Bitcoin is a digital currency. Although this may seem like an innovation, the reality is that most conventional currencies today are quasi-digital: euros, dollars, etc. they are de facto digital currencies, since economists estimate that only 8% of the world currency actually exists in cash. The central banks of each country manufacture new currency digitally without having to be printed, in the form of loans with the commercial banks that exist in each country. In fact, some Scandinavian countries are taking some measures to eliminate all cash in the medium term. Therefore, the fact that bitcoin is a digital currency is not a feature that makes it different from other conventional currencies.
The innovative feature of bitcoin is that it is the first type of cryptocurrency. This means that it uses cryptographic mathematical algorithms to secure all transactions, control the creation of additional units of currency and prevent counterfeits. Bitcoin is a fiduciary currency, that is to say that its value is based on trust that its users give it to accept it as a means of payment as it happens with the currencies issued by the central banks of each country. While in conventional currencies users rely on sovereign states to control money production and provide mechanisms to prevent counterfeiting, bitcoin users rely on an asymmetric key cryptographic algorithm. This algorithm is based on a type of mathematics that allows a digital annotation to be easily verifiable, but at the same time practically impossible to reproduce it. In this way, the currency can maintain its value.
One of the great mysticisms of bitcoin is that noone really knows who was or who were its creators. Bitcoin´s underlying technical principles were created by an anonymous person (or group) known as Satoshi Nakamoto. It is believed that Nakamoto began working on this project in 2007 after the outbreak of the financial crisis of 2007 that diminished trust that users had with traditional banks. In January 2009, Nakamoto published in the network the first software to operate with bitcoins, as well as the first units of the cryptocurrency. He also created a website with the domain name bitcoin.org and continued to collaborate with other developers on bitcoin software until mid-2010, delivering control of the source code repository, as well as several related domains to several prominent members of the bitcoin community finalizing his participation in the project. Until shortly before his absence and transfer, Nakamoto made all the modifications to the source code. Due to the excellent English he used in communications and publications, it is suspected that this individual (or group) is not from Japan as the name suggests but possibly from the United States or Europe. His identity to this day remains unknown.
Blockchain is the technology behind bitcoin. It is a distributed database (shared and replicated in multiple computers) that contains a book of annotations with all the movements of the currency grouped in linked blocks so that each block depends on the previous one. Only when the chain is legitimately modified (through the consensus of the majority of system participants), all the computers that form the Blockchain are synchronized in seconds, meaning that if one of the computers disappears or is hacked, no impact is produced. Once registered, information can never be erased, which allows a reliable record of all the transactions that have been made in the history.
The nature of the Blockchain allows bitcoin users to trust each other and make transactions among themselves, eliminating the need for intermediaries (for example, commercial banks, and also central banks and governments). This also brings unprecedented security benefits since the hacker attacks that usually affect large centralized intermediaries such as banks are practically impossible to perform against a multitude of distributed computers that comprise the Blockchain. That is, a hacker who wants to hack a block in the Blockchain, does not only have to hack that specific block, but all the process blocks that go back to the history of that blocked chain. And he would have to do it with the majority of participants in the network, which could be millions at the same time.
Possibly the most interesting feature of bitcoin is the fact that it is decentralized. This means that it is produced collectively by the whole system at a speed that is defined when the system is created and that is publicly known and that decreases with time reaching a future point in which it will stop creating new currency. This implies that with unlike conventional currencies, governments cannot produce new currency by emulating the behaviour of precious metals.
This whole system is maintained by a community of different parties that do not need to trust among themselves called miners: members of the general public who use their computers to help validate and seal transactions by adding them to the transaction book following a particular time schedule. The security of cryptographically validated accounting books is based on the assumption that most of the miners are honestly trying to keep the transaction book, also having financial incentives to do it which we will see later.
A very desirable feature for a mean to be used as currency is that it is easy to verify, but difficult to counterfeit. While the protection mechanisms in physical currencies are based on holograms, multicoloured banknotes, microprints, watermarks and inks whose colours change depending on the angle of light, bitcoin relies on strange unidirectional mathematical algorithms that allow to verify easily that a mathematical operation is correct through a public key, but does not reproduce the mathematical operation unless you have the private key.
Bitcoins just like physical coins can be lost. If the private key is lost, it cannot be recovered in any way. However, we can make several backup copies of our private keys to prevent such loss. Bitcoins like another currency can also be stolen. This could happen if someone gets our private key.
The new bitcoins are generated by a competitive and decentralized process and used to reward miners for their system support services. When more miners are, it is more difficult to obtain benefits, so the protocol ensures that the number of bitcoins that are going to be created in a certain period does not depend on the number of miners. This is currently the most common way of rewarding community members who hold bitcoin. The other way is optional and consists of charging a small fee in each transfer in exchange for prioritizing the registration of the transaction in the network. Given that the number of bitcoins established in the protocol is finite and the rate of creation of currency is decreasing over time, it will reach a point in the future where the only rewards will be the fees.
Currently the price of bitcoin is very volatile and subject to very high levels of speculation, which hinders its stabilization as currency of current use, having a very long-term upward trend. There are three main types of conditions that have an impact on its value. The first condition is governmental regulations, such as the decisions of governments to prohibit or encourage its use. Japan’s decision in April 2017 to legalize the use of bitcoins as a means of payment or the prohibition in China in September 2016 of the use of ICO (initial coin offering) calls have caused significant fluctuations in bitcoin´s value.
The second condition is the adoption and increase in the size of the market where this currency is accepted. The more merchants accept this means of payment, the value increases.
Finally, the third condition is the use in illegal activities since bitcoin allows a certain degree of anonymity. When the FBI closed the website The Silk Road, a virtual market where drugs could be bought by accepting only bitcoins as a means of payment, this caused a drop in the value of the currency (although it was temporary since this same fact made the popularity of the cryptocurrency increase subsequently increasing its price exponentially).
The final interesting point is the fact that bitcoin has opened the possibility of creating centralized cryptocurrencies. This means using cryptography to guarantee protection mechanisms against counterfeiting, but still the creation of new currency is controlled by a centralized agency (for example, Central Bank) allowing states to continue regulating the economy through monetary policies.
In this case, the maintenance of the transaction book is done in a set of computers supervised by the central bank instead of a distributed network. Compared to decentralized cryptocurrencies, it could provide better control against illegal activities and tax evasion, but also less anonymity. This can provide more confidence and supervision as the currency is secured by an important banking authority, although there remain doubts as to who controls this authority.