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Bitcoins for Beginners
Bitcoins are all over the news. Over the past few years, retail stores have begun to accept Bitcoin as payment. Some nonprofits also now accept them. But there’s also been controversy. After all, Bitcoin was a major player in the Silk Road scandal that broke early this fall. In December, China prohibited Chinese financial institutions from dealing in bitcoins. And just yesterday, the CEO of a bitcoin exchange called BitInstant was arrested on money laundering charges.
Now, I’m reasonably tech-savvy. I’m probably average for my generation. I know a good chunk of the vocab, I’m a quick learner, and like most millennials, I grew up using a computer. But to be honest, Bitcoin didn’t make sense to me. The idea of a crypto-currency is hard for me to wrap my mind about. And I figured that if I was having a problem understanding bitcoin, a lot of average people just like me were too. It took me about 2 hours to become reasonably well acquainted with the system, but I’m figuring most of you don’t have that free time, or a job where spending 2 hours on the computer learning how to use bitcoin is not only acceptable, but encouraged. So I was inspired to write this article–Bitcoin for beginners–to save you all that time and effort.
Let’s start at the beginning.
What is Bitcoin?
Essentially, Bitcoin is a currency. I’m sure your next question is how something intangible and online can be a currency, and I’m going to answer that with an example. United States cash money, at its core, has no inherent value. I just paid for my lunch with a 20 dollar bill, and it was accepted because both myself and the cashier agreed that it was worth that much money. But the piece of paper itself? That’s worth absolutely nothing. It’s not backed by gold or silver or jewels. If an alien suddenly landed on earth and we showed him that piece of paper, he wouldn’t agree that it’s worth 20 dollars, because it would have no value to him. At the end of the day, rendered its most basic form, the only thing that keeps a currency from being arbitrary is the value given by a society.
So Bitcoin is its own online currency, started by a developer with the pseudonym Satoshi Nakamoto. It is given value by the way it is traded, created, and used. It exists based on a set of rules that are agreed upon by all the people who are involved in the Bitcoin market.
But…what’s a Bitcoin?
A bitcoin is a unit of the currency. At this moment, a single bitcoin is worth roughly $800, though that fluctuates.
Why would you want Bitcoin?
There are a lot of advantages to a currency like Bitcoin. One of the most important is that it’s anonymous. It’s completely controlled by the users, so there’s no middleman, like an institutionalized bank. As a result, funds can never be stolen.
How are bitcoins made?
This is where it starts to get a little bit complicated because we’re going to have to go into the history of the online currency, but please, bear with me. This is also going to be very much simplified, so if you’re interested in the process, I’ll recommend some more technical sources at the end of this article.
Satoshi Nakamoto, the person (or possibly, group of people) who created Bitcoin wanted to create a currency that anyone with access to a computer can use and access. So in order to distribute the first bitcoins and create a self-perpetuating market, they made a very complicated software that is essentially a series of giant, very difficult math problems. It takes a ton of processing power to break one of these problems. People who are attempting to mine bitcoins are running a program that tries to answer a problem, and when they do, that information becomes something called a “block.” A “block” is currently worth 25 bitcoins, although that has also fluctuated over time. Since everything is better with a visual, click below.
Who mines bitcoins?
At this point, it’s incredibly difficult for an individual to mine a bitcoin. Individuals who mine them are usually not even able to use their personal computers but rather need to invest is special machines called ASICs. They’re pretty much supercomputers dedicated to bitcoin mining. These machines can cost anywhere from $1000-$5000, which sounds like a lot, but given the huge potential reward, makes sense.
The other way that bitcoins can be mined is in a group of people, or a mining pool. You donate some of your computer’s processing power to creating bitcoins, and then you get a proportional share. It still is hard to do, and takes up a lot of energy, but it is possible. If you’re interested in joining a mining pool, here’s a couple of really great videos that explain how it works.
Is there any other way to get a bitcoin?
Sure. You can buy them. Or, if you have your own company, you can receive them as payment.
