WTF is Bitcoin?

This goes out to all the people who keep asking me if they should buy some bitcoin.

Do you know what bitcoin is?

It’s my aim to answer all your burning questions on bitcoin before you go and pour all your savings into the thing.

Disclaimer alert: I should point out that I’m not a financial adviser.  Also this post does not constitute financial advice of any kind. Full disclosure: I own a small amount of bitcoin, ether and litecoin (other cryptocurrencies).  So with that out the way…

 

bitcoin logo

WTF is bitcoin?

Bitcoin was the first application of blockchain technology. It is commonly referred to as a ‘cryptocurrency’ or ‘digital currency’ because it has no physical manifestation like coins or notes.  Bitcoin is recorded on a blockchain (a digital network) which is a distributed ledger of all the transactions that have ever occurred in that network.

You’ve probably noticed bitcoin has taken off in 2017 and has now made it into many major news channels. It has been around for a few years followed mainly by ‘crypto-enthusiasts’, techies and then later on people from financial/other industries. Like most things, bitcoin was not made out of thin air:

Where did bitcoin come from?

Bitcoin was created in 2008, but there is a huge mystery surrounding who actually created it. The creator published this whitepaper in a forum online under the alias Satoshi Nakamoto. The person or people behind the cryptocurrency is/are still unknown, despite various people coming forward to either claim to be Satoshi, or that someone else is.

Bitcoin was not created in a vacuum. Satoshi Nakamoto was part of a group called the ‘cypherpunks’, an online activist group including Julian Assange of Wikileaks fame. Some of the other members had worked on projects with similarities to bitcoin, like B Money (by Wei Dai), Bit Gold (by Nick Szabo) and Digicash (by David Chaum).

Bitcoin combined some old and some new concepts to create a system with a decentralised peer-to-peer network; a public transaction ledger in the form of a blockchain.  The network contained rules to determine the validation of transactions on that ledger and the creation of the currency in the system. For more on how these bits fit together, see my previous post Blockchain: How does it work?

How is bitcoin revolutionary?

One problem in particular that bitcoin solved is called the ‘Byzantine Generals’ Problem. This problem is essentially: how do you agree on the status or transfer of information between participants that do not trust each other? There is always a chance that some malicious person within the network can hack it and alter or steal the data within it and previously there was no way of securing a public decentralised network from this threat.

The solution bitcoin implemented is the system of forming ‘consensus’, or agreement, about the blockchain ledger. This system is called ‘proof of work’, and involves ‘miners’ solving complicated puzzles. The method of consensus gives people in the network an incentive to act honestly and not commit fraud.  Read more about mining in How Blockchain works: Mining and the Chain. Thanks to the system of mining, the bitcoin blockchain also has a novel system of creating new bitcoins.

 

miner

The network self-regulates to make sure that someone solves the puzzle and mines a block roughly every 10 minutes. The amount of new bitcoins created is halved every 4 years and the total number of bitcoins that will ever be created is fixed at 21 million. Through these rules coded into the blockchain, we know that we will reach the 21 million total by the year 2140 and after that no more bitcoins will be created.

Bitcoin is therefore called a ‘deflationary’ currency, because there are fewer and fewer issued over time. These rules also mean that no central bank or one actor can ‘print’ more bitcoin whenever they feel like, as happens with traditional currencies at the moment, sometimes to devastating effect.

How much is it?

 

dollar sign

The price of bitcoin rose from nothing at its inception to $1,000 during 2017, and at the time of writing it had passed the $6,000 mark. The rise in prices for almost all cryptocurrencies has grown exponentially this year as more and people have become aware of them and wanted a piece of the action.

Partly for this reason, lots of people have got very excited about bitcoin. You may even be getting excited about it… (calm down, there are other parts of the internet for that).

For more details on the history of bitcoin and some of the major players involved, I would definitely recommend watching the recent Netflix show ‘Banking on Bitcoin’, which features key characters such as Charlie Shrem, Eric Voorhees and the Winkelvoss twins, as well as the cypherpunks group.

How are people using bitcoin?

We can think of bitcoin today as having two different uses: as a currency and as an asset.

