Understanding Bitcoin in 16 Bullet Points

But first, a 900-word story…

There once was a village called Nioctib (sounds Inuit or pharmaceutical but was actually in Nebraska). They mostly grew wheat, and bored. They didn’t know nothin about money, but they knew about wheat. What with their advanced technology, they were soon growing more wheat than they could eat. So Mary, who owned a big unused warehouse over on Ihsotas Valley Drive offered to take the excess wheat bags and store them. She vacuum sealed them so they’d last a lonnnng time. And Mary would keep a log of who gave her how many bags.

One Day Jim was over at Larry’s farm and when he saw what a beautiful, big fat pig Larry had, he offered to buy it. Not having any money — no one had invented it yet — he offered to trade some wheat for the pig. After some haggling, Larry agreed to a price of 4 bags for the pig. But rather than run home and make the extra trips, they just called Mary by talking to the walls — omnicom had been invented — and told her to give 4 of Jim’s bags to Larry. They all had more wheat than they knew what to do with anyway. Mary jotted it down on a Postit note, stuck it to the fridge, and that was that. Gosh-darnit, the Nioctib’s now had a monetary system! They dinn’t have no coins or currency, just money… namely, Mary, her bags, her trusty log book, her fridge, her Postit notes, and a warehouse fulla vacuum-sealed wheat bags. You can make ‘money’ more complicated than that but not really. You can throw in bigger computerized log books, more people and buildings, fancy-named intermediary stuff like mortgage-backed derivatives, and enough changes of hands that you have no idea where the bags of wheat are, but no matter what complexity you add, ‘money’ only consists of wealth stored somewhere… and managed by a trusted third party. (And if anyone deserved to be called a “third party” it was Mary, but more on that later.) Money is wealth stored by a trusted party.

[Narrator: So there’s our two-word (a.k.a, “crossword”) definition of money: ‘entrusted wealth.’ Think about it. When you say someone has a lot of money, you’re not implying they have a lot of cash or coins; you mean they are wealthy. And you also don’t mean they have JUST a big house and car (the tangible purchases of that wealth). You mean they have wealth that is stored somewhere, even in the rarest case that almost all of it might be ‘entrusted’ to something like real estate. But back to our story.]

One day, Mary got a little tired of keeping up the log book, so she thought she’d hand out IOUs instead. Brilliant! Her uncle across the road had a sheep farm so she got him to make some fancy sheepskin papers and from that point on she mostly handed out little parchment IOUs that said “Good for One Bag of Mary’s Wheat.” The next time Jim needed to buy a pig or goat or whatever, he didn’t need to call Mary… he just handed over some of those new IOUs, and everyone was happy as a pig in… a sty. Well, wasn’t this quite a development? The Nioctibs now had not just a monetary system but a currency system to boot! Woohoo. It worked so well that once wheat production leveled off a bit, people rarely even visited Mary. But them parchment bills continued doing their job just fine.

Well, lotsa years passed happily in Nioctib when one day, Jim Jr. asked his dad, “How does that money stuff work?” Jim explained that each bill was equal to a bag of wheat in good ol’ Mary’s warehouse, so when you paid someone two bills it was worth the same as the food you could get from two bags of wheat. Little Jimmy asked if they could go see this incredible warehouse some day. So they got in the buggy and took a ride. When they got to Ihsotas Valley Drive they could barely believe their eyes. Right where the warehouse used to stand, all they saw was a couple of rusted bulldozers surrounded by the tallest, densest packed wheat field you ever saw. Jim was dumbfounded. But right across the street was the most beautiful mansion you’ ever seen. The driveway was lined with fancy Italian sports cars and the building looked like it was gold-plated. Jim and Junior Jim walked up to a nice-looking man on the porch, who was sipping at some lemonade, to ask what happened. The man explained that a real-estate developer offered Mary a huge home on Biscayne Bay in exchange for the whole property to build a mall or somethin’. Well, he bulldozed down the whole affair but musta run outa money before he could build the mall. So all that wheat seems to have come back tall as can be, but that’s about it. The Jims started walking away, in a disbelieving stupor, when the man yelled out at them, “Here, take this,” and threw what looked like a brick of paper at them. Sure enough it was real live, perfectly usable Mary Money, maybe a thousand. He continued, “Long as people have a warm home and food on the table, seems I can print this stuff as fast as I want and there’s never really any problem. But don’t tell no one where you got it or it will be worthless faster ‘n you can spit.” They turned again to leave but asked, “What’s your name?” “Oh, it’s Sam. I’m Mary’s Uncle Sam.”

