What are Bitcoins?

let me know. And my roommate from college does not count because he's the one who introduced me to it. Yeah, this, this podcast is not going to be about the Benjamin's No, but it's about currency. It's about a digital currency called bitcoin. Yes, So all the all of all of you who have been asking us about bitcome bitcoin? Is it? Yes? So we have an article on the site about how currency works, which is useful to to kind of get a background

on this. Keep in mind, your currency is sort of based upon just a mutual agreement among everybody that a representation of wealth actually is worth something. Yes, because you know, we we all recognize that there are certain products out there that we either need or want, and we recognize there are also services that we need or want, and there's stuff that we can provide, and that by providing some things, we can get other things and that way

we all can live. Well. Currency is just a method of exchange so that you can get those services or products without having to do a direct exchange, because that gets messy. The Barner system is not really easy to navigate. Yes, I can't think of a thing that I could really do. Uh well, maybe a couple of small things I could do to convince a computer manufacturer to give me a new computers an Xbox. Yeah, um, so it's it's it

can be very useful thing. Although um at one time, for example, the the United States UM currency system was based on the gold standard. You could take a dollar bill uh two the the exchange and get a dollar's worth of gold, um and you would need a microscope to see it. But um, that was the way it used to work, and that is not the way it works anymore. UM. That has been changed for several decades.

So now at this point, of course, you could have always argued that the value of gold was arbitrary anyway, so really it was a piece of paper representing value of a mineral that represented value. Yes, So in other words, of ruining the magic, Jonathan, I'm just saying that eventually you get to the point where currency is based upon a shared delusion among everybody, and that if we all sat there and said, hey, wait a minute, it would all fall apart. Yeah, that's that's kind of the thing.

It's it's a medium of exchange. And uh, for the most part, um, we you know, the people of Earth are are doing business with money that is backed by a government of some type, or in some cases, you know, a coalition of governments, like for example, the Euro, the Euro exactly. So yeah, yeah, usually you've got some sort

of of state backed currency. Yeah. And um uh, you know, back in the old, old old days, currency of course was made out of precious metals, which again were precious because they were pretty and they were hard to get those those scarcity and and uh and pretty are two of the things that really fell into the old currency system. Yeah. And of course at one time salt was a medium of exchange. Sure, that's where we get salary exactly, That's

what I get my salary in. I don't know about you big exactly salt like delicious explains that that big salt crystal at your desk not just a great barbecue joint. Um. So oh yeah. So currency is all based upon various people agreeing that whatever the medium of exchanges actually has value. Right, So that's going to lead us in Just a side note, have you ever heard of Joshua Abraham Norton? That name

does sound familiar, but I don't. I can't play. Also known as Imperial Majesty Emperor Norton the first He's an eccentric. That's one way of saying it. Uh crazy is another way. He essentially declared himself an emperor of the United States while living in San Francisco. Okay, that's why it sounds. Yeah. He one of the things he did, he was he was kind of this eccentric, celebrated guy living in the nineteenth century San Francisco. One of the things he did

was he printed his own money. He printed his own money, and uh, local merchants would some of them would accept it. They would accept his local thing. You know, they thought he was an interesting character, and they would accept his money and and sell him goods with his money, which meant that his currency, at least on a micro level, was valid because two parties, at least two parties agreed that that particular method of currency had value. That just

shows you how tenuous the concept of currency really is. Now, let's move on to bitcoin. I just had to give Emperor Norton a shout out. I figured you, the next uh person of interest in this discussion would probably be Satoshi Nakamoto. Yes, who is the inventor of bitcoin. Now, bitcoin is a digital currency. It's not the only digital

currency out there. There are a lot of digital currencies that are connected to various games or virtual worlds, and um, I mean you could even argue things like, uh, like Xbox points on the Xbox Life marketplace are kind of a digital currency. Um, Facebook credits, Facebook credits. Yeah, there are other versions out there, although as Lendon dollars was the one I was mainly thinking of, that's of course

Second Life Lendon dollars. Yeah. So there are other digital currencies out there, but most of these tend to be very um uh contained, right, there's only there's only a tiny, little niche marketplace where you can you can spend this currency, and otherwise it has really not much value. Usually can't resell the the digital currency to get real quote unquote

real money back. Yeah, I mean you can um. For example, with UH, if you have ten euros, you can uh, you know, have a service that your friend gives you say, you know, hey, yeah, I'll help you. I'll help you move your stuff from your old apartment to your new apartment.

