Today, there is a vast range of cryptocurrencies created to perform different functions, but they all act as digital assets that function as a medium of exchange using cryptography to secure transactions and confirm transfers. Bitcoin was the first decentralized cryptocurrency.
Bitcoin really refers to two different things: a decentralized financial network (Bitcoin) and the digital commodity created by that network (bitcoin). It is the world’s most popular cryptocurrency and the one that spurred the new digital economy.
Bitcoin was created by the pseudonymous Satoshi Nakamoto, although the origins of its underlying technology go back to the late 1980s. Nakamoto created Bitcoin by combining a variety of existing technologies.
Bitcoin is not controlled by a single entity. Instead, the nodes on the network verify that all of the rules, such as the rule that only 21 million bitcoins will ever be released, are followed. When everyone verifies the rules are being followed, there is virtually no way for anyone to steal funds, cause inflation or otherwise create problems for the network. Having said that, the decentralized nature of the network also means rule-changing upgrades can be difficult to implement.
Much like gold, bitcoins are created through a mining process — albeit a digital one. Computer hardware is used to solve an extremely complex math problem about every 10 minutes. The computer (or miner) that finds the solution to the math problem is rewarded with new bitcoins. The amount of new bitcoins created through this process is reduced by half approximately every four years.
Bitcoin is not anonymous; it is pseudonymous. Every transaction can be viewed on the public blockchain, but a real-world identity is not necessarily attached to that. Use of Bitcoin can be more or less private depending on how it is used.
Bitcoin has value because it is useful. For the most part, Bitcoin transactions are most useful for those who are not served by the current financial system. Over time, bitcoin has become increasingly viewed as a mainstream store of value, one that is essentially uncensorable, and its price relative to the U.S. dollar has risen.
It is still very early days when it comes to cryptocurrency’s legal status around the world. Some countries have banned the use of cryptocurrency outright, while others are writing legislation to attract digital businesses to their friendly jurisdictions. In the U.S., bitcoin has been treated as a currency and commodity, meaning most Bitcoin companies fall under existing laws and regulations. In the U.S., it is legal for individuals to buy, transact and sell cryptocurrency for personal use as long as capital gains taxes are paid to the IRS.
A blockchain is a record, or ledger, of digital events that is distributed among many different parties. It can be updated only by consensus of a majority of the participants in the system. And, once entered, information can never be erased without an effort from at least 51 percent of the network.
Bitcoin’s blockchain links blocks of Bitcoin transactions. A new block is “mined” every 10 minutes and added to this chain. The blockchain represents the entire history of Bitcoin transactions; it is what makes it possible to tell who owns which bitcoins on the network.
Since bitcoin was created, more than 1,000 alternative cryptocurrencies have been launched. None of these alternatives to bitcoin have achieved the same level of success as bitcoin up to this point, but many have garnered significant investor and technologist attention and are poised to power central aspects of the future.
Cryptocurrencies are usually acquired in the same way as any other currency or commodity: by trading for them on the open market. Tokens can be bought through online exchanges, traded for cash or earned in exchange for labor.
The safest way to hold cryptocurrency is on a device that is not connected to the internet. Hardware wallets are a popular option that create a physical barrier between a cryptocurrency wallet and an internet-connected device.
A cryptocurrency wallet is a piece of software that holds the private keys associated with a cryptocurrency address and allows users to sign transactions with those keys on the cryptocurrency’s network.
It is currently unclear what cryptocurrencies will mean for the traditional financial industry. Many banks and other legacy financial institutions are looking at upgrading their old systems to include many of the same technologies found in Bitcoin, for instance, without removing their centralized control over money and payments. Some believe that one day, cryptocurrencies will be powerful enough to disrupt and replace legacy financial institutions.
Cryptocurrencies may eventually enable a payment system that combines the best aspects of cash and credit cards. While consumer use of Bitcoin was widely hyped in 2013 and 2014, most experts now understand that this is something that could take much longer to develop than originally anticipated. While the benefits of low transaction fees and no charge-backs are obvious to merchants right now, the immediate benefits for mainstream consumers are unclear.