Disclaimer- I own a tiny amount of bitcoin.
We’re all sitting around having a drink when someone mentions bitcoin. I happen to find bitcoin very intriguing and have read some on the topic, but am far from an expert. The following is how the conversation normally unfolds.
My Buddy (MB): I just don’t get it. What is a bitcoin?
Me: It’s a digitial currency- as they call it a cryptocurrency. So accepting that it’s not a physical thing, I’d say it’s a unit of measure? It’s definitely not like gold though.
MB: Okay, but why does bitcoin matter?
Me: Well, it’s potentially a revolution in currency, but only time will tell.
MB: But haven’t there been other digital currencies? Why is this one grabbing hold?
Me: It appears to be a few factors. It’s decentralized, it has a finite supply even though how long it will take to get at that supply is not exactly known, it is not controlled by a government or really even an organization, and it’s more anonymous and allows for easier transfers .
MB: Okay, that all sounds great, but really what the hell is it?
Me: Erm, because it’s digital it’s less about what it “is” and more about how it is gathered, transferred, and verified. Bitcoins are granted by having a computer solve a really, really hard algorithmic problem . They’re transferred via digital wallets, which have a public key that you could think of as an email address for your bitcoin, but they also have private keys which allow you to access it . Some people have considered making bitcoins into physical objects, but that pretty much seems to defeat the advantages the currency creates.
MB: And how is it gathered? Or ‘mined’ as they say?
Me: Yea, great question, basically it’s all intertwined. I don’t think you could have a currency without being able to obtain it and transact with it. So the ‘mining’ is a race among seriously heavy computer hardware to be the first to verify sets of transactions- that if you’re transferring coins you actually have them- and then encrypting the information so as to not allow anyone to steal it. You get rewarded- in bitcoin- for having your machine be the first one in the network to do these confirmations- as one article aptly put it, it’s like “competitive bookkeeping” .
MB: That makes enough sense I guess. You receive some payment for keeping the whole payment system secure and absent from fraudulent transactions. Why is it worth so much compared to the dollar? Are these mining problems really that hard to solve?
Me: Well, to answer your second question first, yes, they’re just computationally extremely hard. I don’t know the actual numbers, but let’s just say you have to try out one hundred trillion different combinations to get the right one to match . If it’s a race with the prize being serious dollars, you need a huge machine to crunch through those possibilities faster and faster. In the early days of bitcoin, your computer itself was powerful enough to do that. Now you’re competing against huge server farms in Iceland dedicated to this .
MB: Okay, I can dig that. Damn, too bad I wasn’t in early- so why is it worth so much?
Me: Demand, duh.
MB: Ha, don’t be rude- I don’t want any, most people I know don’t want any, so I’m having trouble relating to those who do. I’ve heard a bit about using it to get illegal goods, but I can’t imagine that’s the real driving force. And I have to imagine most people who would use would really hate the instability.
Me: Haha, sorry, I’ll take a step back. You’re right, it has been widely accepted for illegal goods and it also has had some serious swings in it’s value against the dollar. One of the reasons I’m so intrigued with it is because, as far as I can tell, there really is no way to tell what it’s worth. Maybe it’s overvalued by a thousand, maybe it’s undervalued by a thousand; as far as I can tell there’s zero precedent for this currency. Many people are excited because it removes the need for a 3rd party, like a bank or a credit card, to verify accounts and transactions- this is the bitcoin protocol . That’s why I arrogantly called it a ‘revolution’ before.
Back to your question though- who is demanding it? A big part of the recent surge came from China. The government doesn’t allow the Chinese currency to float freely and it’s really hard to get your wealth out of the country, so this pseudo-anonymous, floating system is pretty attractive . Also it’s hugely important to acknowledge the market cap, or total volume of bitcoins. If someone wants to buy, there has to be someone to sell and vice versa. In most other digital currencies, moving large amounts of money would be really hard, but as bitcoin has gained in value this has become easier and easier .
MB: Huh, but if you’re transferring money aren’t you screwed by these valuation swings?
Me: Luckily, from what I understand, the currency isn’t so unstable as to be having drastic swings over extremely short periods, so if your sole purpose is to transfer I think you get in and out pretty quickly. Also, if you generally didn’t have faith in your country’s currency, bitcoin’s fluctuations would be less of a risk factor for you .
MB: Maybe I should have started with this, but who created bitcoin?
Me: Um, supposedly a Japanese guy, but they don’t think it’s a single person and whoever they are has been uninvolved for a while . It’s pretty vague, but what they built has been determined to be really cryptographically sound.
MB: I mean, my basic knowledge of economics says that if there’s limited supply and it’s already worth over $500 USD, I should buy in and hold, right?
Me: I think it’s more important to remember that no one knows what a single bitcoin’s long term value will be and that many many smart people would disagree. I wouldn’t put in any money that you didn’t feel comfortable watching depreciate . I certainly find it more cerebral than playing craps, but I guess with less short term excitement? You could definitely also get some and make an actual purchase, though I don’t think this bar is accepting them just yet .
Me: Excuse me, can I get a PBR?
Lastly, I want to reiterate what I said to at the beginning- I am far from a Bitcoin expert. I barely mentioned cryptography or the blockchain, but my goal was to not go in a direction that could result in a non-bitcoin enthusiast looking for the nearest exit. I highly, highly recommend checking out some of the links below as they were greatly helpful to me in increasing my understanding, which is still honestly not deep. I welcome feedback- corrections, followup questions, or reading I should do- I’m @misterrayco on Twitter. And because of this, I couldn’t complete this article without giving my public bitcoin address if you’d like to throw me a tip!
For visual learners out there:
And while not directly footnoted, I loved this article: