What is Bitcoin?

What is Bitcoin?

So. what is Bitcoin? Rather than let you hear about Bitcoin from a friend of a friend who is a bit of a geek, I thought I’d put together an easy-to-understand summary of this mysterious system. A bit of history, how it works, and in general, what Bitcoin is.

The currency you’ve read the headline about

Chances are you’ve even heard of Bitcoin, maybe you’ve dismissed it as only for geeks, or a sure-to-fail flash in the pan, or maybe even a Ponzi scheme. Whatever your previous exposure to Bitcoin, we’re here to make sure you get the complete (but short) story.

Firstly, unlike Betamax, HD-DVDs, and mini-CDs, Blockchain technology and cryptocurrencies are here to stay.

A bit of history, haha

Bitcoin was invented in 2009, by an anonymous mathematician/computer programmer/s, communicating under the name of Satoshi Nakamoto. The idea of a unit of value existing only on the internet had been around for a while before, but the creator of Bitcoin came up with a clever solution for something called the Byzantine Generals’ problem; some interesting reading if you care to.

Rather than being created out of thin air like most currencies in existence today, Bitcoins are ‘mined’ by Bitcoin miners. Miners solve complicated, increasingly difficult equations to find Bitcoins. Once they do, the Bitcoin is added into the wider pool of Bitcoins and the number of Bitcoins increases. At present there are about 18.5 million Bitcoins in existence, and there will only ever be 21 million mined. The amount can never increase above this level. This is because of an intrinsic limit in the mathematics that Bitcoin is based on. This limit on how many will ever be available plays a part in the value it holds. More on that later.

Where are Bitcoins stored?

Bitcoins can be stored in digital wallets – remember they are not physical and there are no Bitcoin notes. When you see pictures of coins with the Bitcoin logo on it, that’s just an image to help you understand it. They don’t exist in a physical form.

People who want to buy Bitcoins generally do so from a Bitcoin exchange. Like a stock exchange trading in listed shares, these exchanges sell only cryptocurrencies like Bitcoin. There are buyers and there are sellers; much like a foreign currency exchange.

Also interesting to note is that one now also gets index-tracking funds which are similar to ETF’s and which track a basket of cryptocurrencies. These are listed on traditional trading platforms and can be bought and sold really easily.

Crypto – what?

A cryptocurrency is a digital currency that requires the solving of cryptographical problems in order to create more.

A digital currency could be any kind of token or unit that gets used online – but that doesn’t involve maths, eg: like eBucks or your bank’s reward points.

So what is the Blockchain?

The Blockchain is nothing more than a giant network of computers (nodes), all running Bitcoin software, that continually speak to each other and process Bitcoin transfers. In solving the Byzantine Generals’ problem, all these nodes have to agree as to what the series of transactions should look like, and once in agreement, the transaction is made valid.

Nodes are also crucial in that each node has a copy of the entire blockchain, containing a record of every single transaction that has ever occurred on the Bitcoin network. This is what makes Bitcoin decentralized.

Bitcoin are stored on, and move through the blockchain; secured by private keys (akin to secret passwords), and some mathematics so complex that there are hardly any numbers involved.

You can run a Bitcoin node.

I can run a Bitcoin node.

Nobody requires permission to be involved in Bitcoin.

What this means, is that there is no central controlling person, government, authority, or financial institution who makes sure that money goes to the right people. Rather, it is the consensus amongst nodes that clears the transaction.

Put another way, every computer in the blockchain network holds all the history of all transactions. This makes it impossible to hack as there are thousands (if not millions) of nodes around the world that would need to be attacked simultaneously. Also, this means that there is only one truth. Transactions ca not be disputed.

Isn’t that a bad thing – not having anyone in charge?

Well that depends on what your view of the global financial situation is like and your take on central banks.

Linked to this question about no central authority is the other common statement:

Why should I take Bitcoin seriously? – Bitcoin isn’t backed by anything.

Like all current global currencies, Bitcoin is backed by faith.

Gold is backed by faith that alchemy doesn’t exist; Bitcoin is backed by faith that the maths works, and dollars are backed by faith that the US government who issues them always pay their debts.

Alone, Bitcoins are worth nothing, rather, the payment network that they reside on (the Blockchain) is what is required to give them value as this allows them to be transferred from person to person.

