Still Don’t Get Bitcoin? Here’s an Explanation Even a 5-Year-Old Will Understand

Bitcoin how the system works, What Is a Bitcoin and How Does Bitcoin Work?

Bitcoin's Backstory The genesis of Bitcoin is the stuff of internet legend.

What Is Bitcoin, and How Does It Work?

Ina person or persons working under the pseudonym Satoshi Nakamoto published a document outlining the feasibility of the Bitcoin concept. Nakamoto mentioned the financial crisis — as well as the failures of government-backed currencies and corruption of existing banking systems — as a motivating factor for inventing a new currency.

Bitcoin would be, according to its creators, a purer form of money, working for regular citizens of the world instead of being leveraged against them by the powers that be. Advertisement Advertisement InNakamoto released the first Bitcoin application, and also "mined" the first bitcoins for circulation. Then it was just a matter of spreading the word about this new currency.

Bitcoin: How Cryptocurrencies Work

To use Bitcoin, you need a Bitcoin wallet, which encrypts and maintains your bitcoin balance on your computer, smartphone or in the cloud.

Then you can fill your wallet with binary options strategy for an hour by using your bank account, credit card or other form of payment. After that, it's just a matter of finding a vendor that will accept Bitcoin as payment. Although pickings were slim when Bitcoin first launched, these days there are many merchants that accept these newfangled coins.

That includes restaurants, clothing stores, dentists and many others. Some people even use Bitcoin for property rental and vehicle purchases. The gift card website Gyft accepts payment in Bitcoin, letting you turn Bitcoin into store credit that can be spent at every major retailer and restaurant in America.

If you follow financial news at all, you already know that Bitcoin isn't just used for goods and services. A lot of the hype around Bitcoin has centered around speculation.

Every product was carefully curated by an Esquire editor. We may earn a commission from these links. Dec 27, Getty Images The financial world can't stop talking about bitcoin. In recent weeks, the headlines of business journals and finance sections have covered everything from the importance of investing in bitcoin to how the bubble is about to burst within days of bitcoin futures hitting the stock exchange.

That is, people are using online currency exchanges like Coinbase to invest their real-world dollars and yen in Bitcoin hoping that the latter will appreciate in value. Already, fortunes have been made and surrendered as the value of Bitcoin has careened all over the charts. But how does this invisible, virtual currency wield so much financial power? How can a brand-new type of money be a workable concept? Well, it's complicated.

Keep reading and you'll see how Bitcoin comes to life.

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Who is Satoshi Nakamoto? Bitcoin's creator has never revealed his or her or their true identity. According to the Bitcoin website, after working on the project's development for a few years, the mystery founder s moved on, leaving it to the community that had grown around the concept.

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Advertisement One Complicated Coin A photographer's conception of cryptocurrency, done with a little '80s style. No one can dig them out of the ground. They're not like paper money, either. No central authority prints hard-to-counterfeit, tangible Bitcoin bills for circulation.

Instead, Bitcoin depends entirely on a decentralized computer network and some amazing feats of cryptography. For starters, understand that the entire Bitcoin how the system works system runs on a P2P peer-to-peer network. This P2P architecture is similar to file-sharing networks like those that allow people to freely distribute data of all kinds, including copyrighted music, movies and more. It's a resilient system.

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  • Guide: What is Bitcoin and how does Bitcoin work?
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Advertisement Advertisement In other words, there isn't a central computer hub running all of the Bitcoin-related processes. Instead, each Bitcoin user's computer is part of the network, collectively sharing the computing burden of generating bitcoins and logging their transactions.

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It's this decentralized nature that makes Bitcoin impervious so far to government meddling, free of regulation and monitoring. Before anyone can even use a bitcoin, the coins must be mined by a so-called Bitcoin mining process.

Any computer can begin mining for bitcoins by using a free mining application. Mining requires the entire network of Bitcoin-participant computers to do a set amount of work before being rewarded with a bitcoin. Basically, that work means a whole lot of number crunching — and the spoils go to the owner of the computer that completes the set of number crunching at hand. Some people invest many thousands of dollars in very powerful computers just to mine bitcoins.

Bitcoin how the system works has become a computing arms race, and trading programs those at the leading edge stand to gain anything in the way of profit.

The exact amount of work required is variable. The network adjusts that workload so that the number of bitcoins rises at a steady, predetermined rate. It will continue to do so until the number of bitcoins in circulation reaches its ultimate number, which is 21 million. Currently, the mining process creates 25 bitcoins every 10 minutes. Every four years, the number of coins that can be mined will be halved, until the capped limit of coins is reached in the year After that point, the number of bitcoins in circulation will be static.

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As we explained, you hold your own bitcoins in a digital wallet. When you send or receive coins, they are verified by a digital signature, called a public-encryption key, which prevents counterfeiting and makes coins recognizable to the network.

In truth, you hold no actual bitcoins in your wallet, just the public encryption keys associated with each of your Bitcoin bitcoin how the system works.

One of the main features of Bitcoin — and all virtual currencies — is that the decentralized network shares an open ledger called the blockchain of all Bitcoin transactions.

The blockchain provides a trustworthy and redundant way of maintaining the number of bitcoins in circulation. All of this works thanks to Bitcoin's ingenious open-source that is, viewable to everyone code. Open-source software is commonly used by programmers who are opposed to corporate profiteering and control.

