You have likely heard about Bitcoins, and perhaps you’ve followed their rapid ascent in the marketplace over the last six months. But when we talk about using Bitcoins and the increasing popularity of the monetary system, what exactly are we talking about?
The short answer is digital money.
Bitcoins are a form of money, just like the American dollar, the Euro, the rupee and the pound. The primary difference is that Bitcoins exist almost exclusively online.
The Barter System of Old
The premise behind Bitcoins is directly tied to the millennial-old idea of bartering. When civilizations were founded, residents traded goods and services. A farmer might trade eggs for firewood, for example. But over time, the barter system began to get more complicated.
Sometimes the farmer just couldn’t trade eggs or firewood. He needed something more desirable to work with. Coins or other valuable items were introduced to the local economic system. The coins were made of gold or other valuable items with a limited supply, and the market dynamics adjusted over time so that a certain number of coins could buy a particular item or service.
It was noticed quickly, however, that carrying coins was not always desirable. While the jingle of a full purse was fun, it was also a huge draw for thieves and cutthroats. Individuals realized that they could handle transactions more safely if they didn’t actually have their coins and valuables on hand.
Therefore those with valuable coins began to store them with a goldsmith or banker and instead of paying for an item in gold at the time of purchase, they would simply write a promissory note to the merchant and the seller would be able to pick up the promised gold coins from the goldsmith or bank at his leisure.
But an interesting phenomenon developed. Most of the coins – as many as 90 percent – never left the bank despite being promised to one person and then another. Individuals were simply trading promissory notes without bothering to physically collect and redistribute coins.
The banked coins just sat there, so early bankers decided to use them to their advantage. They let other customers borrow them and in return earned more coins as interest – all recorded on promissory notes, of course. Soon, rather than having one gold coin in circulation and nine safe in the bank for every ten on the first promissory note, bankers had almost doubled the funds available in the town leaving almost no funds in the bank should everyone come to claim their gold coins all at one time.
The Monetary System Today
Naturally, bankers then soon realized that virtually all banking was happening through promissory notes. They also knew that digging more gold out of the ground to increase the money supply was more trouble than it was worth. So the solution was simple. Banks would simply print more promissory notes, or tender, and stop trying to tie the paper notes to actual mined gold.
Now banks could print money at will, without worrying about digging gold or silver out of the ground.
The idea of fiat money was introduced.
Fiat currency is simply money that has no backing other than the value it is perceived to have. The U.S. dollar is always fluctuating in value depending on how others perceive its value, for example.
Since only governments or government appointed agencies can now legally print official government money, value is determined by economic factors as well as the amount of money that is actually printed and allowed into circulation.
This is essentially the same concept behind Bitcoins, but without printing presses or government fiscal games.
The Increasing Popularity of Bitcoins
Bitcoins are much like the Euros printed in Europe, but Bitcoins are manufactured digitally using processing power. There are no real coins to hold in your hand when it comes to Bitcoins.They are simply the next manifestation of fiat currency – money that is valued by economic factors.
And the economy seems to like Bitcoins.
The “Bitcoin Standard”
One of the most popular things about Bitcoins is the close resemblance the currency has to gold. Not that the virtual coins are gold and shiny, of course. But the gold standard called for all currency to be tied to actual gold coins or bars, of which there is a limited supply worldwide. This would prevent ever-increasing debt creation by countries and banks, which in turn, leads to inflation and other financial problems.
By comparison, the “Bitcoin standard” ties each Bitcoin to a tremendous amount of effort. There is also a limited number of Bitcoins ultimately available through a process called “mining.” Decades ago, banks abandoned the gold standard because it was so hard to get the gold out of the ground and it prevented full control of monetary systems.
Today, Bitcoins are earned by “miners” must work hard to verify previous Bitcoin transactions, or blocks. Each block that is added to the block-chain (or each transaction that is checked for fraud and added to the list of other previous transactions) earns the miners doing the work digital Bitcoins. The miners can then exchange their freshly mined Bitcoins for other forms of currency in an exchange or marketplace.
