Bitcoin is the name of the first decentralised digital cryptocurrency. These words might not mean anything to you yet, but let’s take them apart to try and understand them a bit more.
A Decentralised currency
At the simplest level, in the same way that the US Dollar or the British Pound is money, Bitcoin is also just money.
Normally someone has to be in charge to track where the money is, when it is being sent from one person to another online and to decide how much money there is in total. The US dollar is controlled by the US government. They decide how many Dollars there are in the world. The British Pound is controlled by the British Government. They decide how many Pounds there are world. That’s normally the job of the central bank. Hence it can be said the currency is centralised.
Bitcoin however, uses a new technology called Blockchain, which lets everyone keep track of who is sending money to whom. There is no special person in charge. No more need for the central bank. Hence the currency is decentralised.
Why would anyone want Bitcoin?
As useful as old fashioned money is for conducting transactions, even if it went completely digital, there are a few problems with it that can be improved.
1) Someone has to be in charge and you need to trust the person in charge. If you want to send money to your friend on the other side of the world, you need a bank, a trusted 3rd party, to do that for you. You send money to the bank, the bank then sends money to your friend (and takes a fee to do so).
2) A currency that is not linked to a limited resource is vulnerable to economic problems. For example, the person in charge can literally print more money for free. Since there is now more of your currency in existence, the value of your savings is reduced and you can buy less with it. They key to maintaining a currency’s value is scarcity.
A currency that could get rid of these issues would be more valuable to the people that use it than something others could devalue. See the Zimbabwean Dollar, or the Venezuelan Bolivar
Why did no one think of this before?
The idea of a new Electronic currency has been around for a while actually. Online in game currencies are an example. More earnest serious examples have been attempted on the internet since the 90s. However, they are usually still controlled centrally. This is because of what is known as the double spend problem.
People can’t be allowed to create counterfeit money. A bank wont let you send the same money twice to different people to double the amount of money since the central bank keeps track of money being moved. In the same way there needs to be a method to stop someone simply copying whatever is on your computer to make a duplicate of the electronic money. This has been a problem ever since the idea of electronic money came up. Known as the double spend problem. The problem is who is going to keep track? If there is a central organisation in charge then they need to be trusted same as we mentioned with old fashioned money, and if they go bankrupt or dissolve the currency also disappears.
In 2008 an anonymous cryptographer with the online name Satoshi Nakamoto, published a paper proposing a solution that solved the double spend problem and would allow people to send money directly from one person to another without a trusted third party.
In simple terms the way Satoshi solved the problem of double spending and keep track of the transactions was to have everyone keep track and agree on the transactions. This way, in order for someone to cheat the system they would need more than half the people using it to agree.
Anyone who wants to, can run a Bitcoin Node. A record of every transaction is broadcast to every node. Every node collects these transactions in a “Block” then looks for a “proof of work”. This is an arbitrary mathematical problem based on the transactions. Once a proof of work is found, it broadcasts the block to all the nodes. If the nodes agree that the block is valid, they start working on the next block.
This method of having no one in charge, means the currency is decentralised.
A Digital CryptoCurrency
Cryptography is the study of codes and encryption systems. It is used every day by banks and people everywhere. When you shop online your internet browser encrypts your credit card data on the way to the bank, using “public key cryptography” technology using the banks public key. That’s so that someone can’t listen in to the signal and steal your credit card data or change it. This Modern encryption can be completely unbreakable and can’t be opened without a private key that the bank holds. This private key can also be used to sign electronic files to show they came from the owner of the key.
This same technology is used in Bitcoin. When a node finds the proof of work, they are rewarded with Bitcoins
An electronic coin can be signed using the same kind of private key technology. You can sign a coin to tell people that you have given that coin to someone else. This signed transaction is what is sent out to the Nodes mentioned above. The coin is simply a collection of these transactions. There are no physical coins, just software.
Because we are using this Cryptography technology to create and transact the coins, these coins have been named a CryptoCurrency.
The idea of using Cryptography as a basis for digital currency has been around for a long time before Bitcoin. The new revolutionary development is the use of the Blockchain to track them. This decentralised Blockchain is what makes Bitcoin special.
All currencies have value if people can reliably agree it has a particular value without depreciating. In the past precious metals were used as coins. Then we used paper notes to each other to represent those metals that were kept in storage. Then later still, we used electronic notes to each other. In the modern age we left the gold standard and the notes no longer represent the precious metals, but just the faith that the currency will be accepted and can be used reliably. If the currency is reliably accepted as a store of value, it can be used by people for their transactions.
In the past Bitcoins value has been driven by speculation of future value and even had similar characteristics of a bubble. However, Bitcoin’s reliability for use in transactions has led to greater adoption worldwide.