How did we transfer money thousands of years ago, when we all still lived in little villages and knew and trusted each other? We simply exchanged things with each other, as we still do with cash today. But when money moved online things got a bit trickier, and the way the banks and credit card systems dealt with this was to create a ‘ledger system’ – basically records of account showing who owns what.
For example, if John wants to transfer $100 to Sarah online, the bank moves the money from John to Sarah. John cannot do it himself because there is a risk he might cheat – he can copy and paste the digital money (it’s only numbers on a computer after all) and send the $100 to two different people; nobody would know. Instead, we trust the bank to send the money and make sure it’s only sent to one person. Now, the bank can also cheat, but we trust them that they don’t.
If the transfer is between two accounts at the same bank, it’s easy to transfer, but if it’s between two different banks it gets a bit more complicated. They might have different ledger systems that need to be reconciled. For this they charge a fee, and it often takes more time to complete the transfer. When they are banks or other financial systems in foreign countries, it gets even more complicated: different languages, systems, currencies, more parties to co-ordinate and so on, so the fees and transfer times increase. That’s why the current financial system is so complex. It’s just a massive entanglement of various ledger systems around the world.
Bitcoin is changing all of this. How? It is simply one global ledger system that synchronizes across the entire internet, so that everyone can access the same ledger account in real time no matter who or where they are. The result? Money can easily be transferred between parties without all the lag times and exorbitant fees. Just like it used to be before the world became big and complicated.
And what do people use Bitcoin as payment system for? Everything that one would do with normal money: send to friends and family – both local or abroad, buy things online, get paid for their work and so on.
“Bitcoin is a faster, cheaper, and easier way to move money.”
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Bitcoin as digital gold
Over the centuries, gold has been considered as an object of value by many different groups of people all over the world. It’s important to note that gold in itself has no value – it’s just a piece of shiny metal. Its value comes from the (somewhat perplexing) fact that everyone just agreed that it has value, and therefore it becomes valuable. The reason they chose gold versus other objects is important – gold has certain characteristics that make it a better ‘store of value’ (as it is commonly known) than other objects:
For one, it is rare, which means it has limited supply(there is only a certain amount of gold in the world – if it was too abundant everyone would have it and then it would have no value). It is malleable (it can be melted and made into smaller units i.e. coins, and importantly the per unit value doesn’t change when you break it into smaller pieces, unlike things like diamonds). It is stable and doesn’t degrade, it’s easy to recognise and very importantly, difficult to counterfeit.
As it turns out, Bitcoin has all of these same characteristics, and more. It has limited supply (only a specific amount of Bitcoin exists and will ever be produced). It can be made into smaller units without losing unit value (1 Bitcoin = 100,000,000 Satoshis – the smallest unit into which a Bitcoin can be broken down to, similar to the cents in a Dollar or pennies in a pound; this is also why one can buy less than one Bitcoin at a time). Its technology makes it very stable, it won’t degrade, and it’s impossible to counterfeit. On top of this, and unlike gold, you can move Bitcoin to any place on earth within minutes, no matter how big or small the amount. That’s why many people say that Bitcoin is not just digital gold, but a better version of gold.
On top of that, Bitcoin has value as a payment system in itself, which gives it even more value. The more people use Bitcoin for payments, the more valuable this system becomes. It’s a bit like buying shares in Visa and then using those shares to buy a coke at your local 7-11. Because you used the Visa shares to pay, Visa (the payment system) becomes more valuable, and Visa shares become worth more. In this way, the value of Bitcoin comes from both its gold-like characteristics as well as its payment system abilities.
How do I get Bitcoin?
There are a number of ways you can get Bitcoin:
Just like traditional money, you can earn it by providing goods or services, and asking for people to pay you in Bitcoin rather than in traditional money. This is often a cheaper and easier alternative to other payment methods and one of the easiest ways to get your hands on some Bitcoin.
Another way is how most people get their Bitcoin: buy it from a credible Bitcoin broker or exchange provider, like Luno. This is similar to how you would buy foreign currency at your bank or shares online. This is often the easiest way to get Bitcoin because you are virtually guaranteed that someone will be willing to sell their Bitcoin to you on such a platform.
You can also get Bitcoin by mining for it, but this has become very difficult to do for the average person. Most mining is now done by huge companies with very expensive and highly specialised equipment, which a typical person or computer cannot compete with. So unless you have a lot of expertise and a huge amount of money to spend on this, rather just buy or earn the Bitcoin.
How is the price of Bitcoin calculated?
Many people wonder how the price of Bitcoin is calculated, but it’s important to remember that it works no different than it would with other currencies or objects. Let’s first look at how the prices of most things are derived – we can use oranges as an example. What is the price of an orange?
Well, it depends. As a starting point, one would derive the price of an orange based on two things: how much someone is trying to sell it for, and how much another person is trying to buy it for. If John wants to sell it for USD2.50 and Sarah is only prepared to pay USD2.00, there is no deal. But if they agree on a price that works for both, let’s say USD2.25, then the transaction will happen. If it’s winter there might be more people wanting to buy oranges, so the price will go up. Or if there is a drought the supply of oranges will become less, so more people are trying to buy less oranges, which can also drive the price up.
