What is Bitcoin? A beginner's guide to cryptocurrency

I have to admit that even though I love this topic, it is a lot of information to unpack. But since Bitcoin and cryptocurrencies are likely the way of the future, it's definitely worth trying to understand what's going on. So, what is Bitcoin? Where did it come from? Is it interchangeable with "real money"? And how secure is it? I'll answer all these questions below.

The origins of bitcoin

Let's start at the very beginning: Bitcoin was invented by someone going by the name Satoshi Nakamoto. No one is exactly sure who he really is. He knew that his ideas would change the world and that they could possibly get him into trouble with the government. His idea was to create a decentralized monetary system, which means that he wanted to put money and power back into the hands of people. Nakamoto asked the question Why do we need the Federal Reserve to control where we send our money? After all, technology is advanced enough that we should be able to do this ourselves.

Satoshi Nakamoto has never revealed his true identity. He wrote a very long "white paper" business plan that explained the idea behind Bitcoin, and he hired a group of well-known cypher expert coders from Silicon Valley via e-mail to make it all happen. At first, the only people using Bitcoin were a small, dedicated group of people who were Libertarians, or Anarchists who wanted some kind of financial revolution. Now, Bitcoin adoption has picked up speed, because people are starting to realize how beneficial this technology can be for the world.

There is no "Bitcoin Bank." Satoshi Nakamoto chose not to become the CEO of a company running the show. The new technology was invented, and now it's being shared for free. It truly is a decentralized system where people can exchange money with one another over the Internet without any need for banks to act as "middlemen" in the process.

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Problems with traditional banking

Before I get into the details about how Bitcoin works, it's important to understand why it was invented in the first place and the problems it proposes to fix.

Have you ever tried to send money from your bank account to your friend's checking account at another bank? Or maybe you have a relative who lives overseas, and you had to send them money through Western Union. This transfer of funds does not happen automatically. It can take up to 3 to 5 business days for money to move from one bank account to another, and it's never free. Most people try to avoid the hassle by using PayPal and Venmo instead, but that doesn't change the fact that traditional banks still use an antiquated electronic money transfer system.

While hand-written cheques are pretty old school, there are still transactions dealing with large sums of money when it's mandatory to use cheques, like buying a house or paying your rent. Once you hand over a paper cheque, the money stays in your account balance until the recipient decides to cash it.

Modern technology has trained people to expect instant gratification. It's very common for people to look at their chequing account balance online or at the ATM and forget that there is a pending electronic transfer or a paper check that hasn't been cashed yet. They withdraw money or make a purchase on their debit card without checking their balance first, completely forgetting that the money in their account is already spoken for. Next thing you know, they get charged by the bank because they accidentally tried to take out more money than they had.

You won't hear people talking about this. If they do, it's because they are angry. They usually blame the bank's policies rather than themselves for the mess-up. Most are too embarrassed to admit that they've overdrawn their accounts to their family and friends because it makes them feel ashamed and financially irresponsible. But these people aren't alone.

In fact, in 2015, American banks made over $32.5 billion in overdraft fees from their customers in just one year. Considering that one Overdraft Fee is $30 on average, this means that millions of Americans are dealing with this issue – the overdraft is not just isolated to a small group of "irresponsible" people. Overdraft fees are big business for banks.

In 2010, the Federal Trade Commission passed laws to try to protect people from being robbed blind by overdraft fees. Following the 2008 recession, such fees had the potential to ruin people's lives. Unfortunately, efforts to combat this issue clearly didn't work, as overdraft charges in 2015 were at an all-time high.

So, if we can text or email someone within a matter of seconds, why does this keep happening? Why does it take so long for numbers in a computer to transfer in the banking system? The answer is that our banking system is heavily controlled by a centralized system. In order for money to move from one bank to another, it must be channeled through the Federal Reserve first. You can read about how wire transfers work on your own if you'd like, but basically, this is a very long, tedious process that is frankly unnecessary in an age of lightning-fast internet and related technologies.

As long as the technology of bank transfers remains the same, the issue will never be fixed, and people will continue to lose money to the bank on transfer fees, account maintenance fees, and overdraft fees.

