What is Bitcoin and why should we care?
The simplest way to think about Bitcoin is as a currency, such as the Canadian or US dollar. Bitcoin is a type of cryptocurrency (there are thousands of different types of cryptocurrencies with another top contender being Ethereum) but Bitcoin is arguably the most well known. Also, the recent disclosure of Tesla’s investment in Bitcoin didn’t hurt its growing popularity.
So, what exactly is Cryptocurrency?
Cryptocurrency (i.e. Bitcoin) is a virtual currency or a digital currency. This means, it is a type of money that is completely virtual – no actual gold coins with a B$ on them or dollar bills printed on special paper.
Cryptocurrency uses cryptography (the art of writing or solving codes) to create a digital signature. Think unique, complex math equations (algorithms) that transform messages into codes that are extremely difficult or impossible to decipher. We already use cryptography/encryption in many aspects of our daily lives – think online shopping with your credit card.
How is Bitcoin different from the cash in my bank account that I only see online? Online banking seems virtual already so why bother with Crypto?
What most of us think of as money today actually changed in the last 100 years. Instead of keeping safes full of gold coins as we did prior to the 1900s, all governments transitioned to Fiat money which is a Government-issued currency that is not “backed” (secured) by a commodity such as gold. Fiat money (physical dollar bills) can be thought of as an “I owe you” from the government. For example, your $20 bill is worth $20 because it is expected that the Government will pay its bills as it has in the past (therefore it is backed by the strength of the Government) and that your financial institution that currently stores your $20 will have it when you want to use it (backed by the strength of the financial institution); if this was not the case, your mattress would start looking like a pretty good place to stash cash.
So, the question becomes, how is Bitcoin different than Fiat currency?
Cryptocurrency is not backed by a commodity (i.e. Gold) or any Government promissory notes (Canadian/US dollar bill) and it isn’t stored in a bank.
So, how is it currency/money at all?
Cryptocurrency are considered money because they allow exchanges between parties and they act as a “store of value” and what makes cryptocurrency unique is that they can be used throughout the world without the need of a bank.
To be able to store your hard-earned money in Bitcoin for example, you would need to create a Digital Wallet, which is like a unique email address that acts like a Bank; you will also get two Keys (passwords) a public and a private one. A Public Key would be like a bank account number that you can share with everyone, but a Private Key is your proof that you own the money in that account.
Once you are all set up and have a Digital Wallet full of Bitcoin, you can transact with other people who have digital wallets and Blockchain will keep track of the transactions, something a bank would normally do.
Okay so if Bitcoin is money, how much is it worth and what will it be worth tomorrow? Can I use it to buy a coffee or a house? Stay tuned to get the answers to these questions and learn more about Bitcoin in Part 2 of this series.
Bitcoin: used when describing the concept of Bitcoin, or the entire network itself, eg “ I was learning about the Bitcoin protocol today.”
bitcoin: without capitalization, is used to describe bitcoins as a unit of account eg “ I sent ten bitcoins today” (BTC or XBT)
Blockchain: the block chain is a public record of Bitcoin transactions in chronological order. The block chain is shared between all Bitcoin users. IT is used to verify the permanence of Bitcoin transactions and to prevent double spending.
Cryptography: Cryptography is the branch of mathematics that lets us create mathematical proofs that provide high levels of security. In the case of Bitcoin, cryptography is used to make it impossible for anybody to spend funds from another user’s wallet or to corrupt the block chain. IT can also be used to encrypt a wallet, so that it cannot be used without a password.
Mining: Bitcoin mining is the process of making computer hardware do mathematical calculations for the Bitcoin network to confirm transactions and increase security. As a reward for their services, Bitcoin miners can collect transaction fees for the transactions they confirm, along with newly create bitcoins. Mining is a specialized and competitive market where the rewards are divided up according to how much calculation is done. Not all Bitcoin users do Bitcoin mining, and it is not an easy way to make money.
Signature: A cryptographic signature is a mathematical mechanism that allows someone to prove ownership. In the case of Bitcoin, a Bitcoin wallet and its private key (s) are linked y some mathematical magic. When your Bitcoin software signs a transaction with the appropriate private key, the whole network can see that the signature matches the bitcoins being spent. However, there is no way for the world to guess your private key to steal your hard-earned bitcoins.
Wallet: A Bitcoin wallet is loosely the equivalent of a physical wallet on the Bitcoin network. The wallet actually contains your private key(s) which allow you to spend the bitcoins allocated to it in the block chain. Each Bitcoin wallet can show you the total balance of all bitcoins it controls and lets you pay a specific amount to a specific person, just like a real wallet. This different to credit cards where you are charged by the merchant.
Yulia Rosenberg, B. Comm, MBA | Senior Wealth Advisor
Scotia Wealth Management™ | ScotiaMcLeod®, a division of Scotia Capital Inc.