When considering Bitcoin and what it means for the future of money, it's important to properly identify its unique properties. And the first thing to realise is that it's not just about being "digital" money, or money of the internet.
The fact is, there was digital money before Bitcoin. One particular example that comes to mind is e-gold, which was particularly successful while it was still operating.
E-gold was launched in 1996 by Douglas Jackson and Barry Downey, and by 2009 it had over 5 million account holders, at which time it was closed down by the authorities on suspicion of money laundering.
The e-currency was backed by gold and transactions were fast and effective. However, because e-gold was a company (Gold & Silver Reserve Inc) with a physical office, it was easy for the government to come in and close down operations.
So while e-gold was most definitely a digital currency, it was still centrally managed, with a centralised database and identifiable corporate officers.
Bitcoin is entirely different.
With Bitcoin there is no company, no "boss", no government license or permission, no "address" and no centralised point of failure. In other words, Bitcoin cannot be closed down like e-gold was.
How is this? Bitcoin is an entirely new type of digital money which exists on a globally distributed database/ledger called the Blockchain. What's more, this global ledger exists on multiple special purpose computers which all have to agree, in sync, on the status of the ledger - providing computational proof that the ledger is accurate and that all transactions are valid.
The entire financial ecosystem of Bitcoin is decentralised, managed by no single person, fully encrypted, and secured by the most powerful computer network in the world.
This is a breathtaking technological breakthrough, because never before in history has the creation and control of money been separated from the governing power. Just think about that. All money, both in our own experience and historically, has been issued by the king, overlord or government. Money has always been the province of bankers, working by permission from and in cohorts with governments and centralised authorities.
What's more. The money we know of today - fiat money, or money by decree - is bought into existence as debt, loaned into existence and canceled upon repayment.
Bitcoin is entirely different, sharing the same properties as gold, in that it is an asset, not a debt. Bitcoin is created by a process known as "mining" where those who provide computational power to the Blockchain are rewarded with newly-created bitcoins. In this way Bitcoin emerges not as a debt, but as an asset.
Bitcoin is also strictly limited to 21 million coins only. It's functionality is extended by the fact it is divisible by eight decimal points, or a 100 million sub-units.
What this means is, unlike government fiat money, which is historically inflated (devalued) over time, Bitcoin is deflationary in nature, increasing in value over time.
When you add all this Bitcoin properties together you end up with some people have termed "digital gold" - a digital age currency that bypasses all central authority and is available to all people in every part of the world.
It is for this reason that Bitcoin is revolutionary, capable of literally changing the social and economic order over time, and in ways we cannot fully imagine and anticipate right now.
Bitcoin wrests control of money from banks and governments and puts the awesome power of money into people's hands, creating a liberating force that will be felt the world over.
How Does Bitcoin Works?
When considering how Bitcoin works, it's important to realise there are two components that make up the whole system - the front-facing wallets and one's personal interaction with the system, and the Blockchain ledger itself and the super-powered computers that secure it.
From the end-users perspective, Bitcoin is pretty simple - a fact that becomes apparent once you start using it.
It starts with a wallet, the piece of software that enables you to send and receive Bitcoin, view your transactions and total balance.
Just like you have an email address for accepting incoming emails, you have a Bitcoin address which can be given to others in order to receive it. And when you need to send Bitcoin to someone, you simply require their Bitcoin address - which is a long string of random characters.
However, unlike email, with Bitcoin you can have unlimited addresses pointing to the same account.
When you send Bitcoin to someone you are in fact digitally signing a transaction which changes the ownership of that amount of Bitcoin, as recorded on the Blockchain, to the person you're sending it to.
Think of your Bitcoin wallet as a "window" into the Blockchain, showing what you personally own and what you are doing with it.
Everything else is managed by the network side of things, the Blockchain.
When you send or receive Bitcoin the transaction is processed by "miners" on the network, those entities who use powerful computers to not only verify and process such transactions, but who also get rewarded in Bitcoin by "discovering" blocks.
