The news these days is flooded with stories about Bitcoin and other cryptocurrencies. There are about a million excellent places on the Internet to learn the intricate technical details around Bitcoin; just fire up Google and type in ‘what is Bitcoin?’
The goal here is to give a basic introduction to the idea of cryptocurrency, and Bitcoin in particular. For our purposes, cryptocurrencies (of which Bitcoin is the most prominent) are virtual stores of value that exist only on networks of computers. This means that there aren’t any actual “coins” despite the pictures you see on news articles about it.
What follows is an explanation of the general idea of what Bitcoin is and how it works. I would encourage you to read through it all, then think about it and decide if a re-read is needed, and proceed from there. This isn’t an easy subject to understand at first, but in the end, it’s really just a new store of value, but that you can’t dig out of the ground. Instead, it’s made by, and stored on, computers.
Cryptocurrency is a virtual currency, meaning it exists only virtually, that is designed to be exchanged for value, like regular, or ‘fiat’ currency. One big difference here is that fiat currency is issued and regulated by governments.
Bitcoin is one of many cryptocurrencies, and is by a fair margin, the most well-known, most popular, and most valuable. It is created by ‘mining’ it on computers. There is no physical coin to Bitcoin, despite that ‘B’ coin picture you see everywhere when you read articles about it. That’s just a visual aid.
‘Mining’ in the case of Bitcoin, is the process of maintaining the general ledger of all Bitcoin transactions via a complex set of encryption calculations. This ledger is maintained by all computers that ‘mine’ and is completely transparent with regard to the amount, timing and other basic transaction information. It contains all of the details for every Bitcoin transaction ever performed since Day 1. The personal identities of the people doing transactions are not part of this information. This process can be boiled down to something called…
Blockchain: Anyone can mine Bitcoin, and anyone who does is working with everyone else to maintain that ledger we mentioned. This record keeping process is referred to as ‘blockchain.’ When a computer runs the Bitcoin mining code, it becomes part of the very large and de-centralized Bitcoin mining network. The software is designed such that all of this mining work is completely transparent to all other computers on the same network, helping to maintain the integrity of the system, insuring that blockchain entries are legitimate and reliable.
Store of value: Bitcoin acts a lot like a commodity with regard to how it’s traded, similar to gold. This is in contrast to the idea of a currency, which is easily exchanged by individuals for goods and services. This was the original intent of Bitcoin, but it hasn’t really worked out that way for several reasons. But as a store of value, it’s going strong, and has been the object of much trading excitement in the last few weeks, gaining over 65 percent in value over just the last month. But, that sort of action brings much volatility, with process swinging up and down as much as 35 percent on a single day, so tread carefully!
Yes, this is a lot to take in. But, the basic nature of it is this: the rough equivalent of Bitcoin in the physical world would be gold. In order to mine gold, you find a good spot to dig a big hole, and when you’re finished, you have some gold. In order to ‘mine’ Bitcoin, you run complex computations on your computer, contributing to the ‘blockchain’ by helping to maintain that general ledger, and when you’re finished, you have some Bitcoin. It’s important to note that mining Bitcoin on your PC would be the equivalent of panning for gold at a tourist stop in the mountains. Yes, you might, in theory, get some gold, but the amount will be so tiny as to be meaningless. Just like mining gold, it takes significant effort and resources to mine large amounts of Bitcoin. But, this isn’t the only way to get Bitcoin.
Like gold, Bitcoin is traded on exchanges where the value is determined by supply and demand within the exchanges, and it is bought and sold in large volumes every day. With gold, you can keep it safe by locking it in a vault. With Bitcoin, you keep it safe by keeping your secret encryption key safe (some people literally write them down and lock them in vaults, just like gold). This key is the Bitcoin. If you lose it, it cannot be recreated. If someone steals it from you, they now have your Bitcoin.
This all surely seems bizarre, but it will become clearer as you find more material to read. The important thing to remember here is this: all it takes for a currency or commodity to have value is a group of people to agree that it has value. As it turns out, there are many, many people who agree that Bitcoin is a valid, functioning store of value, in close to the same way that gold is a store of value. How many people?
Consider this: Bitcoin has been around for fewer than 10 years. The most popular exchange (the place online where people can buy and sell Bitcoin) is called Coinbase. Coinbase has been around for five years. Coinbase has more active customers than Charles Schwab, the famous stock trading company. The current market capitalization of Bitcoin (the total number of Bitcoins multiplied by the price of Bitcoin today) is roughly $250 billion. Just to get an idea of how big that number is, Walmart’s market capitalization is roughly $290 billion. So yes, there are lots and lots of people around who agree that Bitcoin has real dollar value, and they’re spending their U.S. dollars to buy it.
This brings us to an important aspect of Bitcoin. Bitcoin is entirely maintained by a de-centralized network of computers world-wide, and is completely unregulated and uncontrolled by any government entity. This is by design, as the creators of Bitcoin (Google ‘Satoshi Nakamoto’ to learn more) were trying to create a way for people to exchange value without interference from middlemen, or governments artificially messing with the value (like when the Fed changes interest rates or prints more money).
Bitcoin is the largest, most well known cryptocurrency, but there are hundreds more. Some of these ‘alt coins’ are also widely traded, such as Ethereum and LiteCoin. Others are small start-up currencies, trying to cash in on the crypto craze.
Ok, so this is a lot to take in for sure, and if I’m being honest here, it took me, Super Nerd, many attempts and a few Google sessions to begin to understand all of this stuff. Please note that much of this is a pretty liberal simplification of how this all works, so if you really want the gritty technical details, you’ll need to do that Googling I keep mentioning.
Hopefully this has helped bring folks up to speed a bit with regard to the world of cryptocurrency. If you have any questions about this article, please email the paper at firstname.lastname@example.org and I’ll do my best to answer every question. Thanks for reading!