With Bitcoin gaining 670% in the first 10 months of 2017, including a 40% drop in September and a subsequent 60% move higher off its lows, it seems everyone is talking about the cryptocurrency. CEO’s and executives at major financial institutions have been divided, calling Bitcoin a bubble and fraud on one hand, or extolling the virtues of the world’s first cryptocurrency on the other. World governments are equally divided, with some calling for an outright ban of cryptocurrencies such as Bitcoin (China), while others are embracing the new technology in an effort to become hubs of the fintech revolution (Japan).
Without joining in the current debate about how to deal with Bitcoin in the real world, I’d like to present an explanation of what Bitcoin is, and what it is not, to help educate those who are just becoming aware of this revolutionary blockchain technology, and the decentralized ledger. While these concepts are quite complex on the technology side, they are still easily understandable by laymen.
Bitcoin has a history that spans less than 8 years as I write this, but it could perhaps be one of the most important developments humans have made in terms of creating a more trusting world, and a frictionless capital market that will save and create trillions of dollars in wealth. While Bitcoin may not stand the test of time, it will always hold a place in history as being the first ever cryptocurrency based on blockchain technology.
Who created Bitcoin?
The specification and proof of concept for Bitcoin was published in 2008 in a cryptography mailing list by an unknown programmer or group of programmers under the pseudonym Satoshi Nakamoto. It was based on the concept of cryptocurrency that had been put forward by Wei Dai in 1998 on the Cypherpunks mailing list. The actual code for Bitcoin was released as open-source software on January 3, 2009 and thus a new era of decentralized currency was born.
Satoshi Nakamoto left the Bitcoin project in late 2010 and has never been identified as he communicated only via email and social media. Since that time other developers have taken the lead in the project, and Bitcoin has grown exponentially. While there have been concerns expressed regarding the anonymity of Bitcoin’s creator, these are unjustified considering the open-source nature of the Bitcoin software code. The source code is always accessible and anyone can review and modify the code. In fact, many of the subsequent alt-coins created have used the Bitcoin source code as a starting place. The creator of the Bitcoin source code is likely as irrelevant as the creator of the code for the first implementation of Windows as the code has evolved and changed significantly since.
How does Bitcoin work?
As far as the user can tell, Bitcoin is nothing more than a mobile or desktop app (called a wallet) that is used to store and transfer Bitcoins from one user to another. I suppose in that respect it could be analogous with email, although behind the scenes there are huge differences between the two.
Behind the scenes, Bitcoin’s network is a massive distributed public ledger. This is what is known as the “blockchain”. The blockchain contains every transaction ever processed on the Bitcoin network, but more importantly, each transaction also contains a “key” to the previous transaction, hence the “chain” part of blockchain. The transactions are “blocks” and the connections between transactions are the “chain”.
The massive importance of this comes when you add the distributed and decentralized nature of the Bitcoin network. Rather than residing on a single server, the Bitcoin network runs on every computer in the world that has the core Bitcoin application. And these computers all keep a completely updated copy of the ledger that stores transactions. This allows each new transaction to be verified by the entire network through a private key. And it keeps anyone from changing transactions once they are written to the blockchain, because the change would need to be approved by every computer that has a copy of the blockchain. This provides both security and trust that there will be no fraud in financial transactions. More importantly, the same blockchain technology can also be used for a variety of applications in energy, healthcare, and a host of other industries. Truly, we are just beginning to scratch the surfaces of the uses that the blockchain can be put to.
If you’re interested in learning the original purpose and scope of Bitcoin you can read the original whitepaper by Satoshi Nakamoto here.
Who is involved in Bitcoin?
Currently (October 10, 2017) Bitcoin has a market capitalization of more than $79 billion. There are thousands of companies and hundreds of thousands of individuals who are involved with Bitcoin, and that doesn’t begin to include all the companies and individuals who are involved in the more than 1000 other cryptocurrency blockchain projects, or the numerous companies which are developing their own in-house blockchain solutions. And recently Wall Street has taken notice as well, with dozens of hedge funds getting involved in cryptocurrencies, and the Securities and Exchange Commission investigating the field to determine how it can best be included in the securities markets.
What is the Blockchain?
Please see the simple explanation of blockchain technology here.
Are Bitcoins those coins I see in photographs?
No. The “Bitcoins” you see in photographs are nothing more than novelty items created for Bitcoin users who wanted a physical representation of the digital currency. They have no value, and just depict what a Bitcoin “might” look like if it were issued physically, which it never could be.
The Bitcoin is a virtual asset, with no physical representation. It can only be recorded electronically, and can only be used for purchases electronically. With no physical form it has an advantage over traditional currencies as there are no transaction costs with sending electronic currency, and it can be sent anywhere in the world in seconds or minutes. Compare that with a traditional bank transfer, which can take several days, and even longer in remote parts of the world. This is because traditional banks have to use clearing houses, which take significant manpower and time to verify transactions. Bitcoin verifies transactions within seconds, as thousands of computers across the world work to solve and create the secure key required for each block.
While one Bitcoin is currently worth roughly $4,900, the Bitcoin is actually computed to eight decimal places or 0.00000001. This smallest fraction of a Bitcoin is called a Satoshi after the anonymous creator of Bitcoin, and yes you can send someone just 1 Satoshi, which would be worth just $0.000049 at the current price of $4,900 per 1 Bitcoin.
Try not to get confused here as the Bitcoin token, which is used as a currency or store of value, has the same name as the Bitcoin network, which is the blockchain network that processes and records transactions in a ledger fashion.
Can Bitcoin users give themselves more Bitcoins?
