What is Bitcoin?

Bitcoin is a new kind of decentralized digital currency and a revolutionary payment network

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If you are just learning about Bitcoin, you’re probably still trying to figure out why an intangible object is worth so much money.

From the outside, Bitcoin looks like a bunch of virtual numbers that don’t make sense. But once you get a better understanding of what Bitcoin is and how it works, you’ll quickly see just how innovative and disruptive it truly is.

Introduction

In April of 1933, at the height of the Great Depression and in order to induce economic growth by increasing the amount of money available for lending, the U.S. President Franklin D. Roosevelt issued Executive Order 6102, “forbidding the Hoarding of Gold Coin, Gold Bullion, and Gold Certificates within the continental United States”.

This Order stated, essentially, that no one person could own more than $100 worth of gold.

Any amount greater than that would have to be turned into a Federal Reserve Bank by the end of the month, or the owner would face ten years in prison or a fine of $10,000 (over $180,000 in today’s money).

At the time, you see, gold was money. An ounce of gold was worth $20.67, and a $20 gold coin contained 0.967 ounces of gold.

Reasonably, any gold coins turned over to the Federal Reserve Banks were reimbursed at a rate of $20.67 per ounce.

Reasonable, that is, until 8 months later when the Gold Reserve Act of 1fa934 was passed.

This new law raised the price of gold to $35 per ounce – effectively profiting the U.S. government 70% from the gold it had confiscated, and devaluing the dollars that its citizens were forced to accept in exchange.

Governments can do funny things with money.

Bitcoin – a new kind of money

Bitcoin is an anonymous, decentralized, electronic currency. That’s a nice, concise sentence, but it bears some explanation.

You do not have to register with a bank to create a Bitcoin account. When you get started you’ll create a Bitcoin address that only you can control, but there is no record of who owns which address. As long as you take some basic precautions, you can use Bitcoin completely anonymously.

Bitcoin wasn’t created by a government. It was created by a small group of researchers who were interested in the idea of a currency that was outside the control of any organization.

There is no centralized regulatory authority for bitcoins as there is for dollars, euros, and every other currency on the planet. Bitcoin is controlled by rules built into Bitcoin software, and those rules are enforced by every Bitcoin client running around the world. That’s what is meant by decentralized.

You can’t put bitcoins in your wallet; indeed, you can’t touch them at all. They exist solely on computers and are exchanged through the Bitcoin network.

You can access the Bitcoin network by installing some software on your home computer (or by using one of a number of online Bitcoin services). This software is free, easy to use, and incredibly secure.

And finally, by currency, we mean that bitcoins have value and can be exchanged for goods and services. A growing number of online stores accept bitcoins, and some “brick and mortar” retailers, like local coffee shops, have also begun to accept them.

Additionally, you can trade bitcoins for other currencies, such as dollars and euros.

The Financial Crisis and the Birth of Bitcoin

To better understand Bitcoin, you first need to look at the historical events that led to its development – the Financial Crisis of 2008 and the subsequent Great Recession, a global economic recession that took place from 2007 to 2012.

Triggered by irresponsible lending and downright dishonest practices by large financial institutions, the fallout of the Financial Crisis pushed a lot of people into financial hardship.

In the United States, the job market, housing market, and the stock market all experienced a significant decline. While this was happening in the United States, the European Union was dealing with a similar financial crisis from growing government debt in countries like Greece, Italy, Ireland, and Portugal.

When combined, these two events triggered a global recession that affected a number of economies around the world.

Because of the gross incompetence on the part of banks, combined with the fact that government response to the problem was to provide bailouts, most people lost faith in the financial institutions and their ability to regulate the economy.

The following year, an anonymous person (or group) under the name Satoshi Nakamoto published a whitepaper about a peer-to-peer digital currency called Bitcoin, which allowed users to send and receive payments without going through a financial institution.

As you learn more about Bitcoin, you’ll notice that one of the main themes surrounding the cryptocurrency is decentralization. This was likely inspired by the mishandling of money by centralized financial institutions during the recession era.

According to Satoshi, fiat currencies work because of the trust we place in banks, but as we saw with the Financial Crisis, these institutions have proven time and again that they shouldn’t be trusted with safeguarding our money or our privacy.

What Makes Bitcoin Valuable?

As you may remember, Bitcoin has a finite number of coins that can be in circulation – only 21,000,000 of them. New bitcoins can’t simply be made like how central banks just print more money.

Instead, they are created by a complex algorithm which slowly introduces bitcoins into the network every hour, diminishing the number of coins released into the market as we inch closer to 21 million.

As of April 30, 2018, there are 17,010,088 bitcoins in circulation.

When talking about the price of Bitcoin, its dollar value is due to simple economics. When the demand for bitcoins increases faster than its supply, the coin grows in value.

The price you’re currently paying to buy bitcoins is based on how much the market believes Bitcoin is worth – or how much it’ll be worth in the future.

However, reducing Bitcoin’s value to the amount it’s worth in dollars doesn’t do the currency justice. Bitcoin has value for functional reasons as well, such as:

  • Providing global transactions, 24 hours a day, 7 days a week. No downtime because of banking holidays, weekend, or non-working hours.
  • Bitcoin’s limited supply makes it resistant to inflation.
  • Without a financial institution acting as the middleman, Bitcoin’s transaction fees are significantly cheaper.
  • You’re free to send and receive money to/from anyone, anywhere in the world as long as both parties have Bitcoin wallets.
  • Because Bitcoin doesn’t allow chargebacks, it’s useful for buying and selling things online.