If you give me money for beer, okay, well here's you know, here's ten euros and for that person, then he can take that, you know, that ten year o note and go spend it at a store or get really good get really good beer because you're apparently in Europe and uh, the beer there's so much better than in America. Oh, people can write to Jonathan. Come on, everyone knows that why by European beers. I guess it's okay, UM,

but yeah, I mean you can. You can use that in many places, or you could take it to a bank and exchange it for Japanese yen or in a American dollars or wherever. But if you buy um, uh, go to the department store and buy one of those Facebook credit cards cards with Facebook credits UM, and you enter that in your Facebook account. You can't get that back and go exchange it for Japanese yen. Once it's in Facebook, it's in that world, and that's all it is, exactly. Yeah.

And um also there tends another element that tends to happen with a lot of these currency exchanges. There's a transaction fee. There may be transaction several transaction fees, depending upon the nature of the transaction. If you're purchasing something, there may be a transaction fee charged by the financial institution that is overseeing the transaction, assuming that you're not using cash. Right, let's take cash all the elements, all the out of this, because digital currency kind of falls

between cash and credit. It's it's it's in this world that's sort of a vague defined world right in the middle. Um, So cash is there are a lot of different benefits to cash. Cash means that, depending on the nature of the transaction, you may be not paying taxes on something, right, right, I mean that's why a lot of people like to do cash transactions. It means that there's no, uh, there's not necessarily a paper trail. It allows you to make

a transaction between two individuals without a third party intervening. Um. When you're using credit, then that it's different because there's now a trail there and there may be you know, you may have to have taxes come into play so that you cannot break the law. Plus, you know, with a point of sale terminals, there's no risk of skimming your credit card or debit card number if you are paying with cash, so the risk of un and also it's more anonymous. So two people meet with cash, you don't,

you know, cash is an agreed upon currency. It's it's that's fine, You've you've purchased whatever it was you're purchasing, whether it's a service or a good, and it is not. Uh. Again, there's no trail leading to that transaction. Now with credits much more UH, it's much different. The anonymity factor has taken out of it. Digital coins are kind of Bitcoin

is kind of in between it. There's all there's some anonymity built in UM and there's uh an ability to do a person to person transactions so that there's not a third party involved in this. So again you can purchase stuff essentially tax free, depending on the vendor that you're going to or the person you know, whomever it is that has agreed to sell you the service or product. Um and it also, unfortunately, bitcoin has also been used and this is kind of one of the more sensationalized

elements of bitcoin. It's been used in illegal uh transactions for example, um uh purchasing drugs. That's been in the news recently where people have started to adopt the bitcoin currency in order to purchase illegal substances. And the reason for it is because there's no it's not going through any official channels. You can even purchase stuff across country lines because again, it's a digital currency, it's not a

physical currency. So if let's say your supplier is in another country, you can purchase something through bitcoins on an agreed upon amount and then uh that person gets the bitcoins, they can then transfer those bitcoins either into it you know, they can either use those bitcoins by something else that they want, or they can try to sell the bitcoins to someone else where can agreed upon amount of money,

which is kind of interesting. I mean, the the finding out how much bitcoins are trading for, as in in relation to established currency these is uh kind of an interesting situation. That's the part that I have the hardest uh time understanding, Like how do we determine how much a bitcoin is worth to us in our in dollars for example, or euros. Right. Well, Um, from what I've read, the value of bitcoin right now is subject to a

