what is bitcoin?

To cut through some of the confusion surrounding bitcoin, we need to separate it into two components. On the one hand, you have bitcoin-the-token, a snippet of code that represents ownership of a digital concept – sort of like a virtual IOU. On the other hand, you have bitcoin-the-protocol, a distributed network that maintains a ledger of balances of bitcoin-the-token. Both are referred to as “bitcoin.”

The system enables payments to be sent between users without passing through a central authority, such as a bank or payment gateway. It is created and held electronically. Bitcoins aren’t printed, like dollars or euros – they’re produced by computers all around the world, using free software.

It was the first example of what we today call cryptocurrencies, a growing asset class that shares some characteristics of traditional currencies, with verification based on cryptography.

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Who created it?

A pseudonymous software developer going by the name of Satoshi Nakamoto proposed bitcoin in 2008, as an electronic payment system based on mathematical proof. The idea was to produce a means of exchange, independent of any central authority, that could be transferred electronically in a secure, verifiable and immutable way.

To this day, no-one knows who Satoshi Nakamoto really is.

In what ways is it different from traditional currencies?

Bitcoin can be used to pay for things electronically, if both parties are willing. In that sense, it’s like conventional dollars, euros, or yen, which are also traded digitally.

But it differs from fiat digital currencies in several important ways:

1 – Decentralization

Bitcoin’s most important characteristic is that it is decentralized. No single institution controls the bitcoin network. It is maintained by a group of volunteer coders, and run by an open network of dedicated computers spread around the world. This attracts individuals and groups that are uncomfortable with the control that banks or government institutions have over their money.

Bitcoin solves the “double spending problem” of electronic currencies (in which digital assets can easily be copied and re-used) through an ingenious combination of cryptography and economic incentives. In electronic fiat currencies, this function is fulfilled by banks, which gives them control over the traditional system. With bitcoin, the integrity of the transactions is maintained by a distributed and open network, owned by no-one.

2 – Limited supply

Fiat currencies (dollars, euros, yen, etc.) have an unlimited supply – central banks can issue as many as they want, and can attempt to manipulate a currency’s value relative to others. Holders of the currency (and especially citizens with little alternative) bear the cost.

With bitcoin, on the other hand, the supply is tightly controlled by the underlying algorithm. A small number of new bitcoins trickle out every hour, and will continue to do so at a diminishing rate until a maximum of 21 million has been reached. This makes bitcoin more attractive as an asset – in theory, if demand grows and the supply remains the same, the value will increase.

3 – Pseudonymity

While senders of traditional electronic payments are usually identified (for verification purposes, and to comply with anti-money laundering and other legislation), users of bitcoin in theory operate in semi-anonymity. Since there is no central “validator,” users do not need to identify themselves when sending bitcoin to another user. When a transaction request is submitted, the protocol checks all previous transactions to confirm that the sender has the necessary bitcoin as well as the authority to send them. The system does not need to know his or her identity.

In practice, each user is identified by the address of his or her wallet. Transactions can, with some effort, be tracked this way. Also, law enforcement has developed methods to identify users if necessary.

Furthermore, most exchanges are required by law to perform identity checks on their customers before they are allowed to buy or sell bitcoin, facilitating another way that bitcoin usage can be tracked. Since the network is transparent, the progress of a particular transaction is visible to all.

This makes bitcoin not an ideal currency for criminals, terrorists or money-launderers.

4 – Immutability

Bitcoin transactions cannot be reversed, unlike electronic fiat transactions.

This is because there is no central “adjudicator” that can say “ok, return the money.” If a transaction is recorded on the network, and if more than an hour has passed, it is impossible to modify.

While this may disquiet some, it does mean that any transaction on the bitcoin network cannot be tampered with.

5 – Divisibility

The smallest unit of a bitcoin is called a satoshi. It is one hundred millionth of a bitcoin (0.00000001) – at today’s prices, about one hundredth of a cent. This could conceivably enable microtransactions that traditional electronic money cannot.