And to our definition of money we can add one for currency: “trusted IOUs” and nothing more.

Laugh if you want at the details, but that is exactly what ANY monetary system is. Even gold, the more you think about it, is not valuable exactly because of its potential price when melted for use in jewelry or manufacturing applications; instead its value is a combination of belief that it has value and the incredible strength of “that’s the way we’ve always done it.” The ultimate bottom line answer to “why does a currency have value?”… is “because you believe you can trade it for something of value. The minute that belief erodes, it collapses rapidly, whether gold or US bills or any other country’s.”

The Promised 16 Bullet Items

Bitcoin is the most fascinating thing I’ve ever learned about. Its starting point — money — is so abstract that the greatest minds disagree on its essence and mechanism. (They just need to read my little story, above.) It is both huge and tiny; it has billions invested in it but that’s a mere speck of global currency. Its creator is anonymous, despite creating a worldwide, earth-shaking phenomenon that is several years old and very successful. It is a combination of every level of technology that preceded it, from Ben Franklin’s kite to Steve Jobs’ iPhone… yet adds genius mechanisms only its inventor could conceive. Chief among them is an endlessly-accumulating blob of data that gets passed around the world forever; how crazy is that? And it resides equally on private computers all over the world with absolutely no central instance, company, or authority; how cool is that? And finally, it can be either simple or incredibly complicated, depending on who you are. If you are a poor person, whether in a third-world country (or in a “first-world” country with third-world means) you have nothing to lose by downloading a bitcoin wallet and using it with no regard for the complexities or risk of having your money stolen by hackers; but if you want to fully understand the risk and how to manage it, you’ll find an unbelievable rat’s maze of options and explanations… to protect even the smallest amount of money. Wow. We live in interesting times… to an extent that is truly staggering.

I’ve had to read three books to hack through the whole bitcoin puzzle. Perhaps I should have read the Wikipedia explanation first but I didn’t. Here’s my explanation for potential users of bitcoins… consumers. This is not a technical explanation of the internal software machinations of Bitcoin but it will describe the concepts to the extent that a consumer is likely to be concerned.

