Bitcoin is a form of cryptocurrency that has only emerged in the past decade. Instead of paper notes or metal coins, cryptocurrencies are a form of digital currency that we refer to as being ‘decentralised’ because it functions without a central organisation e.g. a bank. Instead, the network is comprised of users who transact between each other without an intermediary. The transactions are verified through cryptography from one node in the network to another and recorded in a public distributed ledger known as a blockchain.
Blockchain technology was created alongside bitcoin and although initially only known to digital enthusiasts, it’s more widely recognised now for the potential impact it can have on the way we trade in the future. Most recently, the Australian Stock Exchange has been developing and testing a type of technology similar to blockchain for cheaper, faster and more secure transactions.
There are a few ways Bitcoin can be earned. It can be purchased using traditional currency or exchanged for products or services. Another way is through the process of mining where bitcoins are then created as a reward. Mining uses computer processing power and is a vital part of the entire process; transactions on the network are confirmed by miners; it’s a record-keeping service for blockchain and keeps them consistent and unalterable. There are a limited number of bitcoins – 21 million to be exact. This was set by Bitcoin’s inventor Satoshi Nakamoto, a pseudonym used by an unknown person or group of people who invented it and some say a cap on the number of bitcoins is used as a method of preventing inflation to occur on the value of bitcoin.
To use bitcoin, you will need to have a digital wallet or cryptocurrency wallet, which is basically a software program that updates the transaction records on the blockchain or public ledger. There is no ‘storage’ of coins, your digital wallet has an address which allows you to send and receive transactions using private ‘keys’. To help you better understand, here’s an example of how a bitcoin transaction would take place[1]:
Alice wants to use her Bitcoin to buy pizza from Bob. She’d send him her private “key,” a private sequence of letters and numbers, which contains her source transaction of the coins, amount, and Bob’s digital wallet address. That “address” would be another, this time, the public sequence of letters and numbers. Bob scans the “key” with his smartphone to decode it. At the same time, Alice’s transaction is broadcast to all the other network participants (called “nodes”) on her ledger, and, approximately, ten minutes later, is confirmed, through a process of certain technical and business rules called “mining.” This “mining” process gives Bob a score to know whether or not to proceed with Alice’s transaction.
Here is a photo of an actual bitcoin transaction to a digital wallet:
The rise of value in Bitcoin has attracted intense media coverage in the last few months. Many investors are sure to wonder whether they should incorporate cryptocurrencies into their portfolio. In a separate post, Darren shares his thoughts on bitcoin mania which you can read here.
[1] Example taken from blockgeeks.com
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Disclaimer: This post has been prepared for general information purposes only. It is not specific advice to any particular person. You should consult an authorised Align Financial adviser before making financial decisions.
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