As technology continues to develop in our society, each new advancement seems to bring with it a new set of complex, technological concepts. Deciphering the terminology can prove to be a tremendous challenge. When I began my research on bitcoin, I discovered this to be true. Because I do not have extensive background knowledge on the workings of computers, it was initially difficult for me to figure out exactly how bitcoin worked. Consequently, an outline of key terms is necessary to fully grasp the concept of the bitcoin system and better understand how it functions.
Firstly, it is important to define the actual term virtual currency. Any form of money that is created and controlled by an online developer and transacted completely digitally could be described as a virtual currency. It is commonly unregulated and caters to a specific virtual community that desires to make exchanges with the currency. Bitcoin clearly falls into this definition; each unit is created and maintained through computer systems, and the currency is not regulated or backed by any governmental body.
The next complexity in understanding bitcoin is the actual process of how the currency is produced. The term mining refers to the creation of bitcoins, similar to “mining” the earth for minerals. Bitcoin is extremely unique in that the units are mined by personal computers, and are not created by a central authority. These voluntary computers work in groups to solve complex mathematical algorithms within the bitcoin encryption function.1 By this method, bitcoins can actually be acquired without purchasing them.
Once bitcoins are mined or purchased, users can exchange them as payment with bitcoin-accepting merchants. All transactions are then recorded in the blockchain. The blockchain is a public ledger that identifies every bitcoin transaction to date, although individual users are still left anonymous.2 The currency is stored in a digital wallet, which each user keeps as merely a file on their computer. This obviously creates a slew of hazards, such as losing the wallet, being vulnerable to theft, or having a user’s identity stolen. Some online digital wallet providers are marketing more high-security digital wallets, which claim to serve as better protection of a user’s own personal bitcoin supply.
Bitcoin is a peer-to-peer electronic cash system, which means that it does not operate with an overarching central authority. Consequently, the production of bitcoins is entirely dependent upon demand and supply in the virtual currency market.1 The network consists of thousands of personal home computers that work in small groups to solve the mathematical equations and produce currency units. This decentralization and lack of chief control is the characteristic that attracts some to bitcoin. Without a prime regulator, the fear of abrupt inflation or a surplus of bitcoins in the market is mostly extinguished.
Finally, a key term that is often associated with bitcoin is money laundering. Running money obtained by illegal actions through other transactions in order to disguise its origin and “clean” it is referred to as money laundering. Skeptics of bitcoin argue that the virtual currency serves as a prime method for laundering. However, the public availability of bitcoin makes access to a user’s identity definitely not impossible to find, and increases the risk of money laundering.
1 Kaplanov, Nikolei M. “Nerdy Money: Bitcoin, the Private Digital Currency, and the Case Against its Regulation.” Loyola Consumer Law Review 25:1 (2013). Web.
2“Bitcoin and Beyond: The Possibilities and Pitfalls of Virtual Currencies.” Central Banker, Federal Reserve Bank of St. Louis. Fall (2014): 6-7.