1. Crossword definition: Digital money.
2. Long definition: totally peer-to-peer, open-source, native Internet, electronic currency and monetary system, maintained by volunteers on their own computers using state-of-the-art cryptography. Culturally it is the techno-democratization of money… and you were here when it happened!
3. It was created by an anonymous person who posted this document https://bitcoin.org/bitcoin.pdf in 2009 under the name Satoshi Nakamoto to propose critical innovations that solve online money’s key challenge: how to prevent counterfeiting, which, for online money is the matter of preventing double-spending.
4. Important: It is both a currency system (a means to conduct value trades) and a monetary system (a representation of value). The part that amazes most people is that its value is intrinsic to itself and not based on some other entity such as gold or any country’s ‘good faith’ whatever that is. Those who are not amazed either consider it a scam or, perhaps by the end of this article, a near miracle. Countries’ currencies are called ‘fiat’ or ‘fiduciary’ money.
5. The currency side: This side is EXACTLY analogous to the lockers at an airport, especially if the lockers use electronic keypads instead of physical keys. You make transfers by putting things in a locker and telling someone the locker number (public key) and PIN number (private key).
6. Its money consists of long strings of alphanumeric characters that the software generates such as 3J98t1WpEZ73CNmQviecrnyiWrnqRhWNLy which are generally transferred by a computer program or QR code. There’s also an even longer secret code portion, like a PIN number, that is needed to actually transfer the money. This long-standing scheme is called public key cryptography.
7. You buy bitcoins from websites — exchanges — that take your credit card or bank account info and then deposit your codes into your bitcoin ‘wallet.’
8. Various wallet “configurations” are available… on a website, on your own computer, on a flash drive that you disconnect… even on a piece of paper. If you use a wallet system that is always reachable from the Internet, even just files on your own computer, it is potentially hackable by thieves; consider how much scumware is on your computer despite your wishes. If they get/learn/copy your private keys, they have gotten your money. They’ll ‘use’ them immediately, by transferring them to their wallet, and you will never recover your ‘money.’
9. Designing online money had a really hard problem, though: preventing double-spending. Imagine if you separately told two people you’d sell them the contents of Locker #412 at the airport and took their money in exchange for the PIN number. The mysterious Satoshi conceived an incredible solution to this problem (apparently known by the colorful name, the Byzantine Generals Problem or variants): every peer stores a complete chain of every transaction ever made. In his PDF he mentions dropping off older transactions when it gets too big. This solution, however, means there’s a 10-minute delay for transactions to be validated. And for large (riskier) transactions, the convention is to wait an hour, to ensure that 6 validations occur… a reasonably strong assurance of no temporary arguments between the peers. For small transactions, it’s expected that vendors will forego the 10-minute wait.
10. The monetary side: As impossible as it sounds that the value of the bitcoins are “created out of thin air,” a careful analysis of all fiat money (not gold) reveals that they too are just as ethereal. This point is demonstrated by our little parable, above.
11. The software is designed to limit the eventual number of bitcoins to 21 million! In this way it is deliberately designed to work like gold… in fact, it is MORE adherent to the gold standard than even fiat money that says it’s backed by gold.
12. The ‘volunteers’ (called ‘miners’) who operate the peer computers to run the system earn bitcoins for processing orders… that’s how the bitcoins are initially created. It gets progressively harder to earn them until the 21 million are finally created, estimated to occur in the year 2140, after which the miners earn only a transaction fee. The initial bitcoin reward was 50 per task, but cuts in half periodically.
13. At the inception, a bitcoin was worthless to the point that someone supposedly paid 10,000 for two pizzas. As others agreed to provide goods and services for the ‘promise’ that bitcoins might be worth something some day, they obtained value precisely and only because you could ‘buy’ things with them. At one point they were each buying $900 worth of goods despite being coined by an algorithm. [2019 update: when I sold some last year, they were up around $20,000 per bitcoin.]
14. Any money — euros, dollars, bitcoins — is worth something ONLY to the extent that you can buy things with them, not because of “the full faith and backing” of any government or even a promise that it is backed by gold.
15. Prediction: Because 1) big companies are getting on board, 2) Bitcoin’s 21-million limit makes it more of a gold standard than fiat money, and 3) Bitcoin has the network effect or first-mover benefit going for it, I predict Bitcoin will thrive. It’s impossible to know how likely it is that a competitor will supplant it, but if it does, Bitcoins will probably be transferrable but rapidly collapse as people ‘run’ to the new replacement. For this reason, online money could be the absolute most volatile way to “invest” and you might be totally insane to think you’ll use it to hold a lot of your wealth but beat the insiders when it’s time to bail. Hybrids always win, so people are unlikely to put the larger portion of their wealth in online money; it’s too fragile. Example from Wikipedia: “…in 2008 Amazon S3 was brought down for several hours when a single-bit hardware error propagated through the system.”. Think about that… a single hardware bit… a single magnetic or optical cluster of molecules delaminating from a spinning platter? If a system like Bitcoin experiences such an outage, how do you think people will react? Answer: quickly, precipitously. So people will keep most of their long-term wealth in fiat money. But eventually Bitcoin or variants will overtake some portion of all fiat money… as soon as we all figure out ways to feel more secure having our wealth in immensely fragile strings of numbers. It will almost certainly disintermediate credit cards for day-to-day expenses.
16. Advice: put a day or two’s income into Bitcoin and learn to use cryptocurrency. Critical: study how important it is to keep your private keys disconnected from the Internet or you will lose all your money.

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Six-Page Version

This is just a longer version of our 16 points, above.

