WTF is bitcoin!?

In late June my old high school friend Kyle took a road trip, with his girlfriend, from Indiana to Keene, NH to attend the 2012 Porcupine Freedom Fest. When he returned, he graciously sent me a rather large package containing all sorts of brochures, pamphlets, booklets, and such outlining the various sponsors, area attractions, events, etc. at the fest and in the area. One of the sponsors that quickly caught my eye was called Bernanke’s Bitcoin Exchange owned and operated by Erik Voorhees and outlined in his blog post here. Seeing this brochure got me curious about bitcoin.

My interest was piqued so I began the research into bitcoin and understanding more about it. My research and quest led me to write my own article about the very basics of bitcoin (link below). In short, bitcoin should interest anyone who likes sound money. Bitcoin’s decentralized model is unique and lends to its huge popularity.

Here’s the reprint of my article which can be found here.

The intent of this article is to provide a basic, easy to follow, guide to understanding the monetary phenomenon known as Bitcoin. The article will outline various information regarding the facts about Bitcoin including what Bitcoin is, what it is not, how and where it is used, and why it has such a devoted following. This article will not delve into the development, history, or deep technical issues surrounding Bitcoin; those topics can be found here.

Bitcoin is a digital, or electronic, currency which can be a difficult idea to reconcile because people are so used to currency referring to the physical notes or bills they carry in their pockets. However, when you think about how you conduct monetary transactions in the modern age, physical currency is quickly being replaced by the use of credit and debit cards as the more common method of payment.

When you buy something online or at your local grocer using your credit or debit card, you are technically working with a digital representation of physical currency. You are not sending or transacting in physical currency and no one is sitting in a bank physically relocating your currency from your account to your grocer’s account; it’s all conducted electronically. If you’ve ever used the ubiquitous Paypal then you are familiar with the concepts found in Bitcoin. Bitcoin, however, stands on its own as a fully digital currency and is not a virtual-representative of any other currency, despite its exchangeability.

Bitcoin is known colloquially as a cryptocurrency. The crypto in cryptocurrency refers to cryptography, not the prefix crypto- meaning “secret”. Cryptography is the encryption method and technology used to secure Bitcoin transactions. Cryptography is in use by most of us on a daily basis. If you’re reading this on your computer or smartphone, somewhere in the communication between the website and your computer/phone, cryptography has been deployed. Every time you use an ATM, make an online purchase or transfer with your credit/debit card, or send a payment via Paypal cryptography has been deployed to secure those transactions.

Bitcoin is also considered a decentralized currency. Decentralized refers to the fact that there is no one person, authority, government, or entity, i.e., no central bank, that controls the creation, distribution, or value of Bitcoin. This is in strong contrast with centralized currency, known as fiat money, such as the U.S. Dollar or the Euro, which are controlled by a centralized authority charged with creation and distribution and therefore value. All value in Bitcoin is determined by its market, which includes its usefulness, its scarcity, and people’s desire to have it, much like a commodity such as gold or silver.

Another aspect of decentralization that is quite attractive to Bitcoiners is that transactions using Bitcoin do not involve the use of a middleman. Debit card transactions have a bank between the buyer and seller. Paypal and credit card transactions have a corporation, e.g., Paypal, Visa, Mastercard, etc., between the buyer and seller. When using any of these methods your transactions are strictly guided by the terms and conditions of your bank and/or credit card provider, meaning these entities may dictate what you can and cannot purchase. The decentralized model of Bitcoin results in zero controls on what you can or cannot purchase using Bitcoins; the only limitation is whether or not the seller accepts Bitcoins for purchase.

Because Bitcoin is an actual, albeit fledgling, currency it has value against government issued currency such as the U.S. Dollar or Euro. As of this writing one Bitcoin (1 BTC) has an exchange rate equal to $6.80 USD. In other words, it takes $6.80 to buy one BTC. Unlike government currency however, Bitcoins are extremely granular. According to the Bitcoin website, “[a]s the value of the unit of 1 BTC grows too large to be useful for day to day transactions, people can start dealing in smaller units, such as milli-bitcoins (mBTC) or micro-bitcoins (μBTC).” Bitcoins carry an exchange value in more than a dozen world currencies.