If there’s no central authority, like a mint, creating bitcoins, what prevents too many from existing and currency from becoming worthless?
Bitcoins are self-managing. They’re mainly kept rare by the fact that at some point there will not be anymore code in the program to break, or unique blocks to create. By 2140, we will run out of the ability to make new bitcoins and the supply will top out at around 21 million bitcoins. In this sense, bitcoins are more of a finite resource–like gold or gas, than printed money.
Where do I…put these bitcoins?
You need to create a bitcoin wallet, which looks reasonably like a simplified online banking account. The wallet is linked to a bank that keeps track of all the bitcoin transactions in existence. When you receive a bitcoin, whether as payment, or through mining, the bank recognizes it and reroutes it to your personal wallet.
What is this about bitcoins being anonymous?
Bitcoins are tied to a private key, which is sort of a signature, but even more secure. Someone has the private key to the their wallet, and they use that to sign and authorize any transactions. There are also public keys that are used for the transfer of money, but those change with each transaction to protect privacy. Essentially, bitcoins are anonymous in the same way that a cash-paying customer is most likely anonymous. For this reason, they were commonly used on the popular illegal drug (and other things) dealing site SilkRoad before it was shut down by the FBI.
If you have a bitcoin, what can you use it for?
A lot of things! Here’s a directory of places where you can spend bitcoins, and there’s some genuinely recognizable and popular companies included. For example, Overstock.com now accepts bitcoins.
Aren’t bitcoins associated with criminality?
Bitcoins have gotten a pretty bad rap through association, but by themselves no, they are not associated with criminals. Because of the anonymity factor, they were used for some sketchy illegal purchases through Silk Road, but that says more about Silk Road than Bitcoins. And yes, a Bitcoin exchange CEO just got arrested for money laundering, but that is possible with any financial manager. Really, bitcoin is about as sketchy as cash, but is by no means associated only with criminals.
Why should I care about bitcoins?
At the end of the day, Bitcoin can best be described as an experiment. When it was first started in 2009, no one who got involved had any idea if it would work. So far it has. People who got in at the ground floor of Bitcoin are now potentially very wealthy.
I think it also says something about the way that our money is used in the future. I rarely carry much cash on me, because I always have my debit and credit cards on me. So not only do I not need cash, but if I ever were to lose my wallet, I could just cancel my debit card without losing any money. If I lost cash and my wallet wasn’t recovered, that cash would be gone for good. We are becoming more and more technology based in the way we pay for things, and I think that Bitcoin, or currencies similar to Bitcoin are just going to get more popular.
So should we all get in on this Bitcoin thing?
Honestly, probably not. If you have $800 to drop on a bitcoin and you want to, it’s probably not the worst idea in the world. It’s like any other investment–it’s a gamble. But it could be a very smart gamble. Analysts are claiming that the worth of bitcoins could skyrocket. For example, Venture Capital Post is predicting that they’ll each be worth between $4000-$5000 by the end of this year. Or they could plummet. The rise in recent months have been nothing if not meteoric, but that doesn’t actually mean much. Given that this is the first company of its kind, it is totally possible for this to crash and burn.
Here’s the thing. I think we may have all missed the boat to get rich off of bitcoins. At one point in 2011, bitcoins were valued at about $1-$2 each. It would have been awesome to have bought one back then and now have it worth $800 but of course, hindsight is 20/20. Now, mining bitcoins as an amateur is very hard. It’s possible to do, if you’re part of a pool, but with all the attention that bitcoins have been getting recently, as well as the crazy prices, the mines are getting pretty crowded. I would recommend that we all see where this quick price rise is going to go before getting into the mix. But, I would also recommend that we start to get used to online currency of this sort.
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Anneliese Mahoney (@AMahoney8672) is Lead Editor at Law Street and a Connecticut transplant to Washington D.C. She has a Bachelor’s degree in International Affairs from the George Washington University, and a passion for law, politics, and social issues. Contact Anneliese at amahoney@LawStreetMedia.com.
Featured image courtesy of [Antana via Flickr]
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