What is Bitcoin?

by Rudd-O published 2012/03/20 09:55:00 GMT+0, last modified 2013-06-26T03:24:35+00:00
A very short explanation of Bitcoin, and the most frequently asked questions about it.

What is Bitcoin?

Bitcoin is money. People give stuff to you, and you give them Bitcoins. You give stuff to people, and they give you Bitcoins. That is: you can buy and sell things using Bitcoins.

How does Bitcoin work?

It's actually pretty simple. Let's say you want to buy a banana from a farmer's market, using Bitcoins instead of dollars.

You have a Bitcoin wallet. You carry some Bitcoins in it. The farmer also has a Bitcoin wallet. His wallet has an address (or more) tied to it. Bitcoins sent to that address appear in his wallet.

You ask the farmer to buy one of the bananas. The farmer says, "Sure, it'll be 1 Bitcoin" and hands his wallet address to you. You give 1 Bitcoin from your wallet to that address; this transfers your Bitcoin from your wallet to his wallet. He gives you the banana. That's it. Now you have your banana, and the farmer has his Bitcoin.

If you want to get paid, this works exactly the same but in reverse. You give your address to the other guy, and he sends Bitcoins to that address. You can even give a different address to each person. This is usually a good idea.

Isn't that a bit complicated?

At a glance, Bitcoin does sound more difficult to use than cash.

But in practice, the farmer won't actually give you a long number in a paper card. What you'll do is pay with a pocket Bitcoin wallet. If you don't have that, you might use an NFC-enabled Bitcoin app for your phone. Worst case, you take a phone picture of a barcode at the register, key in a number of Bitcoins to send, then tap "Send".

As you can see, all of these alternatives are faster than opening the register and making change for cash. They're also faster than keying in your debit card PIN, if you pay with a card.

So, what if you're buying things with your computer? Then you will copy the address of the sender to your clipboard, and paste it on the Send box of your Bitcoin wallet.

And what if you don't have your computer with you? No problem. There are several Web sites that can keep your Bitcoins stored in "online wallets". With them, you can send and receive Bitcoins to other people and between your other wallets too.

And if you don't have a phone or a computer with you, you can pay with physical Bitcoins too.

How do I get one of these Bitcoin wallets? Are they expensive?

Bitcoin wallets are usually free. You get a wallet by:

  • Installing a computer program in your computer.
  • Getting an app for your phone.
  • Opening an online account in any of the Web sites offering wallets.

You can have more than one wallet. You can freely move your money between your wallets, just as easily as you can send money to someone else.

There are also companies that sell physical Bitcoins. These are actual coins with a redeemable Bitcoin address inside them, good for as many Bitcoins as you choose. You do have to pay a bit of a premium for them, but they work if there's no electricity where you are.

Finmally, there are companies working on manufacturing pocket wallets.

Why not just use a credit or debit card?

Two reasons:

  • Cards involve a middle man called a "credit card processor". This middle man complicates everything for everyone.
  • Bitcoins work worldwide, without currency conversion or international payment fees.

If you're selling stuff: you have to pay the middle man a very high fee (~3%) on every sale you make. You also need special equipment. This agreement limits what you can sell, and how you can sell it. You also have to prepare for people who dispute payments, especially from stolen cards.

If you're buying stuff: you end up paying extra money because of the difficulty added by the middle man.

If you want to just send or receive money: you simply can't do that with a credit card. You could "give" money to a friend by buying him dinner. But what if you want to, say, sell a computer to him? Now he has to withdraw cash from an ATM (inconvenient), or use PayPal (and pay a fee)... it's a mess. "I'll pay you later" turns into "meh, I'll buy it from the store".

And if you're abroad: your card will usually let you buy stuff, but you will be paying through the nose in middle man fees.

If you use and accept Bitcoin, none of this is a problem. All you need is a Bitcoin wallet, and presto. It works everywhere.

So why involve a middle man at all?

Isn't cash safer? What about credit cards?

Bitcoin is safer than cash and cards. Let's compare.

A thief who steals your regular wallet can ruin your credit statements and spend your cash freely.

