What is Bitcoin?

Every country has its own currency. Estonia and the Eurozone have the Euro, Russia has the Rouble and the USA have US Dollars. We exchange money in banks or specialized foreign exchanges, transfer it worldwide and invest it. In our times of technological innovation it is safe to say that most, if not all money transfers are conducted through the Internet.

Is it then such a great surprise that an online currency such as Bitcoin has emerged? Interest in the currency has grown towards the end of 2013 due to significant spikes in the currency’s value, but let’s start from the beginning. In 2009, an unknown programmer by the name of Satoshi Nakamoto put forward a whitepaper that proposed a creation of new form of digital currency – cryptocurrency. Cryptocurrency functions the same way as regular currencies do in that its used as a means of exchange, unit of account and a store of value. Cryptocurrency, just like other resources, has some demand for it, and subsequently a market price. The significant difference is Bitcoin’s intangibility – there is no bank-issued notes or papers – meaning that rather being used in hand-to-hand transactions, Bitcoins are stored and exchanged digitally within a decentralized, peer-to-peer network.

How does Bitcoin work?

With traditional money, transferring funds from one account to another requires some intermediary authority or middleman. Even with hand-to-hand cash transactions, the issue, value and fiscal policy of money is controlled by a trusted centralized authority (such as a bank, agency or government). Bitcoin operates differently in that no middleman is required in transactions as the trust between actors is derived from computer science and cryptology, rather than trust in a central establishment. It also means that Bitcoin is transferred directly from the sender to the receiver, with absolutely no intermediaries.

A key point to note is that because of this lack of central issuing body, cryptocurrency is created and transferred with the help of a process called “mining”. This process requires an extremely powerful computer to crunch down the billions of calculations required to solve cryptological functions.

In reality, the mining process is extremely complex and technical. Despite its complexity, the process is transparent and open for review due to the open-source nature of Bitcoin.

What are the strengths and weaknesses of Bitcoin?

Bitcoin is the first decentralized and uncontrolled currency. Since no central body owns the process for issuing new units, new coins are created at a fixed, predetermined rate. Unlike many government-issued currencies, this means that Bitcoin is immune from inflation, and is in fact a deflationary currency. Bitcoin also has the un unique property of “transparent anonymity”- meaning that despite all transactions and wallets being public through the Blockchain, all actors in a transaction are only identified by their bitcoin wallet address. Thousands of addresses are generated daily – this means that the user stays anonymous until they register both their personal details and their bitcoin wallet address somewhere (for example on a Bitcoin exchange). Bitcoin’s unique makeup also creates other strengths from the users perspective- the digital nature of Bitcoin makes it highly divisible and the lack of a central authority ensures that transaction fees are near-zero.

Bitcoin’s digital nature and lack of central body also shape Bitcoin’s weaknesses - lost Bitcoins are non-recoverable (meaning that if you lose your private key or the hard drive with your wallet gets corrupted or if you lose your bitcoin wallet seed, those Bitcoins are lost forever!). Take the case of a British man, who in 2009, threw away the hard drive that contained his 7500 Bitcoins. At the end of 2013, the value of Bitcoin was nearing $1200, meaning there was a hard drive at a dump with over 8.25 million USD stored on it! Stories like this are not uncommon as early miners have been known to mine thousands of new coins, which would have made for a small fortune even with todays weak Bitcoin exchange rate.

So then, what is Bitcoin?

Bitcoin is a peer-to-peer payment system. Its unique properties attract many followers and opponents.

It’s impossible to tell whether Bitcoin will establish itself as the sole payment system for the internet, but for right now – there is significant interest and demand for it. The Bitcoin economy is still in its infancy and there are already many investors and people who are attracted by the prospects this new disrupting technology may bring.

The future of Bitcoin is unclear at the moment due to legal uncertainty (governments cannot issue it, but they can prohibit use), unstable exchange rates and subsequent lack of widespread (albeit rapidly growing) adoption. However, people familiar with Bitcoin and technology often note the similarities between Bitcoin’s ascendance and the rise of Internet in the 1990-2000s. When the Internet first emerged in the early 90s many experts underestimated the impact it would have on the world. It is often predicted Bitcoin will follow the same pattern. Until then, current users are embracing this truly innovative idea and are contributing to establishing a global bitcoin economy.