Bitcoin is a virtual currency which blossomed in public consciousness
after its price-per-coin rose above $13,000 in early 2018. The
cryptocurrency (one of many!) forced a complex intersection of privacy
policy, banking regulation, and technological innovation. Some retailers
accept bitcoin, for example, while in other jurisdictions,
bitcoin is illegal.
Cryptocurrency Defined
Cryptocurrencies are just lines of computer code that hold
monetary value. Those lines of code are created by electricity and
high-performance computers.
Cryptocurrency is also known as digital currency.
Either way, it is a form of digital public money that is created by
painstaking mathematical computations and policed by millions of
computer users called
miners. Physically, there is nothing to hold although you can
exchange crypto for cash.
Crypto comes from the word
cryptography, the
security process used to protect transactions that send the lines of
code for purchases. Cryptography also controls the creation of new
coins, the term used to describe specific amounts of code. Hundreds of coin types now dot the crypto markets; only
a handful have the potential to become a viable investment.
Governments have no control over the creation of cryptocurrencies,
which is what initially made them so popular. Most cryptocurrencies
begin with a market cap in mind, which means that their production will
decrease over time thus, ideally, making any particular coin more
valuable in the future.
What Are Bitcoins?
Bitcoin was the first popular cryptocoin. No one knows exactly who
created it — most cryptocurrencies are designed for maximum anonymity —
but bitcoins first appeared in 2009 from a developer supposedly named
Satoshi Nakamoto. He has since disappeared and left behind a Bitcoin
fortune.
Because bitcoin was the first major cryptocurrency, all digital currencies created since then are called
altcoins, or
alternative coins.
Litecoin,
peercoin,
feathercoin,
ethereum and hundreds of other coins are all altcoins because they are not bitcoin.
One of the advantages of bitcoin is that it can be stored offline on a person's local
hardware. That process is called
cold storage and it protects the currency from being taken by others. When the currency is stored on the Internet somewhere (
hot storage), there is high risk of it being stolen.
On the flip side, if a person loses access to the hardware that
contains the bitcoins, the currency is simply gone forever. It's
estimated that as much as $30 billion in bitcoins have been lost or
misplaced by miners and investors.
Why Bitcoins Are So Controversial
Various recent events turned bitcoin into a media sensation.
From 2011-2013, criminal traders made bitcoins famous by buying them
in batches of millions of dollars so they could move money outside of
the eyes of law enforcement. Subsequently, the value of bitcoins
skyrocketed.
Scams, too, are very real in the cryptocurrency world. Naive and savvy investors alike can lose hundreds or thousands of dollars to scams.
Ultimately, though, bitcoins and altcoins are controversial because
they take the power of issuing money away from central banks and give it
to the general public. Bitcoin accounts cannot be frozen or examined by
tax inspectors, and middleman banks are completely unnecessary for
bitcoins to move. Law enforcement officials and bankers see bitcoins as
"gold nuggets in the wild, wild west," beyond the control of police and
financial institutions.
How Bitcoins Work
Bitcoins are completely virtual coins designed to be self-contained
for their value, with no need for banks to move and store the money.
Once you own bitcoins, they behave like physical gold coins: They
possess value and trade just as if they were nuggets of gold in your
pocket. You can use your bitcoins to
purchase goods and services online, or you can tuck them away and hope that their value increases over the years.
Bitcoins are traded from one personal wallet to another. A wallet is a
small personal database that you store on your computer drive (i.e cold
storage), on your
smartphone, on your tablet or somewhere in the
cloud (hot storage).
Bitcoins are forgery-resistant. It is so computationally intensive to
create a bitcoin, it isn't financially worth it for counterfeiters to
manipulate the system.
Bitcoin Values and Regulations
A single bitcoin varies in value daily; check places like
Coindesk to
check current par rates. There are more than $2 billion dollars worth
of bitcoins in existence. Bitcoins will stop being created when the
total number reaches 21 billion coins, which will be sometime around the
year 2040. As of 2017, more than half of those bitcoins had been
created.
Bitcoin currency is completely unregulated and
completely decentralized.
There is no national bank or national mint, and there is no depositor
insurance coverage. The currency itself is self-contained and
un-collateraled, meaning that there is no precious metal behind the
bitcoins; the value of each bitcoin resides within each bitcoin itself.
Bitcoins are stewarded by miners, the massive network of
people who contribute their personal computers to the bitcoin network.
Miners act as a swarm of ledger keepers and auditors for bitcoin
transactions. Miners are paid for their accounting work by earning new
bitcoins for each week they contribute to the network.
How Bitcoins Are Tracked
A bitcoin holds a very simple data ledger file called a
blockchain. Each blockchain is unique to each individual user and his or her personal Bitcoin wallet.
All bitcoin transactions are logged and made available in a public
ledger, helping ensure their authenticity and preventing fraud. This
process helps to prevent transactions from being duplicated and people
from copying bitcoins.
While every bitcoin records the digital address of every wallet it touches, the bitcoin system does not record
the names of the people who own wallets. In practical terms, this means
that every bitcoin transaction is digitally confirmed but is completely
anonymous at the same time.
So, although people cannot easily see your personal identity, they
can see the history of your bitcoin wallet. This is a good thing, as a
public history adds transparency and security, and helps deter people
from using bitcoins for dubious or illegal purposes.
