By now you’ve likely heard of Bitcoin, not least because the currency made headlines recently when the price of one bitcoin climbed above the price of an ounce of gold for the first time ever. However, if you’re confused about how it works and what all the fuss is about, you’re not alone.
In this brief bitcoin primer, we’ll bring you up to speed and explain why the idea of cryptocurrency warrants some attention.
What is Bitcoin?
Bitcoin is a cryptocurrency – a form of digital currency that uses cryptography to secure transactions and control the creation of new currency units.
Unlike traditional currencies including Canadian dollars, British pounds or Japanese yen, there is no central bank or government controlling bitcoin. Instead, it is managed by a decentralized network of individuals called “miners” who authenticate transactions between parties and enter them into a decentralized public ledger.
At the heart of the technology behind bitcoin is a blockchain, which is a distributed peer-to-peer network. Essentially, this means that the entire bitcoin system – including the public ledger that tracks how many bitcoins are held by each individual user – is spread over countless computers around the world.
This is advantageous because it makes the system more secure and tougher to shut down (there is no single location making the system vulnerable to attack or unauthorized changes). The distributed nature of the blockchain also increases the capacity and speed of the network, which means that transactions can be settled almost instantly, whereas traditional banks can take days to clear transactions.
While there are other cryptocurrencies, bitcoin was the first one to successfully launch as a decentralized cryptocurrency and today it remains the most popular among them. If you’re interested in learning more, this video describes Bitcoin.
Why have cryptocurrencies emerged?
The traditional government-issued currencies (called fiat money) that currently form the foundation of the global economy have been in use for ages, so what has prompted the relatively recent emergence of cryptocurrencies like bitcoin?
For one thing, there was the 2008 financial crisis. Triggered by greed and shady practices in the banking sector, the crisis sent financial markets into a downward spiral and wiped out huge amounts of wealth. This in turn led to central banks around the world printing huge sums of new money in an attempt to stimulate local economies, but this contributed to inflation and the devaluation of traditional currencies.
Another broader concern not strictly tied to the financial crisis is the fact that all money transactions in the traditional system are inspected and controlled by banks and governments.
The emergence of cryptocurrencies – and in particular the adoption of bitcoin – has been spurred by these various concerns. Proponents of bitcoin note that it has key attributes that differentiate it from traditional currencies and address many of these concerns:
- Zero transaction cost, so no wire transfer fees for sending money
- Nearly instant settlement of transfers, so no need to wait days for your money
- A distributed system not controlled by a single entity (“miners” provide computer resources and are paid in bitcoins to maintain the blockchain network)
- Untraceable in that the blockchain ledger contains only the ID codes of the transacting parties, but never names or addresses that can be tied to individuals
- Greater security – the bitcoin network has never been hacked
Should you care about bitcoin?
While bitcoin is not yet a mainstream currency, adoption is growing and interest is expanding beyond the small pool of early adopters. Dozens of financial institutions and governments around the world are studying the opportunities and threats posed by cryptocurrencies, lending further support to the notion that bitcoin is here to stay.
At the same time, there are certainly obstacles standing in the way of a rapid shift to bitcoin. For most people worldwide, their concept of money is firmly grounded in traditional currencies, so making the leap to the complex realm of blockchain, digital wallets and buying bitcoins via an online exchange will not be easy.
While the shift to bitcoin or other cryptocurrencies like it will not happen overnight, it seems likely that bitcoin will become increasingly prominent in financial markets going forward. Whether or not you’re rushing off to purchase bitcoins of your own, being familiar with this topic will help you better understand financial sector developments in the years ahead.