A Layman's Understanding of Bitcoin
Gold. The original standard for value in the world; historically used as currency across the planet. What started as a shiny rock in the ground became the material to which we compared all others, the most treasured substance across the globe. To think that once you could go into a cave and mine such a valuable good, enough to support yourself for the rest of your life, is a foreign concept to most of us in the modern world.
Nowadays to make money you have to get a job, run a business, or invest. There is no currency that can be mined out of the earth or elsewhere, at least not in as direct of a manner as gold. Sure, oil is a natural resource that is worth its weight in paper money, but it is not something the average everyday man can walk out into his yard and harvest all on his lonesome. So the days of mining substances that can be exchanged for currency are gone, right? Wrong.
In steps Bitcoin, the new "digital currency" sparking controversy across the planet. The Bitcoin network, an electronically created medium of exchange, is comprised of individual bitcoins like American currency is comprised of dollars. There is no physical basis for its value. What sets Bitcoin aside from other mediums is that it is a decentralized form of currency, so no government institution, such as the United States Federal Reserve, can control its value.
When I first heard of Bitcoin I was rather confused. I wondered how there could be a currency with no physical basis, with no value related to the physical world. How could there be an exchange of goods when there were no goods to begin with?
Bitcoin is just like any other currency. It began as way for people to exchange goods without having to barter. When Satoshi Nakamoto created Bitcoin in 2009, the idea was to create a currency that was easily transferrable and independent of a central authority. The computer world was in need of something like this—a way for people to exchange internationally without going through the hassle of an economic middleman. The fact that people were in need of a currency with this level of freedom is what backs Bitcoin in the first place.
Bitcoin derives the core of its value from its utility. Its utility comes from the fact that the Bitcoin economy is completely peer-to-peer, as in no third party is required for transactions or storing of Bitcoin. While normal money as we know it generally has to be stored in a bank, Bitcoin can be stored right on your computer and can be sent to anyone else without any third party being aware. Where this becomes advantageous is in the transfer of funds, when a bank can often charge a fee and take several days to complete the transfer. Also, for those secretive spenders out there, Bitcoin is anonymous and cannot be tracked by anyone.
The only place that any evidence of Bitcoin transactions exist is within a virtual entity called "the blockchain." The blockchain is essentially an online transaction log that follows every single bitcoin from its creation all the way to its final destination. While the Bitcoin network is completely transparent and open to be viewed by anyone, every user has their own anonymous Bitcoin address comprised of numbers and letters. If the user wishes to disclose their public address to other users, they can, but their address can only be accessed with their personal passcode that is granted by the Bitcoin network.
Bitcoins are valuable in another way: they're scarce. While you can purchase bitcoins offline with any international currency, most are acquired through mining. The miners utilize specialized hardware that runs several million math algorithms a second in the process of verifying and securing all of the Bitcoin transactions happening across the world. When the miners reach a mathematical solution to the "problem" of processing all these transactions, the solution and all the information involving the transactions is metaphorically "packaged" into a "block,” which is then added to the blockchain. When this occurs, 25 bitcoins are rewarded to the miner or miners who came to the solution. If we're making metaphors here, the Bitcoin miners are like bankers and the transactions like processing computers—together the basis for creation of the currency.
Along with how difficult it is to actually produce bitcoins, there is actually a limit on how many that can be produced, another element that adds to their scarcity. There can only be 21 million bitcoins produced in a year, which makes it unlike any other currency. This makes the mining process extremely competitive, which leads miners to join together into mining teams referred to as "pools." These pools utilize collective processing power to arrive at the solution to the block first, rewarding them 25 bitcoins, which they split amongst the team.
While the entire process of mining bitcoins seems completely out of this world to anyone but a hardcore programmer, the Bitcoin network has received international attention from governments and investors alike who couldn't begin to tell you how it's created. For example, the government of China has officially barred financial and payment institutions from accepting bitcoins as a form of payment. On the other hand, British ex-banker Joseph Lee's meager investment of $100 in Bitcoin several years ago has landed him $200,000 in profit. Through buying up bitcoins in one currency in selling it another, Lee is essentially playing the Bitcoin stock market.
So whether or not we fully understand Bitcoin, where it holds it's value or exactly how it's created, we all need to consider it's weight in the global economy. Questionably there is a need for this so-called "digital currency" as it does serve certain individual functions, but there is no indication of whether it is merely a strange passing internet phenomenon, or a legitimate currency that will live on along with the dollar. The conclusion that we can take, I believe, is that is like any other investment, Bitcoin can be lucrative as a generation embraces it, or it can flop, remembered by future generations as a interesting phase in technology. If you're willing to take the chance, go buy the mining hardware and join a pool, and if not, sit back and watch the calamity ensue
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