Bitcoin was created in 2009 by Satoshi Nakamoto as a peer-to-peer (P2P) digital currency. Peer-to-peer means that there is no intermediary (bank) between transactions and no central authority (Treasury) to either issue more of the currency or regulate its supply. Instead, all bitcoin transactions are controlled by a community-driven network. Bitcoin is the first implementation of crypto-currency, a notion that defines money as anything that can be accepted as payment for goods or services and repayment of debt commonly accepted within the precepts of a given society. Bitcoin employs this idea by using cryptography to control itself and serve as money without relying on any established central authority.
The structure of the bitcoin is very intricate, and certainly not easy to summarize in a single posting. There are several areas that need to be addressed independently in order to generate a holistic understanding of what a bitcoin is and how it works. The first step to understand bitcoins is to define some associated concepts and the essential mechanics, which normally work as simple concepts with sophisticated analytics behind them. Bitcoins’ structure operates under three basic rules: there is a hard limit of 21 million bitcoins worldwide, bitcoins are divisible to 8 decimal places, and the bitcoin net-worth is regulated by “blocks”.
Blocks are sequential bitcoin generators and the basic infrastructure of the model. Blocks are complex mathematical algorithms that need to be solved in order to release new bitcoins; they form the links of a chain that controls how every single bitcoin was created, as each block contains data about the previous transactions, a random number (nonce) and the hash (SHA-256) of the previous block. Every time a block is solved, 50 bitcoins are yielded (currently). This amount is halved every 210 thousand blocks (about every 4 years) and the total number of blocks will be determined when the 21 million bitcoins are released (expected by the year 2045); as of today, the current block count stands at 144,083 and is moving at an average rate of 6 blocks per hour (1 every ten minutes). Solving blocks requires effort and the allocation of resources, for which the reward of yielding bitcoins is given by peers to the individual solving the block after evaluating the proposed solution by following a set of agreed-upon rules. The bitcoin community recognizes this action as “Mining”.
The value of the Bitcoin can be seen from different perspectives. Pragmatically, it’s a currency that can be easily transferred, there is no intermediary and therefore transaction fees are nonexistent or minimal, and they cost very little and are safe from financial instability from central banks. Economically, bitcoins are in fact valuable, as they are accepted as payment for goods and services and therefore their intrinsic value can be translated into other currencies - like the dollar - and they obey the laws of supply and demand. In theory, this means that just as some currencies can be backed up by gold, bitcoins are backed up by an aggregated index of the market. Bitcoins are primarily imbued with valued by the work “miners” put into them and the goods, services and other currencies they can procure. Hey, if some pizza joints now accept bitcoins as payment, then they must have some value.
Throughout the three-year history of bitcoins, their associated financial value has fluctuated tremendously. From the moment the “genesis” block was created in 2009 to this moment, the price of a bitcoin has been all over the place, from 1¢ at its lowest to $18 USD or more at its highest per BTC (the bitcoin financial abbreviation), and as of August 31st, 2011 the dollar-to-bitcoin exchange rate was $8.81.
So there you go, you now have a brief overview of this new currency known as “The Bitcoin System.” Much more can be discussed about it; whether the bitcoin will at some point be regulated by a central bank and will become just another currency, or whether its value will rise or fall or will disappear altogether is hard to anticipate. As a young currency, it’s still too early to know what effects it will have on our current financial markets and how its mechanics are influenced by changing economic conditions. In the meantime, all we can do is observe, learn and not get too crazy about it just yet. But if you want to start acquiring bitcoins, you can always accept them as payment, trade them for traditional currency or solve the next block in the bitcoin chain.
I currently hold no stake at any bitcoin related site nor do I intend to do so for the next 30 days.