Everything you ever wanted to know about Bitcoin (but were afraid to ask)
Just what IS this Bitcoin thing that you keep hearing about? Will it affect you? Do you even need to know what it is?
These are all great questions and if you’re just beginning your journey with this global phenomenon, you’ll likely have a ton more.
When I first discovered it some years ago, I found that all the information available was either very technical or the articles assumed you already knew what it was, which really didn’t help. So, I decided to put this essential guide together with all the commonly asked questions in one place for ease of reference.
What is ‘Bitcoin’?
Its simplest definition is a global peer-to-peer monetary system, but even that may not immediately make it clear, so further explanation is probably required.
When you make a payment to anyone using any traditional banking method, including bank transfers or even Paypal, you have to go through a central body of some sort. That central body controls the money flow and usually takes a cut for its trouble. It can also deny your payment or ask questions about it, should the need arise.
This system has worked for centuries, but it has issues, the biggest of which is trust. Banks have a terrible history of using other people’s money in appalling ways and the growing number of fines being paid globally by these organisations for rate fixing, money laundering and other large scale offences shows how susceptible they are to human greed. Put simply, we can’t be trusted with it and it has created problems for generations. However, we stuck with it mainly because, until now, there has never been an alternative.
In 2009, a mysterious coder, by the name of Satoshi Nakamoto, proposed and implemented a completely trustless way of creating a new, global currency based entirely on maths, cryptography and computing power.
It could be accepted anywhere by anyone without any form of central interference, all that the two people concerned needed was an internet connection of some sort and a PC or phone to make the transfer. The billion or so people who didn’t have access to banking facilities because the banking system didn’t consider them profitable enough were suddenly able to transact with the rest of the world. Thus, a whole new paradigm was invented.
Think of it like a global form of the Euro, a currency that is currently accepted by 19 countries, except that you can use it everywhere on the planet and without touching any of the existing financial system.
Does Bitcoin exist in physical form?
No, it’s a purely digital currency. This is something that causes great confusion since you can’t actually touch it, but the reality is this is much closer to the existing system that we’d first appreciate.
When you’re paid for the work you do, you receive numbers on a screen in a virtual account. You pay your bills with online banking, you even buy your drinks in a bar with a tap of your phone. All of this also exists with Bitcoin, but the difference is you can’t go to a cash point and turn it into something physical, something that many of us still do. That practice itself may be dying as we become increasingly digital anyway, but it’s somewhat reassuring to know that we can do it if we wish.
Technically, since Bitcoin is a currency, you can exchange it for cash and withdraw it as if you were exchanging dollars for pounds, for example, but it can’t be done directly.
Oh, and those nice pictures of shiny Bitcoins coins you see on the net? They are created purely for effect — they don’t exist in a physical sense. Yes, even the ones in the picture at the top of this page.
How do you get and use Bitcoin?
This is simpler than it sounds. You need a computer, tablet or phone and an app, readily available for download on any platform. The app gives you a sort of virtual wallet and key, a bit like your bank PIN, that allows you to see and access your Bitcoin, just like your bank account. If you lose your wallet, you can restore it at any time by entering your secret code and restoring it from the public records, but more on that later.
The following article talks you through how to set up and create a Bitcoin wallet. To put it into context, it’s about as hard as creating a new email account.
Many, but not all, of these wallets allow you to change your local currency to Bitcoin using the app. Effectively, you’re changing one form of digital currency (the numbers that represent the pounds or dollars in your bank account) for another (Bitcoin) so it’s a simple transfer. There’s a fee to do this, the same as there is when exchanging currencies at a Bureau De Change.
To spend your Bitcoin you either use the appropriate QR code-generating app, or you can send it directly using an address, exactly like putting in a sort code and account number for a bank transfer.
At the moment, spending Bitcoin in its native form is quite limited, but there are now a number of Bitcoin only Visa cards that you can use to convert it to local currency in real time at point of sale. You simply use your card wherever you see the Visa sign as you normally would. Every day more merchants are using Bitcoin and more payment systems are coming on line, although it’s still in it’s infancy.
Like the evolution of the internet itself, or in fact any technology, it’s applications and ease of use will increase over time.
Is ‘Cryptocurrency’ the same as ‘Bitcoin?’