1. Crossword Definition
2. “Digital money.” (A crossword definition is a 2-word definition, according to Bellis’s Theorem that any word can be defined by as few as 2 other words, but that’s a rant for another day). A better choice, though for the second word is “IOU’s”… digital IOU’s. The first word is a toss-up between “digital,” “online,” and “electronic,” but doesn’t really matter. “IOU” is better than “money” because it is more instructive of what’s really going on… not just with Bitcoin but any monetary system. More on that later.
3. The Basics
4. Dictionary Definition Bitcoin is an electronic currency and monetary system fabricated entirely from the Internet and software running on it. It uses exclusively peer-to-peer computer technology, open-source software (meaning no one owns it), complex, previously-established cryptography algorithms (logic), and is maintained by volunteers.
5. Inventor It was created by a mysterious person or persons who has kept their identity hidden but has used the name Satoshi Nakamoto in an Internet article that proposes the design of the system. The most logical reason for remaining anonymous is to prevent being charged with the potential crime of undermining government currencies. Another reason, entirely of my own speculation, is that when the time might come for the creator of the system to cash in a large number of bitcoins that he created in the early days of its inception, the inventor wouldn’t want any chance of recourse or challenge at that time. Even though Bitcoin is substantially anonymous right now, it represents a challenge to governments so they could try to make it illegal to trade anonymously. Even lacking government concerns, the knowledge of the founder “cashing out” could depress the value, which would be self-defeating.
6. Usage Its money is managed by long strings of alphanumeric characters that the software generates. An example is 3J98t1WpEZ73CNmQviecrnyiWrnqRhWNLy but people hardly ever type such a code; instead they are either transferred from one place to another by a computer program without ever transcribing them, or represented by a QR code for visual transfer. There’s also a secret code portion, like a PIN number, that is needed to actually transfer the money, an even longer string.
7. Buy You buy bitcoins from websites — exchanges — that take your credit card or bank account info and then deposit your bitcoins into your bitcoin ‘wallet.’ (Does that make you queasy, giving your bank account info to a cryptocurrency purveyor? I hope it does or your education providers failed to wire up your synapses adequately. I was even further amazed on the first site I went to that it offered to take my bank account login credentials to avoid the 48-hour delay of a handshake transaction. What emoticon indicates blood-curdling incredulity?)
8. Personal Security I’m sorry to report that the machinations and considerations for keeping your wallet — with those magic codes that represent your wealth — safe from the hackers, scummers, and scammers are absurdly intricate. Despite my 30 years in the sofware biz, I’ve spent hours reading my options and can’t say I feel completely certain of the process. Bottom line: only experiment with a very small amount of money until you learn it by saturation of the ideas into your brain. The starting point is that if your ‘PIN’ codes — technically called ‘private keys’ — are physically connected to the Internet, you can’t guarantee that your wealth can’t be stolen. For instance if you move your keys to a flash drive and disconnect it, it is safe… uh, unless you lose it… or it gets exposed to heat… or ice cream… or a magnet? I personally trace this weakness back to the fact that Windows and Mac refuse to provide a system that entirely tells us what software is running on our computers.
9. Dual Purposes It is both currency system (a means to conduct value trades) and a monetary system (a representation of value inherent to itself and not based on some other entity, physical or organizational). Most of the rest of this document will try to explain where the value comes from; keep reading.
10. All Money Is Curious If you think the above definition is a vague (and you would be right), then try to describe to a youngster how value is represented by the currency in our conventional monetary system. You’ll realize it’s not Bitcoin that’s complicated, but money… and currency only slightly less so. When a child accepts the simplified “definition” that money can be used to buy things he has simply reflected that physical media has tangibility, which in turn is easier to fool ourselves into equating with value. He has not achieved understanding of value, money or currency… just coinage you might say. When we change the discussion from paper bills or coins to the peculiar prospect of storing wealth in a string of computerized characters, it’s even harder to understand. Adults can be placated by saying “it’s like how we transfer money from our bank or credit card to Paypal, and then pay with Paypal… it’s just codes moving around. And the transferring part is a valid analogy.
