What is Bitcoin?

Bitcoin

If you’ve been following the news lately, you’ve no doubt heard the term “Bitcoin” thrown around fairly often. So what exactly is it? Simply put, Bitcoin is a digital currency that exists solely in cyberspace. It was created in 2009 by mathematician Satoshi Nakomoto, a man so elusive and enigmatic that many doubt his very existence. Bitcoin is traded, generated, and stored on a peer-to-peer network using virtual wallets for each user. The rate and overall number of Bitcoins generated is limited, making it free from the perils of inflation that plague traditional official currencies. Bitcoin has been gaining in popularity, circulation, and media coverage of late, and while the number of businesses willing to accept it is growing, many people remain skeptical of its value and stability.

In his 2009 paper Bitcoin: A Peer-to-Peer Electronic Cash System, Satoshi Nakomoto describes one of the main benefits of using Bitcoin: the elimination of the need for third-party verification of online transactions. Currently, most online purchases involve both parties disclosing a certain amount of information to a bank or financial institution to ensure that everything is fair and fraud free (a service that usually includes a fee). The Bitcoin protocol is set up to make fraud during a transaction prohibitively difficult while allowing both parties to remain anonymous. This ostensibly means that deals are made person to person with no intermediate arbiter. One analogy that is often used to describe Bitcoin transactions is that they are much like sending an email from one person to another (sans NSA snooping). This is an apt comparison because during each Bitcoin exchange, the buyers and sellers have their own “address” for that particular transaction. Each transaction can be assigned a unique address, making it almost impossible to trace the spending patterns of one particular user. Because Bitcoin is operated on a peer-to-peer network, transactions are visible to everyone, but the details of said transactions are hidden from all but the parties involved. 

Bitcoin is generated by computers that solve mathematical problems that increase in difficulty as a function of the number of Bitcoins in circulation. Any user may set up their computer to generate Bitcoin, a process referred to as “mining.” According to Nakamoto, this process is yet another deterrent to theft, as the amount of computational power required to steal Bitcoin from another user could be better served mining Bitcoin legally.

Despite its rather rapid rise in value, most experts still classify Bitcoin as a risky investment. While the value has reached over $700 USD per Bitcoin as of this writing, the Bitcoin market has not been without its ups and downs. After reaching an all-time high of $1240 in early December, the Bitcoin market plummeted below $400 per coin amidst new regulations by Chinese banks that make buying and selling Bitcoin in the country extremely difficult. China has been at the forefront of the Bitcoin revolution and is home to several of the world’s largest and most active Bitcoin exchanges. Although the currency recovered much of its value in the few days following the “crisis,” many critics point to this incident as proof of Bitcoin’s vulnerability. While Bitcoin has been billed by many as a currency that is beyond the reach of any central government or authority, these recent events might suggest otherwise.

Whatever the case, both excitement and controversy surrounding Bitcoin are at an all-time high. There is no doubt that Bitcoin as it currently stands holds real and significant value. Bitcoin has been used to purchase everything from cars, to mansions, to tickets to outer space. Many prominent business owners have come out in favor of Bitcoin, such as Virgin CEO Sir Richard Branson and Overstock.com CEO Patrick Byrne, who said: “Money is too important to be left in the hands of government officials.”

It comes as no surprise that those who are opposed to Bitcoin stand to lose the most from its adoption. Several major banks and governments have labeled Bitcoin as “not real money” and have warned against the inherent dangers of dealing with currency that is unregulated and anonymous. Despite the checks and balances built into the Bitcoin protocol, there have been reports of Bitcoin theft, as well as the use of Bitcoin for illegal purposes.

The United States government has taken a somewhat neutral stance on Bitcoin. During a November 18 hearing on virtual currency, many expressed a desire to understand the pros and cons of Bitcoin, but remained wary of its potential for abuse if left unregulated. This in spite of the fact that the FBI is suspected to be in possession of one of the largest Bitcoin fortunes in existence after seizing more than 144,000 BTC ($90 million USD) from Ross Ulbricht, alleged administrator of the illegal drug website Silk Road.

As with most issues, economists remain divided on the future of Bitcoin. Some believe that an eventual burst of the Bitcoin bubble will cause the value to drop to almost nothing, while others think it has potential to be a significant contender for a global currency.

It’s definitely worth keeping on your radar as we enter 2014.

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