The blockchain and Bitcoin mining

The Bitcoin process is as simple as this:

I want to send $1,500 to my landlord, Mr. Smith. I have Mr. Smith's Bitcoin wallet information, and I hit "send." The money is instantly withdrawn from my account. I can no longer get access to that money. In just one hour, it will show up in Mr. Smith's account. I will get an e-mail confirmation that he received it, which I can save as a receipt.

My transaction of sending the money to Mr. Smith is recorded on a public ledger called "The Blockchain." That information is out in the world for everyone to see, but instead of showing our names, we see a long string of numbers and letters, which is our Bitcoin Wallet account number, or our "Public Key."

Without knowing who we are or why we are sending money to one another, volunteer record-keepers called "Miners" record the transaction on a ledger. This keeps everybody honest. In order to decode this information, there is a lot of math involved to solve the puzzle, or "cryptograph." (That's why it's called a "cryptocurrency.") It is important to make this information so cryptic because it protects the private information of both parties. This is why Satoshi Nakamoto hired the Silicon Valley crypto-legends to build the software. They were the only crew of genius coders who could have figured it all out.

This math happens so quickly that it shows up only momentarily on a feed as a Miner is working on the math. The feed keeps running with more transactions noted as more people use Bitcoin. When a Miner calculates enough transactions, they get rewarded in fractions of a single Bitcoin, which is why they are willing to do this in the first place. These "Miners" are not even humans... they're very expensive, high-end computers. All over the world, people have decided to get in on this system by building massive, computer-filled warehouses called "Bitcoin Farms." The human employees only need to check on the computers every once in a while for repairs, and the computers do all of the work.

The longer Bitcoin exists, the harder the math puzzles get, and the system is designed to release fewer coins over time – just like mining for minerals in the real world. Bitcoin is designed to allow a specific number of math puzzles (and corresponding Bitcoins) to be created, and the final Bitcoin is expected to be mined by about the year 2140.. Right now, it's almost too late for most people to get in on the Bitcoin mining game. After the cost of electricity and the expense of computers, the profits only average a couple of dollars a day. However, for Bitcoin Farms that got in early, they are profiting over $1 million a year.

Since there is a limited number of Bitcoins that exist, the supply of these digital coins is relatively low in the grand scheme of global finance. As more people get interested in Bitcoin, the demand will increase, and the price of one Bitcoin will continue to go up. Some people believe that the recent upward trend in the price of Bitcoin is a fad that is causing a bubble, but financial analysts who understand the bigger picture have speculated that in 10 years, one Bitcoin will be worth $100,000.

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How secure is Bitcoin?

Slow transaction time and fees are not the only issues with traditional banking and credit card systems. You have probably heard on the news how companies like Target had their credit card systems hacked, and that customer information was stolen. When customer data is all stored in one company's central computer system, it's susceptible to attacks from hackers.

Even Equifax, one of the most trusted credit agencies, had 143 million Americans' identity information stolen in September 2017. If you've ever checked your credit score through Equifax, that means your information was stolen, too.

The answer to the problem is that these companies would be able to secure their customers' information a lot better if they used a system that depended on the blockchain's hard-to-crack math problems and cryptocurrency. The ID number for each customer would be an anonymous string of numbers and letters that would keep their identity a secret. Your name would never be attached to a transaction.

Now, you may be wondering: if your Bitcoin wallet number is out there for everyone to see on the Blockchain ledger, what's stopping a hacker from pretending to be you?

When you first open a wallet, you should be given a public key and a private key. The way you store that private key is completely up to you. If you're super paranoid, you can even keep your Bitcoin in a "cold storage" wallet. This means you are taking the coins off of the Internet and putting it on a physical drive. The Ledger Nano S is one of the best "hard" wallets on the market.

The other way to store Bitcoin is with an Internet-based company. But it's important to realize that they're not all created equal. Almost anyone can create a website that promises to safely hold your Bitcoin, but that doesn't mean you can trust all of them. Some people who start these companies are more experienced in computer science, cryptography, and cyber security...and some people aren't. Even with all the talk of high-end security, there was a Bitcoin hack in the news because these online Bitcoin wallets were run by smaller companies who did not have a lot of experience in the field.

One of the most reputable online Bitcoin Wallets on the market right now is Coinbase. If you sign up and invest $100 or more, both you and the person who recommended you get a free $10 in Bitcoin. Coinbase takes security very seriously- almost to the point where it gets annoying to have to go through a two-step security check every time I want to access my money.

