Bitcoin has been in the news recently in both positive and negative ways but what actually is it? Technically Bitcoin or BTC is a cryptocurrency which uses a peer-to-peer system and which is limited in extent.
So what does that mean?
This means that it is a digital currency and that instead of having a central bank with a country’s gold reserves and counterfeiting technology behind it bitcoin uses cryptography to prevent people making counterfeits. In bitcoins’s case it uses a very complicated mathematical formula to let people mine or ‘make’ coins.
Bitcoin’s or part Bitcoins are stored on your PC in a file called wallet.dat. The wallet software communicates online with other Bitcoin users and a register of all transactions is kept distributed on all users machines. That way if you want to pay someone you simply put in their code, for example 1DMChcAHedH9qJDV1QJpTfCNcxhhgDEbDa and your ledger syncs with everyone else’s and the money is effectively transferred. The advantage is that no-one can control the system and that there is no central point required to make payments.
Limited in extent
Because of the way that Bitcoin works the total amount of Bitcoin’s in the world is finite and fixed, even if some of them are yet to be found. This means that the normal biggest problem of new currencies – inflation – is far less likely to be risk. Over time if Bitcoin becomes more popular smaller and smaller fractions of coins will be used to buy things – this is deflation rather than inflation.
All these things put together have several useful outcomes for the end user this means that as the supply of Bitcoin is limited in amount that any money you have in Bitcoin should become more valuable over time, that it is somewhat anonymous and that it is international. The disadvantage is that if you lose the wallet file on your PC (such as to a hard disk crash) there is no way to recover your money and that is there no central authority which means more privacy but less security guarantees. Bitcoin will not replace dollars or pounds in the near future but its or its descendents stand a good chance of becoming a online currency we all can use.
This article was first published on 2 June 2013 and last updated on 6 June 2017.