There’s a relatively new financial buzzword swirling around in the undercurrent of the internet lately: bitcoin. Maybe you’ve never heard of bitcoin, but even if you have, chances are that you’re still a little foggy on what it really is, how it works and if it’s anything more than just something for internet geeks.
Bitcoin might not be completely mainstream yet, but it could be just a few years before it or another digital currency plays a defining role in finance. Before this cryptocurrency revolution grows further, read on to learn a bit more about digital currency and what it means for traditional methods of banking and the economy.
What Is Bitcoin?
Bitcoin is, very simply, the most popular of many virtual currencies that recently became known to the public. It first appeared in 2008, the brainchild of an unidentified programmer or programmers under the alias Satoshi Nakamoto.
The currency is entirely digital: It’s a number stored in the cloud and associated with the holder’s bitcoin address. Bitcoin uses computer networks to verify and keep records of the transactions made. Unlike traditional paper currency, no central bank makes decisions that control the supply. Value is purely dependent on the confidence people place in it and what they are willing to trade for it.
Although there are lingering doubts about the legality of anonymous transactions, bitcoin can already buy things like web hosting or a Subway sandwich — you can even use bitcoin on Overstock.com, one of the first major retail sites to adopt the currency officially.
The Philosophy Behind Bitcoin
The idea behind bitcoin is to take financial control out of the hands of governments and central banking authorities and put it into the hands of the general public. The digital currency is entirely independent of any country and, therefore, not subject to any regulations.
This freedom from regulations makes bitcoin a cheap and easy way to handle international payments. Additionally, many transactions made with bitcoin don’t have any sort of fees associated with them like credit and debit transactions do, and users can purchase goods completely anonymously.
How to Earn Bitcoins: Mining Bitcoins and Using Bitcoin Exchanges
If you’re interested in purchasing bitcoins, you can go to an online exchange, Mt. Gox being the largest, and purchase them with any currency. After you’ve acquired your bitcoins, they are stored in a “digital wallet,” which basically consists of numbers in the cloud tethered to your account.
The bitcoins themselves, which are limited in number, are created by people using competing computer algorithms to solve math problems — a process called “mining” — the solution to which earns them a bitcoin reward. Since bitcoin is without a central authority, it is not insured by the FDIC — so, in the event that your digital wallet is pillaged, infected with a virus or otherwise affected, there would be no legal recourse for recouping those losses.
Effects of Bitcoin on Financial Policy
There are many questions regarding how governments and financial institutions will handle bitcoin. Some of the concerns regard taxation and the relative ease of partaking in illegal activities by paying with an anonymous and untraceable currency.
In October of 2013, the FBI shut down an online exchange called the Silk Road through which bitcoin was used to buy and sell drugs and other illegal goods. Currently, the digital currency is seen as a risky and volatile investment, with the U.S. Security and Exchange Commission warning people against investing.
Other Types of Digital Currency
Bitcoin isn’t the only digital currency out there, although it is one of the most successful. Some other currencies include litecoin, which can be used at some online retailers, peercoin, mastercoin and namecoin. Dogecoin, which made its debut in 2013, is in faster production than other digital currencies. Its influence is expanding, but its value is still very low: It takes almost 3,000 dogecoins to equal just one U.S. dollar.
Governments and banks worldwide are taking bitcoin and other virtual currencies very seriously. Traditional money is regulated according to strict guidelines in order to control inflation and keep world economies stable.
Cryptocurrencies like bitcoin could threaten that stability; with no central authority to control the supply of the currency, inflation could run rampant. Another factor worthy of note is security: Whereas money in a traditional form of currency can be tracked and backed by banks, other financial institutions and governments, bitcoin cannot. A collapse in the bitcoin market like the one that hit Mt. Gox in early 2014 could be catastrophic to economies on a larger scale.
Though the fate of bitcoin remains to be seen, digital currencies could well be the wave of the future.
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