Friday, November 22, 2013

Understanding Bitcoin Basic Concepts

Bitcoin is a Virtual Commodity

Bitcoins have appeared in the news enough recently that commentators talk about it on the radio.  Usually, folks are completely baffled by the concept.  It's helpful to think of Bitcoins as a virtual commodity rather than a virtual currency.

Finding a Bitcoin is like finding Gold

Gold is just a mineral but it's special in two ways. Gold is easy to identify and hard to find. Bitcoins are just numbers defined by a Japanese mathematician but each bitcoin number is special in two ways. Bitcoin numbers are easy to identify and hard to find.

Any chemist can quickly distinguish gold from ordinary minerals but chemists don't know where all the gold is in the world. Any mathematician can quickly distinguish a genuine bitcoin from an ordinary number but mathematicians don't know what all the bitcoin numbers are (yet). This is probably the hardest concept to accept but computers can't solve every math problem instantly. Some math problems are so hard that it takes massive clusters of powerful computers decades to solve. Such is the search for bitcoins.

Miners with shovels dig through dirt hoping to find gold. Bitcoin miners with computers dig through numbers hoping to find a bitcoin. Mining is tedious but not impossible. Of course the bigger your shovel the better your luck.

Nobody controls gold because anybody with a shovel can be a miner and anybody with training can be a chemist. Nobody controls bitcoin because anybody with a calculator can be a bitcoin miner and anybody with training can be a mathematician.

Nobody can make gold. Gold is found by digging through dirt. Nobody can make bitcoins. Bitcoins are found by digging through numbers.

Most people who use gold or invest in gold are not miners or chemists.  They are just ordinary people.  Most people who use bitcoins or invest in bitcoins are not miners or mathematicians.  They are just ordinary people.

"Owning" a Bitcoin is like Owning Real Estate

As humans discovered chunks of vacant land, they stood upon it and proclaimed, "I hath found this land."  In the old days you had to defend ownership of your land but in modern civilization, there are international treaties and borders that are a matter of public record.  As miners discover new bitcoin numbers they quickly stand upon a soap box and proclaim, "I hath found this number!"  The other miners hear the claim, mathematicians confirm the authenticity and the ownership becomes part of the public record.  Just like the ownership over your front yard, the system is only as good as the community and norms that recognize the ownership.

Selling (or "spending") a bitcoin is like selling your house.  It's a change in the public record.  The only way to spend a bitcoin is to proclaim, "I do now bequeath THIS number upon THAT dude!" The new ownership becomes part of the public record and it's recognized by the community.  Dude now has the bitcoin that used to be yours.  You can't take it back unless Dude says so.

The Frequently Silly Asked Questions about Bitcoin

What if I were to simply claim "I hath found a million bitcoin!"?  

Well, any mathematician could quickly prove that is a lie. It would be like trying to pass a chunk of lead as gold.

What if I were to claim "That dude hath given unto me a million bitcoin!"?  

We'd all know that was a lie.  Everybody knows the original owner of every bitcoin. Like real estate, bitcoins are then passed by proclamation in a public record.  You can't simply claim somebody else's bitcoins.  Like your house, it cannot be taken.  It can only be given away.

What if I made my own form of bitcoin by claiming "I hath discovered virtual unicorn dust and I own all of it!"?  

That might actually work but you would have to prove the dust is easy to identify and hard to find before anybody else would consider it valuable. Good luck. Inventing bitcoin was not easy. Certainly other virtual commodities will come along just as gold competes with silver and diamonds but it won't be easy to invent a new one.

Isn't gold valuable because there's a limited amount of it?

That's actually not true. As far as we know, there's an infinite amount of gold in the universe but it gets harder and harder to find as time goes by. In the case of Bitcoin we can mathematically prove there are 21 million numbers that would pass the bitcoin test but that's not an essential property. In fact, many people argue that bitcoin would be better if there was no theoretical limit.  There are only two essential properties for any real or virtual commodity.  It has to be easy to identify and hard to find.