According to the Bitcoin website, “[a]s the value of the unit of 1 BTC grows too large to be useful for day to day transactions, people can start dealing in smaller units, such as milli-bitcoins (mBTC) or micro-bitcoins (μBTC).” Bitcoins carry an exchange value in more than a dozen world currencies.

It’s equally important to understand what Bitcoin is not. First, it is not illegal and it is not counterfeit money. It is also not a commodity, per se, although it does hold some similar characteristics, as far as usefulness and scarcity, to gold and silver.

Bitcoin is also not a perfect model, yet, and as such is not free of risk. Purchasing Bitcoins is based on an exchange rate compared to its government issued currency counterpart. This exchange rate fluctuates constantly and is impossible to foresee. As mentioned earlier in the article, today’s exchange rate is 1 BTC = $6.80 USD. Tomorrow, the exchange rate could be $10.00 USD or $2.00 USD; therein lies much of the risk and as such Bitcoin’s developers urge people “not to make heavy investments in bitcoins.”

Bitcoins are purchased using your local currency by visiting Bitcoin Exchanges, such as MtGox or Crypto X Change or alternatively from a private person who owns Bitcoins. Once purchased, Bitcoins are sent to a specific Bitcoin address which can then be stored in a virtual wallet either online, at a reputable website (the author uses Blockchain.info), or on a personal, well secured, computer using a Bitcoin wallet client program. Each address has its own unique 34-character alpha-numeric address, which serves as an account for Bitcoin holdings. Bitcoin addresses and wallets are free and there is virtually no limit to the number of addresses one can control. Each address and wallet is secured, using super-high tech cryptographic technology.

Purchases, or transactions, using Bitcoins are possibly the simplest part of the whole Bitcoin universe. Bitcoins are simply transferred from one Bitcoin address to another Bitcoin address; straight from A to B, no middleman like a bank or corporation to get in the way. Several of the Bitcoin exchanges and wallet services offer smartphone apps to make the facilitation of transfers as simple as a few button clicks. If you’ve ever used your computer or smartphone to transfer money from your checking account to your savings account, it’s the same idea, only much simpler.

Every day there are more and more merchants adopting the use of Bitcoins for purchases. In fact, there are several merchants that only accept Bitcoins for purchases. It should be noted at this point that Bitcoins can be converted or exchanged back to government issued currency by visiting a Bitcoin exchange (see above) or by private sale. The decentralized model of Bitcoin has made it a very popular currency with liberty-minded individuals and was quite popular at the 2012 Porcupine Freedom Fest (PorcFest) held in Keene, NH in June 2012. Bitcoin aficionado and devotee, Erik Voorhees, blogged about his own Bitcoin experience and PorcFest ’12 vendor booth, Bernanke’s Bitcoin Exchange, a humorous zing at Mr. Central Bank himself, Ben Bernanke.

In addition to the usual merchant services being paid for by Bitcoin there are several crowdfunding ventures popping up in cyberspace. The granularity of Bitcoin allows benevolents the opportunity to help fund projects and charities in smaller amounts than what would be practical in standard currency. The limitations inherent in standard currency limits the number of people who, for whatever reason, are capable of making donations. For example, the transaction fees associated to making a $1.00 donation may preclude those people who are wanting to donate but who can only afford $1.00; Bitcoin’s lack of transfer fees or restrictions and its granularity offers those people an opportunity to help others at the level they can afford.

There can be no doubt that the decentralized aspect of Bitcoin, combined with its usefulness and scarcity, is what make the cryptocurrency so popular amongst its adherents. It doesn’t take long to become disenchanted with the world’s various currencies given the current global economic situation. Greece is on the verge of economic collapse having lost faith in the Euro model; Bitcoin can quite easily serve a valuable and useful purpose to those affected in the Eurozone.

Bitcoin isn’t just for those needing a fallback in an economic calamity, it’s a perfect solution for casual users as well. Moms and Dads no longer need to trust their teens with a credit card when they can make a deposit into the teen’s Bitcoin wallet. This prevents reckless overspending and teaches a lesson in proper money management because, unlike credit cards which can be overused very quickly, teens can only spend the Bitcoins they actually have, no more.

Bitcoin may not be for everyone, but it certainly solves many issues some people have with the current modus operandi. Whether you’re looking for a solution for easy international exchange, as a small hedge against inflation, for crowdfunding, or simply as a way to facilitate a more modern version of an allowance for your teens, Bitcoin is a possible solution.