Ask yourself – What makes your one rand, worth one rand? Well, people trust that it has value and would give you one rand worth of goods or services for it. Gone are the old days where central banks would “Promise to pay the bearer on demand in gold” for any currency presented to the issuer.

If the South African Reserve Bank suddenly decided to create more rands out of thin air that would generally be a bad thing.

Why?

Well if there’s more of something, then your share of it goes down; you’re losing value.

This is one of the main reasons why Bitcoin offers itself as a great store of value. There will only ever be 21 million mined, and that ceiling will never increase.

So the only reason Bitcoin has value is that I can sell it to someone else? How is this not a Ponzi scheme?

One way in which you can try and get your head around how Bitcoin is currently valued, and that might help you understand things a bit better, is to think of it as digital gold.

Gold you say?

But I know that gold actually is worth a lot! People use gold for jewelry and for industrial usage.

You would be correct, but consider the following.

12% of gold is used for industrial purposes (electronic components) and about 75% of this is dentistry;

About 50% is used as jewelry, and that’s because people have an understanding that gold holds value, and the remaining 38% is used as a store of value or for trading on financial markets as a commodity that holds value.

When you consider then that 88% of all gold held is really just because people think it is worth something – I think it safe to draw a parallel with Bitcoin, and that neither gold nor Bitcoin is a Ponzi scheme.

An entirely new form of currency

The Blockchain has many more uses other than a payment network to move Bitcoins around, when one considers all of Bitcoin’s and the blockchain’s properties.

  • Bitcoin is borderless – no country can stop it from going in or out of its borders
  • Blockchain technology is “trustless” – you do not have to trust any intermediary or financial services company to use Bitcoin. Although, they can be stolen (hacked), but that is slightly different.
  • Transactions are private – there is no need to divulge your personal information when you send Bitcoins
  • Bitcoin is instant – it takes anywhere between a few seconds to a few minutes to send any amount of Bitcoins to anywhere in the world
  • Bitcoin is open source, meaning that the software code that supports it is open to the world to see
  • Bitcoins are portable – unlike a briefcase full of cash, or a gold bar. If I could memorize my Bitcoin private key, I could walk across a national border with $1 billion in my head!
  • Bitcoin is decentralized in that there is no one place to shut down, or attack
  • Bitcoin is immutable – this is just a snazzy way of saying that you cannot hack the system and that you cannot alter the blockchain or the historical record of every Bitcoin transaction that has ever happened

You have my attention – tell me more

Only you can control if you wish to spend it.

Once you spend it, someone else owns it.

It is sufficiently liquid, meaning that there is lots available. Each Bitcoin can be divided in 100 million pieces!

The total supply is fixed and no government can make more.

There are no special privileges with Bitcoin. Bob and Carol, who both own Bitcoins, have the same rights.

You can exchange it digitally.

Whoa…..sounds like global finance 2.0

Surely the banks aren’t happy about this? Well, yes and no.

Those that are completely fine with all of this, most likely don’t understand the implications for their business model, while those that are concerned are pretty much powerless to do anything.

Having said that, most countries are starting to discuss and introduce regulations surrounding cryptocurrencies in a bid to manage them, but more importantly, to track and tax them.

The very nature of Bitcoin makes it impossible to regulate by a 3rd party with the exception of violence and persecution of users. Or, voluntary compliance. Political attacks would likely force the economy underground, and to a jurisdiction that would rather align themselves with new technology.

So are you saying that I should go out and buy some Bitcoin?

That depends on your appetite for new technology and your long-term view of the world and financial markets.

Bitcoin and cryptocurrencies are not some dark underground network for hackers and meth dealers; that’s just ignorance. Smart people get some very simple things wrong about Bitcoin sometimes. At the time of writing this article, Bitcoin has been declared dead over 381 times. There is even a website that tracks the number of times someone with some social clout has decried it dead.

Bitcoin is here to stay. Exactly how valuable it will be, or how useful in the next 20 years, is something we will need to wait and see. Pick ‘n Pay ran a trial a year or so ago to accept payments by Bitcoin. Maybe it will be a real thing in a few years time. Maybe not. Perhaps cryptocurrencies become the most sought-after currency, perhaps they become more interchangeable in daily life. We don’t know yet.

Is Bitcoin a good investment? Best you read that article too.

Please share your thoughts

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