The short answer is no. This is because the blockchain is designed to make tampering with any of the “blocks” or transactions impossible because of the decentralized and immutable nature of the blockchain. Any change to a transaction needs to be verified by all the computers on the network, and without a proper cryptographic key this can’t happen, and so none of the transactions can be modified or forged to give a person Bitcoins they should not have.
There are ways to get Bitcoins without buying them. One is through mining, which I’ll describe later. The other is through what are known as faucet sites. These faucet sites have been in existence pretty much since the beginning of Bitcoin and exist to “spread the word” about Bitcoin, so to say. They “drip” out small amounts of Bitcoin, anywhere from 50 to 200 Satoshi per hour per person. Most require you to solve a captcha to collect your Bitcoin, but there is no other cost. One of the longest running and most reliable is the SwissAdsPays faucet. For those interested in Ethereum they also run the SwissAdsPaysEth faucet. Both are an easy way to make a small amount of Bitcoin and Ether for free. I use both and can recommend them.
Who controls the Bitcoin network?
The Bitcoin network is decentralized, meaning no one person or entity owns or controls the network, just like no one owns or controls the internet. Each transaction in the Bitcoin network is broadcast to computers known as Bitcoin miners. These miners receive a payment in Bitcoin for solving the block keys, and this is how new Bitcoins are created.
What is Bitcoin mining?
Bitcoin mining is the name given to the process in which new Bitcoins are created. Mining is a reward system for the computers that help maintain the network and process the transactions in the network. Each new transaction or block needs its own secure key, which must be solved computationally. The computer that is able to solve the key the fastest wins and gets a reward in Bitcoins – currently 12.5 Bitcoins. The reward is halved roughly every four years.
It typically takes about 10 minutes to solve each block, meaning there are currently 12.5 Bitcoins created every 10 minutes. As that number decreases the number of Bitcoins created decreases, but the system was created so that there will never by more than 21 million Bitcoins created. So far there have been about 16 million Bitcoins created, and the 21 million cap is estimated to be reached in 2040.
Mining used to be quite profitable, even with a personal computer, but as the difficulty in solving the secure keys is continually increasing, and the payout in Bitcoins is continually decreasing it is no longer profitable to mine Bitcoin on your own as it requires very powerful computers and large amounts of electricity to run them. You can join mining pools, which are groups of individuals who pool their resources to run Bitcoin miners and then split the Bitcoin payouts evenly.
How can I buy a Bitcoin?
Buying Bitcoin in the U.S. is most easily accomplished through a company known as Coinbase. Creating a Coinbase account is not that different from opening a bank or brokerage account. Once you’ve created the account and taken some steps to verify your identity you can purchase Bitcoin, Ethereum and Litecoin with U.S. dollars using your checking account or with a credit or debit card. It really is quite simple and painless.
Those who wish to remain anonymous and are already familiar with the process of creating a wallet and transferring Bitcoin and other cryptocurrencies can use the service LocalBitcoins, which matches people who then meet in person to exchange Bitcoins for cash without any need for identity verification.
Who decides what a Bitcoin is worth?
While Bitcoin hasn’t yet been classified as a security in the U.S., or in most countries, its price fluctuates in the same manner as any other security or currency. The current price is determined by a bidding system on exchanges in much the same way as stocks, commodities and currencies.
Why do criminals like Bitcoin?
Criminals are attracted to Bitcoin because of the anonymity it affords. A person can send and receive Bitcoin with nothing more than a Bitcoin address, with no need to provide a name or any other identifying information. Because the Bitcoin network is decentralized there is no entity interested in collecting this personal information.
Criminal activity with Bitcoin was first documented when drug dealers began taking payments in Bitcoin on the Silk Road website in 2011. That website has since been shut down, but there are similar sites that have replaced it.
More recently Bitcoin has been in the news as being used to demand ransom payments from those who install ransomware on computers to take them over, and then demand payment to “unlock” the computer.
Even so, the amount of criminal activity financed with Bitcoin is miniscule compared to the total volume of Bitcoin transactions.
Why won’t the government just shut it down?
The government doesn’t control the Bitcoin network, and because of the decentralized nature of the network they never will. As of late 2017 there are roughly 9,500 computers running the Bitcoin core software and helping to maintain the network. In order to shut this down the government would need to locate and shut down all 9,500 computers – except that they are located all across the globe, not in any single country.
Even if a country, such as the U.S., decides to make Bitcoin illegal, the computers would continue maintaining the network, and because there is no personal information required to buy and sell Bitcoins people could still participate if they wished with little chance of being discovered.
Are there legal uses?
Nearly all the transactions on the Bitcoin network are legal. The majority of transactions are people buying and selling Bitcoin on exchanges, simply speculating on future prices. This makes Bitcoin very similar to many other currencies of the world.
In some countries such as Venezuela Bitcoin has been adopted as the local currency due to the high rate of inflation that has completely eroded the buying power of the average person. To avoid this inflation eroding their savings further the people of Venezuela have turned to Bitcoin as a store of value.
More and more companies are accepting Bitcoin payments. I can’t list them all here as the list is quite long and growing nearly every week. But you can have a look at this list of nearly 100 companies that currently accept Bitcoin as payment, including Microsoft, Bloomberg and Expedia.
Are there Bitcoin competitors?
Bitcoin is by far the largest cryptocurrency due to its advantage as being the first, and the fairly broad adoption it has seen. However there is plenty of competition, with more than 1,000 other cryptocurrencies having been created and released, though to be sure only 10 others have a market capitalization greater than $1 billion.
As time goes on there will likely be many more competitors that come and go, and like AOL and Netscape in the internet space, Bitcoin could well fade into obscurity as the blockchain technology is further developed, providing increased security, transactional speed and adoption.