Crypto Currencies

Bitcoin Explained – Chapter 2: What is Bitcoin? - Differences to traditional currencies

25/07/2019 | 4 min read

The first part of the Bitcoin explained series starts with a basic explanation of what Bitcoin is and how it differs from traditional currencies.

Bitcoin: A digital crypto currency.

Without going into too much detail about the technical aspects of Bitcoin at this point, it is important to understand what Bitcoin is all about. The Bitcoin token, what most of us know as the Bitcoin currency, is just a small piece of code that represents the ownership of a digital concept (the Bitcoin protocol) - a virtual promissory note, so to speak. The associated digital concept is the Bitcoin protocol or Bitcoin network. The Bitcoin protocol makes it possible to make payments between the various participants of the Bitcoin protocol - without these payments going through a central authority or bank. Bitcoins are also not printed, such as Euro or USD notes, but are created using free software from computers distributed around the world. Since no central authority directly controls and regulates this network, it is also not possible to create new Bitcoins arbitrarily - in fact, the maximum number of all Bitcoins is limited to 21 million.

Bitcoin was the first digital payment method known as crypto currency. Since its creation in 2009, numerous other crypto currencies have been created (e.g. Ether, Ripple, Litecoin). There are now more than 2200 different crypto currencies, all of which differ in popularity, application possibilities and technology. Nevertheless, all crypto currencies existing today can be digitally exchanged and used for payments through a cryptographically secured verification process.

How does Bitcoin differ from traditional currencies?

Bitcoin can be used to pay for goods and services electronically - traditional currencies such as USD and EUR also have this feature today, thanks to payment companies such as PayPal and Wirecard. However, there are fundamental differences between crypto currencies and traditional currencies. These differences are listed and briefly explained below:

1. Digital absoluteness

Bitcoin exists exclusively in its traditional digital form. Traditional currencies exist both digitally and physically in the form of cash.

2. Decentralization

One of the main reasons that led to the creation of Bitcoin is its decentralization. No single institution controls the Bitcoin protocol. It is maintained by a group of volunteer programmers and operated globally by an open network of dedicated computers. Bitcoin is therefore seen as an interesting alternative by individuals who feel uncomfortable with the control that banks or governments have over their money.

The decentralized nature of Bitcoin makes it possible to solve the problem of the so-called «double spending» of electronic currencies – to copy these currencies and thus possible multiple use of digital assets. In the case of traditional electronic currencies, the verification of only one-off payments by banks is solved by giving banks control over traditional payment transactions. The Bitcoin protocol solves the integrity and double-spending problem through a completely decentralized network that does not belong to any institution, company or individual.

3. Limited number

The number of Bitcoins in circulation is regulated by the algorithm of the Bitcoin protocol. Every few hours, a small number of new Bitcoins is generated at a constantly decreasing speed until the maximum of 21 million Bitcoins is reached. This also explains why many investors consider Bitcoin as an investment. If the demand for Bitcoin increases, but the supply always remains the same, the value of a Bitcoin should theoretically continue to increase. Thus, Bitcoin can be considered deflationary as opposed to the traditional inflationary system.

4. Irrevocability

Every transaction carried out in the Bitcoin protocol is final and irrevocable. Unlike traditional currencies, Bitcoin transactions cannot be reversed. As soon as a transaction is registered in the Bitcoin protocol (at the latest one hour after completing the transaction), there is no authority (e.g. bank) responsible for reversing, modifying or adapting a completed transaction.

While this feature is seen by some as deterrent or very strict, many people see another strength in the Bitcoin protocol - no one can interfere or tamper with completed Bitcoin transactions.

5. Anonymity

Another feature of crypto currencies is a limited form of anonymity. Due to various regulations, tax reforms and anti-money laundering laws, it is necessary in the traditional monetary system to be verified at all times during payment transactions between banks. There are no banks in the Bitcoin payment traffic system that play the role of a "verifier", whereby the participants of the Bitcoin protocol act at least semi-anonymously. Each Bitcoin user is identified by his or her unique wallet (the digital «wallet» or account where Bitcoins are stored). This wallet is marked with a "Public ID", a publicly visible identification number.

Various secret services and criminal authorities have meanwhile developed methods of assigning these identification numbers to the respective users of the wallets. Bitcoin is therefore not a good alternative for criminals and money launderers to disguise their illegal activities.

Next in Bitcoin Explained

Bitcoin was and is in every respect the precursor of an innovative technology and represents a potent competitor and a real alternative to traditional payment transactions. Whether Bitcoin is worthwhile for each individual as a means of payment or as an investment opportunity is up to you to decide. Therefore, it is important for everyone who is interested to deal with the basics of Bitcoin and to understand them.

The next chapter is dedicated to the history of Bitcoin, the inventor and the future of Bitcoin, before the technical properties of the Bitcoin protocol are examined.


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