What Is Bitcoin?

Bitcoin. Digital currency. You’ve probably at least heard of Bitcoin, and likely in some pretty negative light. The digital currency has suffered some bad publicity in the last little while, what with Mt. Gox (responsible for nearly 75% of bitcoin transactions at the time) shutting its virtual doors last year after “losing” roughly $450 million worth of the currency. Several other high profile exchanges have since gone the way of the dodo as well.

What is Bitcoin?

Bitcoin is a peer-to-peer open source payment system. It’s a reward for processing work (called mining) that users do on the public ledger, the record of all payments and transactions done using bitcoin. Sound confusing? It is, and it isn’t.

Basically, Person A makes an online payment to Person B for goods or services using bitcoin. This transaction is added to the (very large) public ledger. A third-party individual or company “verifies” the transaction as real and accurate. They are rewarded for their work (time and computer processing power) with a nominal transaction fee and the creation of new bitcoins that are added to their online “wallet” (this reward is currently 25 bitcoins). As more people use the “currency”, more people and resources are required to verify the transactions, resulting in the creation of new bitcoins.

  • User A sends a few bitcoins to User B using their public key (i.e. bank account number). The system attaches User A’s private key to the transaction as proof that they are a) who they say they are, and b) have enough bitcoins to cover the transaction.
  • The transaction - including User A’s private key - is added to the public ledger, awaiting confirmation.
  • A miner (or group of miners), using powerful hardware and software, cracks a difficult math problem, and unlocks the block of transactions. Everything is compared against the entire existing public ledger.
  • If everything is on the level, the transaction is verified (confirmed), and added to the permanent record to be used against all future transactions. The miner receives any transaction fees, and the reward for cracking the puzzle (currently 25 new bitcoins).

So, bitcoins don’t really exist, and for that reason they are often called digital, virtual, or cryptocurrency. They are nothing other than lines of code existing in cyberspace. Remarkably, since their introduction only five years ago, their value has grown considerably, and one bitcoin is worth about $650 USD at the time of this writing (you can check the current exchange rate here, as it does fluctuate - sometimes wildly - like any other currency).

How Exactly Does It Work?

Bitcoin and its public ledger are nothing more than a series of numbers and letters. When someone uses bitcoin, the system creates a record of that transaction. The record is added to a block (or list) of other transaction records and added to the bitcoin public ledger.  

This record shows how many bitcoins were sent to what wallet (think of it like a bank account) and from where (the original bank account). Before it becomes official, this transaction must be verified by an outside source (miner), much like your bank ensures you have enough money to cover a bill you want to pay.

The entire system relies on strong cryptography and user consensus to verify and protect transactions. A bitcoin verification typically takes less than ten minutes.

Is It Safe?

For the most part, yes. As a bitcoin user, every time you make a transaction (send or receive bitcoins), the system generates a public key (series of letters and numbers...sort of like a bank account number) and a private key (similar to your debit or credit card PIN number) known only to you.

The public key is just that - public. Anyone can see it, and use it to send bitcoins to you. The private key - just like your PIN - needs to be guarded and kept secure. You use it to access your available bitcoin balance, and it is added to your transactions (like a digital signature) as proof that you have and control bitcoins. Provided you have followed the suggested security protocols (backup your wallet files, encrypt your wallet or smartphone with a strong password, and only keep a small amount in your wallet for day-to-day transactions), you shouldn’t have any issues.

A Few Definitions from

  1. Block - A block is a record in the block chain that contains and confirms many waiting transactions. Roughly every 10 minutes, on average, a new block including transactions is appended to the block chain through mining.
  2. Block Chain - The block chain is a public record of Bitcoin transactions in chronological order. The block chain is shared between all Bitcoin users. It is used to verify the permanence of Bitcoin transactions and to prevent double spending.
  3. Private Key - A private key is a secret piece of data that proves your right to spend bitcoins from a specific wallet through a cryptographic signature.
  4. Signature - A cryptographic signature is a mathematical mechanism that allows someone to prove ownership. In the case of Bitcoin, a Bitcoin wallet and its private key(s) are linked by some mathematical magic. When your Bitcoin software signs a transaction with the appropriate private key, the whole network can see that the signature matches the bitcoins being spent.

It’s sometimes hard to wrap our head around something like digital currency. Why would anyone assign value - to the tune of hundreds of dollars - to nothing other than a series of letters and numbers online?! Whether bitcoin survives long-term remains to be seen, but for now, it continues to thrive. Exercise caution.

Photo by Zach Copley

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