March 5, 2014
The widespread use of cold, hard cash has been on the decline for years as credit cards have experienced an uptick in popularity. Now, cash faces another formidable challenge from Bitcoin. This digital currency exists only online and has grown from obscurity to popularity since its introduction in 2009. If the idea of this kind of payment is new to you, keep reading for background, an explanation of how it works, and why its value is on the rise.
In the Beginning
Bitcoin began operating in 2009, and was created by a group of mathematicians. However, the idea of currency based on cryptography goes back to mailing list discussions in the late ’90s. The group of people who took the concept and developed Bitcoin includes Satoshi Nakamoto (widely regarded to be a pseudonym), Gavin Andresen, and Pieter Wuille, among others.
How it Works
This online currency gets handed out initially as a reward for successful mining. The process of mining involves a decentralized network of computers competing to solve cryptographic puzzles. These highly sophisticated puzzles support the functionality of a mechanism that’s known as the block chain, a public ledger of all bitcoin transactions. The owners of computers that are first to solve the puzzles receive new bitcoins.
To protect the identity of those who acquire, trade, and spend bitcoins, users interact with each other behind the anonymity of digital signatures that match an address for an account. Wallets, which are smartphone apps and software, make it easy for users to assess their bitcoin accounts, as well as spend and receive the currency.
Why it Works
Perhaps you’re skeptical, and may wonder if the types of scams that target online transactions includes digital currency. There are mechanisms in place to prevent fraud and abuse of the bitcoin currency system.
Individuals and businesses commit computer resources to processing the puzzles that are the backbone of the public ledger. The integrity of the ledger is important because it tracks every single transaction involving bitcoins. The ledger is designed to be unchangeable once a transaction gets recorded. All computers in the Bitcoin network agree on the same version of the ledger, and the integrity of the ledger brings confidence to this currency system.
Each of these transactions is called a block. These blocks make up the ledger, which is why it’s called the block chain. It’s a complete chronological history (chain of events, if you will) of every instance where bitcoins have changed hands. Remember the concept of mining? That’s where computers compete to solve a puzzle first in exchange for bitcoins. Essentially, computers are trying to be first to finish a block, i.e. process a transaction.
These puzzles that computers must solve to complete a block are math problems that computers answer only by trial and error. Miners run software programs that create, test, and recreate possible answers constantly and quickly. Running this software is resource intensive, meaning it requires a lot of a computer’s resources. At this time, each correct answer merits 25 bitcoins. Every four years, the bitcoin reward gets cut in half. This reduction in reward is set to continue until there are 21 million bitcoins in circulation.
Bitcoins in the Real World
In terms of U.S. dollars, bitcoins have seen increases in value in 2013. That increase happened despite a high-profile take-down of the Silk Road website in October. U.S. officials allege this site was an online market for illegal drugs, and bitcoins was the currency of choice.
The Silk Road scandal prompted Congress to hold hearings on bitcoin and the future of digital currency. The chair of the U.S. Federal Reserve Chairman, Ben Bernanke, has said the Fed monitors virtual currencies but does not seem to have regulatory authority over these systems.
As Bitcoin gains more worldwide media attention, its value is expected to continue to increase. Types of scams involving bitcoins are on the rise as well, which is why it’s more important now than ever to protect yourself from identity theft.
In the meantime, it’s getting more difficult for small-time miners to “win” bitcoins. For that reason, more individuals are pooling their resources to increase their capacity to mine by getting high-end hardware and faster internet connections. They’re then splitting the rewards as though they were running a joint business venture. The world is watching as this high-profile digital currency moves forward.
Have you personally invested in Bitcoin? If so, how has it worked out for you?
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