What if there was a coin that was worth lots of money, but it wasn’t made of gold, platinum, or any precious metals? What if this coin was something that you couldn’t put in your piggy bank, or hold in your hand, but was just as real as any of those things that you can hold? Digital currency is money that exists only electronically, which means that you can access this money virtually anywhere that has an internet connection or the ability to process these types of transactions.
The most popular of all the digital currency that exists today is the one called Bitcoin, and it is unique in that it isn’t attached to any country, or central issuing authority. That means that there is no central authority deciding on how many coins to make, or when to make them, or keeping track of where they are or investigating the movement of the coins from one person to another.
Cryptography is what makes the whole thing work, which is why they call Bitcoin the world’s first “cryptocurrency.” These electronic coins can be traded on a worldwide network that allows communication and trading from peer to peer. If you are unfamiliar with peer to peer trading, think about the networks that allow people to share certain kinds of files like music, books, and other media types.
You ask yourself, what is to stop me from making fake Bitcoins and becoming rich? Well, Bitcoin isn’t the kind of electronic information that can be duplicated. It is rather an entry of a giant global ledger system called a blockchain, and this ledger records every Bitcoin transaction that has ever happened. Currently, there is more than 100 GB of Bitcoin transaction data recorded on this ledger.
When you send the Bitcoins it isn’t like you are sending then a file from your computer, but rather you are writing down the transaction, electronically of course, into this big ledger. There is no one group of people who update the ledger, and like the internet itself the keeping of the ledger is diffused among the many. Anyone can volunteer to help keep the ledger up to date, and a ton of people do donate their time to do this work. Since many people are keeping track of the same thing, it ensures that the information is kept accurate.
It would be kind of like playing a game of poker with your buddies, only no one has chips or money on them to keep track of the winning and losing. In this scenario, a few of you might get out some paper and start writing down the bets, and with more than one of you writing it down the accuracy of the betting can be accurate. Since no one completely trusts the others the ledgers are kept separate, and at the end of every hand those keeping the ledgers compare what they have written down to ensure an accurate record. If anyone makes a mistake, or tries to cheat, it will be caught by the others and that is a great way to self-police the Bitcoin transactions.
Pretty soon, if the game lasts a while, you will have several pages of information about the movement of the money from player to player. Each page can be thought of like a block of transactions, and eventually you will have pages and pages of information, and that is comparable to a blockchain. One might ask how the ledges are all kept in sync since there are thousands of people keeping their own ledgers and uploading the information at different times.
In keeping with the poker analogy we are going to think of the Bitcoin community as a giant poker table filled with people writing down the bets and movement of money from person to person, millions of them. When you want to send or receive money you have to shout that out to the rest of the people sitting at the table so they know you have something coming, and can use the information to update their ledgers. So, for all your Bitcoin transactions you need to give a couple pieces of information to the Bitcoin network. Your account number, and the account number of the person you are sending Bitcoins to, and how many or your bitcoins you want to send. That way all of the users keeping track will update their ledgers to the current block of information.
If all you need is a couple account numbers to send Bitcoin one might ask how secure is this really? Certainly, with real money, just having this level of security wouldn’t be enough to protect one from being ripped off right? Well, Bitcoin is kept pretty safe thanks to the aforementioned cryptography, which uses “keys” which is really just chunks of information used to mathematical guarantees about the messages that get sent out to everyone at the poker table.
When you create an account on the Bitcoin network, otherwise known as a wallet, your account is linked to two very unique “keys.” One is your private key, and one is your public key. The private key has data that works like a signature for your messages, and lets people know that it is really you sending the message. Only you have access to this key, and no one else can replicate it. You can then send out your messages, and the other members can use your public key to check and see if the signature matches. When it is confirmed, and those keeping track of the ledger will know to place your transaction within the blockchain. Unlike your own signature, this information (your private key) can’t be faked, and the checking with the private key also cannot be faked.
Now, the information about “who” is sending these Bitcoin messages is important to be sure, but so is the “when.” Let’s say you have $100 bucks in your bank account and try to buy two things costing a hundred dollars. Your bank would honor the first transaction that comes in and pay out the money, and reject the second transaction and charge you some hefty fees right? A similar check is built into the Bitcoin network. Both your “Wallet,” or account, and the Bitcoin network will check all of your previous transactions to ensure you have enough Bitcoins to make the transaction happen.
Since the ledger keepers are all over the world, in different places and different time zones, how do they keep the transaction requests straight? Math. To put information on the chain, each computer that is keeping an electronic ledger has to solve a specialized math problem created something known as a cryptographic hash function, which basically is an algorithm that takes input information of any size and turns that into an information output that has a fixed size. So let’s say you had to input the numbers 5,6,7,8,9,10, and the hash function instructs you to add all those numbers together. The answer of course is 45, and what makes these hash functions so good for cryptography is that when you are given an input (the question) it is really simple to find the output (the answer), but very difficult to figure out the original input by looking at the output.
Bitcoin uses something called SHA256, which is the name of the hash function they use, which means secure hash algorithm 256 bit, and was originally brought out by the National Security Agency. Computer designed to specifically figure these things out take approximately 10 minutes to come up with the answer (finding the input by looking at all the ways to make numbers add up to the output amount). This means their computers are having to calculate guesses at the answer a billion times or more before the computer gets it right, and whoever’s computer solves the equation first gets to add the next set of information to the chain, and that makes for a new math problem to be generated which will have to be solved. If a bunch volunteers make blocks of information at around the same time, then the network will pick one of those to keep building on. Anything added to the alternate chains get absorbed into a pool and get attached to later blocks of information.
People who volunteer to solve these problems and enter the information into the ledger spend lots of money to buy the special computers needed to solve the problems so that they can add to the chain. One might ask what they get out of all of this. Well, Bitcoin has a built in system to reward them for their work. Every time they win the race to solve the math problem and add their information to the chain they are awarded some Bitcoins to their account. Depending on the value of those Bitcoins, that can add up to a whole lot of money.
So if you’re thinking about getting into Bitcoins there are some really good advantages if you have a Bitcoin investment strategy. This new type of currency may one day make “real” money obsolete altogether.