Bitcoin (BTC) is an online payment system invented by Satoshi Nakamoto, who published his invention in 2008, and released it as open-source software in 2009. The system is peer-to-peer; users can transact directly without needing an intermediary. Transactions are verified by network nodes and recorded in a public distributed ledger called the blockchain. The ledger uses its own unit of account, also called bitcoin. The system works without a central repository or single administrator, which has led the US Treasury to categorize it as a decentralized virtual currency. Bitcoin is often called the first cryptocurrency, although prior proposals existed. Bitcoin is more correctly described as the first decentralized digital currency. It is the largest of its kind in terms of total market value.
Bitcoins are created as a reward for payment processing work in which users offer their computing power to verify and record payments into the public ledger. This activity is called mining and is rewarded by transaction fees and newly created bitcoins. Besides mining, bitcoins can be obtained in exchange for fiat money, products, and services. Users can send and receive bitcoins for an optional transaction fee.
Bitcoin as a form of payment for products and services has grown, and merchants have an incentive to accept it because fees are lower than the 2–3% typically imposed by credit card processors. Despite a big increase in the number of merchants accepting bitcoin, the cryptocurrency doesn’t have much momentum in retail transactions. Unlike credit cards, any fees are paid by the purchaser, not the vendor. The European Banking Authority and other sources have warned that bitcoin users are not protected by refund rights or chargebacks.
The use of bitcoin by criminals has attracted the attention of financial regulators, legislative bodies, law enforcement, and the media. They listed money laundering, financing of illicit activities, theft, fraud, tax evasion, and use in black markets as possible. As of 2013, the criminal activities centered around theft and black markets. Officials in countries such as the United States also recognized that bitcoin can provide legitimate financial services to customers.
The blockchain is a public ledger that records bitcoin transactions. A novel solution accomplishes this without any trusted central authority: maintenance of the blockchain is performed by a network of communicating nodes running bitcoin software. Transactions of the form payer X sends Y bitcoins to payee Z are broadcast to this network using readily available software applications. Network nodes can validate transactions, add them to their copy of the ledger, and then broadcast these ledger additions to other nodes. The blockchain is a distributed database; in order to independently verify the chain of ownership of any and every bitcoin (amount), each network node stores its own copy of the blockchain. Approximately six times per hour, a new group of accepted transactions, a block, is created, added to the block chain, and quickly published to all nodes. This allows bitcoin software to determine when a particular bitcoin amount has been spent, which is necessary in order to prevent double-spending in an environment without central oversight. Whereas a conventional ledger records the transfers of actual bills or promissory notes that exist apart from it, the block chain is the only place that bitcoins can be said to exist in the form of unspent outputs of transactions.
The unit of account of the bitcoin system is bitcoin. As of 2014, symbols used to represent bitcoin are BTC, XBT, and ₿. Small multiples of bitcoin used as alternative units are millibitcoin (mBTC), microbitcoin (µBTC), and satoshi. Named in homage to bitcoin’s creator, a satoshi is the smallest multiple of bitcoin representing 0.00000001 bitcoin, which is one hundred millionth of a bitcoin. A millibitcoin equals to 0.001 bitcoin, which is one thousandth of bitcoin. One microbitcoin equals to 0.000001 bitcoin, which is one millionth of bitcoin. A microbitcoin is sometimes referred to as a bit.
On 7 October 2014, the Bitcoin Foundation revealed a plan to apply for an ISO 4217 currency code for bitcoin, and mentioned BTC and XBT as the leading candidates.
Ownership of Bitcoin
Ownership of bitcoins implies that a user can spend bitcoins associated with a specific address. To do so, a payer must digitally sign the transaction using the corresponding private key. Without knowledge of the private key the transaction cannot be signed and bitcoins cannot be spent. The network verifies the signature using the public key. If the private key is lost, the bitcoin network will not recognize any other evidence of ownership; the coins are then lost and cannot be recovered. For example, in 2013 one user said he lost 7,500 bitcoins, worth $7.5 million at the time, when he discarded a hard drive containing his private key.
A transaction must have one or more inputs. For the transaction to be valid, every input must be an unspent output of a previous transaction. Every input must be digitally signed. The use of multiple inputs corresponds to the use of multiple coins in a cash transaction. A transaction can also have multiple outputs, allowing one to make multiple payments in one go. A transaction output can be specified as an arbitrary multiple of satoshi. Similarly as in a cash transaction, the sum of inputs (coins used to pay) can exceed the intended sum of payments. In such case, an additional output is used, returning the change back to the payer.