Bitcoin and other currencies are a bit different from oranges in that they are what is called ‘homogeneous’ – one dollar is identical to another dollar, just as one Bitcoin is the same as another. Oranges on the other hand can vary in size and quality. All this means is that it’s easier to come up with a price of a currency or Bitcoin. Once again, just what a buyer and seller will agree on.
Many people might not realise that other currencies work exactly the same – if you are holding a coin or note of your own local currency in your hand, at any given point in time there are millions of people buying and selling your local currency, so while you might observe it as stable, it’s value actually continuously changes. When you want to exchange it for another currency at a currency desk, let’s say for USD, one day you pay 10 local currency to a dollar, the next day maybe 11 or 9. Bitcoin works exactly the same way – you can just think of it as a currency other than the one you are used to.
What is Bitcoin mining?
As mentioned in an earlier section, one can think of Bitcoin as one big global ledger system that records transactions (or ‘moving money’) between one person to another. Whenever Bitcoin transactions are processed on the Bitcoin network – that means Bitcoin is moved from one person to another – someone has to make sure all the transactions are recorded properly and that the ledgers on all the systems are synchronized all over the world.
In the case of Bitcoin, this process is not done by people or companies, but by thousands of computers all over the world that are all connected to the internet. These computers are knowns as ‘miners’, but they should really simply be called ‘computers that process transactions’.
To do this processing in a very secure way, these computers need to perform very complicated calculations that take a lot of computing power, and in turn, require a lot of energy and expensive and specialised processing equipment. Someone – the owner of the computers – needs to pay for all this equipment and electricity, so they need to be compensated for all the money and effort they are putting into making this network work. They earn this compensation through newly minted Bitcoin – so in short all new Bitcoin that is created acts as a reward and incentive mechanism for people to contribute their computers to the system to help process transactions.
Another way to look at it is to consider what would happen if a large bank built the world’s biggest global transaction processing system: they would spend a few billion dollar on it and then charge everyone transaction fees to recoup this cost. With Bitcoin mining, the cost of this global system has just been spread over thousands of computers, and they recoup their cost through newly minted Bitcoin. In short, it’s simply a democratisation of financial infrastructure.
What are the risks with Bitcoin?
While Bitcoin is a very exciting technology and new form of money, it doesn’t mean that there is no risk associated with it. As a starting point, it’s important to remember that the same intuitive rules that apply to traditional money also applies to Bitcoin. For example, don’t store cash under your mattress else it might get stolen, or don’t trust your money with strangers.
Bitcoin also has some fairly unique risks: for one, it’s a brand new technology, and while it appears very secure and robust, there is always a chance that it might fail. That is also a reason why you should never put ‘all your eggs in one basket’ and never buy more Bitcoin than you can afford to lose. Bitcoin is also more volatile (i.e. it can move a lot in value both up or down in a short space of time) than many other currencies, and while this appears to be stabilising over time, it’s sure to experience many highly volatile moments in the future.
Also remember that Bitcoin transactions are like cash in that they are irreversible – so if you send Bitcoin to the wrong person, or your Bitcoin wallet is compromised and someone steals your Bitcoin, it might be very difficult if not impossible to get it back. Bitcoin is also not backed by any entity, so if you lose your Bitcoin, your service provider or ‘the Bitcoin network’ will not be able to reimburse your funds. That’s why you need to ensure you use highly trusted product or service providers to help you, similar to how you would ask a bank to help you safely store your money.
Lastly, Bitcoin’s value is determined by the amount of people or business that are willing to accept it, and this is by no means guaranteed. If it grows it will be very good for Bitcoin, but if less people want to use Bitcoin, it will have a very negative impact on the price and might lead to Bitcoin not being used at all.
To summarise, Bitcoin is very exciting and has tremendous potential to change the world, but make sure you understand the risks that go hand in hand with that.
How do I keep my Bitcoin safe?
Safely storing your Bitcoin is very important. Unlike other types of money that is controlled by banks, with Bitcoin you have many more options on how to store and control your money.
Remember your private key that you need to move your Bitcoin? Well that is literally the key to storing it. Whoever has the key controls the Bitcoin. These keys can be either in digital or even in physical format i.e. written down on a piece of paper.
How to store it then? You can leave the key in your pocket, but that’s not too secure. You can put it in a safe – that’s a lot better. But someone can still break into your house and steal it. Given you want to use your Bitcoin regularly, you might also want to put some or all of it in a digital version on your phone so you can access it easier. The only problem is that if you lose your phone it means you will also lose your key, and there is no way to get it back.
