Bitcoin’s been in the news a lot lately. Investors markets recently announced they’d be trading in futures for the cryptocurrency. For a lot of us, that’s all well and good — but what is bitcoin? How do you get any? Can bitcoin wash our car? The answer to the last question is “no,” but hopefully our explainer will answer the other two for you.
What is bitcoin?
As we said above, it’s a cryptocurrency — but that probably doesn’t mean a whole heck of a lot to you. Basically a cryptocurrency is a type of money that, instead of having a backing authority — like how the U.S. dollar is backed by the Treasury — transactions are between users. Those transactions are protected by cryptography, and recorded in a public ledger called a blockchain.
What this means is if Alice gives Bob one bitcoin, that transaction is recorded in the blockchain. With that transaction added to the blockchain, the record is sent all over the bitcoin network. That way, the bitcoin software can tell that particular bitcoin is now Bob’s, not Alice’s, and that way Alice can’t double-spend that bitcoin she gave to Bob. Since there are no physical bitcoins — if Alice gave Bob a dollar, the proof would be that Bob now has a dollar bill in his hot little hand — that’s important.
This setup also helps keep bitcoin safe from hacking; if someone tried to change the blockchain to make it look like Alice hadn’t given Bob that bitcoin, the record of the exchange is kept in so many other places, we know that change is fake and can immediately correct it.
Likewise, each new entry to the blockchain will change the entries after it, so a hacker would also have to change all the entries that happened between now and the time Alice gave Bob her bitcoin.
Bitcoin and “fiat currency”
One thing bitcoin types talk a lot about is “fiat currency.” Let’s break that down a bit further by taking a look at “normal” money first. Until 1971, the U.S. dollar was backed by the gold that the U.S. Treasury had. If you wanted, you could take your money to the U.S. government and get that much actual, literal gold.
In 1971, President Nixon decoupled the U.S. dollar from gold, changing the dollar from a representative currency (meaning it represented a literal amount of gold) to a fiat currency. Fiat currency means that while a dollar, for example, has no intrinsic value — i.e. it’s just a bit of paper — the purchasing power comes from the government has said that the dollar is worth a certain amount.
Bitcoin is not considered a fiat currency, because while bitcoins themselves don’t represent gold, for example, they instead represent work done. Wait, what?
How do you get bitcoins?
As we said above, bitcoin may not represent a physical lump of precious metals, the worth of bitcoin comes from what’s called “proof of work.” And that “work” is bitcoin mining. Much as our country’s gold reserves came from people literally digging gold out of the ground, bitcoin is digging for numbers.
Basically, miners are looking for numbers that can be used as cryptographic keys. With cryptography, it’s easy to check if any given number is a proper key, but it’s difficult to find the keys in the first place.
A miner uses their system — which is usually a dedicated computer expressly for this purpose because it takes up a lot of processing power — and when they find a new number that works, they’ll get a coin.
With a fiat currency, in theory, there’s nothing stopping the Treasury from just printing up a bunch more dollar bills. Of course, that’d destabilize the economy, leading to out of control inflation as we’ve seen time and time again. But since a dollar will no longer get you a specific amount of gold, the government doesn’t have to worry about running out.
With bitcoin, however, there will only ever be 21 million bitcoins. That means, as more bitcoins are “mined” it becomes increasingly harder to find a new number that will work.
How do you use bitcoins?
Like any currency, it’s only worth anything if people accept it. That’s why you just can’t really make up your own currency. You can decide that BobbyBux are worth $50 USD each — but if you can’t get the power company to let you pay your bill with BobbyBux, it doesn’t matter if you’ve got a billion of them.
With bitcoin, however, there are plenty of buyers. Your bitcoins are held in a “wallet,” which is a password-protected program that connects to the bitcoin network. The dangerous thing with wallets is that since there’s no overarching bitcoin administration, if you lose your password, you lose whatever’s in your wallet, and it’s unrecoverable. There’s no one else who has your password that you can ask, nor is there a way to reset your password if you’ve lost it.
There are third-party services that can store your wallet credentials, so if you do happen to lose your password they can help. However, they’re not governed by any body, so you’ve got to trust them completely. Sometimes, unfortunately, that can lead to ruin — in 2011, there was a security breach on MtGox, which was at the time the largest bitcoin exchange. In that breach, 750,000 bitcoins belonging to MtGox’s customers were lost, along with an additional 100,000 from MtGox’s own reserves.
At any rate, your wallet has a specific identification number. And if you want to buy something with bitcoin, you get the other person’s number and use the wallet software to send to it.
So, in our Alice and Bob example, Alice’s wallet might be 1234, and Bob’s is 5678. So Alice tells her software to take 1 bitcoin from 1234 and deposit it in 5678. That transaction is recorded and Bob’s now one bitcoin richer. (Of course, real wallet IDs are much longer and more complex.) Once Bob has his bitcoin, he can then send Alice the veeblefetzer she bought.
How much is bitcoin worth?
Now that’s a complicated question. Bitcoin’s worth is relatively unstable. The very first bitcoin transaction was 10,000 bitcoin for two Papa John’s pizzas. However, each individual bitcoin is worth quite a bit more than that now. As of this writing, an individual bitcoin is worth $17,534.59. However, on Dec. 3 — just 18 days ago — a bitcoin was only worth $11,377.52.
Until this May, however, bitcoin usually hovered around being worth between $500 and $1000. This ends up being one of the tricky things with bitcoin — should you buy something with it now (or cash out) when it could go up or down at any moment?
Some people have said that the current interest in bitcoin is just a bubble — and it will, at some point, pop, sending bitcoin value plummeting. However, one of the trickiest thing about bubbles is that it’s hard to tell if you’re in one until it pops. In fact, whether or not bitcoin’s just a bubble is disputed. Since we’re in the middle of it, it’s impossible to tell at this stage whether or not bitcoin will crash, or perhaps it’ll stabilize.
If bitcoin stabilizes, it’ll become much easier to know how much it’s worth. There will, of course, be fluctuation as there is with any currency. But if that fluctuation settles down into a reasonable range rather than almost doubling in worth in under a month, bitcoin will become more useful and more widely accepted.
Should I invest in bitcoin?
Unfortunately, that’s a question you’ll have to answer for yourself. But always remember to diversify, and never to invest more than you can afford to lose.
Featured image by pixelfit via iStock