To send money to a bitcoin address, users can click links on webpages; this is accomplished with a provisional Bitcoin URI scheme using a template registered with IANA. Bitcoin clients like Electrum and Armory support Bitcoin URIs. Mobile clients recognize Bitcoin URIs in QR codes, so that the user does not have to type the bitcoin address and amount in manually. The QR code is generated from the user input based on the payment amount. The QR code is displayed on the mobile device screen and can be scanned by a second mobile device.
Mining is a record-keeping service. Miners keep the block chain consistent, complete, and unalterable by repeatedly verifying and collecting newly broadcast transactions into a new group of transactions called a block. A new block contains information that “chains” it to the previous block thus giving the block chain its name. It is a cryptographic hash of the previous block, using the SHA-256 hashing algorithm.
A new block must also contain a so-called proof-of-work. The proof-of-work consists of a number called a difficulty target and a number called a nonce, which is jargon for “a number used only once”. Miners have to find a nonce that yields a hash of the new block numerically smaller than the number provided in the difficulty target. When the new block is created and distributed to the network, every network node can easily verify the proof. On the other hand, finding the proof requires significant work since for a secure cryptographic hash there is only one method to find the requisite nonce: miners try different integer values one at a time, e.g., 1, then 2, then 3, and so on until the requisite output is obtained. The fact that the hash of the new block is smaller than the difficulty target serves as a proof that this tedious work has been done, hence the name “proof-of-work”.
By changing the difficulty target number, the average time required to find a nonce can be shortened or extended (A smaller number reduces the range of accepted nonces and increases the time required.) The bitcoin system adjusts the difficulty target number every 2016 blocks so that the average time the entire network needs to find a nonce always remains about ten minutes. In this way the bitcoin protocol ensures that it will always take about ten minutes to add a new block regardless of the size of the network or the sophistication of the mining hardware it employs. For example, at the end of April 2014 miners had to try 34.4 quintillion values at average before finding the requisite nonce, while at the end of October 2014 it was 154.6 quintillion values at average.
The proof-of-work system alongside the chaining of blocks makes modifications of the block chain extremely hard as an attacker must modify all subsequent blocks in order for modifications of one block to be accepted. As new blocks are mined all the time, the difficulty of modifying a block increases as time passes and the number of subsequent blocks increases.
The successful miner finding the new block is rewarded with newly created bitcoins and transaction fees. As of 28 November 2012, the reward amounted to 25 newly created bitcoins per block added to the block chain. To claim the reward, a special transaction called a coinbase is included with the processed payments. All bitcoins in circulation can be traced back to such coinbase transactions. The bitcoin protocol specifies that the reward for adding a block will be halved approximately every four years. Eventually, the reward will be removed entirely when an arbitrary limit of 21 million bitcoins is reached c. 2140, and record keeping will then be rewarded by transaction fees solely.
Bitcoin Transaction fees
Paying a transaction fee is optional, but may speed up confirmation of the transaction. Payers have an incentive to include such fees because doing so means their transaction will likely be added to the block chain sooner; miners can choose which transactions to process and prioritize those that pay fees. Fees are based on the storage size of the transaction generated, which in turn is dependent on the number of inputs used to create the transaction. Furthermore, priority is given to older unspent inputs.
A wallet stores the information necessary to transact bitcoins. While wallets are often described as a place to hold or store bitcoins, due to the nature of the system, bitcoins are inseparable from the block chain transaction ledger. Perhaps a better way to describe a wallet is something that “stores the digital credentials for your bitcoin holdings” and “allows you to access (and spend) them”. Bitcoin uses public-key cryptography, in which two cryptographic keys, one public and one private, are generated. At its most basic, a wallet is a collection of these keys.
There are several types of wallet. Software wallets connect to the network and allow spending bitcoins in addition to holding the credentials that prove ownership. Internet services called online wallets like Blockchain.info, Circle, Snapcard, or Coinbase offer similar functionality but may be easier to use. Physical wallets also exist and are more secure, as they store the credentials necessary to spend bitcoins offline. Examples combine a novelty coin with these credentials printed on metal, wood, or plastic. Others are simply paper printouts. Another type of wallet called a hardware wallet keeps credentials offline while facilitating transactions.
Privacy is achieved by not identifying owners of bitcoin addresses while making other transaction data public. Bitcoin users are not identified by name, but transactions can be linked to individuals and companies. Additionally, bitcoin exchanges, where people buy and sell bitcoins for fiat money, may be required by law to collect personal information. To maintain financial privacy, a different bitcoin address for each transaction is recommended. Transactions that spend coins from multiple inputs can reveal that the inputs may have a common owner. Users concerned about privacy can use so-called mixing services that swap coins they own for coins with different transaction histories. It has been suggested that bitcoin payments should not be considered more private than credit card payments.