A block is a group of transactions that are processed as a batch. When you first initiate a transaction it is broadcast immediately to the network as part of such a block. So when you send Bitcoin to someone, they are immediately notified of the incoming transaction.
However, before they can use that money or spend it, it needs to be confirmed - a process designed to prevent double spending. Confirmation takes time and is a cumulative process of receiving ever increasing numbers of confirmations from the various mining entities around the world. It is this "cross-confirming" that validates the transaction and provides security.
Depending on the use-case, most transactions are considered fully valid after four confirmations, although the confirmations continue to pour in, into their thousands. Once a transaction is confirmed, the money can be used.
Confirmation times vary, according to what transaction fee you have paid. Most new wallets provide options for sending funds, as in "slow", "average" and "fast". You can choose what transaction fee to pay and the time process - according to your particular need. For example, if you were to chose the fast processing and higher fee option, you could expect to have your transaction confirmed within an hour.
The fundamental essence of how Bitcoin works is that once you have funds in your wallet you have complete control over how they are used, and do not have to account to anyone or ask permission as to such usage. In this way, it's just as easy to send $1 over the network as send $1 million.
Many people have referred to Bitcoin as "being your own bank". What they mean is, you literally control every aspect of its usage - how much you want to hold, how often you want to spend it, what you spend it on, how much you want to send to others. Unlike traditional banking, where such transactions and ownership are subject to constant oversight and regulation, with Bitcoin you really are your own bank, accountable to no one but yourself.
This freedom does carry responsibility though. When you are "your own bank" you are also responsible for security. That means ensuring you take such security seriously, by use of secure passwords and two-factor authorisation for example.
Some people choose third parties to manage their wallet, perhaps because they fear loss or don't trust themselves to manage such security. And while this is certainly an option, it also removes the freedom you enjoy when you have the private key, and opens up the possibility of having your funds frozen, account closed, and being asked intrusive questions as to what you are doing with your Bitcoin.
My personal advice is to always use wallets where you manage the private keys, so you have full control over your bitcoins and their usage.
What is The Blockchain?
The technological innovation at the core of Bitcoin is the distributed ledger known as the Blockchain. It derives its name from the fact that blocks of Bitcoin transactions are recorded on it, providing a permanent record of every transaction for all time.
As you can imagine, this takes up space as the Blockchain grows every day.
The distributed nature of the Blockchain is maintained by the existence of many "miners" and "nodes" around the world, who all hold a full copy of the continually updated Blockchain.
Miners are those entities who have invested significant capital in purchasing the specific type of computers that are needed to process transactions and secure the network. As time passes, the level of power increases with the "difficulty" of discovering new blocks. The larger the network grows the more secure it is.
On the other hand, nodes are simply specialised versions of the Bitcoin wallet which download the entire blockchain and assist in decentralising the network. Anyone can host a node by simply using the Bitcoin Core wallet which automatically downloads and continually updates the Blockchain. However, you do need sufficient storage space on your computer to do this!
Many banks and other financial institutions have taken a great interest in this technological breakthrough, as it clearly disrupts the process by which banks and other financial organisations manage their money - typically in proprietary centralised databases.
A lot of money has been invested in to exploring ways to use Blockchain technology apart from Bitcoin - proprietary versions which could perhaps bring new efficiencies and cost savings to banks and others. However, what most such organisations are slowly discovering is that a private blockchain is certainly not the same animal as the public Bitcoin Blockchain.
The reason is simple yet profound. The Bitcoin Blockchain is a fully decentralised, distributed peer-to-peer network. It's impervious to attack, manipulation and criminal activity. It owes its allegiance to no one, but serves all.
In comparison, any private blockchain would always be open to some sort of abuse. But more importantly, a private blockchain would not be able to deliver the same level of security precisely because there would be much fewer entities engaged in securing such a network.
