Bitcoin is the first decentralized digital currency, created to allow transactions to be sent directly via the internet without needing to use and trust third parties like banks. All bitcoin transactions are stored in a blockchain, which is a ledger that is publicly broadcasted and accessible. The key idea here is decentralization, which gives control to the users of bitcoin.
Unlike physical money, digital currency can be be easily copied and sent while the sender keeps the original. For traditional electronic payments, a bank or another trusted third party is needed to make sure that people don’t spend money that they don’t have. This third party facilitates online transactions and regulates disputes, like when a buyer attempts to reverse a transaction. This kind of system relies heavily on this third party, which both the buyer and the seller must trust.
Instead of trusting a centralized institution, bitcoin transactions are verified by having computers do a certain amount of work in the form of solving number problems. In this verification process, also known as mining, the work done by the computers makes it impractical for a fraudulent transaction to be accepted. Someone attempting to send a dishonest transaction would have to put in more computational work than the entire rest of the network combined to add their transaction to the blockchain, and must continue to put in more work for the transaction to remain valid. This is essentially impossible, which allows bitcoin transactions to occur on the internet without the need for trust or a third party.
Perhaps more important, users have full control over the bitcoins in their wallets just as they have full control over their physical cash. When a user’s money is in a bank, the institution is trusted to have the funds available for the user to withdraw at any time. Practices such as fractional reserve banking make it possible for banks to have not enough funds should everyone decide to withdraw their money at the same time. This normally does not occur if the banking institutions manage their risks well. However, if a lot of money is created through loans, then a lot of money can disappear when too many people are unable to pay their debts. This is exactly what happened in the financial crisis of 2008.
Since bitcoin transactions don’t need to go through a third party, transaction fees are lower. Bitcoins can be sent to any address, anywhere in the world, which makes it highly versatile and anonymous. Like cash payments, bitcoin transactions are irreversible, which allows them to occur over the internet without trust. This protects sellers from fraud, while multi-signature transactions protects buyers from dishonest sellers.
Paper money is given its value by a central authority, the government. As a result, the value of the currency is closely tied to the government, which can control the amount of currency in circulation by printing new bills and by destroying old ones. Newly-printed money is sent to banks and are put into circulation when someone withdraws money. New bitcoins are created when miners verify transactions. There is a limit to the number of bitcoins that can possibly go into circulation, which is 21 million. This makes bitcoin a deflationary currency, which is unlike traditional currencies in that the value of each bitcoin is expected to increase over time.
Although bitcoin is in the process of being adopted by the public, only 0.1% of the world’s population is using it. New technology has made it easier to obtain and use bitcoin. Bitcoin ATMs have been appearing in major cities, allowing people to purchase the currency using cash. Companies like TenX have made it possible for users to convert and spend cryptocurrencies anywhere and anytime using a debit card.
The concept of decentralized currency is incredibly powerful. Bitcoin has inspired many other cryptocurrencies that each seek to improve upon existing currencies or solve new problems using blockchain technology.
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