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How Bitcoin Works and How It's Going to Change the World

13/05/2015 16:24 BST | Updated 12/05/2016 10:59 BST

If you're anything like me, in various accounts online you'll have some pounds, some airmiles, some supermarket rewards points, perhaps even some dollars or euros.

These are all forms of money - they're tokens that can be exchanged for some kind of good or service. None of them exist in physical form - even the pounds and the dollars (just 3% of pounds and dollars exist physically) - so, they are all forms of digital money.

If you want to use any of these digital tokens, you have to go through a middleman of some kind. It might be a bank, Paypal, a credit card company, an airline or a supermarket.

Contrast that with cash.

If you're standing near me, I can hand cash directly to you. There is no middleman. The transaction is between you and me, and nobody else.

Even today, cash still has all sorts of uses. It is the most immediate form of payment there is. It's the cheapest form of payment there is (making ideal for low-value transactions). It's the most private form of payment there is. And it's the form of payment that most empowers its users (because you're not beholden to anyone else).

Since the 1980s, coders had been trying to develop a system of digitally replicating the cash transaction. But try as they might, nobody could come up with a system that worked, so that, by the early 2000s, most had given up even trying.

The problem was this. If I send you an email or a picture or a video - any type of digital code - you can copy and paste that code and send it to a hundred or a million different people. If you can do that with money, it instantly loses its scarcity and value, so it is useless.

This problem was known amongst coders as the problem of 'double spending'. Nobody could find a way round it - without using a middleman of some kind.

Until bitcoin.

The genius bit of tech behind bitcoin

The genius of Satoshi Nakamoto's invention was a new system of record-keeping - an enormous automated database, which verifies transactions. A transaction is only complete once it is recorded on that database; once it is recorded, it is final. The database is public for all to see and it is maintained, not by any one individual or corporation, but by computers across the bitcoin network - so it is 'decentralized', to use the buzz word.

If I want to, I can set up my computer to run the bitcoin software and maintain this database. In exchange for doing this, the network will sometimes reward me with bitcoins. This is the process known as mining - you're bound to have heard of it.

It really doesn't matter if you don't understand how all works - so don't worry if you feel baffled. Most people don't understand how the internet works, they still use it. In fact, most people don't understand how the pounds and dollars are created, but they still use them. (If they did understand, there'd be a revolution tomorrow). The same will happen with bitcoin.

This amazing database, which makes the digital cash transaction possible, is known as the 'blockchain'.

Words like 'decentralized' and 'blockchain' and 'mining' are as alien to us now as the @ sign or 'www' were 20 years ago. That will change.

What black markets tell us about bitcoin

It's important to understand that bitcoin is cash for the internet. Except for a few avant-garde places, I see it as very unlikely that in five years time you'll be walking into your local shop and start buying things with bitcoins.

But that bitcoin has become the money of choice for online black markets is very telling. It is testament to the fact that the technology works. Black markets don't have vast pools of venture capital to fall back on, so they are often the first to make new technology work on a practical, day-to-day basis. Black markets were the first areas of the economy to turn the internet to profit, for example - and so it is with bitcoin.

That said, on a global scale, there are still very few people using bitcoin and it will be quite some time before it finds mainstream adoption, if it ever does.

That doesn't bother the coders, however. They're not so bothered about the adoption. That's somebody else's problem. They can see that the technology works. They're now looking at the other applications, beyond alternative money, that this technology can be used for.

A structure of permanent memory that grows organically is going to reform and improve the way accounting now works. It's going to change the way we record and trade ownership (not just of financial assets such as stocks and bonds, but even of land, houses or vehicles). This has serious implications for stock markets, share registrars, accountancy - even law.

A system that eliminates the need for middlemen is going to have a dramatic effect on bureaucracy and healthcare. It's also going to effect the way we communicate. At the moment Gmail or Yahoo or Hotmail have access to the contents of your emails, iMessage, What's App, EE or Vodafone can read your text messages, Facebook and Twitter have all sorts of information about us as a result of the way we social network. These are all middlemen whose role the blockchain could make redundant.

When we send messages over a blockchain, it'll be a bit like an old-fashioned letter - only read by the person to whom it's addressed.

The revolution will not be televised. It will be secured on the blockchain.

It's very exciting.

• Dominic Frisby is the author of Bitcoin: the Future of Money. He will be speaking about Bitcoin at The Times Cheltenham Science Festival in June.