A Beginner’s Guide to Bitcoin
You’ve heard of bitcoin, right? Some people say it’s the currency of the future; some say it’s a glorified pyramid scheme; and then there’s the rest of us, who have no idea what it is or how it works.
Bitcoin just turned ten years old, so it has demonstrated more staying power than a lot of people thought it had. Now let’s take a step back and a deep breath and see if we can arrive at a basic understanding of the world’s first cryptocurrency.
Who’s in charge here? Uh, no one.
Bitcoin was invented by a person or group of people who went by the pseudonym Satoshi Nakamoto. Nakamoto was trying to develop a decentralized electronic payment system – one with no authority figure like a central bank running it. Specifically, he was trying to come up with a solution to what’s called the “double spending problem” – that is, with no central authority to keep records and enforce rules, how do you prevent someone from spending the same sum twice? With cash, it’s easy – when you spend your $20 bill, you give it to someone else, so you don’t have it to spend again. With electronic transactions, you have a bank to keep the official records of what you have and what you’ve spent. On October 31, 2008, Nakamoto posted a white paper entitled “Bitcoin: A Peer-to-Peer Electronic Cash System” that contained an ingenious solution to the double-spending problem. The answer was something called a blockchain.
Without getting overly technical about it, a blockchain is a kind of public ledger where bitcoin transactions are recorded, and it’s shared among everyone who uses bitcoin. What’s more, it’s a ledger that’s designed to be impossible to retroactively alter, so there’s no need for a central authority figure to keep everything fair and square. It might not sound like much of a breakthrough, but that’s exactly what it was. Prior to the appearance of Nakamoto’s paper, many people thought such a thing was impossible.
In early 2009, Nakamoto released the open-source software for bitcoin and started the blockchain by “mining” – more on that in a moment – the first block in the chain, called the genesis block.
And the world’s first cryptocurrency was born.
Grab a virtual pickaxe and let’s get mining!
You may have tech-savvy friends or offspring who have expressed an interest in bitcoin mining. So what’s the deal? Is there gold in them thar CPUs?
Well, kind of. But actually finding it requires enormous amounts of computer power. The way it works (and again, this is a very simplified version – for more in-depth info, check out the links at the end of this post) is that bitcoin miners are actually auditors of a sort, and in return for their efforts, they become eligible to win some cryptocash of their own. Miners provide an essential service to the bitcoin network by electronically verifying transactions – these verifications are part of the solution to the double-spending problem. Once a miner has verified 1 MB worth of transactions, they earn a shot at getting rewarded with 12.5 bitcoin – at today’s exchange rate, that’s worth almost $80,000! But to get it, they have to be the first miner to guess the answer to a numeric problem that’s basically, “I’m thinking of a number between 1 and 10 billion, and I’ll give 12.5 bitcoin to the miner who comes closest to it without going over.” The odds contained in this analogy may be off, but that’s pretty much what it’s like – guesswork, and computer programs generate the guesses. And if you don’t submit the best guess first, you get nothing for your efforts.
Mining serves a second important function besides incentivizing people to verify bitcoin transactions, though: it’s also the only way for new bitcoin to enter circulation. Without miners, the only bitcoin in circulation would be the ones released when Satoshi Nakamoto mined the very first block. And the system was designed to offer progressively less reward for mining as time goes on. Nakamoto’s system caps the number of bitcoin possible at 21 million. As of this writing, a little over 17 million have been mined; all 21 million are expected to be in circulation around 2140.
So is bitcoin mining for you? Well, due to its nature, one person digging away with their trusty desktop computer doesn’t stand much chance of making enough to pay for the electricity it consumes. But investing opportunities called mining pools do exist in which people combine their computer resources to create the sheer scale needed to stand a chance of success.
Okay, maybe mining’s not for me. How else can I get my hands on some?
Mining may be the only way for new bitcoin to enter circulation, but it’s not the only way for you to get in on the rush. There are a number of exchanges on which you can buy bitcoin for real-world cash and hold them in special electronic wallets. Keep this important point in mind, though: unlike conventional savings accounts, bitcoin wallets are not insured by the FDIC. If you use your bitcoin to make a purchase, the transaction will be recorded in the public ledger we talked about earlier, but your identity won’t be revealed; only your unique wallet ID number will be. This anonymity makes bitcoin the currency of choice for people involved in illicit dealings online. As you might expect, governments are weighing regulations to give them at least some level of control over the currency. Tax officials are getting involved, too – with every bitcoin transaction recorded, evading taxes is theoretically impossible, but with the secrecy that’s built into the system, it can be difficult to determine who to send the bill to!
And then there are the scams. As with any human endeavor that creates something of value, bitcoin has also created large numbers of people who would like to separate you from yours. There are fraudulent initial coin offerings for “the next bitcoin”; there are dicey exchanges that will take your bitcoin or cash with no intention of giving you anything in return; there are fake bitcoin wallets into which things disappear like black holes; and there are even those old standbys from the pre-digital age, Ponzi and pyramid schemes.
So would I recommend investing in bitcoin? Only after doing a lot research, and only with capital you can afford to lose. They say, “A fool and his money are soon parted,” but in the world of cryptocurrency, smart people who want to get rich just a bit too eagerly are, too.
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