Wallets and similar software technically handle bitcoins as equivalent, establishing the basic level of fungibility. Researchers have pointed out that the history of every single bitcoin is registered and publicly available in the block chain ledger, and that some users may refuse to accept bitcoins coming from controversial transactions, which would harm bitcoin’s fungibility. Projects such as Zerocoin and Dark Wallet aim to address these privacy and fungibility issues.
Bitcoin was invented by Satoshi Nakamoto, who published his invention on 31 October 2008 in a research paper called “Bitcoin: A Peer-to-Peer Electronic Cash system”. It was implemented as open source code and released in January 2009. Bitcoin is often called the first cryptocurrency although prior proposals existed. Bitcoin is more correctly described as the first decentralized digital currency.
One of the first supporters, adopters, contributor to bitcoin and receiver of the first bitcoin transaction was programmer Hal Finney. Finney downloaded the bitcoin software the day it was released, and received 10 bitcoins from Nakamoto in the world’s first bitcoin transaction.
Other early supporters were Wei Dai, creator of bitcoin predecessor b-money, and Nick Szabo, creator of bitcoin predecessor bit gold.
In 2010, an exploit in an early bitcoin client was found that allowed large numbers of bitcoins to be created. The artificially created bitcoins were removed when another chain overtook the bad chain.
Based on bitcoin’s open source code, other cryptocurrencies started to emerge in 2011.
In March 2013, a technical glitch caused a fork in the block chain, with one half of the network adding blocks to one version of the chain and the other half adding to another. For six hours two bitcoin networks operated at the same time, each with its own version of the transaction history. The core developers called for a temporary halt to transactions, sparking a sharp sell-off. Normal operation was restored when the majority of the network downgraded to version 0.7 of the bitcoin software.
In 2013 some mainstream websites began accepting bitcoins. WordPress had started in November 2012, followed by OKCupid in April 2013, Atomic Mall in November 2013, TigerDirect and Overstock.com in January 2014, Expedia in June 2014, Newegg and Dell in July 2014, and Microsoft in December 2014. Certain non-profit or advocacy groups such as the Electronic Frontier Foundation accept bitcoin donations. (The organization started accepting bitcoins in January 2011, stopped accepting them in June 2011, and began again in May 2013.)
In May 2013, the Department of Homeland Security seized assets belonging to the Mt. Gox exchange. The U.S. Federal Bureau of Investigation (FBI) shut down the Silk Road website in October 2013.
In October 2013, Chinese internet giant Baidu had allowed clients of website security services to pay with bitcoins. During November 2013, the China-based bitcoin exchange BTC China overtook the Japan-based Mt. Gox and the Europe-based Bitstamp to become the largest bitcoin trading exchange by trade volume. On 19 November 2013, the value of a bitcoin on the Mt. Gox exchange soared to a peak of US$900 after a United States Senate committee hearing was told by the FBI that virtual currencies are a legitimate financial service. On the same day, one bitcoin traded for over RMB ¥6780 (US$1,100) in China. On 5 December 2013, the People’s Bank of China prohibited Chinese financial institutions from using bitcoins. After the announcement, the value of bitcoins dropped, and Baidu no longer accepted bitcoins for certain services. Buying real-world goods with any virtual currency has been illegal in China since at least 2009.
The first bitcoin ATM was installed in October 2013 in Vancouver, British Columbia, Canada.
As of 2013 mining had become quite competitive and was compared to an arms race as ever-more-specialized technology was being utilized. The most efficient mining hardware makes use of custom designed application-specific integrated circuits, which outperform general purpose CPUs and also use less power. Without access to these purpose-built machines, a bitcoin miner is unlikely to earn enough to even cover the cost of the electricity used in his or her efforts.
With about 12 million existing bitcoins in November 2013, the new price increased the market cap for bitcoin to at least US$7.2 billion. By 23 November 2013, the total market capitalization of bitcoin exceeded US$10 billion for the first time.
In the US two men were arrested in January 2014 on charges of money-laundering using bitcoins; one was Charlie Shrem, the head of now defunct bitcoin exchange BitInstant and a vice chairman of the Bitcoin Foundation. Shrem allegedly allowed the other arrested party to purchase large quantities of bitcoins for use on black-market websites.
In early February 2014, one of the largest bitcoin exchanges, Mt. Gox, suspended withdrawals citing technical issues. By the end of the month, Mt. Gox had filed for bankruptcy protection in Japan amid reports that 744,000 bitcoins had been stolen. Originally a site for trading Magic: The Gathering cards, Mt. Gox had once been the dominant bitcoin exchange but its popularity had waned as users experienced difficulties withdrawing funds.
On June 18, 2014, it was announced that bitcoin payment service provider BitPay would become the new sponsor of St. Petersburg Bowl under a two-year deal, renamed the Bitcoin St. Petersburg Bowl. Bitcoin was to be accepted for ticket and concession sales at the game as part of the sponsorship, and the sponsorship itself was also paid for using bitcoin.
