Bitcoins are all the buzz. The virtual currency is riding a rollercoaster of speculation, rising exponentially in value and reaching a high of $260 this Wednesday before plummeting to $130. What's more, the largest bitcoin exchange in the world just survived a coordinated hack attack, and bitcoin-generating malware is spreading across Europe like wildfire via Skype.
Yet despite all the sound and fury surrounding this made-up money, most people have a hard time understanding exactly what bitcoins are--and how they work. This is troubling, especially if you're thinking of investing your own time and money in the Bitcoin phenomenon.
Starting your own bitcoin wallet isn't necessarily bad idea. Bitcoins aren't tied to the fortunes of any single nation's economy. They're easy to exchange, and they aren't subject to transaction fees. But you need to know a few important things before throwing your money into the volatile bitcoin market. You need to understand how the Bitcoin system works, where it succeeds, and where it's weak.
Bitcoins are created, traded, and controlled by the people
Simply put, a bitcoin is an algorithm-based mathematical construct--a unit of measurement invented to quantify value. It's sort of like the dollar in that way--but unlike the dollar (or any other form of fiat money, really), bitcoins are decentralized. The original Bitcoin algorithm was created by a developer with the pseudonym Satoshi Nakamoto, but the currency itself is created, traded, and controlled by bitcoin users, rather than by a central authority like a bank or a government. Bitcoins are completely digital, too: You'll never lay hands on a physical bitcoin unless you purchase a physical facsimile like this.
Each of these physical bitcoins has a private key embedded beneath the hologram that links to a Bitcoin address worth the amount shown on the face of the coin.
The currency also has a finite supply that's limited by design. The algorithm that fuels the Bitcoin network is designed to generate 21 million bitcoins, and the system automatically regulates itself to ensure that the supply of bitcoins grows at a smooth, steady pace. At the current rate, all 21 million bitcoins should be generated by 2140. And because the Bitcoin network tracks and records every bitcoin transaction, you can actually see exactly how many bitcoins have been created at any given moment at Blockchain.info, a website that monitors the Bitcoin network and hosts bitcoin wallets, the containers owners use to store their digital riches.
We're definitely in a bitcoin bubble
Bitcoin is big right now, probably too big for its own good. Since a bitcoin has no value beyond what someone is willing to pay for it, the price of bitcoins tends to change quickly. Indeed, in mid-January a single bitcoin was valued at $15, which makes people who bought bitcoins back then and sold them at $260 apiece yesterday very successful investors.
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