This fascination with "blockchain" rather than the Bitcoin Blockchain can partly be explained by the fact that Bitcoin cannot be controlled by banks and other financial authorities. But to get access to the most secure blockchain on earth, you have no other choice but to also accept the Bitcoin that comes with it, as they cannot be separated.
However, Bitcoin is not the only thing that can "pass over" the Blockchain network, and many promising use-cases are emerging - including such things as smart contracts, records of property ownership, and even voting.
These ever increasing use cases are made possible by additional technologies called "side chains" - additional chains which link to the main blockchain and allow different types of information (other than Bitcoin transactions) to make use of the secured network. This area is in constant development and promises to deliver even more value in the future.
The Bitcoin Blockchain is indeed a technological tour-de-force, a revolutionary development which heralds an entirely new era in the way information and property is managed. At its core it is profoundly disruptive, meaning it challenges the status quo in every area and will force banks and other information-related organisations to innovate and catch up - or die.
What is Bitcoin Mining?
When Bitcoin was unleashed upon the world in January 2009, by mysterious and anonymous developer Satoshi Nakamoto, the only way to get your hands on Bitcoin was by "mining" it.
Back then you could do it on your computer, which was at the time powerful enough to process transactions and solve the complex computational calculations required to discover blocks. This led to a situation where many computer geeks found themselves with thousands of these new coins, which at the time had no established value or utility.
The most famous first transaction on the Bitcoin network was when someone bought a pizza for 10,000 bitcoins. No doubt at the time he thought it was a good deal, changing random digits for something tasty to eat. But at Bitcoin's current price I would be surprised if that person doesn't regret that early decision!
The fact is, in its early iteration it was most definitely experimental money, and those playing around with it no doubt thought it fascinating, but had no firm convictions as to its true potential.
As the network grew, so did the difficulty of computational processing, which rendered mining on CPU devices unprofitable. It was then that Bitcoin mining moved up a gear and professional miners turned up on the scene, using dedicated processors known as ASIC chips.
It's a continually evolving technology, as more and more powerful computers are required to efficiently and profitably discover blocks and the Bitcoin reward that goes with it.
The mining process is also the means by which Bitcoin comes into circulation. Every 10 minutes a new block is "discovered" and the miner who discovered it is rewarded with bitcoins. This reward has changed and will continue to change over time, according to a locked-in timetable and process.
When Bitcoin launched, miners could "win" 50 bitcoins in the block discovery lottery (by being first to discover it). But every four years this block reward is cut in half.
The first halving was 28 November, 2012, when the reward dropped from 50 bitcoins to 25. The second halving was on 9 July, 2016, when the reward became 12.5 bitcoins per block. The next halving is estimated to be on 27 June, 2020 - when it will go down to 6.25 bitcoins per block.
The obvious consequence of this is that miners need to see an increased Bitcoin price in order to compensate for a reduction in the reward. But going forward, miners will rely more on transaction fees than block discovery rewards.
This method of securing the network, by requiring very powerful computers to do computational work in order to validate and discover transaction blocks is known as "proof of work", or POW. As of now, this is still considered to be the most secure way to manage a blockchain type of ledger.
I still get questions like, "how can I get started in Bitcoin mining" from those who have recently discovered the cryptocurrency. But the truth is, unless you have a sufficient stash of cash to purchase and continue upgrading process-specific computers, it's something only the "big boys" can do these days.
However, many of these operators offer what's termed "mining pools", which allows smaller users to aggregate their hashing power and share in any rewards generated. There is also the possibility of purchasing mining shares or contracts, but this area is plagued by scams and ponzis and should not be entered into without have verifiable proof of such operations and profitability.
Bitcoin mining represents a perfectly balance incentive system which rewards those who are prepared to put up the capital required to secure and process the Blockchain. It's a symbiotic relationship based on self-interest that naturally serves the self interest of all participants in the Bitcoin economy.