Nobody can create Bitcoin funds without investing quite a bit of hard work and processing power to earn them. And nobody can “mine” new Bitcoins without monitoring the current system for fraud, or individuals trying to re-spend Bitcoins that have already been spent. It’s a surprisingly clean system.
No Government Ties
At the very highest level, Bitcoins are a currency that is unaffected by any government, at least for now. Bitcoins are bought and sold in various markets much like gold is, but unlike gold, the Bitcoins can be used in an increasing number of stores and enterprises. Even large online marketers like Overstock.com have recently started accepting Bitcoins as a form of payment.
Without government printing presses and banks behind the Bitcoins, they operate far closer to the barter system and promissory notes of old than the modern fiat currency of today. Chiefly, the government has no control over the funds, although they do not technically have the ability to monitor cash under your mattress either. Those who prefer to invest in gold and keep cash on hand to avoid the government eye appreciate the similarities between Bitcoins and these other cautious systems.
Chief among the many other reasons Bitcoins continue to grow in popularity, individuals who prefer to operate out of the ever-watchful eye of the government appreciate the relative anonymity provided by the coins as well as the joyful risk of a new investment.
Taking a few excerpts from Nakamoto’s paper, the principle you’re referring to relates to the lack of a central bank or power which can be corruptible.
In most currencies, all transactions must go through a central bank, or trusted party, to be authorized as not being re-spent or duplicated. Bitcoins don’t do this. Per Nakamoto:
“To accomplish this without a trusted party, transactions must be publicly announced, and we need a system for participants to agree on a single history of the order in which they were received.”
So the actual transactions using Bitcoins go through this process (from the white paper):
1) New transactions are broadcast to all nodes.
2) Each node collects new transactions into a block.
3) Each node works on finding a difficult proof-of-work for its block.
4) When a node finds a proof-of-work, it broadcasts the block to all nodes.
5) Nodes accept the block only if all transactions in it are valid and not already spent.
6) Nodes express their acceptance of the block by working on creating the next block in the
chain, using the hash of the accepted block as the previous hash.
Finally, “Nodes always consider the longest chain to be the correct one and will keep working on extending it.”
In short, transactions are made “public” to the nodes. Individual nodes check and verify transactions. The proof-of-works link together as a sort of chain, and the longest chain of valid transactions helps assure that all transactions are correct.
This process moves the power of oversight out of the hands of one entity and into the power of a variety of stakeholders, ensuring that power stays distributed and oversight intact.
Christ this is a sh*t article. Its uninformative, badly written and limited by authors narrow view of economics and cryptocurrencies. This is a fascinating subject; others do it some justice.
Plus bitcoin have not been surging for weeks.
I read it as more of a general overview than an in-depth analysis of the topic. It’s definitely fascinating and hugely complex, but the average citizen has to start somewhere to get the gist of it. I’m pretty sure that was the intent here.
| The short answer is digital money
“Magic Internet Money”
FTFY. :)
Seriously, the implications of bitcoin are huge from a mathematical standpoint. You didn’t mention that it effectively (though not completely) solves a mathematical problem in computer science known as the Byzantine Generals (http://en.wikipedia.org/wiki/Byzantine_generals) or Byzantine fault tolerance.
I’m not the best person to explain it, but It essentially boils down to knowing what message/block to trust. In the case of the blockchain, this is solved by confirmations of a block of transactions. As long as no one entity has more than 51% of the computing power of the entire network, then the longest block of transactions in the chain is the one that is trusted among all the peers (not just the miners, but everyone running a full implementation of bitcoind or bitcoin-qt) in the network.
If someone would like to elaborate on this, please do so. I’m trying to keep it non-technical, and I still don’t have a complete grasp of it, but I do know that no one can say it more elegantly or concisely than the original whitepaper by Satoshi Nakamoto: http://bitcoin.org/bitcoin.pdf.