowing more, read our mining feature.) Needless to say, it is the way that bitcoin is kept completely secure and how bitcoins come into existence.

So can people just keep decrypting code and data on their computers and go on generating bitcoins forever? No! This is important. This is the beauty of bitcoin and what makes it, as we mentioned, a superior currency.

Bitcoin, for many good reasons, has been compared to gold because, like gold, there is a finite supply. This scarcity not only gives bitcoin its value, it also means it is inflation-proof. Only 21 million bitcoins will ever be able to be mined into existence and when that has happened (predicted to occur around 2140), no more bitcoins can be generated. Unlike with government-controlled money (what we call fiat currency — the euros, dollars or pounds in your pocket) bitcoin cannot be devalued by monetary policy. These days, we all know that governments are printing money to boost the supply with a policy called 'quantitative easing.' What this does in turn is debase the very money sitting in our bank accounts by causing inflation and meaning that fiat currency is continually declining in value.

The opposite is true of bitcoin. Its value has continued to go up over the past four or five years that it has existed. Like gold, it can also be divided. Bitcoins can be subdivided down to eight decimal points and currently, one bitcoin (at time of writing) is worth around US$120. The value does fluctuate, which is why the currency has come in for some criticism and why some people are wary of using it. However, the more people that do start using bitcoin and the more transactions that occur, this will greatly help to stabilise its value and calm the volatility. 

The good news is that more and more people are turning to bitcoin and more and more businesses are starting to see the benefits of using it as well, meaning there are more places to spend it and this is helping bitcoin become a more widely-accepted form of currency. In fact, I have heard it said that bitcoin is currently growing at a faster rate than facebook, so right now, things are looking up.

So, in summary, bitcoin is a digital currency, transacted over the internet using peer-to-peer technology. It is cheap, fast and secure and involves no central authorities interfering to devalue it, or banks taking a cut or a fee. It is inflation-proof, and so far shown only to go up in value. An increasing number of people and businesses are accepting bitcoin and the ecosphere is growing on a daily basis. It is a modern-day form of money for the Internet age and the cost and speed at which transactions can be done makes it an extremely attractive and convenient payment method.


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