Less than one year after the collapse of Mt. Gox, Bitstamp announced that the exchange would be taken offline while they investigate a hack which resulted in about 19,000 bitcoins (equivalent to roughly US$5 million at that time) being stolen from their hot wallet. The exchange remained offline for several days amid speculation that customers had lost their funds. Bitstamp resumed trading on January 9 after increasing security measures and ensuring customers that their account balances would not be impacted.
The bitcoin exchange service Coinbase launched the first regulated bitcoin exchange in 25 US states on January 26, 2015. At the time of the announcement, CEO Brian Armstrong stated that Coinbase intends to expand to thirty countries by the end of 2015. A spokesperson for Benjamin M. Lawsky, the superintendent of the state’s Department of Financial Services, stated that Coinbase is operating without a license in the state of New York. Lawsky is responsible for the development of the so-called ‘BitLicense’, which companies need to acquire in order to legally operate in New York.
According to the director of the Institute for Money, Technology and Financial Inclusion at the University of California-Irvine there is “an unsettled debate about whether bitcoin is a currency”. Bitcoin is commonly referred to with terms like: digital currency, digital cash, virtual currency, electronic currency, or cryptocurrency. Its inventor, Satoshi Nakamoto, used the term electronic cash. Bitcoins have 3 useful qualities in a currency, according to the Economist in 1/2015: they are “hard to earn, limited in supply and easy to verify”.
Economists define money as a store of value, a medium of exchange, and a unit of account and agree that bitcoin has some way to go to meet all these criteria. It does best as a medium of exchange. The bitcoin market currently suffers from volatility, limiting the ability of bitcoin to act as a stable store of value, and retailers accepting bitcoin use other currencies as their principal unit of account.
Journalists and academics also dispute what to call bitcoin. Some media outlets do make a distinction between “real” money and bitcoins, while other call bitcoin real money. The Wall Street Journal declared it a commodity in December 2013. A Forbes journalist referred to it as digital collectible. Two University of Amsterdam computer scientists proposed the term “money-like informational commodity”.
The People’s Bank of China has stated that bitcoin “is fundamentally not a currency but an investment target”.
Buying and selling
Bitcoins can be bought and sold both on- and offline. Participants in online exchanges offer bitcoin buy and sell bids. Using an online exchange to obtain bitcoins entails some risk, and, according to a study published in April 2013, 45% of exchanges fail and take client bitcoins with them. Exchanges have since implemented measures to provide proof of reserves in an effort to convey transparency to users. Offline, bitcoins may be purchased directly from an individual or at a bitcoin ATM.
Bitcoin Price and volatility
To improve access to price information and increase transparency, on 30 April 2014 Bloomberg LP announced plans to list prices from bitcoin companies Kraken and Coinbase on its 320,000 subscription financial data terminals.
According to Mark T. Williams, as of 2014, bitcoin has volatility seven times greater than gold, eight times greater than the S&P 500, and eighteen times greater than the U.S. dollar.
Attempting to explain the high volatility, a group of Japanese scholars stated that there is no stabilization mechanism. The Bitcoin Foundation contends that high volatility is due to insufficient liquidity,while a Forbes journalist claims that it is related to the uncertainty of its long-term value, and the high volatility of a startup currency makes sense, “because people are still experimenting with the currency to figure out how useful it is.”
There are uses where volatility does not matter, such as online gambling, tipping, and international remittances.As of 2014, pro-bitcoin venture capitalists argued that the greatly increased trading volume that planned high-frequency trading exchanges were hoped to bring would decrease price volatility.
The price of bitcoins has gone through various cycles of appreciation and depreciation referred to by some as bubbles and busts. In 2011, the value of one bitcoin rapidly rose from about US$0.30 to US$32 before returning to US$2. In the latter half of 2012 and during the 2012-2013 Cypriot Financial Crisis, the bitcoin price began to rise, reaching a high of US$266 on 10 April 2013, before crashing to around US$50.On November 29, 2013, the cost of one bitcoin rose to the all-time peak of US$1,242. In 2014 the price fell sharply, and as of April remained depressed at little more than half 2013 prices. As of August 2014 it was under US$600. In January 2015, noting that the bitcoin price had dropped to its lowest level since spring 2013 – around US$224 – the New York Times suggested that “with no signs of a rally in the offing, the industry is bracing for the effects of a prolonged decline in prices. In particular, bitcoin mining companies, which are essential to the currency’s underlying technology, are flashing warning signs.” Also in January 2015, Business Insider reported that deep web drug dealers were “freaking out” as they lost profits through being unable to convert bitcoin revenue to cash quickly enough as the price declined – and that there was a danger that dealers selling reserves to stay in business might force the bitcoin price down further.