11. Government Currency But the Paypal analogy ALWAYS represents your government’s currency — euros or dollars — however indirectly. Bitcoin does not! It’s hard to articulate what this even means. In your mind, your Paypal dollars do not fluctuate in value… they always represent a euro or dollar, right? Yes, but the euro and dollar fluctuate in value relative to other countries’ currency; they just do so slowly enough that you ignore it. Bitcoins are not a numeric stand-in for euros… they are their own world. Imagine if your Paypal numbers represented the currency of an unstable country, such as for instance Argentina, where the currency in 2015 is in serious trouble. You’d have to get your money in and out of Paypal very quickly and do something — anything — with it that makes it “not in Argentine currency” ASAP. You could buy apples (loses 100% of value in days), pay your rent (liquidates value), buy euros (stores the value in your country’s bank account), or put it in ‘the’ bank (stores the value in a business’s account). Bitcoin is currently like the Argentine peso in that it is still at an unsettled value… and it has no relationship to any other currency, let along something like gold. I’ve entirely avoided any mention of currencies representing gold because you probably realize that your country’s currency doesn’t represent gold. Those days are long gone. And if you’re thinking that your government’s or your bank’s currency is more secure because it’s safer than an online system, then read the front-page story in the February 15, 2015 New York Times newspaper that tells of hackers causing ATMs to spit out millions of dollars of free bills like Monopoly money. It’s not more secure… it’s only ‘safer’ for you because someone else is taking the risk, or spreading it out to all your neighbors.
12. IOUs and Ledgers No government’s bills or coins have ANY intrinsic value; they are only worth something because you believe that someone will take them in trade. Consider the earliest days of trading. Consider an early bank-like place that took 100-kilogram bags of wheat, and exchanged them for IOUs that said “IOU 1 bag of wheat. Abel’s Wheat Exchange.” If Joe the pig farmer was willing to trade a pig to Mary the wheat farmer for one of those notes (because she knew all about Abel), all of a sudden we have money. Abel, by the way learned over time that he had to keep a list of who he really wrote those IOUs to because some other people could write, too, ya know. The list is called a ledger, and you can’t have a trusted money system without a single version of a ledger. Skip ahead 2,000 years and we are dozens of steps removed from the original IOUs and ledgers but EVERY SINGLE ASPECT of that literal system — not just figuratively — is still behind our dollar bills and the ledgers at our banks and credit card companies. We have a massive IOU system and we trust that everyone will take the IOUs in their various forms.
13. The Three Parts of Bitcoin Bitcoin is the realization of three concepts into practical software implementation:
14. A secure transfer system.
15. We’ll make an analogy to the locker systems at an airport or train station. They enable you to keep stuff secure and, if you want, give the key to someone else to exchange things, just as with money. That’s straightforward.
16. A means of ensuring that the money is only spent once (the trickiest part).
17. This is the online equivalent of counterfeiting. What if you made a copy of the airport locker key and separately told two people you’d sell them what’s in your locker and give them each the key to retrieve it? Bitcoin — any digital currency system — has to solve this problem. These first two parts of Bitcoin comprise an IOU system, nothing more.
18. A stored value system.
19. But what’s in those lockers from my analogy??? That’s what we’re building up to, but notice how separate a matter it is from the locker system itself. If it was just the locker system but represented dollars or euros, it would be a public alternative to Paypal and could entirely disintermediate — gosh, I love that word, it’s so much more elegant than the beancounters’ equivalent for personnel, ‘make redundant’ — Paypal. I see that Paypal is starting to work with Bitcoin. Smart; join or die.
20. Currency The currency side of Bitcoin is perfectly analogous to the locker systems you see at public sites such as train stations or airports (although they’re disappearing because of terrorism and other factors).
21. You put stuff in and typically take a physical key, at least that’s what I recall the last time I used one. Perhaps they’ve graduated to the kind of electronic keypads found in hotel room safes.
22. If you wanted to use such lockers as a value transfer system, you’d give the key — that you alone have — to someone else. You tell them, “Locker 265, here’s the key.” This is exactly what Bitcoin supports online.
23. It uses a complex security technique based on cryptography that’s not much different than all the other incredibly obscure logic that runs the most secure online sites like banks.
24. It’s immaterial to one’s understanding of Bitcoin exactly how such cryptography works. But you could extend the locker analogy a bit further. The locker numbers are public; the keys are your private possession. If you picture the lockers using the electronic keypads then the word ‘private’ even makes more sense than with a physical key.
25. Double-Spending Ensuring that the money is only spent once:
26. This part is so incredibly complicated that it’s a good thing the average user of bitcoins doesn’t have to understand it. It starts with a field called public key cryptography and adds an incredibly complex online ledger system to it. If that’s enough for you, skip to the next topic.
27. You’re still here? A glutton for crypto-punishment, eh? OK. First, you can read the actual document that proposed Bitcoin to the world at https://bitcoin.org/bitcoin.pdf . (Google>bitcoin pdf.) It’s only nine pages and a lot of it is actually legible… that is, if you consider the following to be English: “For our timestamp network, we implement the proof-of-work by incrementing a nonce in the block until a value is found that gives the block’s hash the required zero bits.” I’m proud to say that I read 4 whole pages before my eyes fully glazed over and I went into an hypnotic coma.
28. But I do have enough brain cells left to explain some of the technical miracle. And it is so amazing no sane person should believe it. I’ll hardly explain “how” the problem is solved, just introduce you to the overall scheme of how all the pieces work. Be forewarned, technical purists will correctly say that every one of the following sentences is incorrect, but that’s why they write sentences with the word ‘nonce’ in them:
29. Every transaction is broadcast on the Internet (with the secret keys that aren’t useful to anyone but the recipient of the money).
