What is Bitcoin?

What is Bitcoin?

Bitcoin is an electronic currency system that allows payments to be made directly from person to person without using a financial institution (as you would with a credit or debit card transaction) or another third party (like PayPal). Bitcoin functions on a peer-to-peer computer network rather than through a third party, and is open-source and self-governing. You could say that no one is in charge of Bitcoin, or you could say that everyone who uses Bitcoin is "in charge" of it. The current convention is to refer to the technology and network as "Bitcoin" while referring to the currency itself as "bitcoin."

Bitcoin software maintains a public ledger to record and verify each transaction without identifying users. Users who share hardware and bandwidth for transactions are "paid" by the algorithm with new denominations of bitcoin for saving, spending, or selling. This process for earning new bitcoin is known as mining. It is important to realize that should Bitcoin fail, there is no Federal Reserve to act as a safety net. With Bitcoin, risks and rewards can be substantial.

Bitcoin is released into circulation at a software-determined, diminishing rate that stops after 21 million have been issued. The system is expected to reach this limit in the year 2140. As of March 9, 2014, 1 bitcoin is approximately equal to $638. The real-time exchange rate can be monitored here.

Who Uses Bitcoin?

Anyone can use bitcoin. Many online companies, like online gaming company Zynga, have started testing bitcoin payment systems, and some casinos in Las Vegas now accept bitcoin. Some business owners have started accepting payments in bitcoin because the surcharges involved are typically much less than those charged by credit and debit card processors. The actual payment process in a café, for example, would involve opening up the bitcoin app on your smartphone, entering the amount of money in US dollars that you owe, and letting the software convert it to bitcoin value. Then you scan a QR code, and the bill is paid instantly. The growing directory of places that accept bitcoin can be found here.

How Can I Get Bitcoin?

If you don't want to be involved in the bitcoin mining process, you can buy bitcoin online or through a special bitcoin ATM if you live where a company called Robocoin has set up bitcoin ATMs. Do your research before buying bitcoin so that you understand the potential risks first. If you choose to buy bitcoin online, it's basically a two-step process:

1. Choose a Bitcoin "wallet." This virtual wallet is carried with you via your mobile phone, or you can keep your wallet only on your computer. Your wallet should be treated as carefully as you would treat your bank account or credit card information.

2. Buy bitcoin. You can buy bitcoin from someone you know, or from an exchange using your bank account. Bitcoin price can be volatile, and you should treat it as a high risk asset. You should never store money you can't afford to lose in the form of bitcoin.

Once you have your wallet and bitcoin in it, you can spend it at an ever-increasing number of merchants worldwide. While a transaction involving Bitcoin can be refunded by the person who receives the funds, Bitcoin transactions cannot be reversed as you would do a chargeback, for example. Only transact bitcoin with organizations with an established reputation, or that you know and trust.

Controversies Surrounding Bitcoin

Bitcoin has drawn its share of controversy since its 2009 origination. In 2013, the FBI shut down the online black market called Silk Road and seized 144,000 bitcoins, which were worth nearly $30 million at the time.

Another controversy involves Bitcoin trading platform, Mt. Gox, which halted withdrawals on February 7 due to a programming glitch that allowed cybercriminals to dupe the exchange in a scheme similar to receipt fraud. This caused the price of bitcoin on the Mt. Gox exchange to drop significantly.

Mt. Gox was taken offline February 24, and its CEO resigned from the Bitcoin Foundation's board of directors. Bitcoin prices everywhere dropped by about 3%. Whether people who traded on Mt. Gox will get any of their investment back is still unknown as a restructuring of the company proceeds in its home country of Japan.

Tracking Bitcoin Transactions

If you use Bitcoin wallet service Coinbase (the largest and fastest-growing Bitcoin wallet service in the US), you can now track bitcoin transactions alongside your traditional financial transactions using Mint.com. Mint.com is currently the only personal finance tool that allows users to track bitcoin transactions.

While bitcoin should be considered a high risk place to park money, that doesn't mean you shouldn't track it as part of your overall personal finance strategy. By tracking your Bitcoin transactions alongside your traditional transactions, you can make more informed choices about how and when to use Bitcoin in the future.

Photo Credit: moomsabuy / freedigitalphotos.net