What is Bitcoin?
Bitcoin is a virtual currency. As with all currencies, they function as a mean of exchange and a store of value.
As a mean of exchange, you can use them to purchase goods and services just like you will with your physical money. (The actual process is somewhat different but we will come to that in a while).
As a store of value, we can accumulate more bitcoins than we require for now and stash them away in our virtual wallet. One bitcoin in your virtual wallet remains there until you withdraw or spend it just like your one dollar remains in your bank account remains until you withdraw or spend it.
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How is it different from physical currencies such as the US dollar or the Singapore dollar?
Currencies are backed up by the country issuing them. Take a moment to examine the money in your BigFatPurse (pun intended) right now and you will notice the words ‘legal tender’. What this means is that these coins or banknotes must be accepted in payment of a debt.
For example, Starbucks is legally bounded to accept my dollar notes in exchange for their coffee. On the other hand, if I insist on paying for my latte with two bananas, they have every right to refuse me my drink.
Bitcoin on the other hand is not backed by any country. Think of the Bitcoin currency as Gold in virtual form. No nation is on the gold standard now, meaning there is no fixed price for gold anywhere in the world at this time. The reason why Gold (and Bitcoin) is worth a certain value is because of the laws of demand and supply.
What about the value of the currency?
This stability creates confidence in the minds of consumers and businesses utilising the currency.
Because there is no Central Bank doing the same for Bitcoin, the value of Bitcoin is left entirely to market forces (and speculative activity). Unfortunately this caused massive fluctuations in the value of the currency.
At the time of writing, one Bitcoin is worth USD 640
How many bitcoins are there in the world?
If there is an indefinite amount of a commodity in the world, the value of that commodity would decrease. Rarity creates value. It might help to think of the Fed printing money as devaluing the US dollar.
Hence there must be a cap to the total number of bitcoins in existence. A pre-determined schedule allows that and the total number of bitcoins will eventually converge to 21million in the year 2140.
Miners? How does one mine a virtual currency?
Like traditional gold miners who exert physical labour to extract ore from the earth, mining for the virtual currency involves using computers to perform complex data processing activities.
Miners are rewarded for their efforts with blocks of bitcoins after their solutions are submitted to the Bitcoin network. At this moment, one block is worth 25 bitcoins and that number will halve approximately every four years.
All this seems very complicated. Why is there a need to mine?
Mining solves the distribution problem for virtual currencies. Unlike physical currencies where there is a central authority to print and distribute, there is no way to answer the – who gets the money? question for Bitcoin. Mining presents the most elegant solution by demanding and subsequently rewarding, effort.
Most users of Bitcoin can disregard the mining process. Purchasing bitcoins is the more common option for the majority.
Find out how to purchase and use bitcoins in part two of our series coming up