Banking or Other Fees to Use Bitcoins
There are very small fees to use bitcoins. However, there are no ongoing banking fees with bitcoin and other
cryptocurrencies
because there are no banks involved. Instead, you pay small fees to
three groups of bitcoin services: the servers (nodes) who support the
network of miners, the
online exchanges that convert your bitcoins into dollars, and the mining pools you join.
The owners of some server nodes will charge one-time transaction fees
of a few cents every time you send money across their nodes, and online
exchanges will similarly charge when you cash your bitcoins in for
dollars or euros. Additionally, most mining pools will either charge a
small 1 percent support fee or ask for a small donation from the people
who join their pools.
In the end, while there are nominal costs to use bitcoin, the
transaction fees and mining pool donations are much cheaper than
conventional banking or wire transfer fees.
Bitcoin Production Facts
Bitcoin mining involves commanding your home computer to work around
the clock to solve "proof-of-work" problems (computationally intensive
math problems). Each bitcoin math problem has a set of possible 64-digit
solutions. Your desktop computer, if it works nonstop, might be able to
solve one bitcoin problem in two to three days — likely longer.
For a single personal computer mining bitcoins, you may earn perhaps
50 cents to 75 cents USD per day, minus your electricity costs. For a
large-scale miner who runs 36 powerful computers simultaneously, that
person can earn up to $500 per day, after costs.
Indeed, if you are a small-scale miner with a single consumer-grade
computer, you will likely spend more in electricity that you will earn
mining bitcoins. Bitcoin mining is only really profitable if you run
multiple computers and join a group of miners to combine your hardware
power. This prohibitive hardware requirement is one of the biggest
security measures that deters people from trying to manipulate the
Bitcoin system.
Bitcoin Security
Just like holding a bag of gold coins, a person who takes reasonable
precautions will be safe from having their personal bitcoin cache stolen
by hackers.
More than
hacker
intrusion, the real loss risk with bitcoins revolves around not backing
up your wallet with a failsafe copy. There is an important .
dat file
that is updated every time you receive or send bitcoins, so this .dat
file should be copied and stored as a duplicate backup every day you do
bitcoin transactions.
The collapse of the Mt. Gox bitcoin exchange service was not due to
any weakness in the bitcoin system. Rather, that organization collapsed
because of mismanagement and the company's unwillingness to invest in
security measures. Mt. Gox, for all intents and purposes, had a large
bank with no security guards and it paid the price.
Abuse of Bitcoins
There are currently three known ways that bitcoin currency can be abused.
1) Technical weakness — time delay in confirmation:
Bitcoins can be double-spent in some rare instances during the
confirmation interval. Because bitcoins travel peer-to-peer, it takes
several seconds for a transaction to be confirmed across the P2P swarm
of computers. During these few seconds, a dishonest person who employs
fast clicking can submit a second payment of the same bitcoins to a
different recipient.
While the system will eventually catch the double-spending and negate
the dishonest second transaction, if the second recipient transfers
goods to the dishonest buyer before they receive confirmation, then that
second recipient will lose both the payment and the goods.
2) Human dishonesty — pool organizers taking unfair share slices:
Because bitcoin mining is best achieved through pooling (joining a
group of thousands of other miners), the organizers of each pool get the
privilege of choosing how to divide up any bitcoins that are
discovered. Bitcoin mining pool organizers can dishonestly take more
bitcoin mining shares for themselves.
3) Human mismanagement — online exchanges: With Mt.
Gox being the biggest example, the people running unregulated online
exchanges that trade cash for bitcoins can be dishonest or incompetent.
This is the same as Fannie Mae and Freddie Mac investment banks going
under because of human dishonesty and incompetence. The only difference
is that conventional banking losses are partially insured for the bank
users, while bitcoin exchanges have no insurance coverage for users.
Three Reasons Why Bitcoins Are Such a Big Deal
There is a lot of controversy around bitcoins.
Bitcoins are not created by any central bank, nor regulated by any government. Accordingly,
there are no banks logging your money movement and government tax
agencies and police cannot track your money. This laxity is bound to
change eventually, as unregulated money is a real threat to government
control, taxation and policing.
Indeed, bitcoins have become a tool for contraband trade and money
laundering, precisely because of the lack of government oversight. The
value of bitcoins skyrocketed in the past because wealthy criminals were
purchasing bitcoins in large volumes. Because there is no regulation,
however,
you can lose out immensely as a miner or investor.
Bitcoins completely bypass banks. Bitcoins are transferred through a peer-to-peer network between individuals, with no middleman bank to take a slice.
Bitcoin wallets cannot be seized or frozen or audited by banks and
law enforcement. Bitcoin wallets cannot have spending and withdrawal
limits imposed on them. Nobody but the owner of the bitcoin wallet
decides how their wealth will be managed.
Bitcoin transactions are irreversible. Conventional
payment methods — like a credit card charge, bank draft, personal check
or wire transfer — benefits from being insured and reversible by the
banks involved. In the case of bitcoins, every time bitcoins change
hands and change wallets, the result is final. Simultaneously, there is
no insurance protection of your bitcoin wallet: If you lose your
wallet's
hard drive data or even your wallet password, your wallet's contents are gone forever.