Pretty much every time I’ve told someone that I’ve been working on and about Bitcoin for the past while, I’ve been greeted with puzzled looks and flat admissions that my interlocutors have no idea what Bitcoin actually is.
The easiest way to explain Bitcoin is the way its inventor, who goes by the catchy pseudonym of Satoshi Nakamoto, described it in the white paper that started it all: “an electronic peer-to-peer cash system.” Cash is a simple, fast and anonymous means of transferring value from person to person. The only problem is that so many of our transactions today are conducted electronically. Whence the need for something simple, fast and anonymous that’s like cash – but that operates electronically.
As all the currencies heretofore known to man weren’t invented with the digital age in mind, something new and heretofore unknown had to be created to do the job.
In a sense, that’s all there is to it. Unless you like looking under the hood before you buy a used car.
Bitcoin is far more bit than coin: there are no physical manifestations of the currency, and you can’t carry your bitcoin around in your back pocket. Bitcoin exists solely inside the computers of the world and is nothing more than a bunch of code. Or, more simply, a whole lot of 1s and 0s. If you want to know how many bitcoin you have, you’ll have to check your computer. If you want to make a transaction with bitcoin, you are going to require an internet-connected device. If you want to receive payment for services rendered in Bitcoin, the person paying you is going to require an internet-abled device as well.
This is where I’m expecting you to assume that there is some central Bank of Bitcoin that keeps records of who owns what.
Ah, but there isn’t. And therein lies perhaps the currency’s most intriguing aspect.
One of the fundamental principles upon which Bitcoin was built is decentralization. Just like the internet, there is no one person or entity in charge of the currency. Yes, of course, there is an electronic ledger that keeps track of who owns what, but that ledger is kept in multiple places by multiple people. Paradoxically, the Bitcoin edifice is constructed so that these people are kept honest by the fact that they don’t trust each other.
How does it work? Every transaction in Bitcoin is broadcast to all the people (nodes) participating in the network. Each node complies these transactions into sets called blocks, which represent ten minutes’ worth of transactions. One lucky block is selected as definitive, and is added to all the previous blocks stretching back to the currency’s inception. String a whole lot of blocks together and what do you get?
A chain of blocks. Or a blockchain.
All the nodes of the network keep identical copies of the blockchain. As a result, Bitcoin is managed by group consensus rather than by a central authority. If that sounds libertarian and even anarchist, that’s the idea. A blockchain-based currency obviates the need for governmental oversight – and governmental control. The currency becomes truly international, and economic borders will dissolve at its approach.
A further important detail: transactions on the bitcoin blockchain are pseudonymous. That means that someone looking at the blockchain will be unable to determine the identities of the currency’s holders. Just as it’s impossible to know who’s spent cash (and what they’ve spent it on), it’s similarly impossible to know who’s spent bitcoin. (Once again, if that sounds libertarian or anarchist, that’s the idea. This whole school of money has roots in a specific type of computer-oriented anarchist thought.)
Does that make Bitcoin particularly suited to illicit transactions? Yes, yes it does. That, however, is the price that has to be paid for a decentralized and anonymous currency. (Cash itself poses that same problem. Think of drug dealers toting around suitcases stuffed with enormous amounts of paper money.) The price was obviously deemed worth paying.
Word clocks that explanation in at 627 words. That’s more than 25, but I started out by saying I would be a bit over 25 anyway. I’ve left out all the math and technical stuff, so the explanation I’ve given isn’t sufficient for someone seeking to become involved personally with Bitcoin, but I think the explanation is largely sufficient for someone who just wants to know what the heck the stuff is.
I’m writer and not a financial analyst, so I’ve also not answered the second question most people have: why is Bitcoin worth…well, why is it worth anything?
Rather than the result of pixie dust sprinkled over a network of computers, Bitcoin is worth something because its users agree that it’s worth something. Before you dismiss that as another way of saying the Money Fairy waved her wand And There Was Bitcoin, consider this: most of the Dollar’s value stems from the fact that everyone thinks it’s worth something, too. I can go that even one further: while gold does have some useful chemical properties and is rare, it’s value is largely the result of a planet-wide consensus that it is worth something. (Compare that to Californium, which, although a good deal rarer than gold and endowed with useful chemical properties, has no monetary value.)
People believe that electronic cash is the future of money, thus electronic cash has accrued value in “real money” terms. It’s loads more complicated than that, of course, but I was aiming at an explanation brief enough to get you out of the conversation before you get stuck paying for the next round.
The other very important thing to know is that Bitcoin isn’t a unique phenomenon. It is merely the most prominent of over a thousand cryptocurrencies that are transforming the financial landscape. The second most prominent, Ethereum (properly called Ether) has many differences from Bitcoin, but the principles of decentralization, blockchain and relative anonymity apply to it as well. They apply to every other cryptocurrency too.
1011 words. I’m afraid I might be stuck buying that next round after all.
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