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A Beginner’s Guide to Bitcoin

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Is bitcoin part of a bubble, doomed to burst, or will it continue on its’ current upward trajectory?  Before we can attempt to answer this or even to understand why we hear so much about bitcoin in the news these days, we need to know a few things about it.

What is it?

First a little history. It all began in 2008 with a whitepaper written by someone with the pseudonym Satoshi Nakamoto which suggested an easily tradable commodity that was not controlled by any government or institution. Hence Bitcoin was born.

It would be wrong to call it digital currency because unlike currency it has no stable value. Bitcoin’s value is changing all the time. It is more accurate to call it cryptocurrency because it uses cryptography to secure its transactions. It is more of a commodity that is easily transferred or traded without incurring any steep fees. This makes it easier to transfer funds internationally without the usual bank fees.

To understand Bitcoin, you also need to understand the network that creates and protects it.

Bitcoin is not controlled by any government or processed by any company. Bitcoin uses a public digital ledger that records every transaction, the basis of the blockchain, a continuously growing list of records kept secure by cryptography.

The Bitcoin network can be compared somewhat to PayPal. But whereas PayPal is a company that is keeping track of transactions, Bitcoin relies on thousands of people maintaining a network of computers that keep track of Bitcoin transactions and crunch complex mathematical equations. This is known as bitcoin mining.

How is it created?

Some people have engaged in “bitcoin mining”. Bitcoin mining is done digitally, using machines with high-level computing power to try to solve complex equations. Successful miners are rewarded with new bitcoin as the reward for trying to solve complex equations involved in every transaction.

A bitcoin farm consists of many computers that solve complex equations to produce bitcoin.

Specialized computer farms are set up to solve these equations. There are some massive warehouses set up in China, simply to produce bitcoin. As well, an entrepreneurial couple in B.C., Canada, has invested $100,000 in the machines.

There is a finite number of bitcoins that can ever be created, 21 million to be exact.

How does it work?

For security purposes, balances are kept using public and private “keys,” which are long strings of numbers and letters linked through the mathematical encryption algorithm that was used to create them. The public key (comparable to a bank account number) serves as the address which is published to the world and to which others may send bitcoins. The private key (comparable to an ATM PIN) is meant to be a guarded secret and only used to authorize Bitcoin transmissions.

How do you buy and sell it?

While your investment in Bitcoin can make you seem rich, it is difficult to spend it. And many would wonder then, why hold any Bitcoin? You can think of it more as an investment in gold.  Like gold, no one centrally controls production, supply is limited by the effort to produce it, and you can hold on to it as a store of value.

What so great about it?

Because it’s digital, it can be sent anywhere, easily.

Each bitcoin can be divided up into fractions, unlike gold bars, so it is easier to use for actual transactions.

Bitcoin’s value has recently increased dramatically.

Why is value increasing so much?

Because Bitcoin doesn’t pay any dividends, interest or other rewards for holding it, anyone buying it can only hope it’s value continues to grow.

When it was originally launched in 2009, each bitcoin was worth very little. But since then it has increased from $1000 to $4000 in August 2017, and recent highs of $15,000 in December of 2017. As more investors are jumping on this bandwagon, the value will be driven upwards.

Downsides

  • However, because cryptocurrencies are virtual and do not have a central repository, a digital cryptocurrency balance can be wiped out by a computer crash if a backup copy does not exist.
  • There have been wild price swings, and the future value is unpredictable. Since prices are based on supply and demand, the rate at which a cryptocurrency can be exchanged for another currency can fluctuate widely.
  • Scammers have also tried to benefit in some way. According to the Canadian Anti-Fraud Centre, Canadians have been swindled out of more than $1.7 million via scams involving cryptocurrencies such as bitcoin so far this year. A woman received a call from what she believed was her husband’s cellphone and someone posing as a police officer, asking for bail to secure her spouse’s release. Police said the woman followed the caller’s instructions and paid them $5,000 in bitcoin, before receiving a call from her husband who was sitting at home and never arrested in the first place.
  • Since the transactions are untraceable, it also attracted online drug deals via the now illegal SilkRoad, as well as money laundering.
  • The machines used in bitcoin mining eat up a lot of electrical power to run.
  • You need to give up some of your government-backed currency for bitcoins and need to use an app to buy it, trade etc.

Because it is so new, no one really has all the answers. One thing is certain, it’s not going anywhere just yet. It’s going to stick around for a long time. So, if you have some extra money kicking around, why not invest in some Bitcoin? You may be very glad you did!

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