Cryptocurrencies are just lines of computer code that hold monetary value. Those lines of code are created by electricity and high-performance computers. Cryptocurrency is also known as digital currency. Either way, it is a form of digital public money that is created by painstaking mathematical computations and policed by millions of computer users called miners. Physically, there is nothing to hold although you can exchange crypto for cash.
Crypto comes from the word cryptography, the security process used to protect transactions that send the lines of code for purchases. Cryptography also controls the creation of new coins, the term used to describe specific amounts of code. Hundreds of coin types now dot the crypto markets; only a handful have the potential to become a viable investment.
Governments have no control over the creation of cryptocurrencies, which is what initially made them so popular. Most cryptocurrencies begin with a market cap in mind, which means that their production will decrease over time thus, ideally, making any particular coin more valuable in the future.
What Are Bitcoins?
Bitcoin was the first popular cryptocoin. No one knows exactly who created it — most cryptocurrencies are designed for maximum anonymity — but bitcoins first appeared in 2009 from a developer supposedly named Satoshi Nakamoto. He has since disappeared and left behind a Bitcoin fortune.
One of the advantages of bitcoin is that it can be stored offline on a person’s local hardware. That process is called cold storage and it protects the currency from being taken by others. When the currency is stored on the Internet somewhere (hot storage), there is high risk of it being stolen.
Why Bitcoins Are So Controversial
Various recent events turned bitcoin into a media sensation.
Scams, too, are very real in the cryptocurrency world. Naive and savvy investors alike can lose hundreds or thousands of dollars to scams.
How Bitcoins Work
Bitcoins are completely virtual coins designed to be self-contained for their value, with no need for banks to move and store the money. Once you own bitcoins, they behave like physical gold coins: They possess value and trade just as if they were nuggets of gold in your pocket. You can use your bitcoins to purchase goods and services online, or you can tuck them away and hope that their value increases over the years.
Bitcoins are traded from one personal wallet to another. A wallet is a small personal database that you store on your computer drive (i.e cold storage), on your smartphone, on your tablet or somewhere in the cloud (hot storage).
Bitcoin Values and Regulations
A single bitcoin varies in value daily; check places like Coindesk to check current par rates. There are more than $2 billion dollars worth of bitcoins in existence. Bitcoins will stop being created when the total number reaches 21 billion coins, which will be sometime around the year 2040. As of 2017, more than half of those bitcoins had been created.
Bitcoin currency is completely unregulated and completely decentralized. There is no national bank or national mint, and there is no depositor insurance coverage. The currency itself is self-contained and un-collateraled, meaning that there is no precious metal behind the bitcoins; the value of each bitcoin resides within each bitcoin itself.
Bitcoins are stewarded by miners, the massive network of people who contribute their personal computers to the bitcoin network. Miners act as a swarm of ledger keepers and auditors for bitcoin transactions. Miners are paid for their accounting work by earning new bitcoins for each week they contribute to the network.
How Bitcoins Are Tracked
A bitcoin holds a very simple data ledger file called a blockchain. Each blockchain is unique to each individual user and his or her personal Bitcoin wallet.
So, although people cannot easily see your personal identity, they can see the history of your bitcoin wallet. This is a good thing, as a public history adds transparency and security, and helps deter people from using bitcoins for dubious or illegal purposes.
Banking or Other Fees to Use Bitcoins
There are very small fees to use bitcoins. However, there are no ongoing banking fees with bitcoin and other cryptocurrencies because there are no banks involved. Instead, you pay small fees to three groups of bitcoin services: the servers (nodes) who support the network of miners, the online exchanges that convert your bitcoins into dollars, and the mining pools you join.
The owners of some server nodes will charge one-time transaction fees of a few cents every time you send money across their nodes, and online exchanges will similarly charge when you cash your bitcoins in for dollars or euros. Additionally, most mining pools will either charge a small 1 percent support fee or ask for a small donation from the people who join their pools.
In the end, while there are nominal costs to use bitcoin, the transaction fees and mining pool donations are much cheaper than conventional banking or wire transfer fees.
Bitcoin Production Facts
Bitcoin mining involves commanding your home computer to work around the clock to solve “proof-of-work” problems (computationally intensive math problems). Each bitcoin math problem has a set of possible 64-digit solutions. Your desktop computer, if it works nonstop, might be able to solve one bitcoin problem in two to three days — likely longer.
For a single personal computer mining bitcoins, you may earn perhaps 50 cents to 75 cents USD per day, minus your electricity costs. For a large-scale miner who runs 36 powerful computers simultaneously, that person can earn up to $500 per day, after costs.
Just like holding a bag of gold coins, a person who takes reasonable precautions will be safe from having their personal bitcoin cache stolen by hackers.
More than hacker intrusion, the real loss risk with bitcoins revolves around not backing up your wallet with a failsafe copy. There is an important .dat file that is updated every time you receive or send bitcoins, so this .dat file should be copied and stored as a duplicate backup every day you do bitcoin transactions.
The collapse of the Mt. Gox bitcoin exchange service was not due to any weakness in the bitcoin system. Rather, that organization collapsed because of mismanagement and the company’s unwillingness to invest in security measures. Mt. Gox, for all intents and purposes, had a large bank with no security guards and it paid the price.
Abuse of Bitcoins
There are currently three known ways that bitcoin currency can be abused.
1) Technical weakness — time delay in confirmation: Bitcoins can be double-spent in some rare instances during the confirmation interval. Because bitcoins travel peer-to-peer, it takes several seconds for a transaction to be confirmed across the P2P swarm of computers. During these few seconds, a dishonest person who employs fast clicking can submit a second payment of the same bitcoins to a different recipient.
While the system will eventually catch the double-spending and negate the dishonest second transaction, if the second recipient transfers goods to the dishonest buyer before they receive confirmation, then that second recipient will lose both the payment and the goods.
2) Human dishonesty — pool organizers taking unfair share slices: Because bitcoin mining is best achieved through pooling (joining a group of thousands of other miners), the organizers of each pool get the privilege of choosing how to divide up any bitcoins that are discovered. Bitcoin mining pool organizers can dishonestly take more bitcoin mining shares for themselves.
3) Human mismanagement — online exchanges: With Mt. Gox being the biggest example, the people running unregulated online exchanges that trade cash for bitcoins can be dishonest or incompetent. This is the same as Fannie Mae and Freddie Mac investment banks going under because of human dishonesty and incompetence. The only difference is that conventional banking losses are partially insured for the bank users, while bitcoin exchanges have no insurance coverage for users.
Three Reasons Why Bitcoins Are Such a Big Deal
There is a lot of controversy around bitcoins.