Bitcoin – definition and meaning

Bitcoin is a digital currency that can be sent peer-to-peer without the need to go through any central authority (no central bank). It is a type of cryptocurrency – a medium of exchange using cryptography (a special method of storing and transmitting data) to secure the transactions.

A bitcoin is a unit of digital currency – ‘internet money’. Unlike dollars, pounds, yen or euros, it is considered a decentralized currency. However, it still works like real money.

It is the world’s first completely decentralized digital-payment system that operates as ‘online cash’.

The idea was originally proposed by developer “Satoshi Nakamoto” in a paper he published in 2008, titled, Bitcoin: A Peer-to-Peer Electronic Cash System.

Bitcoins
Bitcoins are starting to gain respectability. Several major online retailers are accepting the online currency including Amazon, Expedia and Tesla.

Bitcoin gaining respectability

In October 2014, the digital currency gained a famous backer – the world’s wealthiest individual, Bill Gates, said he found Bitcoin ‘exciting’, and loved it because it was so ‘cheap’.

Mr. Gates said in an interview with Bloomberg:

“Bitcoin is exciting because it shows how cheap it can be. Bitcoin is better than currency in that you don’t have to be physically in the same place. And of course for large transactions currency can get pretty inconvenient.”



In September 2014, he had described the virtual currency as a ‘tour-de-force’ (an amazing feat).

Mr. Gates also cautioned that users should be careful because of its anonymity feature and its alleged usage by money launderers and terrorists.

Transactions cannot be reversed

The transactions of this digital currency are computationally impractical to reverse, protecting sellers and buyers from fraud. In order to prevent double-spending, once a transaction has been validated it is recorded in a ledger known as “the blockchain”.

Each of these transactions that occur require calculations to be made, which are completed by a network of computers around the world. The people who use their computers to help make these calculations are called “miners” and they are rewarded with new bitcoin units.

In order to mimic scarcity, new bitcoins are being minted at a decreasing rate. Researchers at the Department of Computer Science and Applied Mathematics, at The Weizmann Institute of Science, said the rate of new Bitcoin creation will drop every four years until there are 21 million bitcoins in circulation.


The history of Bitcoin

2008 – A paper was posted online by “Satoshi Nakamoto” which outlined the idea of using a decentralized digital currency.

2009 – The Bitcoin network launched and the first client went live.

2009 – The first block of bitcoins were mined by Satoshi Nakamoto, called the “genesis block”, according to an article in Wired Magazine.

2010 – A man in Florida, Laszlo Hanyecz, carried out what is considered the first real-world transaction of the currency, paying 10,000 bitcoins to get two pizzas delivered from Papa John’s.

2011 – Wikileaks and some other organizations began asking for anonymous bitcoin donations, Forbes reported.

2011 – The bitcoin exchange rate dropped from more than $30 in June to less than $2 in October.

2012 – BitPay said that bitcoins are a compelling alternative to using credit cards and they signed up more than 1,000 merchants to accept bitcoin payments.

2013 – Bitcoins are officially recognized as a financial instrument in Germany. Martin Chaudhuri from the Ministry of Finance told CoinDesk: “The German Ministry of Finance does not classify bitcoins as e-money or as a functional currency; they cannot be regarded as a foreign currency. Nevertheless they have to be subsumed under the German term of ‘Rechnungseinheit’ as a financial instrument.”

How Bitcoin transactions work

People use Bitcoin addresses to send and receive the online currency. These addresses are randomly generated and are made up of around 33 characters (numbers or letters).

Bitcoin transaction history
An Electrum Bitcoin client revealing a transaction history and current balance.

There are three different components of a bitcoin address:

  1. Balance – this is can be found in the blockchain – the register of your transactions.
  2. Public address – this can be shared with anyone and is necessary to send bitcoins to a recipient.
  3. Private key – this is kept secret to the address owner and only used as a means of digitally signing and validating the transfers.

Diagram representing how Bitcoin transfers work.

Bitcoin_Transaction_Visual

Users can manage multiple addresses using a digital wallet. These allow people to exchange bitcoins and check their balance whenever they want – providing them with security by keeping the private keys hidden. These wallets are available as stand-alone programs or web applications.

Owners of these bitcoins can digitally sign them over to other people through a transaction and the payee can confirm each previous transaction to confirm ownership.

Essentially bitcoins work like cash does in the real world. There is no need to provide details of your name or for the exchange to go through a centralized system. This allows people to purchase things on the web anonymously.

Live Bitcoin exchange rate

Below is a real time and interactive Bitcoin exchange rate chart:





The future of Bitcoin

There are four groups of participants Bitcoin and the growth of the currency depends on their consistent participation.

The four groups are:

  • Consumers – people who use Bitcoin to make purchases
  • Merchants – people who accept Bitcoin in exchange for selling a product/service.
  • Miners – people who run computers to validate the transactions
  • Entreprenaurs – to build new products on top of Bitcoin

An article published in the New York Times, titled “Why Bitcoin Matters”, highlights the importance of these four groups and, particularly Entrepreneurs. Mark Andeersen said that one of the reasons of the digital currency’s dominance is the “increasing number of outstanding entrepreneurs – not a few with highly respected track records in the financial industry – building companies on top of Bitcoin.”

Video – Bitcoin explained