What is Bitcoin….

Bitcoin is a “crypto-currency”, a form of digital or virtual currency using cryptography to control its creation and operation.

Bitcoin was first launched in 2009, when the Bitcoin algorithm was released online.

The creation and transfer of Bitcoin is based on an open-source cryptographic protocol (essentially, a software program that is free to download, with users having access to the source code and ability to modify it), and utilises a peer-to-peer computer network made up of its users’ machines (Bitcoin network) to validate transactions by solving complex mathematical equations.[1]

This validation process is known as “mining”. Essentially, the mining process involves the Bitcoin network updating and archiving transactions in a shared public ledger or log on the Bitcoin network (known as the “block chain”) to reflect the Bitcoin balances of its users. In addition, new Bitcoin are created with each update to the ledger.[2]

In this way, each Bitcoin represents an allocation of value which is recorded in the public ledger and exist as a chain of digitally signed transactions.

The algorithm that allows Bitcoin to be “mined” also controls the rate at which new Bitcoin are created. The number of new Bitcoin created in each update to the ledger is halved every few years, such that Bitcoin become more difficult to “mine” over time. By the Bitcoin algorithm’s design, the maximum number of Bitcoin that can be mined is 21 million. [3] To date, over 17 million Bitcoin are estimated to be in circulation.

However, a Bitcoin can be “divided” into smaller units (currently up to 8 decimal points — a unit known as a “satoshi”) and those smaller units can be transferred between users.

Notes:

[1] United States Government Accountability Office, “Virtual Economies and Currencies: Additional IRS Guidance Could Reduce Tax Compliance Risks” (GAO-13–516), May 2013 (http://www.gao.gov/assets/660/654620.pdf, accessed 12 January 2014)

[2] “The Economist explains — How does Bitcoin work?”, The Economist (11 April 2013) (http://www.economist.com/blogs/economist-explains/2013/04/economist-explains-how-does-bitcoin-work, accessed 12 January 2014).

[3] Ibid.