It seems like almost hourly there is a new headline about Bitcoin. It’s been a truly remarkable year – starting the year at $900 and quickly surpassing price levels of over $17,000! But what is this technology? Below is a high-level summary of Bitcoin and the fundamentals of how it operates.
What is Bitcoin?
Bitcoin was introduced in a white paper published in August 2008 by Satoshi Nakamoto, an anonymous author. The white paper introduced the concept of a cryptocurrency. A cryptocurrency is a decentralized digital coin designed to store value and facilitate payments. The major difference between a cryptocurrency and our current money system is the way those transactions are validated, processed, and logged.
Currently, when you purchase an item from a store, the payment between you and the vendor gets processed from you telling your bank, your bank talking to the vendor’s bank and validating the information, and finally the vendor’s bank settling the payment. For this service, the banks will take a fee. In the cryptocurrency world, all transactions that happen, occur anonymously and directly with your counterparty. This part of the process happens in what is called the blockchain. By utilizing the blockchain you can interact anonymously and cut out the middleman, which reduces the cost of the overall transaction.
What is the blockchain?
Blockchain is the innovative technology that is the backbone of Bitcoin. A blockchain can be thought of as a community of individuals who authorize and validate transactions. As two individuals enter into a transaction, the information regarding the transaction is sent to all members. The members then validate the transaction and enter this information on their own records. This process creates a block of information. As transactions continue and more blocks are created, the information is then added to a running log or chain, thus creating a blockchain.
But why would anyone want to verify these transactions? That is where the concept of ‘mining’ Bitcoins is introduced. Mining involves solving very complex algorithms using highly sophisticated computing power. The reward for verifying transactions and mining information is a payment in newly minted Bitcoin. This incentive allows the community to continue to validate these transactions and create a strong network.
The blockchain allows Bitcoin to be a secure, anonymous, direct, and decentralized form of currency for transactions. As the two parties decide to transact with one another the information is sent to be validated and stored by the blockchain. Blockchain is a powerful technology that has the potential to disrupt the way that the banking, real estate, healthcare, and legal industries, to name a few, operate in the future.
Bitcoin is a very divisive topic today ranging from being heralded as the “greatest innovation in mankind’s history” all the way to being a flat out “fraud.” We are not sure of what the future holds for Bitcoin, but starting to understand how it operates is the first step towards forming one’s opinion. It will be interesting to see where this innovation ends – will it be the next Dutch tulip bubble or the next Internet?