1) Bitcoin as a currency

Bitcoin functions like a payment network. It’s used as a digital form of currency to send money between people around the world. This function of bitcoin makes it similar to a traditional (otherwise known as ‘fiat’) currency like dollars or euros because you can pay for things with it, or transfer it to other people.

But the price of bitcoin tends to dramatically change frequently, which limits its usefulness as a currency substitute if you compare it to more stable currencies. Compared to currencies in places like Venezuela or Zimbabwe however, bitcoin may be seen as a safer haven for people’s wealth compared to the state currency.

What can I buy with bitcoin?

The Silk Road marketplace set up by Ross Ulbricht and then taken down by the FBI made bitcoin famous as the currency of drug buyers and sellers around the world. The Silk Road was a kind of underground eBay where you could buy anything (supposedly) anonymously, using bitcoin as a means of payment. It was set up on The Onion Router or TOR network, part of the ‘dark web’ that makes it difficult to trace people’s identities.

drugs

But bitcoin is only pseudonymous, not anonymous. This means it is actually possible to link people’s identities through certain information on the bitcoin blockchain. In fact, the whole point of the bitcoin network is that all the information is public, therefore it’s not really the best means of paying for illegal substances (cash is still probably your best bet).

So ruling drugs out, what else can you buy with bitcoin?

Developers of newly built apartments in Dubai recently announced they would be accepting bitcoin for their more than $120,000 one and two bed apartments. If you’re based in the UK, this handy website gives details of places that will accept bitcoin, including restaurants, pubs, shops and more. You can even buy bitcoin itself from ATMs in places like New York, London and Bristol.

2) Bitcoin as an asset

Some people nickname bitcoin ‘digital gold’ because it works like a digital asset similar to gold. In this sense, you can buy some bitcoin and keep it because you believe it is a store of value, and it will increase in value over time.

This has led to some bitcoin billionaires making a ton of money from buying in early and seeing the value of their bitcoins increase by over 600% in the past year alone. The volatility in price is one of the main reasons people argue that bitcoin isn’t actually a ‘currency’ and is why Wikipedia still refers to it as a ‘digital asset’. But maybe in future if the price movements calm down, it could be on its way to meeting Economists’ currency definition.

There are a lot of opinions out there on whether bitcoin is worth buying. Jamie Dimon, CEO of JP Morgan, frequently slags off bitcoin yet his company still seems to be weighing in on the crypto action. There are people who have made so much out of the bitcoin price rise that they are now looking for ways to buy their next major purchase – a new house or car for example, with bitcoin instead of dollars or pounds.

How do I get some?

Exchange arrows

You can buy bitcoin from any online exchange like Coinbase, Kraken or Poloniex by setting up an account and paying with your debit/credit card. Because of the lack of control and security over your own bitcoin (this also applies to any other cryptocurrency), it’s best to get your own ‘wallet’ where you can store your bitcoins after purchasing. There are loads of wallets out there supporting various different cryptocurrencies.

There are broadly two different wallet types: ‘hot’ wallets and ‘hardware’ wallets. Hot wallets work as applications on your computer or phone. They are good for storing small amounts of bitcoin but aren’t all that secure for larger amounts. Popular hot wallets are Mycelium, Bitcoin wallet and Electrum.

Hardware wallets are physical devices that are not connected to the internet (sometimes therefore called ‘cold’ wallets), and need to be connected before the bitcoins on them can be spent. This gives you some extra security. The most popular hardware wallets are Ledger and Trezor. As always, do your research before downloading apps and/or buying bitcoins from anywhere. Take care with your security – there are a lot of scams out there!

Let’s see where it’s headed

 

bitcoin chart

So bitcoin is the original and oldest cryptocurrency and the first application of blockchain technology. There have been multiple developments in the bitcoin network since it was first implemented, but I’ll talk about those in future posts.

You can keep track of the price of bitcoin here:

Now, you know what bitcoin is and where you can get it!  Remember – understand what you’re buying into (literally) before you pour in all your life savings. And don’t spend anything you’re not willing to lose!

If you are interested in learning more about bitcoin from an investment perspective – check out Invest in Blockchain’s comprehensive article on everything you need to know to get started!

 

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