If you have been following financial news lately, you’ve probably heard of the term “BitCoin.” But what exactly is a BitCoin? It’s a revolutionary new currency based entirely online with no government backing, controlling, or overseeing it.
Instead, users determine the value of BitCoins through the laws of supply and demand, while a process known as “mining” is used to create new BitCoins. People who own BitCoins can use them to either make purchases and donations to various organizations that accept BitCoins, or exchange them through one of numerous exchanges for cold hard cash.
BitCoins were created in the aftermath of the 2009 Financial Crisis, which saw world financial markets destabilized and pushed to the verge of collapse. BitCoins represent the evolution of long-going efforts by computer hackers and experts to create a “government-free” currency. Since the early 1990’s numerous Internet activists have tried and failed to create a 100 percent electronic currency free from Government oversight. Most of these early efforts relied on a central clearing house that would essentially act as a “central bank,” but until BitCoin hit the market, all of them failed.
BitCoin bills itself as the world’s first decentralized digital currency and is not overseen by any single clearinghouse or government. The value and rate of BitCoins are determined purely through peer-to-peer (P2P) users and market exchange rates. P2P refers to using a network of “peer” computers to share information. Often, personal computers form the backbone of a P2P network. The actual functioning of BitCoins is similar to file sharing systems, like BitTorrent, with individual users essentially supplying all the “muscle” to run the network.
BitCoins were started by a person or group under the pseudonym of Satoshi Nakamoto in November 2008. Nothing is known about Nakamoto, not even his real name, gender, or location. Nakamoto posted his theory for an online currency based on “mining,” or using computers to crack immensely complex equations, to “create” a Bitcoins. Nakamoto then went on to mine the first 50 BitCoins himself and slowly built up a following of other computer experts.
As mentioned, BitCoins are created through “mining.” In order to create a new BitCoin, super computers, or huge networks of PCs, are needed to solve complex equations to create a new coin. This limits the supply of BitCoins and requires that genuine, actual resources be put into their creation. In a sense, Mining could be thought of as a sort of “gold backing” for the currency. While the price of a BitCoin is determined through transactions, its value is derived from mining.
There are only 21 million BitCoins available to be mined. Currently, experts estimate the half of them have been successfully mined. This means that companies and computer experts must compete against one another to mine the limited supply. This also means that no Central Bank or other entity could try to flood the market with BitCoins and devalue to the value of the currency. In theory, there are 21 million potential BitCoins in the the world today, and in 200 years there were will still only be 21 million BitCoins.
The total number and value of all BitCoins are tracked in an open and public ledger that monitors all transactions. The protocols and security protecting this ledger have been increasing, though in 2010, a major security breach was found and 180 million BitCoins were artificially created. These artificial BitCoins where erased from the log within a few hours, however, restoring the security and value of legitimate BitCoins. This ledger is run through an open network of computers and is kept public and transparent, thereby allowing the whole community to monitor it.
BitCoin uses a “wallet” to track each individual user’s total holdings. This wallet acts like an online bank account and allows the user to make transactions at stores and places that accept BitCoins. So far most major online stores and banks are not accepting BitCoins, limiting its actual use in making purchases. BitCoins can also be traded through various exchanges in return for money.
Do BitCoins sound confusing? Truth is, the BitCoin currency is so radical and new that few people fully understand how the system works. The novelty of the currency has been one of its main selling points, however, it also increases the risk of investing in them. BitCoin prices have been experiencing wild price swings in the last few weeks, reaching as high as 250 dollars per coin before plummeting below 100 dollars. Clearly, BitCoins are a high risk investment and any investor should only invest money he or she can afford to lose.
