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What you need to know about bitcoin
Publication Date: February 2, 2016
Trying to explain bitcoin is like trying to explain the Internet to someone in the 80s, as Vox so aptly put it; or even the 90s if you remember the video of the then-younger Today show hosts trying to comprehend the Internet. The reason it’s so difficult to explain (and understand) is because like the Internet before it, bitcoin is a brand new concept.
What is bitcoin?
At its most basic component, bitcoin is a crypto-currency. Meaning, it is a digital system of (non-physical) ‘tokens’ which have an ascribed value and are used for trading goods or services, much like cash or credit.
Like other currencies and commodities, the value of bitcoin fluctuates wildly based on supply and demand and its perceived value. At the time of this writing, the value of a bitcoin is $9979.00 US. However, these coins can be broken down into smaller units, the smallest being one hundred millionth of a bitcoin – called a Satoshi, after the anonymous founder of bitcoin.
The digital system of bitcoin was founded upon mathematical proof. The mathematical rules of bitcoin stipulate that there can only ever be 21 million bitcoins. So unlike other currencies, no more can be printed. Despite the finite number, not all 21 million have been ‘mined’ yet, so more are being discovered every day.
How does it work? And what is ‘bitcoin mining?’
Instead of using middleman – say, a bank – to hold the records of all transactions, the records (known as a ledger) are held publically by a network of computers across the world. Every time a transaction occurs the ledger is updated across the network.
The network is composed of computers that solve open source mathematical cryptographic problems in order to add ‘blocks’ to the network, known as the blockchain. It’s a little like solving a riddle in a computer game that then reveals a part of the game that was previously inaccessible. In return for solving those problems, the computer’s owner receives bitcoins. The mathematical algorithm adjusts in level of difficulty so that bitcoins are not released into the world too quickly. This process is known as mining.
Anyone with a computer that is sophisticated enough to solve the algorithm can become a miner. The exact number of miners changes all the time, but it has grown from a handful of early-stage enthusiasts into an industrial-level venture for power players backed by specialized machinery.
Because the digital system runs on a peer-to-peer basis, everyone in the network holds their own copy of the ledger. It gets rather complicated from here, but essentially that network timestamps the transactions and creates a unique math problem for every transaction that occurs. Then every computer in the network must solve the problem and check the answer for accuracy. For a more technical video explanation, see here.
With that said, you don’t have to be a miner to use bitcoin. You can use bitcoin through a sort of online wallet, or account.
What separates bitcoin from currencies that have gone before it?
Bitcoin is decentralized. No single bank, government, company or individual owns the network or has control over it. This means that your accounts can never be frozen, a government cannot devalue the currency, it can be used in every country, and, more ominously, because of the anonymous nature of bitcoin, the technically savvy can avoid taxation and use bitcoin as payment for any kind of illegal good or service.
(Note: In the U.S. bitcoin is currently taxed as a capital asset. Miners who produce bitcoin must declare the fair market value of their digital currency on the day it was mined as income, as do contractors who are paid in bitcoin.)
Why has it been in the news so much?
Bitcoin has the potential capability of changing how the world handles finances, but there are still problems with it.
Many people only know of bitcoin’s reputation by its association as a favorite payment method of criminals and the widely publicized New Silk Road, due to its anonymity. But as the former head of the New Silk Road discovered, discovery and prosecution are still possible.
There have also been reports, some very recent, that claim bitcoin has failed or will fail. The network has thus far weathered all storms, but some of its investors have not been so fortunate. When the largest bitcoin exchange of the time – Mt. Gox – suddenly shut down in February of 2014, investors collectively lost $460 million worth of bitcoin.
If bitcoin adoption continues to grow, the financial structure as we know it will be altered — but no one really knows how.
Header image©Julia Tsokur/shutterstock