Despite a growing level of interest in bitcoin and a rapidly expanding number of blockchain technology resources, it can be very hard to find a simple bitcoin explanation. Bitcoin is a specific type of blockchain created to serve as a currency. In 2009, partly as a response to the banking crisis, an anonymous individual or group known as Satoshi Nakamoto created a digital peer to peer payment system based on a complex mathematical formula (whitepaper.) The intent was to use that ledger as a record keeping system for financial transactions between individuals anywhere in the world without using the services of any bank or central authority. The system is supported by having complex mathematical equations solved by a network of connected computers (miners) distributed throughout the world. These miners perform complex calculations in order to win the right to record a block of transactions. The miner that successfully completes a block receives a reward in bitcoin and the transaction fees associated with that block of transactions. Other computers throughout the world test the result obtained by the first miner to confirm the validity. Once enough miners validate the transaction, it is permanently recorded in the blockchain. The record is immutable, it cannot be modified or deleted.
Simple bitcoin explanation restated
This is why bitcoin and blockchains are referred to as immutable, decentralized or distributed ledgers. The records cannot be modified once confirmed. The blockchain is not stored on any one central server. The series of records, or blocks, are recorded in the order processed to create a chain. No one institution, government, or individual can control the process or the results. It is also noteworthy that bitcoin transactions and addresses (the public keys) are completely transparent. You can search bitcoin wallets for amounts held, received and sent using bitref and other blockchain search sites. Despite the public nature, access to the funds stored on any blockchain address is controlled using a private key (password) created along with the public key using a complex encryption algorithm. Although you can see address balances, the funds can only be accessed with this private key. The encryption is considered to be unbreakable by anything short of a quantum computer.
Bitcoin has a limited supply
The complex math involved in the bitcoin software algorithm results in a finite limit of 21 million bitcoins. By mid 2017, there were 16.5 million mined, or created. Some of those have been lost forever by individuals who threw away their private keys or devices used for their storage, or who simply forgot about their bitcoins and addresses. The mining difficulty increases over time, so supply will increase at slower rates until 21 million total is reached. The supply will reach the 80% mark in 2018, but isn’t expected to see the 95% point until after 2024. However, bitcoin is traded in fractions of as small as 0.00000001. This results in a much higher number of available units of currency for transactions. You don’t have to buy, sell or trade in whole numbers.
How does bitcoin get its value?
The most common question about bitcoin is probably “why does it have any value?” The best answer is that the market determines the value. Running the mining nodes requires considerable equipment costs as well as power costs. There has to be some value assigned, or the networked miners would stop. There is increasing demand throughout the world from individuals and institutions who want to buy and hold bitcoin. No one can predict whether that will continue or whether interest and demand will wane. Bitcoin went through a similar cycle of price fluctuations in 2013-15.
How is bitcoin used?
You will not only need to understand the simple bitcoin explanation put forth here, it is important to also note that market and societal pressures have influenced bitcoin’s progression since inception. Although bitcoin was initially conceived and created as a means of transacting business throughout the world without involving banks, governments, or fiat currencies, it has begun to transition into more of an investment vehicle. Most buyers of bitcoin in 2017 are doing so to either speculate on future value increases or to store some portion of their wealth outside of institutional control, or both. Institutional investors are also beginning to take an interest. Many large funds are unable to purchase and hold bitcoin due to their own internal restrictions on allowable asset classes. This is gradually changing. The Chicago Mercantile Exchange will soon begin trading bitcoin futures. Goldman Sachs has begun following the market with their dedicated analyst issuing regular reports.
Should I buy bitcoin?
Individual investors will most likely buy bitcoins from exchanges like Coinbase, Gemini, or Kraken. Localbitcoins and ATM’s are additional ways to get started with bitcoin investing. Be sure to read our Easy Ways to Buy Bitcoin article, and make sure you understand wallets by reading Cryptocurrency Wallets and Why You Need One. The decision whether to buy bitcoin will be up to the individual, of course. It can be a very volatile asset with regular price swings of 20-30%. Be sure your risk tolerance is high, and never invest more than you can afford to lose. Be sure you have expenses and debts covered, as your bitcoin value may drop at any time.
Hopefully you found our simple bitcoin explanation informative and helpful. Now that you understand why bitcoin is called a decentralized, immutable peer to peer transaction ledger, you’re ready to dive deeper in your research to get a better understanding of how things work. Those buzz words shouldn’t be intimidating when you encounter them in other articles.
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