Bitcoin is a type of digital currency, which is created and held electronically, and has no control over it. Bitcoins aren’t printed, like fiat currencies, they are produced by lots of people running computers all around the globe, using software that solves mathematical problems. It’s the first example of a growing category of money known as cryptocurrency.
How does Bitcoin differ to other forms of digital 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.
But 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.
But 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 the currency.
Instead, bitcoin is created digitally, by a community of people that anyone could join. Bitcoins are ‘mined‘, using computing power in a distributed network. This network also processes transactions made with bitcoins, effectively making bitcoin its own payment network.
Does that mean that you can’t mine 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).
What is it based on?
Bitcoin is based on maths
Conventional currency used to be 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). 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.
What are its characteristics?
Bitcoin has several important features.
1. It’s decentralized
The network isn’t controlled by one central authority. Every machine that mines bitcoins 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.
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. You can set up a bitcoin address in seconds, no questions asked, and no fees.
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 block chain. The block chain 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.
5. Transaction fees are miniscule
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, after 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 sends them to you. They’re spent.
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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