What On Earth Is Bitcoin?

If I had to explain bitcoin in one sentence it would be this: bitcoin is like a wheel without a ‘hub’. It’s a peer-to-peer system where all transactions (spokes) occur between users directly without going via an intermediary such as a bank (hub).

(Yes, I know, that was more than one sentence).

But if you wanted more bang for your bitcoin, I would describe it to you this way.

In its simplest form, bitcoin is a ‘cryptocurrency’. So…

What is a Cryptocurrency?

A cryptocurrency is a digital payment system of (non-physical) ‘tokens’ with an ascribed value used for trading goods or services, much like cash or credit. It is used as both a currency and an investment.

Bitcoin is just one of approximately 1700 cryptocurrencies, just like the Australian dollar is one of many different cash based currencies. E.g. The Pound, Eurodollar, US$, etc. [1]

Most significantly, cryptocurrencies have two defining points of difference which separate them from normal currencies:

1. A cryptocurrency uses cryptography for security. Meaning, each token has its own encryption code making it impossible to copy or steal. The encryption code is like the bar codes on goods bought in a supermarket. [2]

2. Cryptocurrencies are decentralised. Meaning, they don’t have a centralized banking system like the one you and I operate in now. I.e. no single government, bank, company or individual has control over it. It’s like an online banking system without an administrator (bank). [3] A wheel without a hub.

Importantly, point 2 means this. A cryptocurrency cannot be devalued, manipulated or interfered with by any government. More ominously, because of the anonymous nature of bitcoin, it can be used as payment for any kind of illegal good or service as well as avoid taxation.

How Does Bitcoin Work?

Firstly, because cryptocurrencies are decentralised, bitcoin does not have an intermediary such as a bank to keep a record of all transactions. Instead, the records (known as a ledger) are held publicly on a worldwide network of computers and updated every time a transaction occurs.

Secondly, bitcoin was founded upon an algorithm. Meaning, the mathematics of it stipulate there can only ever be 21 million bitcoins. This is one of the attractions of bitcoin because no more can be printed, unlike cash based currencies.

Yet, despite the finite number, not all 21 million have been ‘mined’ yet. As of October 30, 2017, 16,654,762 BTC (Bitcoin digital currency) have been mined, so more are being discovered every day. [4]

And if bitcoin wasn’t already intriguing enough, this is where it gets even better…

The network is composed of computers that solve mathematical cryptographic problems in order to add ‘blocks’ to the network, known as the ‘block-chain’. It’s a little like solving a cryptic-crossword, only numerical. [5]

In return for solving these problems, the computer’s owner receives bitcoins. The mathematical algorithm adjusts in level of difficulty so that bitcoins are not released into the world too quickly. This process is known as ‘mining’.

Anyone savvy enough to solve these mathematical problems can become a miner.

The actual mechanics of bitcoin gets even more complicated beyond this point, so all you need to know is you don’t need to be a miner to use bitcoin. You can use bitcoin through a type of online account or ‘wallet’.

Why the Interest in Bitcoin?

Like all currencies, the value of bitcoin fluctuates wildly. But because bitcoin was one of the very first cryptocurrencies it has received a lot of publicity which has helped fuel its growth in addition to its limited supply.

At the time of writing, the value of a bitcoin is $7,926 US. It initially traded at $0.008 in 2010. Put simply, if you invested $10 in March 2010 it would be worth $13.9m today!

However, bitcoins can be broken down into smaller units, the smallest being one hundred millionth of a bitcoin – called a Satoshi, after the anonymous founder of bitcoin. (Yes, you read that right, anonymous). [6]

So the question remains, is bitcoin a good investment?

The difficulty with bitcoin is that it’s so difficult to value. And even though supply is limited, that’s no guarantee its value will hold.

My advice would be the same as every other investment or acquisition. If you don’t understand it, don’t touch it.

Have a great weekend!

Adam

Sources:

[1] www.coinranking.com

[2,3,5,6] https://www.investopedia.com/terms/c/cryptocurrency.asp

[4] Min Park, www.medium.com

Back paddock – A correction is when your neighbours property drops in value and a crash is when yours drops as well. (Source: Pritchett Financial Services)