Newshub's guide to bitcoin

From humble beginnings in 2009, bitcoin has become a global economic force, with all bitcoin worldwide valued at well over $NZ200 billion.

Much of this growth has come in the past year, with the price of bitcoin increasing by more than 10 times its starting value in January, to sit at around $NZ23,000 today.  

To help make sense of this remarkable growth, Newshub has gathered the answers to some of the most basic questions about the world's most powerful 'cryptocurrency'. 

What is it?

At its simplest, bitcoin is a 'digital currency', which means it only exists electronically and isn't tied to any tangible asset. 

It is also called a 'cryptocurrency', which means it is 'encrypted' in such a way that it is safe from being copied unlike traditional printed money.

Bitcoin is essentially a valid currency because enough people have decided that it is, and doesn't have any intrinsic value, as opposed to something like gold. However like traditional currency, it can be exchanged for tangible goods and services at participating traders.

How does it work?

Bitcoin is exchanged on a global 'peer-to-peer' network, which means direct exchange of information between computers, similar to what happens when people use file-sharing software, like 'Utorrent'.

However instead of sending something like a music file, when sending bitcoin you're essentially sending a basic unit of information, 'person one sends X amount of bitcoin to person two'.  

All transactions of bitcoin are recorded on a digital record called 'the blockchain', which acts like a digital ledger with a receipt for every exchange of bitcoin that's ever happened. Each time new transactions are processed a new 'block' is added onto the 'chain'.

Whenever people exchange bitcoin, it is automatically checked against the entire history of transactions recorded in the blockchain to ensure someone isn't trying to spend the same bitcoin twice. 

Who runs it?

What makes bitcoin so unique is that there is no governing body which controls the currency, it isn't tied to any nation or bank, meaning it is completely 'decentralised'.

In practical terms, this means there is no-one in charge of making more bitcoin, determining its value, or validating transactions. All of these processes are determined organically through a combination of community input and clever mathematics.

Thousands of people worldwide collectively volunteer their computer's processing power to maintain the 'blockchain' and process each new transaction. They don't do this for free as there is a built in mechanism to reward people who help in this way.

Bitcoin transactions are protected from hacking by a dense layer of mathematics, so to process a new transaction of bitcoin, or 'create a new block on the chain', all computers maintaining the network essentially race to solve an extremely complicated equation which will validate the transaction.  

If you have volunteered your computer and it solves the equation, bitcoin are automatically generated and awarded to you. 

This is called 'bitcoin mining' and your chances of being the one to solve the problem go up the more powerful your computer is, hence why people build 'mining rigs' of specialised hardware. 

Right now, computers in the bitcoin network are performing more than 300 million billion mathematical operations per second. Since so many computers are interconnected and working together simultaneously, transactions are processed with relatively short delays.  

In this way, bitcoin is self-policing and self-sustaining, as users worldwide dedicate their computers to maintaining the blockchain, while being rewarded with bitcoin themselves for doing so, with no one person or organisation in control. 

Crucially, as the total amount of bitcoin increases, the system rewards miners with fewer bitcoin, meaning there are a finite number of bitcoin to be mined. This was done intentionally when bitcoin was conceived, in order to more closely mirror a real asset, such as gold. 

This means there is a cap of 21 million bitcoins which will ever be produced, which is one of the reasons the value of bitcoin has skyrocketed this year. Supply is constantly decreasing while demand has radically increased as bitcoin has come into the public eye. 

Is it safe?

Investing in bitcoin carries all the risks of traditional investment and you should never invest money you aren't prepared to lose. Whether or not bitcoin is a safe system for investing money in general is more complex.

In theory, the components of bitcoin are well protected from hacking. Your bitcoins are kept in a 'digital wallet' which is created when you sign up to the network and all transactions are protected through a digital signature. Unlike their physical equivalents, both your digital wallet and signature are protected through mathematical algorithms which make them very difficult to steal or forge. 

However bitcoin is still very vulnerable to human error. If you lose the password used to log in to your digital wallet, it can be extremely difficult to replace and the safety of your wallet will immediately become compromised. Your wallet can also become lost forever if the computer you have saved it on becomes damaged. 

Your money may also be vulnerable if you transact your bitcoin through a third party, known as an 'exchange'. This was infamously illustrated when Mt. Gox, the world's largest bitcoin exchange at the time, went into liquidation in 2014. It was later revealed Mt Gox was hacked and lost the equivalent of over half a billion NZD in bitcoin. 

Bitcoin being decentralised is both a strength and a weakness. Without a regulatory body, bitcoin is convenient and democratically controlled but there are fewer security checks around its use and no dedicated organisation to investigate fraud or theft.  

Will it burst?

Bitcoin is considered by many to be a 'bubble', commonly defined as when the price of a good becomes radically divorced from its intrinsic value. Bitcoin's huge surge in value this year coupled with its entirely digital nature support the 'bubble' theory. This means that at some point, the price may tumble and billions of dollars could be lost. Just this week the Chicago stock exchange allowed investors to 'speculate' on the future value of bitcoin, prompting fresh warnings of a bubble.

Wall Street mogul and head of JP Morgan Jamie Dimon was pessimistic about bitcoin's future, telling CNBC in September that "It won't end well. Someone is going to get killed."

However a case for optimism about bitcoin can also be made. As it becomes more embraced globally as a payment method, structures to support it may also flourish. Japan has recently officially accepted it as a viable form of payment and heavyweight investors in America have also shown their support, with Bill Gates famously calling it 'Better than currency' in 2014. 

Where did it come from?

The origin of bitcoin is still mysterious. The network started in 2009 and is credited to 'Satoshi Nakamoto', who published a paper that year called  Bitcoin: A Peer-to-Peer Electronic Cash System, explaining the principles of the system. 

It is still unknown whether this was the work of a single person or an organisation, as no-one has ever come forward with definitive proof that they are 'Satoshi Nakatomo'. 

CNBC reports that whoever Nakamoto is, they still allegedly own 5 percent of all bitcoin, making them a multi-billionaire. 

While the value of bitcoin has this month passed the NZ$20,000 mark, the value of the first bitcoin were negotiated by individuals speaking on forums and were worth next to nothing.  

According to the book, Rise and Fall of Bitcoin, in those early days 10,000 bitcoin were used to purchase two pizzas.

Today, 10,000 bitcoin would be valued at over $NZ200m.