Ultimately, Bitcoin is so much more than virtual numbers. It’s a way for you to exercise more control over your money.

It democratizes money by allowing everyone to participate in the global economy, even people without bank accounts.

Advantages of Bitcoin

Built in privacy

Every Bitcoin user has one or more Bitcoin addresses, which are equivalent to a bank account number. A Bitcoin address looks something like this:

19QhXjxByTWXQEaqvu7GrR7JhnfTG9UWiY

Unlike a bank account, no identifying information is linked to the address, so no one knows who owns the address.

Along with the address, you’ll get a set of secure “keys” that lets you, and only you, record transactions related to that address on the Bitcoin network.

Your Bitcoins cannot be seized

Every Bitcoin transaction (when someone sends bitcoins from one address to another) is recorded on every computer on the Bitcoin network.

This record, called the Blockchain, ensures that every transaction is legitimate and that no one can take your bitcoins without your permission.

For that matter, no one can tax you without your permission either. You’re free to do whatever you want with your money. Transactions are secured through the use of cryptography.

Essentially, only the secure keys that go along with a Bitcoin address can create a transaction, ensuring that no one but you can move your money.

Bitcoin gives you control over your money by removing the need for a central bank to monitor and regulate your transactions.

When you store your money in banks, you’re essentially handing over your assets to a third-party that’s able to exercise some control over how you send and receive money.

With Bitcoin, your money is stored in a wallet that’s in your possession and under your control – not under the control of a central banking authority.

Even the way you send and receive money with Bitcoin is decentralized. Instead of using the bank’s network to facilitate transactions, Bitcoin transactions are grouped together into collectives known as “blocks” and distributed over an open network through a process known as Bitcoin mining.

Miners are the people who keep the Bitcoin network active and running. They use hardware processing power to compile transactions into blocks and then add those blocks to the existing blockchain on the Bitcoin network.

Due to the open and decentralized nature of Bitcoin, anyone can become a miner, provided they have internet access and the right hardware.

Without the help of miners, none of the Bitcoin transactions would go through. For this reason, they are rewarded with transaction fees and portions of newly-released bitcoins that enter the market.

Very low transaction fees

Transaction fees for traditional currencies can be a sizable cost of any transaction. Credit card transaction fees are usually 2 – 3%. International bank wire fees will cost at least $20. Bitcoin transaction fees are incredibly small and go to the miners discussed above.

Bitcoin is decentralized

There is no central governing institution that has control over the Bitcoin network or the over the bitcoins you have stored in your wallet.

Bitcoin has a finite supply

With fiat currencies, central banks are able to manipulate the value of money by putting more notes into circulation. With Bitcoin, only 21,000,000 coins are able to be in circulation. This has effects on the coin’s monetary value, which we’ll go into further down.

Bitcoin provides semi-anonymity

You don’t need to disclose personal information when sending and receiving bitcoins, but your records are open to the public. Anyone can see your wallet activity and your transactions, but there isn’t any sensitive information like your name, address, government identification number, or financial details that explicitly link you to a transaction.

Bitcoin transactions are irreversible

Bitcoin transactions are immutable. This advantage is primarily for merchants who are tired of chargeback fraud. If you haven’t heard of it, a chargeback is what happens when someone disputes a credit card charge with their credit card company.

Almost always the credit card company will find in favor of the purchaser, despite any evidence the merchant may provide. The merchant ends up losing the money and their product.

Because Bitcoin is decentralized, there is no middleman that arbitrates disputes and can roll back a transaction. As the saying goes, “all sales are final.”

Disadvantages of Bitcoin

Of course, nothing is perfect. Bitcoin has some disadvantages compared to traditional currencies. Whether or not the advantages outweigh the disadvantages depends on what you’re considering using it for.

Advanced technology

Since Bitcoin is such a new and revolutionary, it’s still not widely accepted, let alone understood or appreciated. This issue has only been improving as the technology improves and more merchants around the world continue to accept Bitcoin.

Lack of regulation

Since Bitcoin is so different than anything anyone has ever seen before, the government has still not adapted to the technology. This has impacted adoption and has created loads of problems with the big banks.

Bitcoin’s price is volatile

The price of Bitcoin can swing quite a bit from day to day although its volatility has been decreasing in parallel with its growth. A volatile currency is not practical as a form of payment.

Transactions are not instant

When you buy something online in a traditional currency, say a book from Amazon.com, the transaction is complete within moments.

This happens because Amazon.com can connect quickly to your credit card company’s servers and request the transfer of money and because your credit card company has invested heavily in making this transaction as fast as possible.

The centralization of this network works to its advantage.

With bitcoins, every transaction must spread throughout the Bitcoin network before it is accepted as being valid, which takes time. There are different levels of acceptance (number of confirmations) for Bitcoin transactions.

Most individuals will now accept a transaction after one confirmation. Exchanges will accept after two confirmations from the network.

Improvements in transaction speed

The implementation of the Segregated Witness across the Bitcoin network was a major step to improving the network speed. The next major breakthrough will be once Lightning really goes live. Lightning promises instant Bitcoin transaction – the dream.

Why should I be interested in Bitcoin?

This is, of course, a matter of personal decision. You might consider getting into Bitcoin if any of the following apply to you:

  • Buy a good or service using Bitcoin
  • Send money internationally
  • Hedge against inflation in your country
  • Don’t have access to a financial system
  • Pay an international employee or supplier
  • Safeguard funds privately online
  • You want to transact in private.
  • You’re worried about the security of your money elsewhere
  • You just like the novelty of it.

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