Updated: Dec 12, 2020
Bitcoin is a digital currency which uses blockchain technology to track, process and secure payments between users.
If that all sounds a bit technical to you, don’t worry. We can understand what Bitcoin really is by learning why it was created in the first place.
Why is there Bitcoin?
In the mid-2000s, the United States experienced a housing bubble. Too many people were walking away from mortgages they couldn’t afford, which caused a major problem for the banks that had invested in them. By 2008, a number of the world’s most premier financial institutions were at risk of failure. Merrill Lynch and Bear Sterns--kings of Wall Street--were sold off to other banks. Lehman Brothers, a 700 billion dollar institution, went completely bankrupt.
The housing crisis precipitated a Wall Street collapse, which trickled into every corner of the global market. By Fall 2008, the entire globe was in the throes of what we now call the Great Recession. Poverty and homelessness skyrocketed, entire nations teetered on bankruptcy, and, for the first time since the Great Depression, people didn’t know whether their money was safe in their bank accounts.
In short, the financial system had failed.
In the midst of it, an anonymous computer scientist published a paper to an online cryptography mailing list. The title: “Bitcoin: A Peer-to-Peer Electronic Cash System.” Writing under the name “Satoshi Nakamoto,” the author made their intentions clear from the very first sentence:
“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
This electronic cash was a rebuke to the financial system which was falling apart before our very eyes. As politicians debated taxpayer-funded bailouts for “too big to fail” banks, Satoshi argued an opposite approach: to forget Wall Street entirely, and put finance directly into the hands of ordinary people.
But what is Bitcoin?
Bitcoin is just a list.
Isn’t that wild? You could spend years trying to learn the intricacies of Bitcoin’s underlying technology, but when it comes down to it, it’s all just a list (or, as it’s referred to in the industry, a “ledger”).
To understand what this means in practice, let’s do an exercise. Imagine you were to create your own currency. How would it work?
You’d start by giving it a name. Let’s call it: “Pitcoin.”
What do you need to ensure that Pitcoin is actually useful to the people who own it? Two things, mainly. First: its owners have to believe that Pitcoin has value (we’ll get to this issue in another article). Second: you need a way to prevent your friends from gaming the system.
To prevent cheating, you start a list. Everybody who makes a Pitcoin payment has to add it to the list. If Alice gives Bob 12 Pitcion, it goes on the list. If Bob uses 5 of those Pitcoin to pay Charlie, it goes on the list. Because everybody’s payments are recorded in the list, you can keep track of who owns how much Pitcoin at any given time. Even more crucially: because everybody can see the list, nobody can fudge the numbers without everyone else noticing.
That’s Bitcoin, in a nutshell! Every bit of complicated technology that goes into making Bitcoin work is about keeping track of who owns how much, and making sure no one can cheat.
How Does it Work?
Bitcoin is peer-to-peer. There is no one place where Bitcon “is”--no data center where it’s stored, no company that controls it.
Instead, it’s thousands of actual Bitcoin users and companies around the world which operate the network on their own computers. With the right software, anybody can be their own data center, and participate in the actual operation of the network.
Let’s say Alice pays Bob 0.01 Bitcoin. The coin doesn’t immediately enter Bob’s possession. Instead, the transaction is signaled out to the wider network, for anyone to see.
From there, network participants from around the world compete to verify and process the transaction. These participants are called “miners.” We’ll cover mining further in a future article, but for now what’s important is this: miners make sure that Bitcoin payments aren’t fraudulent, and they earn rewards for doing this work. When Alice sends Bob 0.01 Bitcoin, a small fraction of that 0.01 is actually sent to the miner who verifies that Alice has the proper funds, then processes the transaction.
There’s a lot more nuance to this process, of course. By the end, though, what we end up with is a decentralized network of users who, collectively, maintain that giant list of all Bitcoin transactions that have ever occurred. Because every payment is verified and recorded on the list, you can track how much Bitcoin everyone owns. Because the list is completely transparent to everyone, no one can cheat the system.
The Bottom Line
In 2008, Satoshi Nakamoto proposed a digital currency capable of facilitating transactions between any two people in the world, without the need for a bank in the middle.
It was a crazy idea. Banks are necessary, after all, for keeping track of everyone’s money. If nobody’s guarding your bank account, can’t anyone just steal your life’s savings?
Despite how crazy the idea was, a dozen years later, Bitcoin has not failed. It has not been hacked, and cheating is nearly non-existent. It works because thousands of people around the world, collectively, operate and police the network. And because anybody in the world--even you--can join in the process.
The proof is in the pudding. As of this writing, the Bitcoin network is worth 200 billion dollars.