The initial price of bitcoin, set in 2010, was less than one cent. On Nov. 29, it crossed $11,000. Once seen as the province of nerds, libertarians and drug dealers, bitcoin today is drawing millions of dollars from hedge funds. The recent price surge may be a bubble. Or it could be a belated recognition by the broader financial community that so-called cryptocurrencies — digital forms of money — are going mainstream. It might be time to nail down what a bitcoin is, and why its price has been going through the roof.
1. What exactly is bitcoin?
It’s a form of money that’s remarkable for what it’s not: It’s not currency you can hold in your hand. It’s not recognized by most Main Street stores. It’s not issued or backed by a national government. At their core, bitcoin and its imitators are sets of software protocolsfor generating digital tokens and for tracking transactions in a way that makes it hard to counterfeit or re-use tokens. A bitcoin has value only to the extent that its users agree that it does.
2. Where did the bitcoin system come from?
The original software was laid out in a white paper in 2008 by a person or group of people using the pseudonym Satoshi Nakamoto, whose identify remains unknown, despite several efforts to assign or claim credit. Online fantasy games had long used virtual currencies. The key idea behind bitcoin was the blockchain — a publicly visible, largely anonymous online ledger that records bitcoin transactions.
3. How does that work?
Think about what happens if you make an online transfer using a bank. It verifies that you have the funds, subtracts that amount from one spot in a giant database it maintains of accounts and balances, and credits it in another. You can see the result if you log on to your account but the transaction is under the bank’s control. You’re trusting the bank to remove the right amount of money, and the bank is also making sure you can’t spend that money again. The blockchain is a database that performs those tracking functions — but without the bank or any other central authority…