30. Thousands of computers that are running special bitcoin software attempt to process your request in exchange for earning a very small amount of bitcoins as a transaction fee. You don’t need this software to simply ‘use’ bitcoins.
31. They all simultaneously try to add your transaction to the running log (ledger) of all bitcoin transactions ever made(!), called the ‘blockchain.’
32. Greatly simplified, the first one to add it gets the transaction fee. The portion they add is called a block, thus blockchain. A miraculously intricate scheme ensures that only one copy of the most recent block is added… which in turn ensures that money is spent only once. Easy peasy… a few million lines of code, algorithms developed by the accumulation of 70 years’ programming, 10 layers of technology, thousands of servers, millions of watts of electrical power (a serious issue, by the way), and you have yourself a substitute for fiat money… the broad name for currency that we trust as much as our political system with, say, governors who run off to Argentina to meet their mistresses on taxpayer dollars, or congressmen who keep in their freezer $90,000 of our dollars that they’ve extorted from businesses; that trustworthy political system.
33. Value But what’s in the lockers?
34. If Bitcoin were used to transfer money between people’s checking accounts, the lockers would contain something like your bank account and routing number and the amount you are transferring. With checking accounts, the analogy isn’t perfect… maybe it would be better to say the locker includes a hand-written check. If the ‘locker’ were totally online, it could contain a photograph of the check I wrote. Or consider Paypal. If the lockers contained a Paypal transfer, the contents would contain the same info that’s in a Paypal transaction. Or the locker, if it were physical, could contain the hard currency of some union/country such as euros or dollars. In all three examples the “value” has nothing to do with the locker system; the value is in some other system. Checking accounts and Paypal are just another step removed from other currencies, but still represent those currencies.
35. But that’s not what Bitcoin is all about… no, no, no! The value is inherently from the Bitcoin system! Initially this sounds totally ludicrous, impossible! Value doesn’t come out of thin air. It has to be from something, just like real money, right, or it will never be ‘worth’ anything and sooner or later HAS to collapse because of that.
36. Let’s start by examining our US dollars.
37. It’s sort of represented by gold, right, even if not literally? No, our government long abandoned that notion and it doesn’t appear that any country still does or I think it would be common to talk of having funds in that country’s currency. Around the rest of the world, the dollar is more useful than some currencies because it is ‘trusted’… but that really only means that you trust that you can buy things with it… and that it’s value won’t change dramatically the next day. It has nothing to do with something of inherent value.
38. Money has value only to the extent you can use it to trade or keep… to trade later. And it’s the same with Bitcoin… if people accept it for payment it has value. If they regard “one bitcoin” equivalent to one dollar, then that’s its value. Initially, when there were no vendors that accepted bitcoins, they had no value. A story is told that someone once offered 10,000 bitcoins for 2 pizzas. The recipient was betting on their future value. Skipping ahead but only from 2009 to 2013 perhaps, bitcoins were trading at over $900.
39. All that matters, whether it’s dollars, bitcoins, or Argentina’s money, is how much you can trade one for the other… at any point in time.
40. And now for Bitcoin’s value proposition. First the easy part, its technicalities.
41. Gold-Like Standard Bitcoin was designed so that when the system is fully mature there will be a fixed number of bitcoins, and that number is 21 million. Surprising, eh? In a way it’s not. The inventor modeled the system after gold, which is finite on Earth (or at least we assume they can’t create more). In fact he has this analogy in the PDF: “The steady addition of a constant of amount of new coins is analogous to gold miners expending resources to add gold to circulation. In our case, it is CPU time and electricity that is expended.”
42. Miners Volunteers who run the computers that process trades are called miners. They earn bitcoins — they’re created out of thin air just like dollars and euros — in exchange for processing transactions. That’s their incentive. But unlike fiat currency, the software logic makes it harder and harder over time to create the same amount of coins, so that they entirely stop being created when there are 21 million. Brilliant! This is expected some time around the year 2140 if Mankind lasts that long, or the cockroaches learn how to run Linux. (I’m guessing they’re still learning Windows ‘95.) The miners also earn a small transaction processing fee. When all 21 million coins are created, they will only get the processing fee… no more incentive-newly-minted bitcoins.
43. Business Use Many businesses are now accepting bitcoins. So it has trading value despite being minted out of thin air just like dollars, euros, and Argentinian pesos. And the main question is how valuable will it be long-term… and will it collapse entirely. There are whole books on the plusses and minuses and this essay won’t tackle the analysis, just the summation.
44. I should have convinced you by now that no currencies have value, only perceived trust for trading.
45. Keeping any substantial amount of wealth — more than a week’s income — in online currency for either speculation or long-term storage is a totally different and unrelated matter. Doing so is an extreme risk. Do not put any money in any online currency that you cannot afford to completely lose.
