How Does Bitcoin Work?

If money is only valuable when we believe in it, how much is a Bitcoin actually worth? Christian explains the virtual currency as well as how to mine it and the risks involved in investing.

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Episode Transcript

Speaker 1 (00:02):
Welcome to brain Stuff from How Stuff Works. Hi, I'm
Christian Seger. This is brain Stuff, and I've got some
bad news for you. Money is imaginary. Now, I don't
mean that printed pieces of paper are make believe. I
can feel a dollar's texture and the ink even smudges

(00:22):
on my hands. But when you compare it to a
blank piece of paper, what's really the difference. Well, one
is a recognized currency and the other isn't. And the
reason why people agree that one piece of paper is
a dollar and has value, that's where money's worth comes from.
We all pretend it's a currency. This is one reason

(00:44):
why the digital currency bitcoin appeals to some people. It's
not tied to any political system or government, so it's
not vulnerable to any of their failings, like the economic
collapse in two thousand and eight. All it needs is
for people to believe in it. But lately, well some
people are having a crisis of faith. That's why today
on brain Stuff, we're going to quickly establish some facts

(01:05):
about bitcoin to better inform your beliefs about it. Basically,
it's virtual money you can use to buy and sell
things online, and it mimics real world limited resources like gold,
for instance, it's also a cryptocurrency, meaning it's encrypted in
a way that prevents it from being copied. See every
bitcoin transaction is recorded using a blockchain. That information acts

(01:28):
like a ledger that is encoded onto the bitcoin itself.
This prevents people from spending the same bitcoin more than once,
since everyone else on the currencies peer to peer network
knows that it's been spent. It's essentially just a number
associated with an Internet address. You can store it on
your phone or a hard drive until it's used again.
Here's some ways you could acquire bitcoins, accept them as

(01:51):
payment for goods and services, exchange them for a more
traditional form of currency. Or you can mind them. That's right,
Like gold, bitcoins are mind not by old timey grizzled prospectors,
but by powerful computers. And like gold, the more people
mind bitcoins, the less there are to be found, so
they become harder to find. Instead of physically mining with

(02:14):
the pick axe, you can attempt to solve math problems
with a computer. Imagine the problem is something like X
plus Y equals fifteen. If you can figure out what
X and why are, you get a bitcoin with little competition.
The problems are easier to solve. But when more people
join the search, you've got a race, and the problems
get way more difficult. People start teaming up, crunching numbers

(02:38):
by networking multiple parallel processors together. Suddenly it's like Deadwood
meets Silicon Valley and them bitcoins ain't so easy to
find no more, especially because there's a limited supply of
about twenty one million bitcoins. These can be divided down
fractionally to eight decimal places. So the more we mind,
the less bitcoins there are possible to find. Mind. In fact,

(03:01):
every four years the amount of bitcoins you can find haves.
We're at a point now where people need computers specifically
designed for bitcoin mining to even have a decent chance
of getting them. But as bitcoin miners dwindle, the math
problems will get easier again. To ensure the flow is steady,
their value is boosted and they remain inflation proof. Not

(03:24):
all have been mined yet, and we expect they won't
be until around So let's say you just heard all
this and you thought, well, I want to grow up
and be a professional bitcoin miner and trader. Well, there
are a few risks you should probably know about first.
For instance, because there's no regulatory agency setting a bitcoin's value,
it tends to fluctuate wildly. Let's go back to the

(03:47):
dollar bill. Today, I might be able to buy a
candy bar with it, but what if tomorrow it could
buy dinner at a nice restaurant, or a week later
it could buy the entire restaurant itself. Bitcoin is kind
of like that, except the dollar would suddenly drop in value,
so you couldn't even buy a piece of gum with it,
And why would you spend it anyway if it could
be worth a hundred times more tomorrow. Another bitcoin problem

(04:10):
is security. Actually, the format itself is fine, but that
doesn't protect it from hackers who targeted the banks and
exchanges that deal in bitcoins. So, for example, Mount Cox,
one of the largest bitcoin trading floors, was hit for
the equivalent of around four hundred and eighty million dollars
that's seven percent of the world's supply of bitcoins. Flex Coin,

(04:31):
a bitcoin bank, announced to all its users that their
accounts had just disappeared, and when the online market silk
Road was shut down in October, the FBI became one
of the largest holders of bitcoins in the world. Now again,
This isn't the fault of the currency. If a bank
was robbed, you wouldn't blame the dollar bill for getting stolen, right. So, yeah,

(04:55):
Bitcoin has its slumps, and for it to become widely used,
its volatility needs to settle down quite a bit. It's
currently a high risk currency that is totally unpredictable, and
we didn't even get into the mysterious identity of Bitcoin's founder,
Satoshi Nakamota. Check out the Brainstuff channel on YouTube, and

(05:18):
for more on this and thousands of other topics, visit
how stuff works dot com.