What is Bitcoin, and how does it work?

If you find the concept of Bitcoin confusing, you are not alone. The virtual currency has been a constant source of controversy, but it is still not well understood.

On Tuesday, one Bitcoin was worth USD$4,394.

Are Bitcoins those coins I see in photographs?

No. Those coins are novelty items that newspapers used in photographs because they couldn’t find anything else to illustrate their stories about Bitcoin.

A Bitcoin is a digital token — with no physical backing — that can be sent electronically from one user to another, anywhere in the world. A Bitcoin can be divided out to eight decimal places, so you can send someone 0.00000001 Bitcoins. This smallest fraction of a Bitcoin — the penny of the Bitcoin world — is referred to as a Satoshi, after the anonymous creator of Bitcoin.

This all gets confusing, because Bitcoin is also the name of the payment network on which the Bitcoin digital tokens are stored and moved.

Unlike traditional payment networks like Visa, the Bitcoin network is not run by a single company or person. The system is run by a decentralized network of computers around the world that keep track of all Bitcoin transactions, similar to the way Wikipedia is maintained by a decentralized network of writers and editors.

The record of all Bitcoin transactions that these computers are constantly updating is known as the blockchain.

How can I buy a Bitcoin?

There are companies in most countries that will sell you Bitcoins in exchange for the local currency. In the United States, a company called Coinbase will link to your bank account or credit card and then sell you the coins for dollars. Opening an account with Coinbase is similar to opening a traditional bank or stock brokerage account, with lots of identity verification to satisfy the authorities.

For people who do not want to reveal their identities, services like LocalBitcoins will connect people who want to meet in person to buy and sell Bitcoins for cash, generally without any verification of identity required.

Who decides what a Bitcoin is worth?

The price of Bitcoin fluctuates constantly and is determined by open-market bidding on Bitcoin exchanges, similar to the way that stock and gold prices are determined by bidding on exchanges.

What is Bitcoin mining?

Bitcoin mining refers to the process through which new Bitcoins are created and given to computers helping to maintain the network. The computers involved in Bitcoin mining are in a sort of computational race to process new transactions coming onto the network. The winner — generally the person with the fastest computers — gets a chunk of new Bitcoins, 12.5 of them right now. (The reward is halved every four years.)

There is generally a new winner about every 10 minutes, and there will be until there are 21 million Bitcoins in the world. At that point, no new Bitcoins will be created. This cap is expected to be reached in 2140. So far, about 16 million Bitcoin have been distributed.

Every Bitcoin in existence was created through this method and initially given to a computer helping to maintain the records. Anyone can set his or her computer to mine Bitcoin, but these days only people with specialized hardware manage to win the race.

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Source: What Is Bitcoin, and How Does It Work? – The New York Times