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Cryptocurrency 101: Bitcoin and blockchain explained

It might sound like something a certain Italian plumber collects in between eating mushrooms, but Bitcoin is actually a hugely popular digital currency. 

A digital currency is, as you might have guessed, a currency that is housed entirely online. No paper, no coins, no debit cards and, most importantly, no banks. Bitcoins can be used by anyone, anywhere - and you can even ‘mine them’ yourself - if you’ve got a computer big enough. Bitcoins don’t just represent a way to make a quick buck on the Internet though, they are becoming more and more commonplace in everyday life - and challenging people, companies and governments to reevaluate the way they trade money.

Originally worth less than one tenth of a cent, a single Bitcoin is now worth over  $1,000. The volatility of the price of Bitcoins means they are widely open to speculation - in English, their value fluctuates on a daily, hourly, or even minute-by-minute basis. To help combat this, only a certain amount can be generated per hour. Bitcoin was created in 2009 by an anonymous online writer under the pseudonym Satoshi Nakamoto. He described the Bitcoin as a “peer to peer electronic cash system” and that is pretty much what it is.  Although not the first crypto-currency ever created Bitcoin is probably the most widely used.

The more computer savvy can mine for their own Bitcoins by  cracking a computer algorithm. Each cracked code is worth one Bitcoin. Simple. Well, not quite. Although the first Bitcoin algorithms were easy to crack, eight years later they’re far more difficult and require the most sophisticated computers.  People now have whole server rooms dedicated to mining Bitcoins, and have formed syndicates to help pool their computers’ processing power together. This increasing difficulty helps to limit the amount of Bitcoins that are created, thus regulating their value.  

But how can a digital coin that doesn’t physically exist be worth anything, let alone thousands of pounds? Matthew Tyler, CEO and founder of cyber-security firm Blackfoot, explains there's nothing inherently valuable about inanimate objects such as a coin or paper notes.

He says: “If you think about it a £20 note has no intrinsic value - it’s not worth £20 pounds. It doesn’t cost £20 pounds to make it, but it is worth £20 because in the UK we have confidence in this piece of paper.”

Basically, it is the transaction and interactions that create value. The physical money is worth something because we all agree it is. However, many of the transactions we once carried out physically, at the shops or at the bank, now occur digitally. There is no physical exchange of cash at all in most cases.  The money we use online on a daily basis is nothing more than a 'collective fiction' supported by a binary code on a computer.

For centuries, banks have acted as the gatekeepers of physical money. They stored it, exchanged it, facilitated transactions, and lent and borrowed it - all for a fee. And, because this was the status quo, banks naturally became the gatekeepers of digital money too. This means banks have retained control of how and by whom money is transferred, and how long it takes. Cryptocurrencies like Bitcoin eliminate the need for banks and remove the barriers they put in place.

But it’s not all as simple as that. Digital and crypto currencies still need some kind of guarantee to stop fraud and theft. Just as new £5 notes have over 20 security features to prevent counterfeiting, cryptocurrencies must also include safeguards to ensure they are secure. Enter blockchain.

A blockchain is a digital ledger - imagine a big, dusty book of transactions zapped into the 21st century and onto the internet and you’ve got blockchain. It’s a public record of all of the transactions that take place in a given network. Once a transaction is added to a blockchain it can’t be edited or deleted.

It works like this: First a transaction is made. This is represented as ‘a block’. The block is then sent to all the people in a network. If the transaction is valid, (there are enough Bitcoins to pay) then the people in the network approve it. The transaction is then recorded in the blockchain (remember the big dusty ledger), providing a transparent record of all of the transactions that have occurred within the network.

Blockchain ensures people can only send and spend Bitcoins they actually own, and prevents fraud and duplications. The ledgers exist on the internet and have no fixed location, which means they are not tied to any given state. For this reason purchasing cryptocurrency is attractive to people who want to remain anonymous - and, in a world where privacy is increasingly important, this is becoming more and more desirable.

This doesn’t mean the digital ethics of Bitcoin or blockchain are problem free. The introduction of cryptocurrencies into the marketplace has already created questions. Many are worried that the anonymity this new digital currency offers is too easily bent to criminal activity, while others have developed clever ways to avoid paying the tax duties in their countries.

Despite this, people have put their faith in cryptocurrencies as a way to shelter their money away from growing political uncertainty. The technology is only set to become more and more popular, with the music industry, entrepreneurs and charities exploring ways to adopt it and revolutionise the way they store money and data or sell produce. The future is hard to predict, but cryptocurrency will certainly play a big part in it.

Matt Tyler from Blackfoot recently gave a talk at the Lush Summit, on the potential of Bitcoin and blockchain, watch it on Lush player now.

 

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