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Bitcoin Explained Simply
Can you answer the question “what is bitcoin?” After you read this, you’ll be an expert and will be able to explain Bitcoin simply to your friends and family.
Bitcoin was created by an anonymous person or people who went by the name of Satoshi Nakamoto.
Bitcoin is a number of different things, but we can think of it as digital cash or as digital gold.
The main distinction that it has now is that it was the first cryptocurrency, meaning that it is a digital currency that uses encryption to make it secure. It was also the first instance of blockchain technology being used.
Bitcoin is also the first decentralized currency that’s not issued by a central government.
Bitcoin exists outside the traditional banking system which is pretty unusual because so far for all of our lives the money that we’ve dealt with has mostly been issued by a central bank and this is the first time that we’re really seeing money in the form of software.
Another reason why Bitcoin is unusual and novel is that it’s really the first scarce digital resource we have. And by that I mean that previously if we were sending things on the Internet those were typically copies of things. For instance, if I sent you an mp3 file, a photo or a text message I would also have a copy of that same mp3, photo or text message.
Bitcoin was the first time that you could send something digital to someone and once I sent it to you everybody in the world would know for certain that I no longer have it and that now you have it.
And Bitcoin has really ushered in a new era for the Internet where the technology underlying Bitcoin, known as blockchain, has enabled these new digitally scarce objects to exist, and this wasn’t possible before.
People are calling it a trust layer for the internet because you can trust that something has not been counterfeited in a way that you couldn’t before.
Blockchains will usher in all kinds of new and novel products that we’re simply not possible before.
In a way, Bitcoin is really the first application for blockchains in much the same way that email was the first application for the Internet.
Another thing that is important to be aware of is that Bitcoin really is a new form of money that also represents progress in the types of money that we’ve had before.
For money, humans have used livestock and plants, seashells and yap stones, silver and gold and, more recently, paper money. Now we have a new kind of money that is more fungible (mutually interchangeable), easily divisible and much more transportable.
And so some are saying that this is the best form of money we’ve ever had. And that seems possible, although since it’s so early in the days of cryptocurrency, it’s hard to know really which of the many different cryptocurrencies will be winners. So whether or not Bitcoin retains its first mover advantage is too early to tell.
Bitcoin vs Banks: Isn’t the Banking System Already Digital?
No. The interface that we see is just a digital veneer on a centuries old banking system which is called double-entry bookkeeping. And in that system both of the parties that transact keep their own ledgers and then reconcile them later.
And within that system there are numerous middlemen.
For instance, if you try to send an international wire transfer to me and I am in Chile and you are in Libya. Most likely that’s not a very common corridor for people to send international wire transfers through, so your local bank and my local bank probably do not have a direct connection.
And so that transaction would be passed along through a number of other banks that act as hubs similar to the way that certain airports are hubs connecting less well-trafficked cities.
But with Bitcoin you are actually using the software to make that transfer.
And it is direct peer-to-peer.
Let’s take our same example but apply it to Bitcoin.
So, let’s say again like you’re in Libya and I’m in Chile. You and I can just pull out our phones and you can send me some Bitcoin or another cyrptocurrency.
And that can happen near instantaneously or within a few minutes, whereas an international wire transfer can take days or even a week or more.
And wire transfers can even get lost, which has happened to me personally. But with cryptocurrencies, since all the transactions are recorded on a blockchain, which is (with most cryptocurrencies) a public recording of all the transactions, both you and I and anyone else who is interested can actually see where that transaction is and track it.
Depending on which blockchain you’re using the money can take minutes or even seconds.
Bitcoin can be moved in ten minutes, Litecoin takes two and a half minutes and the Ethereum network has an even faster block time of around 15 seconds. And the reason for that is because the assets themselves are actually digital.
In addition to this, Bitcoin and other blockchains are generally very, very secure and tamper-proof, which makes it so you don’t even need to trust the other person you are transacting with.
And since trust is built in, since you can completely trust the system, then no middlemen are necessary.
If you want to understand why this is the case and really go under the hood of Bitcoin, then read our article on blockchain explained simply.
So, this is a vastly superior system to the traditional banking system and that would apply even to things like PayPal which seemed digital as well but really are not because they run on the traditional banking system’s rails.
What is Bitcoin Mining? How Are Bitcoins Created?
Bitcoins are created through a process called mining and they are essentially released by the software with each new block (collection of the latest transactions), which is referred to as a block reward.
When Bitcoin was first launched the software released 50 new bitcoins with every block and then every four years the Bitcoin software undergoes what’s called a halving event where that figure of the block reward gets halved. So after four years the block reward decreased to 25 bitcoins and then in the summer of 2016 we had a number of another having event.
And so now the number of the coins being released every 10 minutes is 12.5 Bitcoins.
The people who get those new Bitcoins are called miners in the Bitcoin network. And these people are essentially the people or the entities who are securing the network or “running” the network.
And the reason that this block reward exists is to incentivize them to run the network. The more you mine or “run” the network, the more Bitcoin you will receive.
So, what determines which miner wins the block reward?
Basically there’s a math problem that happens with each new block. And so the computers on the network are all racing to try to solve that first and whoever solves it first wins the Bitcoins in that particular block reward.
And what’s really interesting is that the more computer power you put on that network the more likely it is you’ll win more Bitcoins.