‘Cryptocurrency’ is the term used to describe any decentralized digital only currency that is based on a mathematical cryptographic system, literally the words ‘cryptographic’ and ‘currency’ combined together. Bitcoin is the biggest, most well known one by first mover advantage, but there are actually thousands of others.
For most of those, known as ‘altcoins’ (literally the words ‘Alternative to Bitcoin’ and ‘Coin’ combined) their longevity and actual use is questionable, so most people, myself included, don’t expect them to be a long term proposition as market forces and technology evolve.
So if it’s just code, can’t I just copy the Bitcoins off your hardrive?
It’s a great question and one that comes up often.
On the face of it, you’d think so wouldn’t you? After all, you can copy a song, program or image from one device to another with relative ease, it’s just 1’s and 0’s, the same as Bitcoin itself.
However, this process is impossible because of the way that Bitcoin is coded and distributed. Assuming you even found a way to do this, your Bitcoin would instantly be rejected by the ‘blockchain’, an irrefutable ledger of all the transactions that have ever been. This blockchain is stored on thousands of random machines all round the world simultaneously, making a single fraudulent transaction impossible without their express agreement, something that would be physically impossible to do.
The reasons for this are very technical and I don’t propose to go into that here, but suffice it to say it can’t happen. As Bitcoin approaches its eleventh birthday, the fact that there has never been a successful attempt to do this shows how robust the system is.
How many Bitcoins are there?
This is a key point of any monetary system — there has to be a finite, or at least a perceived finite number of units, to have value. In Bitcoin’s case, this number was set at inception to be 21,000,000. There will never be more than this, and in reality there will be far less.
This is one of the major difference between Bitcoin all other traditional monetary systems. In those cases, more money is simply printed when it is needed, thereby reducing the purchasing power for everyone as whole — we see this effect as ‘inflation’. The dollar, for example, has been doing this at an alarming rate for many years which is why the US debt figure is sky rocketing so fast. Bitcoin’s supply is fixed forever and cannot be changed.
Again, the reasons for this are extremely technical, but the short explanation is that the code that runs Bitcoin across all these computers across the world is set to release new coins at a set rate over time, and that rate diminishes by 50% every four years according to a fixed schedule. This reduction in coins has been set to coincide with increased adoption and the expected future increases in computing power. Approximately 18 million Bitcoin have been ‘mined’ (we’ll come back to this term shortly) thus far, but it will take another 111 years to mine the last 3 million as the computing power required to get them increases exponentially over time.
Of those 18 million, an estimate 4 million Bitcoin have been lost forever due, mainly, to carelessness. The simple fact is that in the early days when it was worthless and you can buy, or mine, thousands of them for little or no money, they had no value and people didn’t take care of them. This is not likely to happen now, although individual mistakes still happen on a small scale.
By doing the maths it’s clear that there will never be enough Bitcoin for everyone on the planet to own one each. There’s actually not even enough for every millionaire to own one, but luckily Bitcoins can be transacted in using fractions of it, down to eight decimal places in fact. These portions of Bitcoins are called ‘Satoshis’ in honor of its creator and there are 100 million of them to each Bitcoin. It is widely thought that in years to come, most of us will be dealing with Satoshis rather than whole Bitcoins.
So … Who actually owns the Bitcoin ‘system?’
The short, but possibly misleading, answer is ‘no-one and everyone’. Whereas all the currencies on earth are centralized and controlled by official bodies, Bitcoin is not. The code that runs it is completely open-source, meaning that anyone can look at it and tinker with it, although making changes on your own to try and get to the system to accept it is not possible as we’ve already seen.
Anyone can join, or leave, the Bitcoin ecosystem at any time via mining (we will come back to this, promise!), but, to be clear, you don’t have to be involved with the system infrastructure to use it. If you do decide to be involved, the software will recognize you and make your inputs as valid as anyone else’s. The whole point is that it is a global monetary system for the people, by the people.
Yes, it’s true that corporations and governments can get involved if they want to, but they can’t control the network or influence the code without global consent. In other words, they have no more power than you or I.
Even the mysterious Satoshi Nakamoto bowed out once his creation was adopted by the community, never to be seen again.
So, if no-one owns it, who runs it?