Any skilled programmer can see how Bitcoin's programming works, and that's OK — it's not the code that protects transactions. Instead, it's the shared blockchain ledger that verifies the legitimacy of each transfer. Advertisement A Question of Money Once you have a stash of Bitcoin in your walletyou can leave it there and hope that it appreciates in value. Or you can cash it out into local currency. If you store Bitcoin on your computer, it's imperative to remember that there's no central company with a backup bitcoin how the system works your wallet.

That means you have to create a backup record of your balance. It's best to store that record on a device such as a flash memory drive that can you keep in a safe location. Otherwise, if your hard drive dies and takes your wallet down with it, you'd lose your Bitcoin savings. Advertisement Advertisement Another option is to use an online Bitcoin wallet that stores all of your encryption keys in mobile trading robot cloud.

How Bitcoin Works | HowStuffWorks

The advantage of an online wallet is that you don't have to worry about constantly backing up your data, but the downside is that you're putting your Bitcoin security in the hands of a third party.

If they lose your keys, there's no way to get your Bitcoin back. Bitcoin transactions are irreversible and excellent signals for binary options fast, but not instantaneous like credit cards.

Because the Bitcoin verification process must share data regarding the transaction with the entire network, sometimes you'll wait minutes before a payment is completed. A big advantage of Bitcoin is its lack of transaction fees.

Still Don’t Get Bitcoin? Here’s an Explanation Even a 5-Year-Old Will Understand

Because there are no national or international regulations for Bitcoin, you can transfer the virtual currency into or out of any country without the steep wire fees that banks and services like Western Union charge.

And because the system has no governing authority, your account has no limits and can never be frozen. It's at this point that many people wonder about the legitimacy of Bitcoin. How can a currency just appear overnight on the internet and have actual value? Economists might offer a long, philosophical explanation about the history of moneybut the short answer is this: all currencies have value only because people believe that they have value. Bitcoin is no different in that regard.

It's been embraced by libertarian-minded activists, financial speculators and people who simply no longer trust government-backed banking systems. These people trust the mathematics and encryption of the Bitcoin system, de you can make money on the internet their trust has proven contagious, lending even more legitimacy to this virtual currency. Advertisement More than a Bit Scary Bitcoin is slowly gaining more legitimacy.

But, risk free binary options strategy the matter of people really trusting a currency.

And that's where this new currency gets scary. Rampant speculation has turned the valuation of Bitcoin into a neck-snapping roller coaster ride. Ina unit of 1 bitcoin was worth just a few cents. Over the next few years, Bitcoin's value rose and fell from hundreds of dollars to just a handful.

Advertisement Advertisement To many observers, the surging popularity and price of Bitcoin looks a whole lot like the dot-com and housing bubbles. Economists warn that the Bitcoin how the system works bubble, like all bubbles, will eventually burst and take a lot of fortunes with it. From this angle, Bitcoin sounds like a currency built only for suckers and speculators.

There's also the fact that online currency exchanges continue to be a hub for most Bitcoin transfers. The exchanges are necessary, of course, because they help you convert Bitcoin to and from local currency.

However, in a system that's supposed to be decentralized, these exchanges offer up a tasty target for government regulators and malicious computer hackers.

How does Bitcoin work?

Hackersfor example, may not yet be able to exploit Bitcoin's elegant blockchain technology to create fake coins or fraudulent transactions. But they can definitely attack the exchanges, which are as vulnerable as any other kind of website.

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In one widely publicized incident, hackers launched a DDoS distributed denial-of-service attack on the popular exchange Mt. Gox inwhich resulted in the loss ofbitcoins [source: Gibbs ]. Chaos ensued and Bitcoin's value plummeted.

Let's explore each concept a bit closer. Then, both computers start talking to each other and your browser shows images, buttons, etc. To understand how Bitcoin works, it's essential to figure out what's a decentralized network. In a decentralized network, the data is everywhere.

Bitcoins are definitely a high-risk asset. And as you're about to see, there are other potential downsides to the Bitcoin system. Advertisement Bitcoin's Extralegal Activities If Bitcoin seems a bit anarchist, well, that's because it is. Bitcoin dodges the traditional paradigm in which government regulators control and manipulate the money supply. With Bitcoin, people all over the world can engage in online gambling, which the U.

Bitcoin was also infamously and irrevocably linked to Silk Road, a black market website where people could anonymously purchase about anything, including illegal drugs.

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The original Silk Road was shut down in and its founder sentenced to life in prison, but plenty of Silk Road-style marketplaces have since popped up on the dark web [source: Greenberg ].

Advertisement Advertisement Bitcoin's reputation was soiled by these early associations with Silk Road and other criminal networks. Media reports frequently highlighted the role of Bitcoin on the dark web.

Need a kidnapper or hired gun?

How Does Bitcoin Work? Here's a Simple Explanation

How about some compromising pictures of your political enemy? With enough Bitcoin and some investigative work, you could potentially find the right person for any job [source: Buterin ]. But as more cryptocurrencies have entered the market, criminals are relying less on Bitcoin.

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In fact, Bitcoin's much-heralded anonymity can be compromised by law enforcement, pushing more cybercriminals to switch to fully encrypted currencies like monero and dash [source: Cheng ]. The relative anonymity of Bitcoin and other cryptocurrencies is also a boon for tax evasion. Traditionally, hiding your assets in some offshore account takes some real bitcoin how the system works.