What Is Bitcoin – History, How It Works, Pros & Cons
Bitcoin is a virtual currency, or cryptocurrency, that’s controlled by a decentralized network of users and isn’t directly subject to the whims of central banking authorities or national governments. Bitcoin is by far the most popular and widely used out of hundreds of cryptocurrencies in active use today– the closest equivalent to traditional currencies.
Like traditional currencies, Bitcoin has value relative to other currencies and physical goods. Whole Bitcoin units can be subdivided into decimals representing smaller units of value. Currently, the smallest Bitcoin unit is the Satoshi, or 0.00000001 Bitcoin. The Satoshi can’t be broken into smaller units. However, Bitcoin’s source code is structured to allow for future subdivisions beyond this level, should the currency’s value appreciate to the point that it’s deemed necessary.
Bitcoin is the most versatile cryptocurrency around. It can be used to purchase goods from an ever-growing number of merchants who accept Bitcoin payments. It can be exchanged with other private users as consideration for services performed or to settle outstanding debts. It can be swapped for other currencies, both traditional and virtual, on electronic exchanges that function similar to forex exchanges. And, unfortunately, it can be used to facilitate illicit activity, such as the purchase of illegal drugs & black money.
For all its promise, it is subject to wild value fluctuations. Despite the pronouncements of its proponents, it’s not a legitimate investment or trading vehicle.
How Bitcoin Works
Bitcoin is a cryptocurrency, meaning it’s supported by a source code that uses highly complex algorithms to prevent unauthorized duplication or creation of Bitcoin units. The code’s underlying principles, known as cryptography, are based on advanced mathematical and computer engineering principles. It’s virtually impossible to break Bitcoin’s source code and manipulate the currency’s supply.
- Intense privacy protections built into Bitcoin’s source code.
- The system is designed to publicly record Bitcoin transactions and other relevant data without revealing the identity of the individuals or groups involved.
- Users are identified by public keys, or numerical codes that identify them to other users, and sometimes pseudonymous handles or usernames.
- Additional protections allow users to further conceal the source and flow of Bitcoin. For instance, special computer programs available to all Bitcoin users, called mixing services, obscure the source of the owner’s holdings.
- Bitcoin exchanges allow users to exchange Bitcoin units for legitimate currencies, such as the U.S. dollar and euro, at variable exchange rates.
- Allow exchange of Bitcoin units for other cryptocurrencies.
- Bitcoin exchanges ensure that the Bitcoin market remains liquid, setting their value relative to traditional currencies – and allowing holders to profit from speculation on fluctuations in that value.
- Bitcoin’s value is subject to wild swings – weekly moves of 50% in either direction have occurred. Such swings are unheard of among stable currencies.
- Bitcoin’s block chain is vital to its function.
- It is a public, distributed ledger of all prior Bitcoin transactions, which are stored in groups known as blocks.
- Every node of Bitcoin’s software network – the server farms and terminals run by individuals or groups known as MINERS.
- Their efforts to produce new Bitcoin units result in the recording and authentication of Bitcoin transactions, and the periodic creation of new blocks & contains an identical record of Bitcoin’s block chain.
- Because new Bitcoin transactions constantly occur, there’s no predetermined length at which the block chain will stop growing.
- On an average, miners create a new block chain, which includes all prior transactions and a new transaction block, every 10 minutes.
- Every two weeks, Bitcoin’s source code is designed to adjust to the amount of mining power devoted to creating new block chains, preserving the 10-minute average creation interval.
- Bitcoin’s block chain is the sole arbiter of Bitcoin ownership. No complete record exists anywhere else.
- The block chain also serves as a payment processing system, like Visa or PayPal, with the miners functioning as the system’s employees.
A Bitcoin transaction occurs once it is added to the block chain, at which point it becomes irreversible – unlike traditional payment processors.
- Every Bitcoin user has at least one private key (basically, a password), which is a whole number between 1 and 78 digits in length.
- Individual users can have multiple anonymous handles, each with its own private key.
- Keys confirm their owners’ identities and allow them to spend or receive Bitcoin.
- Without keys, users can’t complete transactions & can’t access their holdings.
- When a key is lost for good, the corresponding holdings can’t be recovered.
- Actual Bitcoin units are stored in “wallets”.
- These are secure cloud storage locations with special information confirming their owners.
- These are vulnerable to hackin
- The largest and most notorious Bitcoin hack involved wallets held by Mt. Gox, a Japanese Bitcoin exchange that shut down after hackers stole hundreds of millions of dollars in Bitcoin (in contemporary valuations) from its supposedly secure servers.
- Hackers often target public wallets that store users’ private keys, enabling them to spend the stolen Bitcoin.
- Unlike keys, they can’t be stored on paper.
- Miners play a vital role in the Bitcoin ecosystem.
- As keepers of the block chain, they keep the entire Bitcoin community honest and indirectly support the currency’s value.