lot of speculation. UM. As in speculators, Yeah, as in people who are investing in bitcoin because they believe that this is something that's going to really take off and and be successful, and therefore they can make a lot of money if they get in on the ground floor. Yeah, sort of like sort of like the stock market is in a lot of cases like UM, you'll see that with initial public offerings of stock, UM, people will uh an I p O will take off immediately, especially for

a lot of the tech companies. If you watch that, UM people say, oh, well you know X y Z Industries, they make that cool software. Everybody's gonna want that. So I think the stock is going to go up. I'm gonna buy as soon as it comes out, because it will never be lower, it will only go up. Um. And so that's sort of what we're talking about now. UM. The weird thing about bitcoin is that it's made by you,

or could be made by you. Yeah, it's um. You actually have to mine bitcoins, but mining in this sense, it's it's kind of interesting. What what what bitcoin does is it kind of emulates what an actual mining operation would be like, in the sense that let's say that you are prospector for gold back in the old gold rush, and you find a vein of gold and you start

you start mining that gold for all it's worth. Well, of course, the more you mind, the less gold there is, right, And then you eventually get to a point where you're having to put forth a lot of effort to get a little amount of gold because you've already mined the most of the gold out. And then you start to have to make to say, jians of is the effort I'm putting forward worth the amount of gold that I'm getting back? Well, the the bitcoin system emulates that, and

it's such an interesting process. So essentially what's going on is that it's a peer to peer network. Now that means that in order to be a part of mining bitcoins, you join this this network of other users, and your computer ends up making connections with other computers trying to solve a hash problem. The hash problem is when you take uh at least two figures and you make another figure from them, and then you have to UH, you have to to solve some problem related to that new figure.

And in this case, UM, the way bitcoins works is that there are fifty bitcoins released at at specific intervals, and if your computer solves the hash of that particular for that particular group, you get the fifty coins. Okay, Now, early early on in this, remember it was launched in two thousand nine, early on in this it was relatively

easy to solve the hash. And by solving the hash, this is the same sort of process that a lot of UH networked computer like grid computing systems use, where you connect in our our folding proteins or something along those lines, or or back in the old set program, you would UM, I hate to say the old SETI program, but would have no more funding for it, but you would have your computer analyze radio signals for any potential actual like UM intended radio signal as opposed to just

random noise. UM. Your computer would work on this problem and then send results back to a master system which would corelate all that and then analyze it. Well, that's sort of the same thing that's going on with bitcoin, except instead of trying to solve a an actual problem problem what you're doing is you're trying to mind these coins, and in the early days you didn't have to have

much processing power to do it. But as more and more processors joined the network, more and more nodes in this peer to peer network joined, than the problem would get progressively more complicated, to the point now where um, actually, if you go to the bitcoin website and you read about mining, it says that most bitcoin users don't mind at all because it's very competitive, and you've got people who are building machines computers designed specifically to be bitcoin miners,

and they're using they're using powerful processors including uh and not not CPUs, they're using graphics cards processors yeah, GPUs, because they're faster to solve the kind of time type of problems that are that Bitcoin depends upon for mining. So the odds of you solving the problem of or your computer, I should really say, your processor solving the problem of that particular batch offty bitcoins is very low, and it gets lower every time someone joins on with

an even more powerful machine. And again this is where we get into that that analogy of mining for gold. Eventually you're talking about spending so much money building and maintaining a machine, including things like paying for electricity that it doesn't make sense to keep going it. You know, you're spending more money than you would earn through mining bitcoins. So it's a kind of interesting situation. And also the the the bitcoins themselves will decrease over time. There's a

finite number. I think it's twenty one million bitcoins are allowed. Ever, yeah, that's a that's a basic law of UM of the markets. I mean, some people, um, you know, when when you don't really understand how this works, will say, well, I heard that the you know work short twenty million dollars

or whatever currency. It's like, why don't they just print more? Well, if you if you make too many of a currency, or you you have too many UM certificates of stock for your company, at some point it begins to devalue the institution that is represented you know, represented by that. So, um, the more money you print, the less the money is worth. The more stock certificates you release to two shareholders, the last the company is worth. So it's it's essentially the

