Last updated on January 2nd, 2018 at 12:00 am
Bitcoin is a new kind of money. My purpose here is to explain it in very simple terms. If you are already an experienced Bitcoin user, or if you know a great deal about business and finance, this essay may seem very facile, and you may prefer to read the more detailed “What is Bitcoin?“. The objective is not to bore you, but to address complex topics so that new users, including young children, can understand. You might think of this article as a variation on the theme of “Bitcoin for dummies,” or “Cliff Notes for new Bitcoin users.” This article is only the first in a series, which will be linked together once all have been published.
What is Bitcoin?Bitcoin is money. Which is a great answer in some ways and challenging in others. Some people who consider themselves experts on money don’t agree that Bitcoin is money. And, of course, you might not be too sure what money is. To paraphrase an old Supreme Court decision, “I don’t know how to define it, but I know it when I see it.”
If you are like many other people, you know money when you see it. Money might be coins, it might be paper notes, it might be credit card or debit card plastic, it might be in your cheque book. You know when you have money, you know when you are running out, and you probably know what you can do to get some more.
Again, if you are like many other people, you know what things cost in your country’s currency. You know how much it costs to buy some fast food you like, or a can of soda, or a candy bar. You know what groceries are going to cost, especially if you buy the groceries for your home. You know what fuel for your car costs, and when prices for basics change, you know whether you are going to have more money or less money at the end of the month. All of these ideas about money are what we might call “operational definitions.”
You know how money works, even if you don’t have a good simple definition for the term. Or, to quote from the film “Heist,” from a character played by Danny DeVito, “Of course you need money. Everyone needs money. That’s why we call it money!”
If Bitcoin is Money, Then What Is Money?Money is what you use to buy goods and services. Traditionally, money has three uses. Money is a store of value. Money is a unit of account. Money is a medium of exchange. Okay, but what does all that mean?
As a store of value, money is something you can set aside today and use tomorrow. A good store of value is a type of money that will be worth about as much tomorrow as it was worth today. Gold and silver coins have traditionally been used as money because they are a good store of value. Dollar bills are a pretty good store of value, although, over time, national currencies tend to become less and less valuable. Bitcoin’s value has gone up since the year 2010, and it has gone down since late 2013. On most days, the value of Bitcoin is about the same as the day before. So it is a fairly good store of value, even if it has times of volatility.
A unit of account is simply a way of keeping track. The money in your bank account is denominated in your national currency, and is yours, unless something strange happens. Still, at times, in the past, national governments have substituted a new currency for their existing one, and people have had to deal with the problems that causes.
When we say that money is a unit of account, we mean that you can use it in keeping track of debts, pensions, bank accounts, and in figuring up how much money you can get your hands on. Your credit card has a “credit limit” which is denominated in your national currency. So, you have some sense of how many dollars or euros or yen or rubles you can get at, if you make purchases with your credit card. Credit cards illustrate that money isn’t always in physical form. And, of course, bitcoin is a digital currency, not a physical one. Some people today keep track of how much money they have in the unit of “bitcoins,” though many more still use their favorite national currency.
Mostly, money is a medium of exchange. All that terms means is that you can buy and sell things using money. People offer money for goods or services. Some take the money that is offered, some negotiate for more money, some give discounts. But, if it is money, it is good for buying stuff. If there is stuff you want, and you cannot get it for what you have in your pockets, then the stuff in your pockets isn’t money. Or, it might be money somewhere else, but it isn’t money where you are. One of the nice things about Bitcoin is that you can use it at a lot of different places, all over the world.
Finally, money is exchange-able. In other words, if you have one type of money, you can exchange it. If you travel to another country you may find at the airport, or in a big city, or at a bank, a place where you can exchange money. These services go by different names such as “cambio” or “cambist” or “currency exchanger.” Currency exchange rates are typically published in newspapers and on web sites. You can easily find out how much your bitcoins are worth, in your national currency, by visiting a sites such as Coinbase, Trucoin, Bitpay, Bitfinex, Bitstamp, or any number of others.
A Lexicon of Bitcoin Terms
Every child learns the language in the way that is customary for his or her country. For languages with an alphabet, it is common to learn “the ABCs.” Very often, children’s books include an entire lexicon with a different common word or animal representing each letter. A is for apple, B is for boy, and so forth. Here is a listing of some common terms you may encounter when first learning about bitcoin.
A is for Acceptability
The main question about money is: what can I buy with it? In the case of your country’s national currency, the answer is typically: just about anything. In the last few years, that has also become increasingly true for Bitcoin. Here at Coin Brief, we report frequently on companies that accept bitcoin.
B is for Blockchain
If you use Bitcoin for even a few days, you are sure to hear the term “blockchain.” That word refers to the open source and public transaction ledger that keeps track of all bitcoin transactions. If you want a copy of the complete blockchain, you can get it by downloading Bitcoin Core. Of course, the complete blockchain is, today, tens of gigabytes of data, so it may take you a while to get your own copy.
What does that mean, “gigabytes of data”? Well, a byte is the amount of data needed to specify a single character, either a number or a letter. A byte consists of eight bits, and a bit is simply a one or a zero. We use the metric system to understand prefixes like kilo, mega, and giga. Kilo refers to a thousand, mega to a million, and giga to a billion. So, when I say that the complete blockchain of every transaction ever made with bitcoin is tens of gigabytes of data, I mean that it is tens of billions of characters of information.
By way of comparison, the complete works of Shakespeare is about 5 megabytes of data. All twenty-six volumes of the 1911 edition of Encyclopaedia Britannica are 25 megabytes of data. The online information resource Wikipedia is roughly 100 times as big as Encyclopaedia Britannica, or 2.5 gigabytes. When the Bitcoin software was first released, in 2009, most computer hard drives stored about 100 gigabytes. Today they are often much larger, storing trillions of bytes of data, or terabytes.
What does this all mean? Basically, Bitcoin’s blockchain is an incredibly large record of every Bitcoin transaction that has ever happened.
C is for Cryptocurrency
Bitcoin is the first and most popular of the cryptocurrencies. A cryptocurrency uses mathematics from the science of cryptography (which is a term from the Greek words for hidden writing). The particular maths function involved is called a “hash” function. Cryptocurrencies are sometimes called “cryptocoins” and include not only bitcoin but also Litecoin, Dogecoin, DarkCoin, Reddcoin and assets such as NameCoin, which establishes ownership of domain names using a blockchain ledger.
D is for Decentralised
Bitcoin uses a decentralised process for establishing whether a transaction has taken place. The Bitcoin Core software, and compatible software that works with it, not only track the transactions published on the blockchain, but also allows for the mining of new bitcoins, which is how bitcoins are created. Bitcoin mining is also the way that transactions are verified, and recorded, on the blockchain.
In the early days of bitcoin, back in 2009, it was not possible to encourage new users with transaction fees, since so few people used the currency. Instead, people operating the bitcoin software were able to set it to work computing hash functions to find new bitcoins. Today, a large decentralised network of hundreds of thousands of computers are used to not only find new bitcoins but also process transactions for very small fees. The people who do this work are called bitcoin miners.
This is the opposite of the process for mainstream banking, which is much more centralized. In fact, there is a group in almost every large country called “central bankers.” The central bank for the United States is called the Federal Reserve System. Central banks centralize the process of creating new currency, processing payment transactions, and publishing ledgers. In most of these countries there are regulations requiring that banks not only use the national currency issued by the central bank, but also make reports about how they process transactions, how they prevent money laundering, and how they operate in general.