What Is Bitcoin and How Does it Work?

What Is Bitcoin and How Does it Work?

If you've seen any technology news in the past several months, chances are that you've heard about Bitcoin. Lots of people are scrambling to purchase this alternative currency and want to sell it for a profit.

This all seems pretty confusing if you're not familiar with Bitcoin. Today, we're going to offer a simple overview of what Bitcoin is, how it works, and why it's become so popular.

What Is Bitcoin?

Bitcoin is a completely digital currency. Unlike traditional money, it's not printed by a central bank or maintained by a government. In fact, one of Bitcoin's central aspects is that it's decentralized. This means that no one person or group of people "owns" Bitcoin like a government is in control of physical money.

Due to this, Bitcoin is a private currency. You don't have to provide any personal information when you sign up for a Bitcoin wallet (a place to keep your Bitcoin). Each user has an address, which is all you need to send Bitcoin to that person. Some online retailers accept Bitcoin too.

So know we know the basics of Bitcoin, but how does it actually work?

How Does Bitcoin Work?

Let's take a real-world example to understand how Bitcoin functions.

Say two people, Adam and Beth, are sitting on a bench. Adam has one apple and Beth does not. If Adam gives his apple to Beth, she now has one apple and Adam has zero. This is obvious -- if you give a physical object to someone, you no longer posses it yourself.

But this doesn't work in the digital realm. Say Adam has a digital apple -- a picture of an apple, for instance. If Adam sends that digital apple to Beth, there's no guarantee that the apple is now hers and only hers. Adam could have made ten copies of the apple before he sent it, or put it online for millions of people to download.

What's the solution to this? Adam could create a ledger, keeping track of all the digital apple transactions everyone made. But then we have a bigger problem. Adam could interfere with the ledger and create more digital apples whenever he felt like it. And when anyone wanted to send an apple, they'd have to consult with Adam first.

The way this works is by giving the ledger to everyone. Instead of just Adam, everyone who wants to send digital apples will have a copy of the ledger on their computer. That way, whenever someone makes a transaction, it updates the ledger on everyone's computers. Nobody could cheat the system.

As you can probably tell, the digital apples in this example represent Bitcoin. Every Bitcoin user keeps a copy of the ledger -- known as the blockchain -- on their computers. Thus, if anyone tried to cheat the system by copying their Bitcoin, it would quickly be found out when their ledger didn't match everyone else's. In the same way, nobody can simply create more Bitcoin for themselves out of nowhere.

How Is Bitcoin Value Generated?

The other big Bitcoin word you've probably heard is mining. Essentially, mining involves a computer doing a lot of advanced computations to update the blockchain (ledger) when new transactions are made. By solving these complex calculations, the people who mine with their computers are awarded more Bitcoin for their trouble. In turn, mining benefits the entire Bitcoin economy by keeping it updated.

Mining requires powerful computer hardware. This is why PC parts like CPUs and graphics cards rise in price during periods of Bitcoin popularity. People who mine run special software on their computers to solve the computations.

Why Do People Use Bitcoin?

Now that you know what Bitcoin is and a bit about how it works, you might wonder what the use is.

One of the benefits of Bitcoin is that it's private. As long as you have a user's address, you can send them Bitcoin. Some online services accept Bitcoin from users who don't want to have their purchases traced.

Bitcoin is also popular because it's not centralized. People who don't trust governments or banks can put some of their money into Bitcoin, where no one entity has control over it. This makes Bitcoin popular in countries where the national currency has fallen in value. And during international transactions, you don't have to worry about exchange fees like you do with traditional currency.

However, Bitcoin is also quite volatile. A variety of factors, including media coverage, political events, and changes to Bitcoin itself can sent its value through the roof or down into a slump. Thus, investing in Bitcoin is a risky venture.

Bitcoin is an interesting example of how computer users can create a deregulated and open alternative to traditional currencies. It's far from the only digital currency, but it's certainly one of the most popular. Even though you'll probably never deal with Bitcoin, knowing a bit about it helps you understand what it's all about when you see it in the news.


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