key takeaway there is currency and wealth are two different things. Yes, just because you have more currency does not mean you have more wealth because the wealth is dependent upon the perceived value of that currency, and the more currency there is, the less value people will perceive in it, right, which is you know, that's why you you can see historic issue problems with with massive depressions breaking out across the globe in various air is because the currency would get

flooded and then you would have, uh, you know, you would have a brief moment where everyone appears to be wealthy, and then costs would adjust to the amount of currency that was in the market, and then the currency would be practically worthless. Um. Actually that maybe what happened to Spain after the the discovery of the New World and the expansion into into really exploiting the New World and

pulling the the the wealth back over to Europe. People ask, well, what happened to all that gold that Spain was mining and shipping back to uh, Spain, you know, front the New World? What happened to it? Well, a lot of what happened to it was it some of it sunk, some of it was stolen, but a lot of it made its its way back to Spain. And people said, well, then Spain later on suffered some really some real economic hardship. Well, you get all this influx of gold in there, and

it devalues the gold. You know, suddenly, yes, you've got all this precious material, but it's no longer as precious because there's more of it that there's that scarcity problem. So by capping bitcoins at twenty one million, there's already a finite limit. You're not gonna make any more after that. Um, And as more blocks are are solved, the the problems are contained in blocks. As more of these problems are solved, uh than fewer coins will be released over time. So

remember I said that they be released in fifty coin batches. Well, after a certain number of blocks are solved, that gets reduced to twenty five coins, and then after that so it's half the amount, right, the same sort of thing. After each time it gets closer to the UH than the end, it's going to have again and half again and half again. Now it's not infinitely divisible. Bitcoins can be divisible down to UH to an eight to eight digits. It's like a like eight bits you could think of, um,

So UH, it's not going to continue ad infinitum. There will come a point where the last bitcoins will essentially be released. Um, so you know you're not gonna end up with like a bitcoin like point zero zero zero zero zero zero zero zero zero zero zero zero zero one bitcoins and then it gets divided again by another tenth. That's not gonna happen. Um. The it's to me, it's an interesting concept. I still, I still, frankly I grapple with us a bit, but it's probably from a more

philosophical standpoint than technical. I understand technically, Um, well, there is quite a bit of technology uh involved in it to make it more sturdy, if you will, um, because while there is some anonymity involved, there is a signature that goes along with a bitcoin transaction. There's a public key and a private key encryption uh that's involved in this, and every single transaction is recorded yes um, and becomes part of a history of transactions that then is a

part of every future transaction. Yeah. So it's not so much to track people's purchases and what they buy, so you know, you uh, there there are many companies that that take bitcoin, although most of them are I didn't see anybody who wasn't an independent company and taking bitcoin. I didn't read uh, every a list of every company. Yeah, and a lot of them have bit in the name, which suggests that their business was built around this currency in the first place. But I've see I saw that

some web hosting providers use it. So let's say, uh, you know, you pay for a month's worth of web hosting with bitcoin. Um, people aren't going to go Jonathan just bought web hosting with you know. Basically what they want to do is verify the authenticity of it and make sure that no one is counterfeiting, right because if it's a if it's a digital if it's a digital currency, then what stops you from say any as you want or sending or trying to spend the same bitcoin twice?

I mean, that's that's one of the big issues. That's why it has to be um uh, why it has to be recorded, so every single transaction has the history of all transactions as part of it. Now that that data gets kind of compressed and hashed, so it's not getting you know, it's not growing exponentially with every single purchase. But the the idea here is that, uh, it will prevent people from trying to spend the same currency multiple times just because it's in digital format, and that's an

important element. I mean, it's um. There are other problems that have popped up around bitcoin. For example, a lot of vendors now will no longer um or a lot of a lot of bitcoin traders will now no longer make payments to PayPal accounts in return for bitcoins because UM or well no longer no longer accept PayPal accounts and return for bitcoins. So let's say I'm a bitcoin trader and I've got all these bitcoins and someone comes

