Bitcoin explained like an onion: Let’s talk about money.

My mother was irritated that she had no idea what Bitcoin was. I tried to explain, but couldn’t, as I didn’t know myself. So I did a whole lot of reading, so I could. Bitcoins turned out to be very, very interesting — so I’m explaining them to my mother in this multi-part series.

Bitcoins are best thought of as onions. They’re a fancy name for something we know already. Under the skin, things get more complicated — but they’re easy enough to understand, if you go one layer at a time.

Really, the key to it all is that bitcoins are just a way of being sure about something.

That’s it. Bitcoins are a digital way of knowing something is true. For bitcoins, that ‘something’ is who owns what money.

You could leave it at that key idea, and you’d know most of what bitcoins are about. But you’d miss out on what’s making people interested in bitcoins. And you’d miss why the way bitcoins work is so useful.

Let’s keep on going. But hold that key idea in your head.

Let’s talk about money.

Sometimes, when a new digital idea comes along, it turns out to be an old idea with a new twist. That’s what bitcoins are. They are money, made digital. The first layer of the Bitcoin onion is just to be sure we know exactly how money works.

We’ve had money for a long time, which makes Bitcoins harder to understand. We’re so used to money that we understand its rules without explicitly knowing them.

The nuts and bolts of it is, money is a way we trust to transfer value from place to place.

This scenario should be familiar:

Jane the giraffe gives $5 to Tom the penguin.

Now, let’s get really specific about what’s happening in the picture.

  • Jane can only give that $5 to Tom once.
  • Tom trusts that the $5 note is valuable, as it’s a real $5 note.
  • It’s a real $5 note, as it’s easily verifiable as coming from the Reserve Bank.
  • There is a limited supply of $5 notes.
  • Because the $5 has these properties, other people will exchange the note for valuable objects or services.

This is almost exactly what a Bitcoin is. Let’s look at another example:

Jane’s bank transfers $5 to Tom’s bank.

This time, there’s no physical dollar notes changing hands.

  • Jane starts with $5 in her account, and Tom has $0.
  • Jane’s bank tells Tom’s bank that it wants to transfer $5.
  • The two banks agree that the transfer happened, and adjust Jane and Tom’s account balances.
  • Tom and Jane’s account balances exist as numbers on a computer.
  • If Tom wants to withdraw $5, the bank promises to give him a physical $5 note in exchange for adjusting his account balance down by $5.
  • Jane and Tom trust the banks to manage their bank account balances.

That should be familiar? Think it through slowly.

This time, there is no physical $5 note changing hands. The money that goes from place to place is now the digital transaction, instead of the physical $5 note. Jane and Tom trust the banks to do the digital transaction on their behalf.

Bitcoin is a way to establish trustworthy digital transactions without needing banks.

Click here to read the next part, where I explain why Bitcoin transactions can be trusted without banks being involved.

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