Bitcoin is a cryptocurrency and a payment system invented by an unidentified programmer, or group of programmers, under the name of Satoshi Nakamoto. Bitcoin was introduced on 31 October 2008 to a cryptography mailing list, and released as open-source software in 2009. The system is peer-to-peer, and transactions take place between users directly, without an intermediary. These transactions are verified by a network and recorded in a public distributed ledger called the blockchain, which uses bitcoin as its unit of account. Since the system works without a central repository or single administrator, the U.S. Treasury categorizes bitcoin as a decentralized virtual currency. Bitcoin is often called the first cryptocurrency, although prior systems existed, and it is more correctly described as the first decentralized digital currency. Bitcoin is the largest of its kind in terms of total market value.
Bitcoins are created as a reward in a competition in which users offer their computing power to verify and record bitcoin transactions into the blockchain. This activity is referred to as mining and successful miners are rewarded with transaction fees and newly created bitcoins. Besides being obtained by mining, bitcoins can be exchanged for other currencies, products, and services. When sending bitcoins, users can pay an optional transaction fee to the miners. This may expedite the transaction being confirmed.
Despite storing over fifteen billion dollars in value, Bitcoin still generates confusion around its classification. The Commodity Futures Trading Commission (CFTC) asserts that it’s a commodity, the Internal Revenue Service (IRS) deems it property, and the U.S. Securities and Exchange Commission (SEC) has decided to approach it on a case-by-case basis. The term cryptocurrency further muddles the regulatory situation, as it implies cryptocurrencies are a subset of the currency asset class, which we think is not the case. In our opinion, Bitcoin is a new asset class. Bitcoin is a currency and a share rolled into one.
Just remember Bitcoin can be used as a currency and has all the features a currency has but at the same time Bitcoin can be viewed as an asset. A share in the Blockchain. There are many use cases for this new invention so it’s not limited to a currency only.
What is currency?
So Bitcoin is a currency which uses cryptography and peer to peer networking to create a decentralized virtual currency. Before we explain what cryptography is and what peer to peer networking means we must first understand what a currency is.
The invention of money and currency
So a currency is a medium that can be exchanged for goods and services and is used as a measure of their values on the market. Currency can come in different shapes, sizes and forms. Money is the currency we use today but back in the day the currency of choice was for example salt, sugar or gold. Money isn’t just pieces of paper. It’s a medium of exchange that facilitates trade. Suppose I have a Charizard Pokémon card that I’d like to exchange for a new pair of shoes. Without the use of a currency, I have to find a person, or combination of people who have an extra pair of shoes to give up, and just happen to be looking for a Charizard Pokémon card. Quite obviously, this would be quite difficult.
Since money is a recognized medium of exchange, I do not have to find someone who has a pair of new shoes and is looking for a Charizard Pokémon card. I just need to find someone who is looking for a Charizard card who is willing to pay enough money so I can get a new pair at the local shoestore. This is a far easier problem, and thus our lives are a lot easier.
but what about cryptography?
So Cryptography is the art of protecting information by transforming it (encrypting it) into an unreadable format, called cipher text. Only those who possess a secret key can decipher (or decrypt) the message into plain text. Cryptography systems can be broadly classified into symmetric-key systems that use a single key that both the sender and recipient have, and public-key systems that use two keys, a public key known to everyone and a private key that only the recipient of messages uses. Bitcoin and other cryptocurrency’s are based on a public-key system.
You mentioned Peer to Peer, what the heck is that?
Peer-to-peer (P2P) is a decentralized communications model in which each party has the same capabilities and either party can initiate a communication session. Unlike the client/server model, in which the client makes a service request and the server fulfills the request, the P2P network model allows each node to function as both a client and server. P2P systems can be used to provide anonymized routing of network traffic, massive parallel computing environments, distributed storage and other functions.
Typically, peer-to-peer applications allow users to control many parameters of operation: how many member connections to seek or allow at one time; whose systems to connect to or avoid; what services to offer; and how many system resources to devote to the network. Some simply connect to some subset of active nodes in the network with little user control, however.