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Read more to find out how bitcoin transactions are processed and how bitcoins are mined, what it can be used for, as well as how you can buy, sell and store your bitcoin. We also explain a few alternatives to bitcoin, as well as how its underlying technology – the blockchain – works.

Authored by Noelle Acheson. Network image via Shutterstock.

NEXT: WHY USE BITCOIN?
why use bitcoin Because it's fast, it's cheap to use, it's private, and central governments can't take it away.
INDEX: A BEGINNERS GUIDE TO BITCOIN AND BLOCKCHAIN TECHNOLOGY
What is Bitcoin? It's a decentralized digital currency
Why Use Bitcoin? It's fast, cheap to use, and secure
How Can I Buy Bitcoin? From an exchange or an individual
How to Buy Bitcoin in the UK Buying bitcoin in the UK
How to Store Your Bitcoin Use a digital or paper wallet
What Can You Buy with Bitcoin? Spend your bitcoins
How to Sell Bitcoin A guide on how to sell your bitcoins
How to Accept Bitcoin Payments for Your Store Learn about bitcoin POS systems
How do Bitcoin Transactions Work? Bitcoin addresses and private keys
Is Bitcoin Legal? The current regulation around bitcoin
Who is Satoshi Nakamoto? The founder of bitcoin
Understanding Bitcoin Price Charts A primer on bitcoin price charts
How Bitcoin Mining Works By confirming transactions
How to Set Up a Bitcoin Miner Generate bitcoins yourself
What are Bitcoin Mining Pools? What are pools how and how to join them?
How Does Cloud Mining Bitcoin Work? Alternative bitcoin mining solutions
How to Calculate Mining Profitability Can you make a ROI?
How to Make a Paper Bitcoin Wallet Creating an unhackable bitcoin wallet
Can Bitcoin Scale? A look at the debate and the tech
What is SegWit? A new way of storing transaction data
What is the Lightning Network? Off-chain transaction channels
What is Ethereum? A blockchain application platform and 'world computer'
What is Ether? The 'fuel' of the ethereum network
How to Use Ethereum Wallets, trading and ‘dapps’
Who Created Ethereum? Vitalik Buterin
How Ethereum Works 'Turing-complete' programming, 'state' and the 'EVM'
How Ethereum Mining Works 'Proof of Work' and 'Proof of Stake'
How to Mine Ethereum GPUs, mining software and pools
How Will Ethereum Scale? ‘Sharding’ and ‘off-chain’ transactions
How Do Ethereum Smart Contracts Work? Code, transaction fees and 'gas'
What is Bitcoin Cash? Same blockchain, different characteristics.
Hard Fork vs Soft Fork Why and how do blockchains split?
What is the Difference Between Litecoin and Bitcoin? It's the silver to bitcoin's gold
How to Buy Litecoin How to buy the bitcoin alternative litecoin
How to Mine Litecoin and other Altcoins How to generate your own altcoins
What is Ripple? Is it a token? Is it a payments platform?
What is Blockchain Technology? A system of distributed data and logic
How Does Blockchain Technology Work? Cryptographic keys, distributed networks and network servicing protocols
What Can a Blockchain Do? Identity, recordkeeping, smart contracts and more
What is a Distributed Ledger? A dynamic, independently maintained database
What is the Difference Between Public and Permissioned Blockchains? Can anyone read or write to the ledger?
What is the Difference Between a Blockchain and a Database? It begins with architectural and administrative decisions
What Are the Applications and Use Cases of Blockchains? Tokenization, auditing, governance, settlement and more
How Could Blockchain Technology Change Finance? Cross-border payments, new asset classes, regulatory compliance and more
What are Blockchain's Issues and Limitations? Complexity, size, costs, speed, security, politics and more
Why Use a Blockchain? To manage and secure digital relationships as part of a system of record
What is a Decentralized Application? A distributed 'smart contract' system
What is a DAO? A 'decentralized autonomous organization'
What is an ICO? Initial Coin Offerings refer to the distribution of digital tokens.