Welcome to the digital world, where things that once were tangible now live in the abstract universe of code and data, and seem to travel through space as if by magic. Paper mail and bills, photographs, record albums and other objects that we could once hold in our hands now reside in our computers and the cloud, never to see the light of day.
It was only a matter of time until money met a similar fate. And while online banking and digital credit card transactions have gone a long way in taking physical money out of our hands, the novel payment system of bitcoin takes it even further.
In 2009, an anonymous person known by the alias Satoshi Nakamoto created a consensus network, Bitcoin, that supports a novel payment system using a new type of digital currency, bitcoins. These units of currency can be traded for goods or services with vendors who accept bitcoins as payment. Basically, it's cash for the Internet.
Based on the idea of "cryptocurrency,” the new form of money uses cryptography to control its creation and transactions, rather than a central authority. There are no banks, no governing agencies, no taxes, no regulation. Transactions are anonymous and bitcoins are accepted at an increasing number of sites, from webhosting services to pizza, even trips to outer space; the anonymous nature of the transactions also make them an attractive currency for illicit businesses.
The Bitcoin network kind of runs itself; it is a peer-to-peer system that is controlled in collaboration by its users across the globe. Developers can improve the software, but they can’t change the system because users are in charge of selecting their own software. For the system to remain viable, all bitcoiners need to use software that plays by the same rules. The success of the system relies on compliance by its users.
As explained by bitcoin.org, the Bitcoin network shares a public ledger behind the scenes called the "block chain." This ledger contains every transaction ever processed, allowing a user's computer to verify the validity of each transaction. The authenticity of each transaction is protected by digital signatures corresponding to the sending addresses, allowing all users to have full control over sending bitcoins from their own addresses. Bitcoins can't be counterfeited.
Users start by acquiring a “digital wallet.” This can be a mobile app or a computer program; it's like a bank account and it's the way in which users save and spend bitcoins. If you lose your bitcoins, like if you send your hard drive to the dump without saving your wallet, they’re gone forever.
Bitcoins can be collected by accepting them for a transaction or by buying them at a marketplace called a “bitcoin exchange” where people can buy or sell bitcoins using different currencies. The value of a bitcoin is determined by supply and demand. When demand increases, the price increases; when demand falls, the price falls.
They can also be acquired by “mining.” Rather than being produced at a mint, bitcoins are created when people "mine" for them by solving complex math problems on their computers. In the beginning, the puzzles were relatively easy, but as more people earned bitcoins, the puzzles became increasingly complicated — simply to balance the rate of distribution and value. So difficult are the problems at this point that groups get together and pool their problem-solving skills, and the corresponding profits. Currently, someone is rewarded with 25 bitcoins around every 10 minutes.
When the system was first designed, a schedule was put in place limiting the total number of bitcoins so that they gradually would reach a total of 21 million. This limit is “hard-wired” into the protocol; there will never be more bitcoins. While a cutoff of 21 million units may seem like a debilitating limitation, bitcoins can be divided up to eight decimal places and possibly even smaller amounts, meaning the value can continue to increase without problems should the popularity of bitcoins require it.
But will it come to that? Are bitcoins here to stay? Boston University Professor Mark Williams, a former trader and bank examiner for the Federal Reserve, told Forbes.com that while Bitcoin proper may maintain some nominal value as a virtual commodity, he thinks that smaller local tenders will eventually dominate the digital currency space.
But it may have longevity in another form; in the future, it’s expected by some that the word bitcoin may live on as the generic term for digital currency at large.
For a quick visual tutorial, watch the video below.
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