A Simple Guide to Understanding Bitcoin
What is bitcoin
Got confusion in your brain about Bitcoin? You're not alone. There's a large crowd scratching its collective head along with you.
Let's get basic.
Bitcoin is a digital currency. It has no physical form. You can't see, touch, smell, or taste it. Those images you keep seeing online - the ones with a cute little ‘B' blended with a money sign? Nothing more than novelty items created to make the accompanying article more visual. Trust us. Bitcoin does not jingle in your pocket, and you can't pull it out and spend it like traditional money.
Hopefully, you're starting to get an idea of what this digital or cryptocurrency isn't. Let's talk about what it is.
No Substance but Real Money
Before we get too much further into this, let's get one thing straight. Despite Bitcoin's lack of physical substance, it carries real value in today's world.
When it was released in 2009, a single bitcoin was worth less than a penny. As of this writing, it's trading for around $15,000 US dollars. That means real-world value. You could take it to town and buy a cheeseburger or even book a flight to Amsterdam online once you locate a vendor that accepts digital currency payments, of which there is an increasing number.
Again, What is Bitcoin?
Like the British pound or US dollar, Bitcoin is a currency or medium of exchange between two parties interested in transacting. The similarities end there. Whereas traditional currencies are controlled by a single entity like a government or central bank, Bitcoin is a free agent, so to speak. It was designed to be anonymous, decentralised, free from manipulation, and unhackable. The scary part, for traditional institutions like those governments and banks, is that it cuts out the middleman - you don't need banks!
Obviously, this is a completely foreign concept to the way financial systems have worked in the past, so it's no surprise that a great many people expect the whole thing to be shut down by the powers that be. They might try at some point, but we expect the cat is out of the bag and won't go back in willingly.
Since Bitcoin has no physical substance, you won't be able to bury it in the backyard or stuff it under the mattress. Hmm, where will you put it?
Any bitcoins you own are stored in what is called a "digital wallet," which is an electronic account, much like any checking or savings account. Your wallet is either in the cloud or on your home computer. This virtual bank account is how you send and receive bitcoins as payment for goods or services.
Are you ready for the not-so-good news?
No digital currency is insured, so if something wonky happens to your stash (like the wallet gets hacked or infected with a virus), you are out of luck. While the blockchain technology that underlies Bitcoin is essentially hack proof regarding the actual transactions, there have been examples of trading exchanges and wallets being compromised.
YOU SAID TRADING EXCHANGE…WHAT IS THAT?
Much like investors and traders buy and sell shares of stock through exchanges, you can buy and sell Bitcoin on designated exchanges too.
Thanks to strict regulations regarding the operation of financial services, it's not as easy as falling out of bed to make a Bitcoin trading platform. Remember, Bitcoin is all about freedom and deregulation while the government (and others) are in the taxation and control business.
Still, you can buy Bitcoin with your hard-earned cash via the following process:
#1. Put money into a banking account.
#2. Open an account with an approved cryptocurrency exchange like Coinbase, Kraken, or Bitfinex.
#3. Enable all the security measures including two-factor authentication.
#4. Go through the verification process and link the two accounts.
#5. Fund your cryptocurrency account with your USD account.
#6. Buy, buy, buy!
Pretty simple, right? The process of sending USD to your cryptocurrency account means that you are now the proud owner of Bitcoin (BTC). Good job.
As the popularity of cryptocurrencies has skyrocketed in recent years, exchanges often offer to trade in a variety of cryptocurrencies. Wait, you mean there are other digital currencies besides Bitcoin? Oh, yes. Many, many more. But we digress.
AND THEN THERE'S MINING
Have you heard of Bitcoin mining?
Mining is another way to acquire this cryptocurrency without actually buying it. Without getting too geeky, Bitcoin mining is the process by which the computers on the network that keep the master transaction ledger verify transactions. Remember how we said the process is decentralised?
Here's what we mean.
In traditional banking, the master accounts ledger is stored in the bank's database. The way it works with cryptocurrency is that the ledger is kept in its entirety on thousands or even millions of individual computers. This is serious decentralisation, and why it's so hard to hack. Once a transaction is verified it is sent out to be updated on each network node. To corrupt the ledger, you'd have to figure out how to manipulate each and every copy at once.
The process of verifying a Bitcoin transaction is accomplished by sending it out to the network in the form of a math puzzle that has to be solved. Not just any math problem. These are complex mathematic puzzels that require serious computer resources. Whichever computer (and its owner, obviously) solves the puzzle first is awarded Bitcoin as a prize, which goes straight into the digital wallet of the winner.
The mining process is how new bitcoins are released. Sort of like the real world equivalent of a government printing new currency. The catch is that Bitcoin's inventor, Satoshi Nakamoto (a pseudonym), programmed a hard limit into the currency. Once 21 million bitcoins are in circulation, that's all, folks, and we're about halfway there right now. After that, the printing press is closed.
ANONYMITY AND THE CRIMINAL ELEMENT
One of the most compelling features of Bitcoin is that an account holder cannot be identified beyond his or her user ID that they designated when they set up the account. This is a pretty big deal. It means that transactions cannot be traced beyond the wallet ID. Obviously, the criminal element has been drawn to the idea with an eye towards money laundering and other secretive activities.
THE BOTTOM LINE
Right now, Bitcoin exists in a strange netherworld somewhere between a novelty and a legitimate currency. Only time will tell which way the pendulum ultimately swings. One thing is for sure. Real people are making real money with Bitcoin and other digital currency variations. Mass public use and popularity might eventually be too much for institutions like governments and banks to overcome. At that point, they'll likely want to figure out how to tax it rather than do away with it. Stay tuned. We're just getting started.