Although uses for the P2P networking topologies have been explored since early days of the internet, the advantages of the P2P communications model didn’t become obvious to the general public until the late 1990s, when music-sharing P2P applications like Napster appeared. Napster and its successors — like Gnutella, and more recently, BitTorrent – cut into music and movie industry profits and changed how people thought about acquiring and consuming media. And now it’s time for Bitcoin and the blockchain to do the same to the financial services industry.
Reggie Middleton on what the Peer to Peer economy is and how it will change things forever:
So what is a Cryptocurrency? (Bitcoin)
A cryptocurrency (or crypto currency) is a digital asset designed to work as a medium of exchange using cryptography to secure the transactions and to control the creation of additional units of the currency. Cryptocurrencies are a subset of alternative currencies, or specifically of digital currencies.
Bitcoin became the first decentralized cryptocurrency in 2009. Since then, numerous cryptocurrencies have been created. These are frequently called altcoins, as a blend of bitcoin alternative. Bitcoin and its derivatives use decentralized control as opposed to centralized electronic money/centralized banking systems. The decentralized control is related to the use of bitcoin’s blockchain transaction database in the role of a distributed ledger.
Decentralized cryptocurrency is produced by the entire cryptocurrency system collectively, at a rate which is defined when the system is created and which is publicly known. In centralized banking and economic systems such as the Federal Reserve System, corporate boards or governments control the supply of currency by printing units of fiat money or demanding additions to digital banking ledgers. In case of decentralized cryptocurrency, companies or governments cannot produce new units, and have not so far provided backing for other firms, banks or corporate entities which hold asset value measured in it.
As of March 2015, hundreds of cryptocurrency specifications exist; most are similar to and derived from the first fully implemented decentralized cryptocurrency, Bitcoin. Within cryptocurrency systems the safety, integrity and balance of ledgers is maintained by a community of mutually distrustful parties referred to as miners: members of the general public using their computers to help validate and timestamp transactions adding them to the ledger in accordance with a particular timestamping scheme.
The security of cryptocurrency ledgers is based on the assumption that the majority of miners are honestly trying to maintain the ledger, having financial incentive to do so.
Most cryptocurrencies are designed to gradually decrease production of currency, placing an ultimate cap on the total amount of currency that will ever be in circulation, mimicking precious metals as opposed to fiat currency which can be printed endlessly. (In europe currently 60 billion euro’s a month.) Bitcoin is inherently deflationary as a currency due to its hard cap at 21 million — or at least it will be deflationary when that cap is finally hit (the current inflation rate is roughly 9%). Most economists, such as Paul Krugman, find deflation to be a horrible thing, which is why they do not think bitcoin could work well as a currency. Part of where this fear of deflation comes from is, historically, it’s associated with very bad economies. So, during the Great Depression of the 30s, there were falling prices. And there are other periods where prices fell when things were bad, but I would argue that the causality was the other way around. Partly what was going on there was people were concerned because the economy was so terrible. And, so what do you do when you’re afraid? You don’t want to invest in companies and things like that. You rush to liquidity. You rush to hard money. That’s why you often see in periods of panic people will rush to the money, so you see prices of all other things quoted in money fall. So, it’s not that the falling prices caused the bad economy. It’s the other way around. Of course, whether or not deflation is a net good for the entire economy does not matter when it comes to the adoption of Bitcoin as a currency. If one currency is deflationary and another currency is inflationary, which one would the general public rather store over the long term? Obviously, individuals will choose the one that rises in value over time.
Want to learn more about the Blockchain and how Bitcoin works? (the technical stuff)
read more in the next chapter: How does Bitcoin work?
*Sources: https://en.wikipedia.org/wiki/Bitcoin, http://research.ark-invest.com/hubfs/1_Download_Files_ARK-Invest/White_Papers/Bitcoin-Ringing-The-Bell-For-A-New-Asset-Class.pdf, https://en.wikipedia.org/wiki/Cryptocurrency, http://searchnetworking.techtarget.com/definition/peer-to-peer