As before, everyone and no-one. Bitcoin is a self-governing, self-correcting mathematical algorithm that automatically adjusts itself according to transactions and computing power on the network and, as stated before, anyone can be part of that.
It’s an incredibly clever system and it’s covered in more detail here:
Is it backed by anything?
Up until around the 1970’s, many currencies were backed by gold, which meant you could take your promissory note (e.g. your five pound note) to the central bank and exchange it for gold to the same value at any time. However, since then, all currencies work independently of any gold backing, which means they are backed purely by belief of people and their confidence that the next person will accept it. They are backed by nothing else.
Here, Bitcoin has an advantage because it is actually backed by something more solid and finite than gold — mathematics. Essentially, and by way of a very simplified example, as long as two plus two equals four, your Bitcoin will have value. Again, the code that makes this happen is incredibly complex, but detailed information about it, even the code itself, is readily available on the internet should you wish to examine it.
OK, so what is this ‘mining’ I keep hearing about?
Mining is a key part of the Bitcoin infrastructure. Anyone can be a miner using specialist equipment available from manufacturers all around the world. You buy your machine, plug it in, and it contributes its processing power to the grid. You are rewarded in Bitcoin for your contribution, and you pay for the electricity you use to power the machine through your normal route. This power consumption can be significant and most machines are noisy, making mining at home difficult and usually unprofitable.
In the early days it was possible to mine with your home computer or graphics card, but the network power is now so high this is no longer viable.
Miners are responsible for enabling Bitcoin transactions between parties and the way they do this is in organised blocks of data containing the details of transactions between parties freely available across the network. Miners take the next block in the chain (hence the term ‘blockchain’) and, in simple terms, verify and confirm them by ‘guessing’ the next hash code in a cryptographic sequence. Once someone has guessed the code correctly, the other miners verify it and the transaction is confirmed. The miner who found the code is rewarded in new Bitcoin produced by the computer code at a set rate.
This is a complex process and is very much the business end of Bitcoin. However, you don’t need to fully understand the process to use it, although, again, this information is in the public domain if you want to look for it.
In this sense, it’s a bit like driving a car: you can still turn the key and operate it, even though you may have no idea how to strip down and fix the engine.
Is Bitcoin used for illegal practices?
I would hope so! Let’s face it, if it wasn’t, could you really describe it as money? However, transactions are traceable on the public Bitcoin blockchain, so criminals have found — the hard way — that this is not a panacea for everything they want to do. Bitcoin transactions for fraudulent activity actually account for a very small percentage of overall transactions as a result, despite what the mainstream press have to say on the matter.
Cash or complicit banking systems are likely to remain king here for the foreseeable future.
Interestingly, no government has yet passed a specific law making Bitcoin or cryptocurrency illegal, although there are jurisdictions where its use it seriously discouraged.
What’s with the price? It’s up and down like crazy!
While the numbers may seem big (anywhere between $1bn and $4Bn dollars’ worth of Bitcoin are traded daily) Bitcoin is a tiny market at the moment. It’s whole market cap is just a percentage of even one global company. It’s literally a rounding error in the grand scheme of the financial markets, which are measured in trillions, not fiddly little billions.
This means just a few large transactions can move the price very quickly up or down and trying to predict the future is all but impossible. Many people consistently try and there are those who believe it will reach staggering levels in the coming years as well as those who are convinced it will go to zero.
However, in theory the price is likely to stabilize the larger the market gets as it will be harder for any individual or group to affect the price. It’s also impossible to say when, or even if, that will happen.
Bitcoin is still an experimental technology, but the industry is moving at an incredible pace. It’s often likened to the start of the internet which was, in the early days, slated for having no purpose, hard to use and a passing fad.
But it’s not the only technology it can be compared to. We’ve seen large scale mass adoption in other areas too, such as that of mobile phones and there’s much that can be learned there also, covered in this article.
Many think that some form of digital payment is now inevitable, but since there is arguably better technology placed to take the number one spot, Bitcoin will become the MySpace of the industry and die out.
At this point, no-one knows, but it is clear that investing in Bitcoin remains a very risky proposition so if you are thinking of doing this, it’s important you do your own research.
And whatever happens, the next few years are going to be very interesting!