Bit-mining
In 2009, Satoshi Nakamoto released a software program, also called Bitcoin, that for the first time allowed users who installed it on their computers to begin operating as ledger-keepers on the fledgling Bitcoin network. The software was open-source, meaning anyone who wants to can read the actual programming code it uses, which lets tech-savvy types check to ensure the software does only what it says it does, and nothing else nefarious or bothersome (such as stealing your passwords or using your computer to send spam emails).
To encourage broad distribution of the software, and most importantly, large numbers of copies of its ledger, the system includes a reward for those people who offer their computers to serve as ledger-keepers. At the moment, those people receive, on occasion (based on an extremely complicated mathematical formula), some new bitcoins. This process is somewhat confusingly called “mining,” which is meant to evoke the idea that by doing some work (keeping the ledger, checking new transactions, and updating the ledger), new bitcoins are discovered, as one might mine a precious metal.
At any given moment, the number of ledger-keepers varies. People connect their computers to the internet and disconnect them; people turn off the Bitcoin software and turn it back on again. The system doesn’t care, as long as there are several connected, and there are lots.
It’s an analogy of convenience, and only works to a point; we advise not getting too caught up in mining or ledger-keeping. (If you’re a programmer with thousands of actual dollars just lying around, there’s plenty to learn and do along those lines; if not, best not to worry, but instead to know that large numbers of independent, security-minded, anti-fraud experts have checked out the system and been satisfied that it’s safe and secure, protected by the principles of mathematics that underlie computer cryptography and secure transmission of information. Also, it’s useful to know that when the rare problems have been found, they’ve been fixed quickly, easily, and without harm to innocent parties.)
Now, and increasingly into the future, those who spend the time, energy, expertise, and real-world expense (in electricity and computing power) to keep the ledger are paid not by “mined” bitcoins — the 21-millionth and final bitcoin will be mined in about the year 2140 — but by small fees added on top of ordinary everyday bitcoin transactions. There are somewhere around 12 million bitcoins in circulation right now.
Once the network was established, with several copies of the transaction ledger in place and the ledger-keeper programs communicating with each other, it became possible to actually spend bitcoins. That’s where you come in — and where the promise and problems all begin.
Money by numbers
A bitcoin is, in reality, nothing more than a few pieces of electronic data. You can do silly things like print them out on pages of paper, or engrave them into metal (and people have), but their only useful form is electronic.
There are, for all practical purposes, only two ways to get bitcoins. First, you can buy them, in online exchanges that will take your dollars and give you bitcoins, the same way you might give your dollars to a bank in exchange for euros or yen before an overseas trip. (The exchange rate varies, just like those other currencies; its highest ever was in December, at over $1200 per bitcoin. The current price is around $800, though you can buy smaller increments without purchasing an entire bitcoin.)
Second, you can sell a product or service that’s desired by people, and accept bitcoins as payment. (You’ll likely have to accept other forms of payment too, just like stores that take cash, checks, and credit cards.) When you have a customer who wants to buy using bitcoins, you accept the payment. Simple as that. Among the major players already accepting bitcoins are online retail giants Tiger Direct and Overstock.com; so does the Sacramento Kings basketball team; eBay is considering accepting bitcoin bids and payments.
(The aforementioned “mining” is the third way to get bitcoins, and it’s extremely technical, expensive, and not particularly accessible to regular people. I’ve tried it, wouldn’t recommend it, and it’s generally accepted as appropriate only for techie types with a lot of actual dollars (and time) on their hands. Think of this system as the equivalent of the US Mint — it makes the actual physical money and enables a particular economic system, but we don’t know how and shouldn’t try it at home. There is one significant difference: Only a finite number of bitcoins can ever be made, unlike the almighty unlimited dollar.)
To truly understand how the bitcoin system works, and where its strengths and weaknesses lie, we have to look at the mechanics of how money changes hands.
First, there’s the cash method, which is obvious. I give you a dollar bill, and you give me something I want in exchange. It’s immediate, private (nobody other than the two of us know it happened), and secure (you and I have both looked at the bill and agree it is a real dollar and not counterfeit). It also has the potential to be anonymous; even if you know the face of the person you handed a dollar to at the toll plaza, you have no idea what their name is, and they don’t know you either. If you ran into each other tomorrow, you probably wouldn’t recognize each other.
Next is the electronic method, which includes checks, credit cards, wire transfers, and pretty much everything else. In that situation, I have account data (sometimes printed on a check or magnetically encoded on a credit card) that connects me to a pile of dollars held electronically in a bank somewhere. I give you that information and the authorization to deduct one dollar from that pile, in exchange for which you give me something I want.
It seems simple, and is often instantaneous, but it’s actually very complicated — and expensive. When I swipe a debit card at a store, for example, the merchant’s machine has to read the code and transmit it securely to a central authority, which checks its database to see which bank I’m with, and then contacts that bank to ask if I have a dollar available in my pile. The bank isn’t going to answer that question for just anyone — it should only answer it for me or people I authorize — so it needs to be sure the request is coming from a legitimate user. This can be done a few ways, one of which is to ask for my PIN code, which I have established secretly with the bank in advance. I enter my PIN, which is then transmitted and verified, and then my bank responds by saying (I hope) that I do have a dollar available. Because it has received authorization from me (in the form of my PIN), my bank also sends a message along telling the store that it will transfer the dollar to the merchant’s account.
The cost adds up. Each of those steps takes electricity; some of them require specific equipment (the card-swiper, PIN-entry device, for example); others require high-speed data networks. Of course, the banks charge for their services, and for playing the middle-man in this transaction. And since every step is recorded electronically, it’s hard to keep transactions untraceable or anonymous.
The bitcoin system throws all of that away, leaving an interaction much more like the cash transaction, but handled electronically — making it unnecessary to carry around large amounts of cash, as well as enabling transactions across distances.
