Understanding Bitcoin: The Basics

The concept of Bitcoin, or the more general term cryptocurrency, remains a mystery to many people (including myself) for the simple reason that it really is something completely new within a concept that is very old, money. While we have all gotten used to many things in our lives turning digital i.e. pictures, books, retail stores, etc., the idea of money becoming truly digital can have a strange impact. At first one might say, “Hey this is no big deal, we already have electronic credit card payments, wires, ACHs so what’s the fuss?”. However, once you dig a little deeper the questions become a bit more comprehensive. How can I really give someone value over the internet just like handing someone cash? Who’s in charge of this operation? Where does the value of Bitcoin really come from (you can check the current dollar value of a Bitcoin at coindesk.com/price)?  These are just a few of the questions that arise when one considers the implications of an operational digital currency. Now to fully understand the Bitcoin system it would take much more than one blog post, however I will expand on the basic rules of the Bitcoin system here.

Bitcoin is a system of exchange whereby value in the form of Bitcoins are transferred over the internet from one party to another. There is no third party involved to verify or track the transactions. The system if fully self regulated. One of the main attributes of the system is the idea that Bitcoins can only be transacted once. For example, if you have a digital picture on your smart phone and you want to send it to a friend, you can very easily text or email that picture in seconds. However, you still have the picture on your phone. You haven’t actually ‘given’ anything to your friend. This is the case with many types of digital content and this is why digital content that can be easily copied does not have any intrinsic value. Bitcoins could not operate in this kind of environment.

Bitcoins must have intrinsic value to serve as a medium of exchange. Think of Bitcoins as gold, only in this example the gold is not only the asset of value but also the medium of exchange. Long ago when humans traded largely with the barter system the asset of value was the medium of exchange. With modern currency, or fiat currency, currency represents value but is not the asset of value. Also, with the repeal of the gold standard in the US in 1971 the US dollar ceased to be directly attached to any physical asset. With Bitcoins, you are basically using digital bits of ‘gold’ to buy and sell items. Items can be bought or sold as part of commerce or for speculation, just as if physical gold were actually used as a medium of exchange (and if it was, people would still want to save it or invest in it for speculative purposes because of its value).

At this point you may have more questions then answers (I would urge you to visit bitcoin.org for more information) but if nothing else remember this: one of the main motivations of the Bitcoin model is to bring back an asset backed currency to the world that is not regulated by banks or governments and can be used by anyone in the world.

Some of the major concepts that the success of Bitcoin depends on that were not explained in this article are:
1) The solution for ‘double spend’ (which I alluded to earlier with the picture being digitally copied)
2) The blockchain
3) Bitcoin exchanges
4) Privacy
5) Open source code
6) Decentralization
7) Security (digital signatures)

Do you think Bitcoin has a future in commerce? How do you think Bitcoin will affect the businesses you work at or patronize? There is much more explanation necessary to fully understand the Bitcoin system which is why I am considering writing a series of blog posts on this subject diving into each of the concepts listed above. Is this someone you are interested in continuing to read about?

Please leave me your comments.