WTF's a Bitcoin ..... Dude?

What is Bitcoin? Eleven things you need to know about the digital currency

Sunny Freeman
sunny.freeman@huffingtonpost.com

The rise of Bitcoin marks the first time you’ve probably heard the words “trendy” and “currency” uttered in the same sentence. And given the momentum it’s seen lately, both in international headlines and on exchanges, the buzz around digital currency is only going to grow in the next year. Here are answers to 11 pressing questions that will help even the biggest Bitcoin neophyte sound in the know at cocktail parties and water coolers in 2014.

1. What is Bitcoin?

Bitcoin is the most popular type of digital currency, an online-only alternative form of money. Bitcoin represents two things: Capital “B” Bitcoin refers to the payment network, the whole system behind making payments, while lowercase “bitcoin” refers to the unit of currency itself. The payment network and the currency are both decentralized, meaning that — unlike traditional currency — they are not created, controlled or regulated by a central body.

2. Why digital currency?

Libertarians tout the “people power” that Bitcoin enables. Because there is no central authority, two people anywhere in the world can transact freely, with no fees and no bank account, instantaneously. They can’t be censored or have their money confiscated or controlled, which happens in some unstable countries. Freedom from government means the rules of bitcoin are set by the market, without political interference. Supporters say that freedom from political interference, along with bitcoin’s limited supply, makes bitcoin a more stable store of value than currencies that can be inflated or deflated through control of the money supply.

3. Why am I hearing so much about it now?

 Bitcoins have been around for more than five years, but gained attention at the end of last year for both positive and negative reasons. On the positive side, demand for the currency spiked a whopping 5,000 per cent in 2013, driving the price of a bitcoin from about $13 U.S. in January to more than $1,000 U.S. in November, largely because of demand in China.

Shortly after prices peaked at $1,073, China cracked down on Bitcoin use, forbidding banks from dealing in the currency, and prices plunged. The U.S. bust and seizure last fall of $25 million in bitcoins from the Silk Road — an online exchange for criminals — also shone a spotlight on the digital currency. Still, most of the attention these days surrounds its sharp price appreciation and the host of merchants and venture capitalists moving into the space.

4. How is it traded?

At the most basic level, bitcoins are traded from one person’s digital wallet to another. Think about it as a peer-to-peer network like file-sharing, in which a network of computers interact with one another, but there is no centre of control, and what they share isn’t files but money. Bitcoin exchanges have also been set up where units can be bought or sold on the open market at the going average rate, plus a fee that goes to the owner of the exchange. Increasingly, bitcoin ATMs are being set up where users can trade cash for bitcoins for a fee.

5. How do you make a transaction?

Bitcoin owners hold digital wallets — there are a number to choose from. A buyer sends money to the seller’s bitcoin address, generally over a mobile phone, and both are issued an e-receipt for the deal. Because it’s not a physical currency, bitcoins can be divided infinitely, so a holder can buy a coffee for a fraction of the current value of a bitcoin.
 
Every time a transaction is made, it is recorded on a public ledger called the Block Chain, which is shared among all Bitcoin users.

6. How are bitcoins created?

Bitcoins are “mined” similarly to gold, meaning there is a finite supply in the world. However, instead of pick-axes in the ground, bitcoin miners use increasingly sophisticated computers to solve increasingly difficult computer algorithms. Each time a miner solves one of these cryptographic puzzles (think of a sort of a global math riddle race), she is paid in the currency, adding it to the money supply. The current maximum of mineable bitcoins in the world is 25 every ten minutes.

7. How are bitcoins valued?

Like gold, there is a finite number of bitcoins in the world, with a threshold of 21 million bitcoins and the last expected to be “mined” in 2140. There are about 12 million currently in circulation. Just like a traditional currency, the going rate for a bitcoin is based on supply and demand on global exchanges, and is measured against local currencies. The standard unit of representation is called a BTC, similar to a CAD or USD. Bitcoins hold a fictional value just as much as the piece of paper we hold with $100 written on it.

8. Who started it?

The origins of Bitcoin are shrouded in mystery. In 2008 a Japanese programmer or group of programmers operating under the pseudonym Satoshi Nakamoto published a paper describing digital currency. In 2009, Nakamoto launched software that created the first Bitcoin network and bitcoin unit of currency. Contact between Nakamoto and the community faded in 2010, when he/they gave away control over Bitcoin properties.

9. What makes it different from other currencies?

The finite number of bitcoins and decentralized nature of Bitcoin are two key characteristics that set it apart from established currencies. The lack of a connection to a central authority means it cannot be artificially manipulated to set monetary policy, under which central banks can release or restrict the supply of money to ease economic cycles.

10. What are some of the other types?

Bitcoin is just one of many digital currencies flooding the market. Other popular internet currencies include PeerCoin, LiteCoin and Ripple, each of which has unique properties. There are also several novelty coins making headlines such as the Coinye (a play on Kanye West) and the Dogecoin (modelled after the internet meme). While bitcoins are designed for buying and selling in a marketplace, other currencies can perform functions tailored to real estate or derivatives trading, for example. The Royal Canadian Mint is even devising its own, called the Mint Chip and backed by the Canadian dollar.

11. What are some of the concerns?

There are several barriers that could prevent the Bitcoin experiment from succeeding, including concerns about online security, a lack of regulation and the anonymous nature of transactions. Some observers wonder whether the bitcoin’s sharp appreciation signals the value of the coin stems from a speculative bubble that could burst at any point, leaving it worthless. In addition, bitcoin has no fixed value, one of the key characteristics of a good currency; it is near impossible to quote the value of a carton of milk or a pair of pants in bitcoin.