At the same time, the amount of computer power on the network is also what keeps it secure because the more computer power that is on the network the more difficult it is to attack the network.
And so it’s a pretty cool kind of circular mechanism by which the software is being kept secure.
The software incentivizes people to try to win Bitcoins and when they attempt to do so they are actually also protecting the software and keeping it from being vulnerable to attack.
How Many Bitcoins Are There? What is the Supply of Bitcoins?
There will only ever be 21 million Bitcoins, which is a limit imposed by the software.
Bitcoin was structured to be deflationary, which is in contrast to most fiat money issued by central banks which tend to be inflationary as more and more money is printed and released.
So, as time goes by and demand for Bitcoin goes up, presumably the value of each individual one will go up.
And because of this, you will often see in the Bitcoin community people who fervently hold on to their Bitcoins and refuse to sell despite the ups and the downs. And in this context you might encounter the word “hodl”.
“Hodl” comes from a drunken Bitcoin talk forum post a few years ago where this person was quite drunk when they typed up their post. They were upset about not doing so well in their timing and transacting of Bitcoins and said that from now on they would simply “hodl” Bitcoin, which was a typo for “hold”.
And so that post became very popular and, in turn popularized the term hodl within the community. For a more detailed explanation and history, read this article about the hodl meaning.
What is Bitcoin Used For?
Currently, bitcoin has two primary uses:
1) Storing wealth
2) Buying and selling items or services that accept bitcoin as payment
In addition to these primary uses, people have begun using the bitcoin blockchain (the technology underpinning bitcoin) for other purposes, such as MIT issuing diplomas using the bitcoin blockchain. However, most of the time new and separate blockchains are created for experiments and new ideas.
Some people associate bitcoin with criminals and many criminals were in fact early adopters of the technology.
However, a recent report by the Center on Sanctions & Illicit Finance discovered that less than one percent of all transactions were being used for criminal activity.
Is Bitcoin Anonymous?
Many people mistakenly think it is, but it is actually not anonymous.
In fact, it is much easier to track someone using bitcoin than cash. Law enforcement agencies have been able to track down numerous criminals because their activity permanently resides within the bitcoin blockchain.
Why Is Bitcoin Valuable?
The price of bitcoin and many other cryptocurrencies have gone up exponentially since bitcoin first became available. Many people ask the following questions:
1) Why is bitcoin valuable?
Like everything else, the value of bitcoin is determined by how much people are willing to pay for it and sell it for. In other words, the supply, demand and perceptions of what it is and what it can do.
2) What is bitcoin backed by?
This is a good question, but it comes from an incomplete understanding of what currency really is. Currency being backed by something (such as gold) is a relatively new concept.
Currency being backed by gold or the faith people have in a government has been shown to be seriously flawed.
For most of history, currency (what represented value) was not backed by anything at all. Early forms of currency such as seashells, cattle and even coins were not backed by anything in particular.
This answer does not satisfy many people, though it is in fact the case. So, another way to think about it is that bitcoin is backed by mathematics and logic.
If you know for sure that 1 + 1 is always 2, then you can be certain that bitcoin will safely execute your transaction. This is an oversimplification, but is a pretty accurate way to think about it.
Another way to think of it is that bitcoin is backed by the amount of faith that people have in it. It is a way to send value directly to someone in a secure way, unlike anything the world has ever seen.
It is useful, like gold, silver or a computer. And people will pay for things that are useful.
What is a Bitcoin Wallet
Like cash, you can keep your bitcoin in something called a wallet. A cryptocurrency wallet essentially stores the information that is needed to transact with the cryptocurrency.
However, because this technology is still in its infancy, there have been many cases of bitcoin wallets being insecure and causing problems and even being outright scams. So, if you choose to use and hold bitcoin, it is recommended that you choose one of the best bitcoin wallets in order to protect your cryptoassets.
Why Are So Many People Excited About Bitcoin?
More and more, people are realizing that there is much more to bitcoin than meets the eye.
Most of the time people get really excited about bitcoin when they have a “rabbit hole moment” where they realize what the technology underpinning bitcoin (blockchain) is capable of.
Some people say blockchain technology will transform the world as much as, if not more than, the internet did.
Some believe that blockchain will:
- empower the poor
- be a great equalizer
- eliminate many middlemen
- provide massively powerful solutions to businesses and organizations
- finally protect our identities and our data
- bring an era of peace
- dramatically reduce corruption
- decentralize and democratize power
- protect the integrity of election voting
- simplify tax systems dramatically
- improve health and access to health care
- and much more…
Whether or not these will happen is uncertain, but those who begin to see the possibilities of blockchain will see that these are definitely possibilities.
It is my opinion that blockchain is the single most exciting technology of our time.
If you would like, you can dig deeper and learn more about how blockchain could transform our world by reading our explanation of what is blockchain.
By sharing this with family and friends you will:
- help to realize the amazing potential of this technology and
- contribute to mass adoption, which means…
- more people will buy bitcoin, and that will…
- make your bitcoins more worth more
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Please share your comments, questions and ideas below. What do you think the future of bitcoin will be?
Richard has developed and ran multiple online websites and communities with tens of millions of monthly visitors. He first discovered bitcoin and blockchain in 2012 and has been helping to educate others on its potential since then. Richard is very passionate about the crypto community. Read his inspiring story into cryptocurrency here.