Photo courtesy of via Flickr. Public domain Bitcoin logo by bitboy via Wikipedia Commons. Modified by Curiousmatic.

What Is Bitcoin? A Simple Guide To Understanding The Virtual Currency

The origin and inner workings of the virtual currency, masterminded by its mysterious, AWOL creator Satoshi Nakamoto.

Photo courtesy of the LA Times.

Just in time for their paper relaunch, Newsweek released a feature article on March 6, claiming to have found the elusive mastermind behind Bitcoin.

The man in question, however, a 64-year-old retired systems engineer named Dorian Prentice Satoshi Nakamoto, later categorically denied involvement with Bitcoin in an interview with the Associated Press.

Meanwhile, an account on P2P Foundation believed to be operated by the actual Bitcoin creator posted for the first time in four years, stating that he or she was not Dorian Nakamoto.

There are millions of bitcoins, but none of them exist in the physical world. It’s a completely virtual currency, meaning it only exists as data distributed across the Internet.

There’s no central authority guaranteeing its value, the way the value of a dollar bill is backed by the Federal Reserve. Despite this, the market exchange value of all Bitcoins has reached billions of dollars, after only five years of existence. Before 2009, there was nothing.

How was it possible to create a billion dollars out of thin air?

In fact, not much is known about the origin of Bitcoin. It was created by Satoshi Nakamoto, a name many believe to be either a pseudonym for someone else or a group of people. Nakamoto’s email and domain are anonymously registered, and all his communications are written in flawless English that for some reason alternates between British and American spelling.

The idea for the currency was first broached in a white paper published in 2008 by Nakamoto, outlining how it would work. In January 2009, the first version was launched, and while he was active for a time, Nakamoto gradually began to fade away from the project, until April 2011, when he announced that he had “moved on,” naming current lead developer Gavin Andresen in his place.

Nakamoto hasn’t been heard from since, although various publications have attempted to uncover his identity, including the New Yorker, Vice, Fast Company, and now  Newsweek (see update at the top).

Despite the apparent absence of its creator, however, the currency is thriving – some say due to its solid, transparent fundamentals.

How Bitcoins work

It works by distributing all data across a peer-to-peer network. Whenever a transaction is performed, all the information pertaining to the transaction – including the amount of coins and the network address of the sender and recipient – is broadcasted to all computers in the network, creating a public account of each transaction. The network address is not the IP address, however, but a randomized string of numbers, anonymizing the transaction.

Once computers in the network obtain the transactions, they are gathered into blocks. Each block contains a math puzzle that takes a computer an average of 10 minutes to solve, and once they do, the block is considered completed and sent out to all other nodes, which can then quickly authenticate the answer to the puzzle.

Blocks contain the timestamp of their creation and information about the block before them, creating a chain of blocks that shows every transaction performed in the currency. All transactions are irreversible, but there is no central authority to determine whether a given amount of Bitcoin has been spent elsewhere the way a credit card company verifies each transaction. To prevent this, all transactions are measured against the longest block chain at the time of the transaction, which represents the most complete log of transactions.

This creating of blocks is a process called “mining,” as each user who completes a block is rewarded with a certain amount of brand new Bitcoins. It’s the method through which new currency is added to the supply pool; however, the total amount of Bitcoins will never exceed 21 million, its website states. To prevent everything from being mined at once, the number of Bitcoins generated per block will be reduced by 50% every four years, meaning 21 million will not be reached until 2140.

The currency is highly granular, however: A single coin can be split up into fractions as small as 0.000,000,01 – known as a satoshi, after its mysterious founder. With Bitcoins  fluctuation widely in value, that’s good to know.

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Ole Skaar