Bitcoin is a new currency that was created in 2009 by an unknown person using the alias Satoshi Nakamoto. Transactions are made with no middlemen – meaning, no banks! There are no transaction fees and no need to give your real name.
What makes Bitcoin different from normal currencies?
Bitcoin can be used to buy things electronically. In that sense, it’s like conventional dollars, euros, or yen, which are also traded digitally. However, bitcoin’s most important characteristic and the thing that makes it different to conventional money is that it is decentralized. No single institution controls the bitcoin network. This puts some people at ease because it means that a large bank can’t control their money.
Who created it?
A software developer called Satoshi Nakamoto proposed bitcoin, which was an electronic payment system based on mathematical proof. The idea was to produce a currency independent of any central authority, transferable electronically, more or less instantly, with very low transaction fees.
Who prints it?
No one. This currency isn’t physically printed in the shadows by a central bank, unaccountable to the population, and making its own rules. Those banks can simply produce more money to cover the national debt, thus devaluing their currency.
Instead, bitcoin is created digitally, by a community of people that anyone can join. Bitcoins are ‘mined’, using computing power in a distributed network.
This network also processes transactions made with the virtual currency, effectively making bitcoin its own payment network.
So you can’t churn out unlimited bitcoins?
That’s right. The bitcoin protocol – the rules that make bitcoin work – say that only 21 million bitcoins can ever be created by miners. However, these coins can be divided into smaller parts (the smallest divisible amount is one hundred millionth of a bitcoin and is called a ‘Satoshi’, after the founder of bitcoin).
Bitcoins can be used to buy merchandise anonymously. In addition, international payments are easy and cheap because bitcoins are not tied to any country or subject to regulation. Small businesses may like them because there are no credit card fees. Some people just buy bitcoins as an investment, hoping that they’ll go up in value.
Buy on an Exchange
Several marketplaces called “bitcoin exchanges” allow people to buy or sell bitcoins using different currencies. Mt. Gox is the largest bitcoin exchange.
People can send bitcoins to each other using mobile apps or their computers. It’s similar to sending cash digitally.
People compete to “mine” bitcoins using computers to solve complex math puzzles. This is how bitcoins are created. Currently, a winner is rewarded with 25 bitcoins roughly every 10 minutes.
Bitcoins are stored in a “digital wallet,” which exists either in the cloud or on a user’s computer. The wallet is a kind of virtual bank account that allows users to send or receive bitcoins, pay for goods or save their money. Unlike bank accounts, bitcoin wallets are not insured by the FDIC.
Wallet in the cloud: Servers have been hacked. Companies have fled with clients’ Bitcoins.
Wallet on the computer: You can accidentally delete them. Viruses could destroy them.
Though each bitcoin transaction is recorded in a public log, name of buyers and sellers are never revealed – one their wallet IDs. While that keeps bitcoin user’s transactions private, it also let’s buy or sell anything without easily tracking it back to them. That’s why it has become the currency of choice for people online buying drugs or other illicit activities.
What are its characteristics?
Bitcoin has several important features that set it apart from government-backed currencies.
1. It’s decentralized
The bitcoin network isn’t controlled by one central authority. Every machine that mines bitcoin and processes transactions makes up a part of the network and the machines work together. That means that, in theory, one central authority can’t tinker with monetary policy and cause a meltdown – or simply decide to take people’s bitcoins away from them, as the Central European Bank decided to join Cyprus in early 2013. And if some part of the network goes offline for some reason, the money keeps on flowing.
2. It’s easy to set up
Conventional banks make you jump through hoops simply to open a bank account. Setting up merchant accounts for payment is another Kafkaesque task, beset by bureaucracy. However, you can set up a bitcoin address in seconds, no questions asked, and with no fees payable.
3. It’s anonymous
Well, kind of. Users can hold multiple bitcoin addresses, and they aren’t linked to names, addresses, or other personally identifying information. However…
4. It’s completely transparent
…bitcoin stores details of every single transaction that ever happened in the network in a huge version of a general ledger, called the blockchain. The blockchain tells all.
If you have a publicly used bitcoin address, anyone can tell how many bitcoins are stored at that address. They just don’t know that it’s yours.
There are measures that people can take to make their activities more opaque on the bitcoin network, though, such as not using the same bitcoin addresses consistently, and not be transferring lots of bitcoin to a single address.
5. Transaction fees are minuscule
Your bank may charge you a £10 fee for international transfers. Bitcoin doesn’t.
6. It’s fast
You can send money anywhere and it will arrive minutes later, as soon as the bitcoin network processes the payment.
7. It’s non-repudiable
When your bitcoins are sent, there’s no getting them back, unless the recipient returns them to you. They’re gone forever.
So, bitcoin has a lot going for it, in theory. But how does it work, in practice? Read more to find out how bitcoins are mined, what happens when a bitcoin transaction occurs, and how the network keeps track of everything.
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