TECH
05/02/2018 12:55 GMT | Updated 05/02/2018 15:08 GMT

What Is Bitcoin And Cryptocurrency And How Do They Work?

Baffled by Bitcoin? Don't panic, here's our handy explainer.

Bitcoin might be the most widely-known form of cryptocurrency but it’s certainly not the only one. Instead it’s just one part of an entirely new currency that offers as many benefits as dangers.

Initially kept to the fringes of the banking world, cryptocurrencies are now being taken so seriously that banks like Lloyds are actually banning purchases of Bitcoin for fear it could leave thousands in debt.

If all this sounds like the code from an enigma machine then don’t panic, here’s a brief and simple guide to cryptocurrency and Bitcoin.

What is a cryptocurrency like Bitcoin?

Cryptocurrencies like Bitcoin are in essence a series of virtual ‘tokens’ that can be exchanged just like normal money except all the transactions take place over the internet.

Unlike normal money, Bitcoin isn’t regulated by any one country, or stored in banks. Instead it follows a shared set of rules that every owner must agree to.

Chesnot via Getty Images

Finally, every cryptocurrency shares a similar technology called Blockchain. This is in effect a giant database that holds the historical transactions for every Bitcoin or cryptocurrency in existence. It isn’t stored on a single computer or within a single building, rather every miner of Bitcoin has these records stored on their computer.

Think of it as a giant trail of breadcrumbs that allow you to trace each Bitcoin right back to the moment of its creation.

What is Bitcoin mining and how to buy Bitcoin?

Bitcoins and other cryptocurrencies are created through a process called ‘mining’. In much the same way that we mine for gold, a person can chose to become a Bitcoin miner.

This process involves using a computer to solve complex mathematical problems, at the end of which a person may or may not be rewarded with their very own single Bitcoin.

When Bitcoin first started this was an easy way to make money but as the requirements to earning one have shot up, the sheer number of computers needed to earn a Bitcoin mean you’ll probably end up losing money in electricity bills.

Also this is not an infinite currency, the rules of Bitcoin (and many other cryptocurrencies) state that there are a finite number that can be created. In the case of Bitcoin, there can only be a maximum of 21 million Bitcoins in existence.

It is this mining process that, just like gold, has helped Bitcoin reach the enormous financial values that it currently holds. As such when buying or selling, nothing is simply worth 1 Bitcoin, mostly because a single Bitcoin is now equal to around £5400.

What can I buy with Bitcoin?

More than you might think. However the real advantage of Bitcoin and other cryptocurrencies is not what you buy with it, but rather how you are buying it.

Many up and coming companies like to say that will take Bitcoin as payment, but on a day-to-day basis it’s surprisingly limited.

You can’t pay your taxes in Bitcoin, or pay a parking fee in Ethereum.

Instead cryptocurrency’s advantage comes in the way that every transaction is traced.

What is blockchain?

As we mentioned earlier, cryptocurrencies operate using a technology called Blockchain.

This is a process that means every Bitcoin is traced and verified by a vast network of computers, rather than a single entity like a bank.

Blockchain underpins all cryptocurrencies and it comes in varying forms of security and resilience against hackers e.g. Bitcoin’s blockchain technology is less focused on security than say Ethereum’s.

Now in the example of Kodak’s newly formed cryptocurrency, blockchain offers photographers a major benefit regarding image copyright. Because every coin and transaction is traceable and open to see, image rights can be virtually handed to the new owner and then verified by everyone else. You can’t then just try and sell it on without the original owner being notified.

Of course there’s a flipside to this too which is that it’s a very handy feature for criminals. Whereas a bank has the power to literally remove money from your account (if it suspects you of money laundering). Bitcoin is not a bank, so any transaction that takes places is completely unregulated. It doesn’t know the difference between a person buying a car or a drug dealer receiving a payoff.

Why is Bitcoin failing?

It’s not just Bitcoin that’s suffering at the moment. Ethereum, Litecoin and Ripple are all suffering significant drops in value.

It’s hard to put a definitive reason on it, but the most probable cause is fear of the unknown.

Cryptocurrencies are currently unregulated in much of the world, and it is this lack of regulation that is causing concern for investors and governments. Only recently South Korea started imposing strict new rules on how cryptocurrency transactions are carried out.

The new rules would ban anonymous cryptocurrency accounts, stop banks from settling bitcoin exchange trades between parties that are unidentified, and give regulators the power to shut down cryptocurrency exchanges if necessary.

Considering one of the main benefits of using a cryptocurrency is its lack of regulation and anonymity it’s no surprise that the decision caused Bitcoin to tumble 8% at the time.

What’s the future of Bitcoin?

The more interesting question is: what’s the future of blockchain. This democratic technology allows thousands of computers to keep impartial records of transactions around the world.

As long as it can’t be hacked it’s a potentially revolutionary approach to carrying out business around the globe by creating transparency across the board.

The problem is that no-ones really worked out what to use it for and how to use it in such a way that everyone can get with the program.

It’s that reason that keeps cryptocurrencies on the fringes of our radar and it’s also that reason that means its value has fluctuated so violently in the last 6 months.