46. Bitcoin could collapse by any number of causes that are probably much more likely than with the dollar or euro. I personally consider the most likely possibilities to be 1) a software flaw that botches the enough of the blockchain to wreak havoc, 2) a better system displacing it.
47. But because it is not tied to any country and is the only currency that has a defined coinage limit — 21 million bills — it has the chance if it survives, to be worth a lot more over time. No other currency has this chance. In this way, Bitcoin is THE ONLY CURRENCY THAT IS ON THE ‘GOLD’ STANDARD… the standard of not being printed without limit.
48. Predictions and Advice
49. Goodbye Visa… Sort Of The first major inroad to the mainstream is that online currency (not necessarily bitcoin) will displace an increasing portion of the business conducted by credit card companies. This is a certainty and already underway. (For those who were wondering what ‘unpredictable’ new waves of unemployment would be next, now you know.) Long-term, credit card companies will probably go on a downward trajectory like movie theaters: they will shrivel up to about 20 percent of their hay-day volume, and continue to evolve an increasingly miserable customer experience until threatened with complete extinction, at which time they’ll show feeble signs of remorse such as PIN numbers, stratified cost-per-risk interest rates, legible credit rules, and slightly better service.
50. Good For Government Online money will aid, not hinder governments because they should only be governing in the first place… not diluting wealth or operating an IOU system any more than, for instance, my home state of Pennsylvania USA operates our liquor retailing business. Politicians are not good retailers, of booze or money. They get drunk on both, and much faster on money; it’s virtually instantaneous or maybe even inborn. I’ll bet that the US wouldn’t spend more than the rest of the world combined on our military if we weren’t printing money without challenge. What would happen is that military vendors would start to insist on bitcoins instead of dollars at some point.
51. Benefits I haven’t even tried to explain the benefits of ‘cryptocurrency’ but there are many, especially for smaller transactions. You can read whole books on just the “irreversibility” benefit to businesses. In the near term, consumers will almost certainly be using online money — and Bitcoin in particular — because of all the ‘major players’ getting involved in it.
52. Collapse? Let’s think a bit more about bitcoin’s stability or more specifically the possibilities for its collapse. In 2008 in the US, the stock market dropped about 20% in a week and 15 banks failed. Presumably the bank customers were protected up to the US’s $200,000 FDIC insurance limit. People who were invested heavily in particular sectors had their equity decimated. I bring this up just to put some context on the notion that any investment is protected against a ‘run’ against it. If a bank has a run against it, people aren’t questioning the value of their holdings, just the likelihood of getting them back in the first place. But the effect is identical. Compare that to a run on a stock… let’s say Google (so we can imagine what we perceive as genuine value, not rash speculation). If people become convinced that Google’s value proposition is dead, they’ll run to sell the stock, being first before the price plummets. The emotional circumstances cause a ‘feedback cycle’ that drives a stock price nearly to zero. But with Google, however bad it gets we perceive substantive value to our shares even plummeted; they still represent the potential for future business, perhaps changed, and attendant stock price growth again. Even if rebirth is impossible, Google has a bare minimum value: that of its liquidated hard assets such as computers. Not so with Bitcoin; its value is only as an exchange medium. Its price growth from zero accrues ONLY on usefulness as coinage. If another system comes along that gets better traction, people could run from Bitcoin. For instance, consider Bitgold which looks like it’s going to try to back online currency with gold. Fascinating premise, and remember, I told you that hybrids always win. (Bitcoin faithful will tell you that such a scheme can’t possibly have Bitcoin’s ‘trustlessness’ benefit.) Of what if an alternative comes along that makes it easier to secure your private keys from hackers. When people run from a completely online vehicle such as Bitcoin, do you think it will be faster or slower than with any commodity that has a more substantive backing? It could be precipitous in the extreme. And interesting. Within minutes, people won’t be able to get online exchanges to buy bitcoins for cash, so they’ll run out to stores to try to ‘convert’ their bitcoins to groceries and other commodity-like merchandise that can be resold. Within an hour or two, merchants will stop taking bitcoins, as they notice the little ticker display on the top of their cash registers dropping. It could be over in two hours… 12 updates of the blockchain. And the next online currency will move into place. Just as we are starting to see that whole companies come and go with single products’ rise and fall, so too could — and my instincts are telling me, should — cryptocurrencies. Brave new world indeed.
53. So, don’t think of Bitcoin as a replacement for any whole tool such as credit cards or banks. You’ll still use those when you need reversible transactions, long-term security, or simply want to remember what being mistreated was like… being on hold, standing in lines, reading small print, labyrinthine voice response menus, painful surveys. “Your satisfaction is our top priority. Please remain on the line.” Ah, those were the days.
54. Instead, picture having the equivalent in bitcoin, of a small debit card account that you use for suitable purchases. You never have more than a few hundred dollars in it so a complete collapse wouldn’t make you lose sleep.

