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Bitcoin Basics: What is Bitcoin and what are the risks and advantages?
June 10, 2015
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What are these “Bitcoins” I’ve been hearing about?

Good question. I’m starting this series of posts with a super-basic introduction to Bitcoin: what it is, why it’s good or bad, and why someone would want to own them.

In future posts in this series, I’ll go beyond the Bitcoin basics and get into some of the laws surrounding Bitcoin and other issues that are involved in this new and exciting “virtual currency.”

What is it?

Bitcoin itself is two things – a virtual digital currency and a protocol for making “decentralized transactions.”

Bitcoin was invented in 2009 by the pseudonymous Satoshi Nakamoto. Little is known about the inventor of the Bitcoin specification. They left the Bitcoin project just a year later. Since Bitcoin is open-source, many other developers have had their hands on the project since it was created.

Bitcoin itself is two things – a virtual digital currency and a protocol for making “decentralized transactions.”

Virtual digital currency

Bitcoins are digital money that is “mined” by having a computer attempt to solve complex math problems. If the computer solves the problem, a new Bitcoin is mined. According to the Bitcoin protocol, there is a maximum of 21 million Bitcoins that can be mined (currently there are around 13 million already mined).

There is a limit on the number that can be mined, and the more that are mined, the more difficult it is to find more. Because of this, the last Bitcoin isn’t expected to be mined until 2140.

Once they are mined, however, they can be exchanged freely. You can use them to pay for goods and services, or you can sell them on an exchange for traditional currency.

Decentralized transactions

When you own Bitcoin, they are saved in a digital wallet that is governed by the Bitcoin protocol. This allows for them to securely transfer funds using an encrypted transaction identifying you by your wallet ID.

Unlike traditional currencies, which have a central party issuing the currency, Bitcoin is set up so that anyone can mine them. There is also no single exchange for that currency – anyone can create an exchange that conforms to the protocol. The transactions are all recorded onto something called the “blockchain,” which is a ledger available to the public.

As a cool aside, the blockchain isn’t only for recording Bitcoin transactions. Users can take advantage of the blockchain to record “smart contracts,” which can automate things like mortgage payments and sports betting. The blockchain can also be used for holding funds in escrow and for recording title to property. Lots of cool stuff may come from this if it gains more acceptance.

So what are the advantages?

Why would someone want to use Bitcoin? That’s a good question.

There are a few big advantages to using Bitcoin, including the fact that:

  • Transactions are peer-to-peer, meaning that there is no intermediary and no processing fees (credit card fees, international transfer fees);
  • Transactions are pseudonymous, which minimizes the impact of a data breach on personal information;
  • Transactions are not reversible in order to combat fraud – charge-backs need to be requested and approved by the other party.

That last one could work against you, of course, if you didn’t receive the goods you paid for and can’t get your money back. Let’s look at some other risks and disadvantages to Bitcoin.

Bitcoin disadvantages and risks

The big issue with Bitcoin has to do with volatility. The price of a Bitcoin has fluctuated wildly since its inception. Check out this chart:

Those peaks and valleys could seriously screw you if you were investing in Bitcoin as your main currency or if you are a retailer accepting Bitcoin for goods. Many prefer to work with a more stable currency in their businesses.

However, some of the exchanges will do an immediate exchange of currency into the current dollar value, so the retailer is not holding on to Bitcoin. This may mitigate the fluctuations.

Those peaks and valleys could seriously screw you if you were investing in Bitcoin as your main currency or if you are a retailer accepting Bitcoin for goods.

Another risk is also one of Bitcoin’s advantages. Its decentralized nature means that no government backs it, so it lacks inherent “value.” Many would argue that, since dropping the gold standard, the US dollar has no inherent “value.” Rather, both types of currency rely on the fact that there is a market for that particular currency, which gives it value. It’s just that the US dollar in this example has a much longer track record, which most people would find more reliable.

I should note that I neither own nor desire to own Bitcoin. I just think it’s a fascinating subject that may appeal to those who are digital nomads or long-term expats.

Next time and call for questions

In the next post, I’ll touch on some of the laws that deal with Bitcoin, particularly in the US. Until then, happy mining.

Also, if you have any questions or need clarification (I know there’s some jargon in this post), please post a comment. I’ll address it there or update the post to clarify!

About author

Zachary Strebeck

I'm a solo practice lawyer and full-time digital nomad. I run my law practice at www.strebecklaw.com, representing Internet, mobile software and gaming entrepreneurs. I also blog about digital nomad travel at A Lawyer Abroad.

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