Bitcoin is a digital payment currency that utilizes cryptocurrency (a digital medium of exchange), blockchain technology, and a peer-to-peer (P2P) network as opposed to a central authority (such as a bank) to create and manage monetary transactions. The open source, P2P Bitcoin network facilitates the creation of all bitcoin and manages all bitcoin transactions.
Often referred to as “cash for the Internet,” Bitcoin is one of several popular digital payment currencies along with Litecoin, Peercoin, and Namecoin. When the word Bitcoin is capitalized, it usually refers to the software and systems used for bitcoin (in lowercase it refers to the actual currency).
First introduced in 2009, bitcoin is considered the biggest, most widely traded cryptocurrency in use today. Bitcoin as an implementation of the cryptocurrency concept was described by Wei Dai in 1998 on the cypherpunks mailing list. Dai suggested a new form of money that uses cryptography to control its creation and transactions, rather than a traditional bank or other central authority.
In 2008, the Bitcoin specification and proof of concept was published in a cryptography mailing list by a person or group named Satoshi Nakamoto. The first bitcoin transaction took place in early 2009, effectively mining the first block. Satoshi Nakamoto supposedly left the project in late 2010 without revealing any identifying information, as noted in the Official Bitcoin FAQ. Despite immense speculation, no conclusive evidence has pointed to the true identity (or identities) behind the Satoshi Nakamoto pseudonym.
How bitcoin works
Investment in bitcoin begins by establishing a secure bitcoin “wallet” that stores public and private keys for bitcoin transactions. These wallets are typically a mobile application or desktop program. Some countries require specific information to verify the identity of a user trying to buy and sell bitcoin; in the United States, a user must provide a valid driver’s license, Social Security Number, and other documents in compliance with anti-money laundering legislation.
From there, a user can purchase bitcoin in a bitcoin exchange using traditional payment methods like a credit card, bank transfer, or debit card. Bitcoin can be used to pay for goods and services just like traditional currency, but it can also be exchanged for traditional currency or other cryptocurrencies like Litecoin, Ethereum, Ripple, and Stellar.
To complete a bitcoin transaction, a user must know the input key (or address) of another user’s wallet typically a string of 16-35 alphanumeric characters, which creates a pseudo-anonymous environment. The Bitcoin protocol verifies that the sender has sufficient bitcoin to complete the transaction based on transaction history, and confirms the transaction. A transaction also requires a fee, which is self-offered and goes to a volunteer bitcoin miner whose computer processes the transaction. (More on miners below.) The higher the fee added to a transaction, the quicker the transaction will be processed.
Because bitcoin has had an extremely volatile trading history, the first bitcoins were traded for pennies. In 2010, the price of a single bitcoin increased 1.000% from $0.008 USD to $0.08 USD. The beginning of 2017 saw a rise in significant price fluctuations, peaking at nearly $20K USD and steadily dropping to an average of $7K USD for a single bitcoin.
Although bitcoins do not physically exist, they are “discovered” by volunteer coders called miners. These miners use high-performance computers to solve complex computational problems and process transactions. This process creates (or “mines”) single blocks, which are then added to a public record called a blockchain. Because the blockchain is publicly available, the essence of bitcoin is decentralized.
Regardless of how many miners are simultaneously processing transactions, the Bitcoin protocol dictates how long it takes to mine a single bitcoin. This ensures new bitcoins are created at a fixed rate, although the cost of mining said bitcoin is a variable that leads to intense competition among bitcoin miners. It is also worth noting that the Bitcoin source code dictates that the lifetime supply of bitcoin is limited to 21 million.
While attackers target Bitcoin-related sites, there is an important distinction between the security of the Bitcoin marketplace and the Bitcoin exchanges. According to InternetNews.com, no one has ever found a critical vulnerability within the Bitcoin protocol itself that would allow a user within the Bitcoin network to fraudulently create coins or forge transactions.
However, there have been compromises of various Bitcoin exchanges throughout the virtual currency’s lifetime, and as the value of a Bitcoin increases, so does the risk in using exchanges. Successful attacks of the protocol would require 51% blockchain ownership (something that has not yet been achieved), but smaller compromises have resulted in forks in the bitcoin network.