Not so with Bitcoin. Bitcoin wallets can be protected by a password; the thief can't pry your Bitcoin wallet open, and your Bitcoins can be recovered if you backed up your wallet. Why would a thief steal something he can't use?

This is especially true of PayPass ("wireless" or "no-swipe") credit cards. Clever thieves can wirelessly swipe everything from those, just by walking near you. Name, home address, card number, expiration date and security code. This can't be done to Bitcoin wallets.

About the only thing that someone could steal from you and then spend, is physical Bitcoins. They are like cash in that sense.

Why should I use Bitcoin rather than, say, dollars or Euros?

You don't have to choose one or the other.

For example, you can buy or sell some things using dollars, and other things using Bitcoins. You can buy and sell Bitcoins for dollars too. In fact, you can trade Bitcoins using practically any major currency out there.

Also, you can "top up" your Bitcoin wallet at many online places.

But the best reason to buy and use Bitcoins is actually unique to Bitcoin: they cannot be "made up" by punching numbers on a computer or a printer, and they cannot be counterfeited either. Thus, Bitcoin protects your money much better than any other currency.

See, with any other national currency in the world, the Central Bank of that country can (and often does) arbitrarily "make up" more and more money.

This means that the money you saved is worth less and less as time goes by. Remember that $50 supermarket bill last year? Today, you're either paying $80 or getting less food. Tell me it ain't true.

This gradual but terrible tragedy simply can't happen with Bitcoin. Bitcoin has a hard mathematical limit. This limit cannot be fooled by any means. Not by a Central Bank, and not by a private counterfeiter either.

I have some Bitcoins now. How were they made?

Bitcoins aren't made by anyone. They are "mined" (like gold in the real world, or diamond in Minecraft).

"Mining" is a mathematical race. It's about randomly guessing big numbers and doing calculations with them. Whoever gets to an undiscovered number first, "wins" the race. Everybody else in the race uses the same math to verify the win. Then the winning miner gets some confirmed Bitcoins.

As you might have guessed, numbers games are best played with computers, and lots of people (called "miners") happily play it. They play it for two reasons:

  1. To win newly "mined" Bitcoins.
  2. To confirm and profit from Bitcoin transfers that pay (very small) fees.

As time goes by, "mining" gets harder and gives miners fewer coins. The Bitcoin system does this to prevent newer and faster computers from mining too many coins at once.

Why can't anyone just "invent" their own Bitcoins and throw them into the world?

The short answer is:

Because Bitcoins must be "mined". Mining involves very hard math that cannot be faked.

The somewhat longer answer is:

Bitcoins mined with one computer are checked by millions of other computers to see if they are genuine. The mined Bitcoins are only valid after several computers confirm "yes, these Bitcoins are genuine".

The checker computers verify that the mined Bitcoins:

  1. didn't re-use previously discovered numbers
  2. didn't use fraudulent or faulty calculations

Checking Bitcoins for authenticity is much, much faster than mining. It's much like checking a password -- it's also much faster than trying to guess it.

How many Bitcoins are there?

Right now, about 8 million Bitcoins have been mined. The hard limit is 21 million. 99% of it will be mined by 2036, according to estimates.

Only 21 million? Bah, that's not nearly enough for the entire world!

Unlike dollars (with 100 cents to a dollar), Bitcoins can be divided beyond millionths. The smallest amount of money you can make with Bitcoins goes down to 8 decimal places. There's no practical reason why a pack of gum can't cost 5 microBitcoins (μBTC).

If 1¢ was equivalent to 0.01 μBTC, then:

  • $1 would be worth $1 μBTC,
  • $1,000 would be 1 mBTC (milliBitcoins),
  • a million dollars would be 1 Bitcoin,
  • a billion would be 1,000 Bitcoins (U.S. "billions" here, sorry for that),
  • a trillion would be 1,000,000 Bitcoins,
  • 21 trillions would be 21,000,000 Bitcoins (the total carrying capacity of Bitcoins),

And that's just for Bitcoins themselves. The amount of debts and promises to pay Bitcoins has no limit, just like it doesn't have any limit with any currency today.

Now that you know this... 1 Bitcoin sounds like a helluva lot of money to pay for a banana, right?