to me and they say, I want to purchase some bitcoins. Uh, I want twenty bitcoins, and I wanted at the trading rate that is going right now, which is the thirteen dollars American or whatever. Um, let's make this transaction happen

and I'll pay you through PayPal. Well, the problem that's been coming up is that these these vendors will sell the bitcoins and will the transaction will complete, and then some unscrupulous people would then contact PayPal and complain stating that they made a purchase but didn't receive anything in return. And bitcoin, you know, it's this digital stuff. It's just bits,

it's information, it's it's not a physical thing. And paypals response maybe to stop the payment on that, and then the person may may close out their PayPal account and essentially what they've done is stolen some bitcoins. So a lot of the traders, the big traders for bitcoins, won't accept PayPal payments anymore, all right, because it's just you know,

it's it's too risky. So again we're you getting into that level between the anonymity and freedom of cash and the um, the the the trappings that are all around using credit. Because of course, if you're using credit and not only are you being tracked, but you're also spending extra money just to purchase whatever it is you want.

You read an article UM by John Evans a tech Crunch about bitcoin um and according to what he said, the the Electronic Frontier Foundation is now accepting donations using bitcoin UM and apparently they are. That organization is UM about basically freedom expression and UM, you know, protecting your personal rights online. And uh, from what I've read, the organization likes the idea of bitcoin because there isn't a

government behind it UM. So you know, you're you're if you you can't have your assets frozen by a government because bitcoin isn't part of a government, um, which is an interesting thought. UM. On the other hand, if it's you know, there there's a flip side everything, and if it's being used to fund to legal activities or you know, a war machine, maybe that's not such a good thing. I don't know. It all depends on you know, ethics

and legality are two different things. So let's say that you live in a country that is has a repressive government and there are specific things that are not allowed to be UM sold through normal means, which means that you know, you don't have to go to some sort of black market to buy something that in another country you could purchase legitimately with no problem. Right, then the bitcoin transaction may give an avenue for that person to purchase such a thing without it ever being seen by

that government. And so you're talking about clandestine buying at that point, and you're kind of undermining a financial system. So some people who adopt bitcoin are doing it specifically because they see it as sort of the subversive way to undermine the status quo that uh that they feel is either corrupt or or inefficient or whatever, you know, whatever reason they have in their minds that says, I don't want to be a part of this system anymore. I think the system is broken. I want to use

this other system that's not dependent upon a state. Um, you've got a lot of people interested in bitcoin for that. So you've got your your speculators who just who are looking at bitcoin is a way to make money. Some actually literally in this case, Um, although I guess I shouldn't say literally. The money is there, they're not making it,

they're just uncovering it. Right. But then, um, you've got the people who are using it because they want access to things that they normally could not get through quote and quote legitimate means. And then you've got the people who just don't have any faith or trust in any institution, and so they want to avoid using those institutions as much as possible. Now, again, the whole value of bitcoin exists only so far as people agree that it exists.

You know, why does bitcoin have a value because people agree that it has a value. If if vendors were not accepting bitcoins in return for goods and services, then that currency would be worthless. So there's nothing intrinsic about bitcoin that makes it a desirable, valuable thing except that we agree that it does, which blows my mind. But

then so does currency. Currency blows my mind. I mean, any any time you get away from once you start moving away from the the demon demonstrable this has value to me because blah blah blah um. Then my brain starts to hurt. And also I start looking at my four oh one k and I think, I hope I've got enough chickens to get that Xbox sixty because you know what, BioShock is coming out soon, and I want to play that game. Ah well, you know it's it's just safe to say that the Xbox three sixty is

a lot less messy than those chickens will be. You'll be happier, is made. The moral of the story is, don't count your bitcoins before their mind. All right, Well, do you have anything else to add about this after that joke? Okay? Well, this is a really fascinating subject, and there's there's plenty on the net, uh that you

