Heard about Bitcoin and digital currencies (digital money) and haven’t got any idea what they’re talking about? Don’t worry! It can be complicated, but we’ll explain everything you need to know clearly.
Bitcoin is a pretty new currency that only exists in digital form, so there’s no bank notes or coins, everything happens across the internet using your phone or computer. However, it’s particularly unique, and an evolution of traditional currencies that currently exist (such as Pounds or Dollars – also called fiat currencies).
It has 3 core elements, which we’ll cover in more detail later:
- There is no government or central bank control.
- There is a fixed supply – only 21,000,000.
- It can be sent directly from person-to-person across the world.
Bitcoin was the first cryptocurrency and currently the world’s largest. It was created in 2008 by an anonymous person, or team or people, who called themselves ‘Satoshi Nakamoto’, and largely inspired by the mismanagement of money by governments and central banks (banks of a certain country, such as the Bank of England) – particularly around the global financial crisis that occurred during that time, when governments bailed out large banks who themselves were mismanaging money. And unfortunately, it’s all got a lot worse since then, particularly during the coronavirus pandemic.
No government control
We won’t go into the details too much, but governments and central banks have the ability to create more money whenever they like (and also adjust the interest rate of their borrowing), and as a result, causes the value of money to reduce (called inflation), which means things get more expensive over time, like food and bills. Effectively, creating new money makes the poor, poorer and the rich, richer (as the things rich people own, such as property and businesses, often grow in value too).
Almost every government in the world, and so the country itself, is in fact in huge amounts of debt, and most are potentially bankrupt. Many people out there believe that governments have too much power when it comes to public finances and money creation – and Bitcoin is seen as the perfect solution.
Fixed money supply
Bitcoin has a fixed supply of money (coins), new bitcoin can never be created, and so there can never be any mismanagement, now or in the future – in terms of money in circulation.
The supply is 21,000,000 (or will be in the year 2140 when all the bitcoin are created – called mined. More on that later).
As we mentioned above, this means inflation (reducing the value of your money) is near impossible (although currently the price changes often). And, people have full control over their own money, rather than a government. In fact, it’s possible the value of their money will actually naturally increase in value similar to a savings account.
It’s also seen as a ‘store of value’, which means it’s a safe place to leave your cash as it won’t decline in value (like cash does), similar to gold. However, the price fluctuates (goes up and down) too much for most investors to do this currently.
Sent directly from person-to-person
Did you know that when you send money via your bank account to someone else, it actually goes through loads of different banking systems and then finally ends up in their bank account? And if you’re sending internationally, there’s even more systems. It can take days – not to mention the hefty fees you pay for sending money abroad! Plus hidden fees like currency exchange fees.
With Bitcoin, you can send it directly to someone else, in seconds, without a bank(s) as a middleman. And for almost zero fees. It sounds so simple, but it’s never existed before. There’s no need for a bank to confirm the transaction, it all happens on the Bitcoin network, effectively run by software and computers. It’s the modern version of money transfer.
But it gets much better than that, as you can send bitcoin near-immediately, for free, and directly to someone else, businesses that take payments (e.g. a shop) can actually receive bitcoin as payment rather than a card payment – which saves them a huge amount of money, as much as 3% per transaction. That’s a seriously good saving, this saving can be passed on to the customer making things and services cheaper. They'll also get the cash immediately, rather than waiting days for transactions to settle (complete).
How Bitcoin works
While creating Bitcoin, ‘Satoshi Nakamoto’ also created a new technology called ‘blockchain’, and it’s this technology that Bitcoin runs on, and is also the technology that has created an entire new industry called cryptocurrencies (we’ll cover that a bit more later).
Without getting too technical, a blockchain is very similar to a database, but it can never be changed or altered, only new information can be added to it, and this information is contained in a ‘block’ that is added to the ‘chain’. In a long, permanent, never changing line of blocks. This is also called the Bitcoin ledger.
So imagine making a bitcoin transaction, and sending money to a friend, your bitcoin transaction would be added to the latest block, then the block is added to the chain. And, then this is permanently stored in the ‘database’ (the Bitcoin ledger). The technical term for this is the Bitcoin network, or simply Bitcoin blockchain, and the way this all happens and bitcoin transactions are recorded is called the bitcoin protocol (set of software rules).
As no one controls the Bitcoin network, these transactions can never be changed (or hacked), it is a permanent record (and so your bitcoin is very safe).
The Bitcoin blockchain is completely public to see, and so everyone (and most importantly software), now knows that you sent your friend some money, and their balance has gone up by that amount and your balance reduced by the same amount.
You could think of it like a bank statement, with money coming in, and going out, in a fixed order, and once it happens, it can never change. It’s still very private for individuals however. No one knows who owns which bitcoin address (unless it’s public, such as a charity’s address).
Now you might be thinking that doesn’t sound very complicated or clever at all. Well, it’s actually never been done before, and the genius behind the technology is that it is distributed across the world, so there’s no one central company (such as a bank) deciding which transactions are right or wrong, and the right time order of transactions.
There’s a huge network of computers, called bitcoin miners, all over the world, who process the transactions and confirm that the order of transactions within each block is correct, and then add it to the blockchain to make it permanent. (More on that below.)
When you make a transaction on the bitcoin network, you’ll pay a small transaction fee (when you send bitcoin), which goes to the miners as a reward for including your transaction in the block.
Although making bitcoin transactions in shops and other places is completely free, as they use the bitcoin ‘lightning’ network. We won’t go into that now, but it makes transactions super fast, effectively free, and more private. Learn more on the lightning network website.