That is why companies like Luno exist – not just to make it easier to buy, sell and use Bitcoin, but also to securely store it. We do this by taking your private keys and storing them in a physical bank vault with access controls like fingerprint and retina scans. In fact, it’s not just one vault, it’s a number of vaults across many continents. And we build it in a way that you have to access the keys from multiple vaults and put them together to actually be able to extract the Bitcoin, similar to the old movies where nuclear submarines need 3-5 ‘launch codes’ from different generals to be able to launch nuclear weapons. This is commonly knowns as ‘multisig’ (multiple signatures required).
Bitcoin is very safe when it is stored like this, but there is one potential weak link: you need to trust the people storing the keys on your behalf. There are many reputable companies like Luno that you can rely on, but also many others that either don’t store it properly or might pretend to store it and then misappropriate it. The great thing about Bitcoin is that unlike old money, you have the choice – whether you store it yourself, in physical or digital format, or whether you rely on someone else to safeguard it for you (or even a combination of all of these).
The way Bitcoin is often stored is also one of the biggest ironies of Bitcoin – the world’s global currency that was designed to be used online, is mostly stored ‘offline’, in physical bank vaults and detached from the internet. Who would have thought!
What are Bitcoin private keys?
Moving around Bitcoin is very easy, but in the background an important part of moving and storing Bitcoin involves something called a ‘private key’. The easiest way to understand private keys is to think about an old-fashioned mailbox system:
Let’s say Maria wants to send mail to Peter. First she needs to know what Peter’s mailbox address or number is. Let’s say Peter’s mailbox is number 2034. Similarly, if she wants to send Bitcoin to Peter, she needs to know his Bitcoin address, which is a number that uniquely identifies him. This is also sometimes called his wallet address, or public key, which functions similar to your bank account number. It’s a long and complicated number because there are so many Bitcoin post boxes in the world, but thankfully you don’t have to remember it, you can find it on the internet.
So now Maria deposits the Bitcoin in Peter’s mailbox. She can have a peek inside and see the Bitcoin there, in fact anyone who walks by can see that mailbox 2034 is filled with one Bitcoin. This is part of the exciting part of Bitcoin – that everyone can see all the transactions but without anyone having to share their identity. People can see there is one Bitcoin in 2034, but no-one, except for Maria and Peter, will know it belongs to Peter.
Now let’s see how Peter gets his Bitcoin – well he can see it’s there, so he doesn’t have to do anything. But if he wants to move it, he needs to open the box to send it to someone else. To open this he needs a key – and this is his own unique key, also called a private key, that him, and only him can use to open the mailbox. When he opens it he can remove the Bitcoin and deposit into someone else’s box, let’s maybe say he is buying an online game from Microsoft, now he can deposit it into Microsoft’s box and once they can see the Bitcoin received, they will ship the new game to him.
If Maria deposits into the wrong mailbox, she cannot move it back. This is similar to cash – once you paid it to someone you can’t easily get it back. Also note that no-one can move the Bitcoin, except for Peter, who has the key to the mailbox. And if he loses his key? Well then no-one can access that post box, forever! It’s also important for Peter to make sure no-one steals his key, because if they do they can unlock his box and steal his Bitcoin. So it’s important he keeps the key safe, or entrust it with someone that can do so.
Is Bitcoin used by criminals?
There is often public misconception that Bitcoin is mostly used by criminals, but nothing could be further from the truth. This is mainly because many people think Bitcoin is anonymous, when in fact it’s the opposite – all Bitcoin transactions are transparent for the whole world to see. People might not be able to link the identity to Bitcoin right away (that is also why it is sometimes called ‘pseudo anonymous’), but once they do, they can track everything you’ve ever done on the Bitcoin network. This makes it a particularly bad tool for illicit use.
While Bitcoin might actually turn out to be one of the safest and least ‘bad’ ways to use money, it doesn’t mean that criminals don’t use it. Just like normal money, they do. But there are two important things to note – firstly, that as more data becomes available in the industry, the more it is becoming clear the number of bad uses is very, very minute – if the entire Bitcoin ecosystem is represented by a big mountain, the size of the bad parts is a couple of rocks. Second, that in any financial system, this is a risk that can never be eliminated, merely mitigated, and Bitcoin has some of the best tools in the world for that.
It’s worth expanding on Bitcoin’s parallel with the internet particularly in the context of all the ‘bad stuff’ that people associate Bitcoin with. Is the internet all good? Definitely not. Terrorists, money launderers and drug smugglers use Facebook, Twitter and Whatsapp to communicate and coordinate every single day. Some people might feel uneasy about the fact that at least 5–30% of visible online traffic relates to pornography. And here we’re not even considering the deep and dark web, where there are all kinds of really bad things going on that we’re not going to even mention here.
But despite all these issues, does society make a concerted effort to try and ban the internet? No. And it’s not so much because it’s hard to do so, it’s more because the positives to society grossly outweigh the negatives. For these same reasons, we should all be very careful how we think about Bitcoin, because most evidence suggests Bitcoin to have the same net positive effect, if not more, than the internet. Both the internet and Bitcoin are tools that can be used by the ‘bad guys’ or the ‘good guys’, and thankfully most of the world are in the latter category.