Cryptocurrency On The Rise: What The Hell Is Bitcoin

January 14th, 2014

Originally published in Las Vegas Citylife on January 2, 2014

On November 27th, after a short period of sudden and sustained growth, the price of one Bitcoin surpassed $1000 USD. From there it continued its ascent, peaking at $1203 before undergoing a two-week series of jagged rises and falls, finally settling at the current market average of around $700.

Four years ago, James Howells, using a Dell XPS laptop, mined 7500 of the newly introduced Bitcoins on a lark. At the time, the value of a single Bitcoin was nearly negligible. A year later, while tearing down the laptop for parts, he set aside the hard drive storing the information necessary to retrieve the coins and forgot about it. This summer, he absentmindedly tossed the spare drive in the trash. Today, had he access to the now-buried-under-tons-of-landfill hard drive, its contents would be worth over 5 million dollars.

Okay, you say, so there’s money involved, and it sounds kind of like the stock market or gold or something, and I guess some people at least have become or almost become super rich as a result, but here’s the important question: what the fuck is a Bitcoin?

In late 2008, after a year and a half spent developing and prototyping the system, an anonymous individual (or group, no one really knows), writing under the pseudonym Satoshi Nakamoto, published a paper describing a new electronic cash system that could function entirely on a peer-to-peer basis without a requiring a third party or institution to manage transactions.

Conventional electronic monetary systems such as PayPal or credit cards require a central authority, typically a for-profit corporation. That authority can then charge whatever it likes, restrict certain types of transactions, and track (and market to) an individual based on their spending history.

Bitcoin is different. By utilizing a public transaction log called the blockchain, Bitcoin bypasses the need for a central authority, instead relying on the computing power of everyone currently on the Bitcoin network. The blockchain is a master list of all the transactions that have ever taken place, and tells us which coins belong to which address. Note that there are no names involved in the blockchain – as long as you’ve got the required key to an address (within what is known as a Bitcoin wallet, but could be more accurately titled a keyring), you control the coins contained within.

Whenever someone makes a purchase with Bitcoin, the log is updated and the network timestamps the transaction, preventing users from spending coins they do not have.

Okay, you say, so no central authority, that’s kinda neat. But the whole sharing the processing thing, that sounds expensive. Why would I want to do that?

The answer? Mining.

Dedicating computing resources to maintaining the blockchain isn’t simply an altruistic gesture. As part of the process, a miner’s computer takes part in a competitive effort to perform computations between everyone involved. These complex cryptographic computations are designed to protect against fraud while also rewarding the first computer (or often, pool of computers working together) to solve the computation with both newly minted Bitcoins and any fees paid during the most recent block of transactions. Once the process is complete, it begins again with a new block. Receiving coins in this way is known as mining.

See, Satoshi designed Bitcoin as a finite resource, much like gold or silver any other natural resource, and mining is the only way new Bitcoins can be created. Additionally, to further meter the output, the difficulty of the competitive cryptography grows and shrinks based on the power of all the computers taking part, ensuring a continuous and measured flow of Bitcoins – currently 25 BTC every 10 minutes or so – into the network. As time passes, the rate of creation will slow, eventually ceasing entirely after a total of 21 million Bitcoins have been created. At that point, the number of transactions taking place should allow miners to retain some profitability based on transaction fees alone.

Right then, so that’s mining. Now that you’ve got Bitcoins, what can you do with them?

While the intention is that they be used as currency, for many the answer is simply to trade. The speculative market exploded violently in 2013, and as a result of the influx of traders, the price of a Bitcoin is extremely volatile. Still, many businesses, dissatisfied with the high fees of credit card companies and allured by the open nature of the currency, have begun to accept Bitcoin, including several here in town. I’ll write about them in a future column.

As for Satoshi? His (hers, its, their) involvement dwindled in 2010, and following the 2011 handover of further development to an organizing body called the Bitcoin Foundation, Satoshi Nakamoto disappeared completely, leaving untouched a personal trove of Bitcoins estimated to be worth nearly a billion dollars.