A Beginner’s Guide to Bitcoin (Part 2): Bitcoin vs Money

Previous Article   –   Next Article   –   Table of Contents

Bitcoin Overview

Basics

As I’ve already said I’m not assuming you know anything about Bitcoin.  To get started, below is a high level overview of the basics of Bitcoin and how payments in our new money are processed.  You may well know some of this already.

  • Bitcoin is a ‘cryptocurrency’, which is a form of electronic money or currency.
  • As such, it can be used to make and receive electronic payments that have value.
  • Bitcoin is public.  Anyone can make or receive a payment and see the payment details.
  • Payments can be made anonymously.  No-one can tell who is paying or who is receiving the payment.
  • Bitcoin is not controlled by any one person or group of people.  In particular, unlike most money it’s not controlled by any government.  No-one runs it, it’s ‘decentralized’.
  • Bitcoin doesn’t need trusted identified third-parties (like banks) or even specific trusted computers to work.  It’s a ‘trustless’ system.

Processing Payments

  • The computers used for Bitcoin are owned by independent and competing people who are paid for this (payment processors or ‘miners’).
  • These payment processors simply follow a set of rules that define how Bitcoin works.  The payment processors don’t define the rules and they have no control over Bitcoin.
  • The rules are carefully designed to incentivize the payment processors to play fair, and to make it very difficult to cheat the system by breaking the rules.
  • Payment processors and their computers can join or leave the network at any time, and Bitcoin is not dependent on any individual payment processor or computer.

The Distributed Ledger

  • The details of all payments that have been made, and consequently of who currently owns the money, are stored in one electronic ledger that is public.
  • The ledger is stored on the payment processors’ computers.  These computers form a network connected by the internet.  Each computer has a copy of the ledger.  It’s a ‘distributed ledger’.
  • The payment processors (the miners) add new payment details to the ledger as they arise, in accordance with the rules mentioned above.
  • The payment processors only get paid for adding new payments to the ledger, not directly for running Bitcoin computers.  They get paid automatically in newly-issued Bitcoin: no single individual pays them.
  • There are developers who wrote the original code for Bitcoin.  However they don’t control the system either.  In fact it’s proved quite hard for them to change the code.

As I said, these points are very high level.  They may seem contradictory (a public ledger where every payment is anonymous) or even impossible (money gets paid but no-one controls anything).  The remaining articles in the series will go into much more detail about how this can actually work in practice.  First we’ll consider how Bitcoin compares with real money.

Money Overview

In the previous section I said the Bitcoin is ‘a form of electronic money’.  I haven’t assumed much here, but I’m assuming you know what money is.  At least, I’m assuming you think you know what money is.  It’s not as straightforward as it seems.

Definitions

The Oxford Dictionary definition of ‘money’ is ‘A current medium of exchange in the form of coins and banknotes; coins and banknotes collectively.’

If you think about that for a minute you’ll see that it isn’t really a great definition.

The Merriam-Webster definition of ‘money’ seems better:  ‘something generally accepted as a medium of exchange, a measure of value, or a means of payment’.

Properties

In any case, here are some things that we can probably agree are usually true of traditional money:

  • Money can take the form of cash: coins and banknotes.
  • It can also take other forms.  If I have a balance in a checking account at a major bank then that’s money.
  • Conventional money is thus distributed throughout the banking and cash system, and there’s no central record of where all the money is.
  • Payments using money can also happen anywhere in the system; they are not centralized.
  • Payments can take many different forms. They can be simple: I can give you a $20 bill to pay you.  Or I can tap my credit card on a reader in a supermarket to pay for my groceries.  Payments can also be fairly complicated.  I can write a check and mail it to you, you can take it to your bank to pay it in, after which, eventually, our associated bank balances will be updated.
  • Money is one of the things that varies by nation.  Different countries have different types of money.  There are ways of exchanging the money of one country for the money of another, but not any general way of using one country’s money in another country.
  • Money is usually controlled and managed by governments or their proxies, such as central banks.  There are major advantages to governments of nations if they have control of their own money.

The reason I’m discussing this is that Bitcoin doesn’t work this way at all.  None of the bullet points above are true of Bitcoin.  It’s something radically different.

Is Bitcoin Money?

You’ll find plenty of people arguing that Bitcoin is not ‘money’ at all because, as discussed above, it doesn’t have many of the features of what we think of as traditional money.  In one sense this is true: if your definition of ‘money’ is ‘something issued by a government and given stability by government institutions then Bitcoin is not ‘money’.  I don’t think most people define money in this way, and the dictionaries don’t seem to either.

If we go back to our original dictionary definitions of ‘money’ then Bitcoin is money.  It is something generally accepted as a medium of exchange, it’s a means of payment, and it can act as a measure of value.

Even this has some exceptions: it can be difficult to convert Bitcoin into traditional money and to pay it into a regular bank account for example.  Even if you manage that it can be difficult to spend the money.  It’s also not a great measure of value since its value fluctuates wildly and could well go to zero in the long term.  This is in part because no-one controls or manages it.

Note that there’s nothing physical of actual value backing up any of this money, either traditional money or Bitcoin.  In the UK there was in the past: there were times when UK banknotes could theoretically exchanged for gold.  Nowadays money has value because we all accept that it does.

Previous Article   –   Next Article   –   Table of Contents

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s