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Bitcoin 101: What is Bitcoin?

Bitcoin LogoI have become interested in Bitcoin over the past several months, but have not had the time to investigate it.  The reason for my interest is due to numerous stories that have come out:

  • The ECB releasing a pamphlet that equates Bitcoin with a Ponzi scheme.
  • The U.S. Government releasing a statement that Bitcoin transactions can be prosecuted under money laundering laws.
  • Cyprus getting the first ever Bitcoin ATM.
  • The EFF deciding that it wasn’t going to keep the Bitcoin(s) that it had been given,
  • The Internet Archive setting up its own Bitcoin exchange box, and offering to partially pay employees in Bitcoins.
  • Several stories about Bitcoin being used for illegal activities.
  • And, finally, several stories about some Bitcoin sites being hacked.

On the Kernel Panic OggCast we have talked about a few of these stories, but none of us really understood Bitcoin completely, and why it should matter.  Obviously with the escalating stories, both in number and level of attention it is getting, it seemed to me that it was time to try to understand Bitcoin better.

So, I am starting a series of articles.  The first is just explaining what Bitcoin is while trying to de-mystify the technical jargon associated with most explanations.  In future articles, I will try to pick up on why Bitcoin is important, and why the news stories are relevant.  Hopefully along the way, I will offer a larger perspective on Bitcoin and its current function within our society, and its potential future function within our society.

What Is Bitcoin?

After reading pages on several web sites, and watching several videos, I found that the most complete explanation in the “New to Bitcoin? Start here!” post on the Bitcoin Talk Forums.  However, as someone pointed out over on the Bitcoin Stack Exchange, this is a rather lengthy “elevator ride” – that is, it is not an explanation that you could give a friend in 1-2 minutes it takes for an elevator ride.

So, that’s my challenge: coming up with a 1-2 minute explanation.  Now, knowing that we are in a society that most of the press likes to focus on sound bytes, I thought I would try to come up with a sentence that summarizes Bitcoin.  Here it is: Bitcoin is a fully de-centralized and distributed virtual monetary system implemented by algorithms with extremely high security and integrity.

Yeah, quite a buzz-word, jargon ridden mouthful.  However, each keyword or phrase in that sentence explains key concepts of Bitcoin:

  • Fully de-centralized: There is no one central authority for Bitcoin.  Most monetary systems have banks or governments backing them.  Bitcoin does not.
  • Distributed: The owners of the coins hold them.  There is no single, central repository of the currency, like the Federal Reserve in the United States.
  • Virtual: There is no physical form of the currency.  No dollar bills, euros, or other physical representation of the currency.
  • Monetary system: Bitcoins have a value associated with them, and can be used in exchange for goods or services.  Bitcoins are like a “local currency” or a “shell money” type currency compared to our current currency systems.  The difference is the “local” scope is the internet, and there is no physical shell.
  • Implemented by algorithms: this just means that it is computer based.  The whole system is software programs that have been carefully designed to implement the currency.
  • High security: the security measures implemented for Bitcoin is stronger than any banking system uses.
  • Integrity: All Bitcoins are registered in perpetuity.  The transactions are accounted for, and stored using the built-in security system.  The transactions are not stored in a single location, instead they are stored in multiple places.  This prevents over spending (such as writing a bad check) or double spending (presenting the same Bitcoin to two places at once).

And that, is your “elevator ride” explanation.  Yes, it is still complex.  Trying to explain a monetary system in a few words is always complicated. But this explanation makes all the key points about what Bitcoin is and isn’t without using too much technical jargon.

A Few More Properties

Now, once you get off the elevator, the person you are talking with is likely to still have some questions.  These questions will likely be more about the subjective properties of Bitcoin, but they are wroth comments now.

One: “How does Bitcoin get value?”  That is completely based on the speculation and consensus of the participants in Bitcoin.

Two: “But wouldn’t it be unstable?” The Bitcoin website says it can be, however it has proven that it can handle the instability.  For example, Bitcoin has weathered a large sell-off of a block of 30,000 Bitcoins on April 4th, 2011.  Yes, the value dipped, but it recovered within a few days.

Three: “How do I get Bitcoins?” The answer to this: same as the real world.  You can exchange an item for Bitcoin(s) (like our current, real world currency), you can offer products or services for money.  You could also, potentially, have Bitcoin(s) transferred to you as a gift.

Four: “How do I get out?” Same way you got in: through some form of exchange.  Either with a Bitcoin exchange, or possibly through someone you know (in a private sale).

Five: “Couldn’t the whole thing crash?”  See question two.  The system is stable enough to take a large hit.  The only way for the system to “crash” would be for everyone to leave the market.  At the time of the article I read, there were over 100,000 Bitcoin accounts. That was in May of 2011.  There are most likely lots more accounts now.

There is probably a lot of other questions that would likely be asked, but there is a lot more ground to cover on Bitcoin, so I will save those for future articles.  However, there are a couple of articles on the Bitcoin website worth looking at: Bitcoin for IndividualsBitcoin for Enthusiasts and Some things you need to know.  Finally, one last point: currently Bitcoin is not recognized by governments as an official currency, and therefore any money you put into Bitcoin is still taxed as if it is regular income.  It’s up to you to handle your taxes appropriately.

4 thoughts on “Bitcoin 101: What is Bitcoin?

  1. The US Government statement is an interesting one, mainly because I don’t know how they are going to enforce it, much less organize it. The disorganized nature of the system seems like it would make it nearly impossible to do anything.

    Very interesting though. I like the idea of BitCoin, just haven’t done much with it yet.

    1. Yes, I don’t know how they would enforce it either… Except to say that all transactions are recorded, which is the whole idea of the block chain in the first place. However, in order to establish the records of a transaction that would can be prosecuted would take a lot of work to decrypt the records and trace everything backwards. Of course, given the government resource, it may be possible.

      But I think there are other reasons and factors for the statements. I also believe that there are some other attributes of Bitcoin that need to be examined a bit more. I know I am not the only person looking at them, so there are likely to be some interesting opinions and facts to write about on this topic. 🙂

  2. Good stuff Soundie, look forward to following along on this Elevator ride to the 3, 4 or 22 floor as you cover this in more depth.

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