Bitcoin really refers to two different things: a decentralized financial network (Bitcoin) and the digital commodity created by that network (bitcoin). It is used to send funds around the world in seconds at almost no cost.
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 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 ten 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.
Bitcoins are acquired in the same way as any other currency or commodity: by trading for them on the open market. Bitcoins can be bought through an online exchange, traded for cash or earned in exchange for labor.
The safest way to hold bitcoins is on a device that is not connected to the internet. Hardware wallets are a popular option that create a physical barrier between a bitcoin wallet and an internet-connected device.
A bitcoin wallet is a piece of software that holds the private keys associated with a Bitcoin address and allows users to sign transactions with those keys on the Bitcoin network.
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 and its price relative to the U.S. dollar has risen.
It is still very early days when it comes to Bitcoin’s legal status around the world. Some countries, such as Bolivia and Ecuador, have banned the use of the digital currency outright, while others are writing legislation to attract Bitcoin-related 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 bitcoins 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.
Bitcoin’s blockchain links blocks of Bitcoin transactions. A new block is “mined” every ten 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 (known as altcoins) have been launched. None of these alternatives to bitcoin have achieved the same level of success as bitcoin up to this point.
It is currently unclear what Bitcoin 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 without removing their centralized control over money and payments.
Bitcoin 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 chargebacks are obvious to merchants right now, the immediate benefits for mainstream consumers are unclear.
Where Bitcoin is ultimately headed depends on who you ask. Bitcoin has been proclaimed dead by various figureheads in the media dozens of times, but it’s still here and has been hitting all-time highs in price.
For now, it is clear that Bitcoin is useful to some people for either value storage or censorship-resistant transactions. In the future, microtransactions appear poised to serve as the next major use case. There are also upgrades for better privacy and more advanced smart contracts in the works and these developments will certainly be worth watching over the coming years.