can read. You can read up on for a bitcoin, including things such as the actual mechanics of what goes into making it work, the the nature of the hash problem that computers have to try and solve in order to mind bitcoins, the type of rigs that people build to mind bitcoins, the various vendors out there, the whole political philosophy behind people who have adopted bitcoin. All of

that stuff is out there on the web. It's a huge topic of discussion, and if you're interested interested, I do recommend checking out some more um information on that. And of course, like I said at the beginning of the show, we have how currency works at how stuff works dot com if you just want to get a good grounding of the basis of currency period, because I mean that you kind of need that in order to

go beyond and started understanding that the working is a bitcoin. UM. If you guys have any other big topics you would like us to tackle, let us know. You can send us a message on Facebook or Twitter. Are handled. There is text stuff h s W or you can send us nan now and that addresses tech stuff at how stuff Works dot com and Chris and I will talk

to you again really soon. Breaking news everyone, So um, we recorded this podcast if you weeks ago at the time, and I'm recording this update, and some stuff has happened with bitcoin that we really need to address. First of all, there was a hacking attempt a successful one against a currency exchange company that handled bitcoin operations called mount Cox,

g o X and UH. It was not an attack directly against bitcoin, Bitcoin itself and the peer to peer network, and all of that remained secure, but through getting the the account information through this currency exchange company, the hackers were able to essentially, um well, steal about a hundred thousand bitcoins and then immediately start to sell them off, which caused the value of bitcoins to plummet. It was trading at around seventeen dollars a coin and dropped down

to essentially nothing. Since then, the the value has stabilized. The company, the mount Cox has managed to h to freeze all the accounts, and at the recording of this up date, is trying to roll out the accounts again to users, requiring them to create a new strong password UM and is essentially refunding everyone the money that they would have lost UM but and also in that process.

Shortly after the the attack, another big event happened. The Electronic Frontier Foundation the e f F, which had been accepting donations in bitcoin format, decided to drop that they are no longer accepting bitcoin donations. Now the reasons for doing so are not directly tied to the hacking attack, although the timing is very coincidental. Um. They're more tied to things like concerns about the legality of bitcoin in the sense that a lot of people are using or

maybe I shouldn't say a lot of people. Some people are using bitcoins two create illegal transactions, whether that's to purchase illegal goods or services, or to try and circumvent taxation laws or other laws. That's beside the point. The point is that the e f F did not want it to look like they were endorsing a currency that might have questionable legality, and so they have backed away from that. Now, the e f F is all about protecting freedoms on the Internet, so they champion causes like

net neutrality and privacy. So for them to back away from this currency, it's kind of a big deal, at least within the the Internet elite circles. Will this actually spell the end of bitcoin? I don't think so. I think that bitcoin has enough support from other parties where it's going to keep going. It might actually slow down adoption of bitcoin, so you may not see more vendors and and other providers popping on to accept bitcoins quickly.

It might take a while, but it's important to remember again that this was not a direct attack against the service itself. It was an attack against one of the preliminary vendors um although it does once again illustrate the importance of computer security and how houlnerable things on the Internet can be to hackers. And as we all know, there are plenty of hackers out there from all different walks of life, including professional hackers to just script kiddies

who are running some stuff that they found online. Anything that's gonna be online is gonna be prone to to attack. Whether or not it can stand up to those attacks as another matter entirely. So bottom line, do your research. Make sure that whatever it is you are investing in, whether it's bitcoin or some other property, has good security.

And even in this case, when it wasn't bitcoin itself that was the problem, your investment might take a hit for a while, but if if we're all careful and we're all smart, then hopefully we rebound from that pretty quickly. So that's the update on the news, and by the time this goes live, there maybe even more developments. But I just thought we should address that, since otherwise the podcast would sound horribly out of date. This is Jonathan sy me Off. Be sure to check out our new

video podcasts, Stuff from the Future. Join How Staff Work Staff as we explore the most promising and perplexing possibilities of tomorrow. The How Stuff Works iPhone app has a rise. Download it today on iTunes. Brought to you by the reinvented two thousand twelve camera. It's ready, are you