The simplest explanation of bitcoin is that it is electronic money.
Bitcoin is a form of digital currency, it is decentralised, and created and held electronically. No one controls it. Bitcoins aren’t printed, like Rand, dollars or euros – they’re produced by lots of people running computers all around the world, using software that solves mathematical problems. These people and their computers are called ‘bitcoin miners’. It’s the first example of a growing category of money known as cryptocurrency.
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.
Bitcoin was invented by anonymous user ‘Satoshi Nakamoto’, who published his invention in 2008, and released as open-source software in 2009.
Satoshi Nakamoto proposed bitcoin as 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.
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.
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).
Conventional currency has been based on gold or silver. Theoretically, you knew that if you handed over a dollar at the bank, you could get some gold back (although this didn’t actually work in practice). But bitcoin isn’t based on gold; it’s based on mathematics.
Around the world, people are using software programs that follow a mathematical formula to produce bitcoins. The mathematical formula is freely available, so that anyone can check it. The software is also open source, meaning that anyone can look at it to make sure that it does what it is supposed to.
Bitcoin has several important features that set it apart from normal fiat currencies.
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 do in Cyprus in early 2013. And if some part of the network goes offline for some reason, the money keeps on flowing.
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.
Users can hold multiple bitcoin addresses, and they aren’t linked to names, addresses, or other personally identifying information. However, a person’s identity can be associated with a Bitcoin address through other means. Once that occurs, it’s possible to determine that person’s transactions backward and forward through the blockchain history. A single anonymity breach can uncover an individual’s entire Bitcoin transaction history. Many users use a new bitcoin address for each transaction, while some companies publicise their wallet address for transparency reasons.
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 transferring lots of bitcoin to a single address.
Your bank may charge you a high fee or percentage for international money transfers. Bitcoin does not. Transfer fees are optional with all transactions, and small transactions typically take little longer if the optional miniscule transfer fee is not added. No transfer fees are necessary at all if the transaction is smaller than 1,000 bytes, or all outputs are 0.01 BTC or larger.
You can send money anywhere and it will arrive minutes later, as soon as the bitcoin network processes the payment.
When you send bitcoin to someone, there’s no getting them back, unless the recipient returns them to you. They’re gone forever from your wallet and there is no central authority who you can contact to dispute a payment and get your money back. This is why merchants love bitcoin. Merchants lose millions each year after customers get their banks to reverse credit card purchases, and the the money is simply taken from the merchants bank balance. With bitcoin, this is not an option, so merchants do not need to worry about customer chargebacks.