- Miners are individuals or cooperative organizations with access to powerful computers, often stored at remote, privately owned “farms.” They perform incredibly complex mathematical tasks in an effort to mint new Bitcoin, which they then keep or exchange for normal currency.
- Bitcoin’s source code harnesses this computing power to collect, record, and organize previously unverified transactions, adding a new block to the block chain about every 10 minutes.
- Each time a new block chain is created, a predetermined number of fresh Bitcoin are minted. Miners are “rewarded” these Bitcoin for their effort and often also receive transaction fees paid by buyers.
- Sellers have an incentive to charge transaction fees, which usually amount to less than 1% of the transaction amount.
Bitcoin’s own source code places a strict limit on the number of Bitcoin units that can ever exist: 21 million. This is achieved by slowing, over time, the rate at which the creation of new block chain copies produces new Bitcoin. Every four years or so, this rate halves. The last Bitcoin is projected to spring into being sometime around 2140 – that is, if the currency still exists and people still care enough to mine it. After that, miners’ sole compensation will be Bitcoin transaction fees.
This enforced scarcity is a key point of distinction between Bitcoin and traditional fiat currencies, which central banks produce by decree, and supply of which is theoretically unlimited. In this regard, Bitcoin has more in common with goldthan the U.S. dollar.
Origins & History of Bitcoin
Bitcoin’s origins date back to the early 1980s, when the algorithms that support modern cryptocurrency were first developed. Its closest predecessor was Bit Gold, a proto-cryptocurrency developed in the late 1990s by Nick Szabo.
Bitcoin’s Birth and Early Development
The first public record of Bitcoin dates to October 2008, when a pseudonymous person or organization known as Satoshi Nakamoto published a white paper with the technical outlines for a new, decentralized cryptocurrency. Nakamoto’s identity remains unknown,
Advantages of Using Bitcoin
- Greater Liquidity Relative to Other Cryptocurrencies
- Increasingly Wide Acceptance as a Payment Method: Hundreds of merchants accept Bitcoin payments.
- International Transactions Easier Than Regular Currencies
- Generally Lower Transaction Fees
- Anonymity and Privacy Relative to Traditional Currencies: As against Traditional Currencies, Bitcoin’s built-in privacy protections allow users to completely separate their Bitcoin accounts from their public personas. While it’s possible to track Bitcoin flows between users, it’s very difficult to figure out who those users really are.
- Independence From Government Control and Creators:Bitcoin isn’t created or controlled by any state entity, such as a central bank. Since it exists outside any political system, though the use is illegal it is difficult for governments to freeze or seize Bitcoin units, whether in the course of legitimate criminal investigations.
- Built-In Scarcity:
- Central banks can create new units of traditional currency at will, and often do.
- Bitcoin’s built-in scarcity feature – only 21 million will ever exist – is likely to support its long-term value against traditional currencies. Bitcoin’s scarcity supposedly imbues the currency with intrinsic value – similar to gold and other precious metals.
Disadvantages of Using Bitcoin
- It is an Illegal Currency
- Exposure to Bitcoin-Specific Scams and Fraud
- Black Market Activity Bitcoin remains attractive to criminals and gray market participants.
- Susceptible to High Price Volatility
- No Chargebacks or Refunds
- Potential to Be Replaced by Superior Cryptocurrency
- Environmental Ills of Bitcoin Mining. Bitcoin mining consumes vast amounts of electricity.
The list of merchants that accept Bitcoin is steadily lengthening. You can now buy plane tickets (Expedia), furniture (Overstock), and web publishing services (WordPress) with Bitcoin.
However, before you rush out and cash in your dollars for Bitcoin, remember that Bitcoin has a long way to go before it’s a legitimate currency on par with the U.S. dollar, euro, or pound. And despite the seductiveness of cryptocurrency as a means of exchange, there’s no guarantee that Bitcoin – or any other decentralized, virtual currency not controlled by a national bank – will ever be a viable alternative to traditional currencies.
Some experts believe that, in the coming decades, national governments will rework their currencies with state-sanctioned means of exchange that have some cryptocurrency features, like built-in scarcity and virtually impenetrable counterfeiting protections. Others believe that traditional currency and cryptocurrency will continue to exist in parallel, but that cryptocurrencies will fail to expand beyond the niche currently occupied by gold and other precious metals – that of an alternative investment whose primary purpose is to hedge against inflation.
Did You Know: As Bitcoin grows more valuable (albeit amid gut-wrenching market volatility) and more commonly accepted, so too does the business of mining Bitcoin. But it comes at a notable cost: the consumption of vast amounts of electricity, often powered by non-renewable sources. According to the Bitcoin Energy Consumption Index, Bitcoin mining consumed approximately 51 trillion terawatts of electricity per year as of February 2018. That figure has risen steadily and inexorably over time, irrespective of day-to-day market movements, prompting policymakers to take a closer look at Bitcoin’s carbon footprint.