How is Bitcoin different than PayPal?

At least a few of you out there must be thinking, "Hold on a second. This technology isn't anything new. I can send money instantly through PayPal and Venmo." This is true — but PayPal charges a 3.5% fee every time you receive money.

Paypal's servers are in a central location in the United States, so the company must follow US trade regulations and laws. Paypal is also staffed with live human beings who I need to trust with my personal information. And once I make $20,000 or more per year through PayPal, everything I do is reported to the IRS to ensure I pay my taxes.

There is also the issue of potentially hacked PayPal accounts. I have seen countless examples while working at a bank, and again as an e-commerce seller where PayPal accounts were hacked and someone went on a buying spree with the money. The merchant suffers because the customer needs to get a refund, and yet the seller never gets reimbursed for the fraud.

PayPal is also not available in every country. There is a list of countries where PayPal is prohibited from doing business. These rules are obviously politically motivated based on whatever trade embargo the United States has going on at a particular time. Since Bitcoin does not exists in one particular country, users can send currency to anywhere in the world and even help develop countries that could seriously use the business and money to get out of poverty.

International transfers and banking the unbanked

One day, a gas station attendant told me that he was from India, and he came to the United States because he could earn so much more money here than he could back home. He sends his earnings back to India. His family back home was able to buy a house and live a comfortable life while he selflessly stands in the sun and pumps gas into our cars.

This man is not alone. In fact, migrant workers will send $450 Billion back to their home countries in 2017 alone. Roughly 200 million migrant workers are responsible for supporting 800 million family members. This means, every one migrant worker is financially supporting an average of four people back home.

While some of these immigrants are full-fledged citizens who made the effort to apply for a checking account, many of these people are living in the United States on a work visa or they're here illegally. These people are considered "unbanked," which simply means that they don't have bank accounts. They left their old lives behind in exchange for better opportunities to earn money, and most of them are self-sacrificing enough to give the majority of their paychecks to their family back home. Their only option to send money back to their relatives is via services like Western Union.

On the official Western Union website, you can see that sending a transfer from a bank account is only $5, but it jumps immediately up to $40 if you use a credit or debit card. The fees only go up from there if you use cash at an in-person Western Union site at a local Walmart. Immigrants who are "unbanked" and must pay in cash are losing an entire day or two of wages to fees every single time they send money back home.

With Bitcoin, all you need is a cell phone and a bitcoin address to send money. Immigrants could send money to their relatives within an hour without losing so much money in fees. They could also send money to countries that have been blacklisted from PayPal and Western Union. There are so many people who are refugees from these blacklisted countries, and they do not have the option to send money or help their loved ones because of government regulations.

The blockchain will change the world

The one major issue with Bitcoin is that it has the potential to attract criminal activity. Anyone who has heard of the Silk Road knows that Bitcoin can be used to keep drug dealers' identities anonymous. However, drug cartels have been using cash in traditional currencies like dollars and pounds and laundering money under the guise of legitimate businesses for years. That doesn't make traditional currencies bad, and it doesn't mean that the average person should stop using it. Right now, people can't seem to logically separate the criminality from the currency or realize that Bitcoin itself is not inherently bad. It's expected to take years for people to accept cryptocurrency as a normal part of life.

However, the thing that's picking up a faster application in society is the blockchain. This system of peer-to-peer interactions isn't just good for sending money. It will be able to increase security for things like cloud storage, create more secure "smart" contracts, and protect your identity from theft for things like healthcare, citizenship documentation, and online retail. Blockchain will also be able to secure voting, so elections can't be hacked. Blockchain alone is going to change technology and our lives as we know it, starting in the next 3 to 5 years.

One example of a well-received cryptocurrency was created by a company called Ripple. Ripple which uses blockchain technology combined with their cryptocurrency called "XRP" to send money back and forth between users, just like Bitcoin. Instead of trying to avoid regulation from the banks, Ripple is actually working together with banks to help improve their outdated technology. They have already got the US Federal Reserve and some of the world's largest banks to invest in XRP rather than Bitcoin. Some people who believe in the resilience of banks think that Ripple will be worth far more than Bitcoin one day.

At the moment, predictions on the future of cryptocurrency is all speculation. But one thing is certain: blockchain is going to improve technology for the better. People will save money, and our world will become even more connected and secure than ever before.

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