Bitcoin is an alternative type of currency, a “cryptocurrency,” that was created in 2008 in response to the financial crisis of that same year. It is essentially digital money that is created, or ‘mined’, purchased, and then either stored in a secure location or exchanged in a transparent transaction on a public ledger. All of this takes place outside of the mainstream financial infrastructure of banks and other financial institutions. Bitcoins can be traded, spent, swapped, bartered, and used completely anonymously. People who are distrusting of technology such as Amazon Alexa, tracking devices for insurance in personal vehicles, or cell phones with activated location services are naturally drawn to the Bitcoin currency because of its trustworthy transparency.
The creator or creators of Bitcoin, who are unknown, wanted to address some major financial concerns when they established Bitcoin: governments’ ability to print as much money as they want to provide liquidity to banks or avoid financial market crises, the public’s lack of trust in the banks or financial institutions that hold or manage their capital, and personal financial security.
The first problem exists because governments give banks money so they can lend more out. Because of FDIC insurance, banks lend out at a rate of ten to one. If the bank has $1 million in their money market account, they can lend up to $10 million, essentially creating new capital in the form of debt. When there is too much debt, situations like the financial crisis of 2008 occur. Additionally, the more money printed, the less valuable money already in circulation becomes. This is part of inflation.
The second problem comes from the first problem. Individuals have to trust that the bank or financial institution they use will protect them and their finances. In 2008, many people found their pensions drained and their money gone, and that trust disappeared.
So the question arose, how does one go about solving these problems? One way was to limit the supply of currency available. Any asset that is scares or limited usually is sought after and has a value. Bitcoins are limited to 21 million coins that can be spent in 8 decimal point increments or 0.00000001. This increment is called a Satoshi or Stat. The creator(s) of Bitcoin understood that if their new currency was successful, Stats rather than full bitcoins would be how people paid for things. As of April 2021 nearly 89 percent of the total supply of bitcoins has been mined. That means only about 2.4 million bitcoins are left to be created before the supply is exhausted.
Creating a trustworthy financial system in which to manage Bitcoin was a little more complex. Bitcoin requires three groups of people to operate: those who download the program to buy bitcoins, called validators or nodes; those individuals or companies who make Bitcoin transactions; and the miners, who attempt to solve complicated math problems using a cryptographic algorithm called SHA256 to validate bitcoin transactions. For miners, this process is like a lottery system. The faster their computer is, the better chance they have to get the correct number first and earn Bitcoin as a reward. Once they earn bitcoins, they sell them to cover electrical and personnel costs. The miners are incentivized to be not only fast but also accurate, leading to a system validators can trust because the miners rely on them buying currency to profit from their efforts.
The last problem of financial security was solved with a cryptographic technique. Anyone can create what is called a wallet in which to store their bitcoins. This wallet has a 16-digit number and letter combination that is totally random, combined with a 24-word phrase to unlock it and transfer in and out of it, making getting into someone’s wallet impossible unless they are careless.
With these three problems solved, Bitcoin becomes decentralized (no bank involved), transparent (anyone can download the program and see their own Bitcoin transactions), and instant settlement (a bitcoin transaction settles every ten minutes and a wire from your bank could take days), making it the most secure currency ever.