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Bitcoin FAQ / Questions

The following questions are answered in detail above, but some quick answers here, mostly for web searchability.

• Where does the value in bitcoin come from?

From exactly the same place as your government’s money: its value is entirely psychological, to the extent that you believe you can buy something with it. As that belief drops, the “real” exchange rate of the money, relative to other currencies, drops. If the belief turns to fear, the currency collapses.

• How do I get bitcoins?
• 1) From an exchange website, in the same manner that you exchange other currencies. I used Coinbase.com since it looked reputable. It transfers from your bank account. But it has a several-day lag time and does not take credit cards. Maybe others don’t have these limitations.

2) From others who’ve already used an exchange or gotten bitcoins sent to them from someone who has them. This will almost certainly be the vast majority of where people get bitcoins from as time goes on.

• How do you buy things with bitcoin?

You use software called a “wallet” that provides functions to send and receive bitcoins. Wallets are offered by many sources. The system works very smoothly on phones, using QR codes to intermediate transactions.

To buy from an individual or vendor, they will display a QR code that you shoot with your phone’s camera while in your phone’s wallet app.

On a website, there will typically be a button like the credit cards that says Bitcoin. Using it will display a QR code and again you use your phone’s camera and wallet app.

How do you send bitcoins to someone?

• As with purchasing, you use software called a “wallet” that provides functions to send and receive bitcoins. Some of them support sending to an email address or text message recipient, but those typically just prompt the recipient to log into the company from which you got your wallet

Is bitcoin safe from online theft?

Just as safe as your credit card data at the top corporations, and that’s only been stolen how many times? But the proponents will argue that it’s safer because you control the passwords entirely. Hackers have not breached the cryptography system on which bitcoin and all software security ultimately rests: public key cryptography. They have however breached other failure points. You do in fact control the failure points with cryptocurrency but explaining the full security story is pretty complicated. The ultimate security is to get your “private keys” off of the Internet and your Internet-connected devices, meaning onto paper or flash drives. Hmmmm… you could lose those couldn’t you?

Is bitcoin a good investment?

No one knows. It could conceivably plummet like a rock when any competing system comes up with a showstopper improvement. At that time, all the insiders will sell before the general public and it will have been a good investment for the insiders and a catastrophe for many others, same as Enron, the housing bubble, and every other financial skyrocket. It would be damn near miraculous if nothing bumps it off.

• Who runs bitcoin?

Despite claims that “no one does” because it’s a pure peer-to-peer software system, there is a core group of developers. Looks like it’s a Github project. I sure hope there are enough super-geniuses to maintain it when the current ones wander off.

• Who created bitcoin?
• An anonymous person who posted a 9-page PDF with the key software concepts.

Is bitcoin the only online currency?

• No, there are lots of them.
• What is a bitcoin miner?
• Someone who runs the bitcoin server software, which processes all of the send/receive transactions, and in so doing gets compensated with either newly created bitcoins or a transaction fee levied on the transactors.

Do I have to download the bitcoin software to use bitcoins?

• No, you only download a wallet app, a triviality by comparison. You could even use bitcoins, conceivably, without software, in the form of a paper printout. To receive bitcoins you’d need just a QR code of an address in your wallet. To posess or have the ability to spend bitcoints, presumably the paper would have (I think) a QR code that embeds the public and private keys for the address that holds the bitcoins, not sure.

Learn more

• Beginner: Wikipedia explanation
• Intermediate: Interesting article from the Chicago Fed Letter that mostly focuses on the double-spending considerations for the semi-technical reader. It’s also nice to hear a perspective from someone on the other side of the whole value proposition.
• Advanced: https://bitcoin.org/bitcoin.pdf

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