Do You Really Know What Bitcoin Is? A Guide for the Confused

Maybe it as those stories you heard — Lamborghinis and second mortgages, fortunes made and lost off of something you didn’t even really know existed until six months ago. Maybe it’s those eye-popping charts you keep seeing, the ones that go $5,800 per unit to $19,00 per unit in just one month … and the other ones that go in the opposite direction in just one week. Maybe all of your friends are constantly watching their phones, tracking their own investments, celebrating their newfound riches, freaking out about their sudden, sharp losses, and you just hate feeling left out. However you heard about it, it is now clear that this is at least something you should know about — whether to invest, or just to inform your Schadenfreude. The problem is, well, what is a bitcoin, exactly? Secretly, you know you don’t understand the thing, even though you may pretend to. 

All right. Seriously. Remind me what a bitcoin is?

A bitcoin is one unit of an anonymous digital currency called, yes, bitcoin

Hang on: “anonymous digital currency”?

That’s what it was built to be, at least — a theoretically untraceable and unhackable version of PayPal, more or less. But so many people got so excited about buying into the system that a market developed around buying and selling it — with bitcoin becoming less important as a currency than as a commodity, like gold. You can still buy things in bitcoin (like you can with gold, sort of), but many more people are now using it as an investment vehicle.

So bitcoin is a currency and a commodity?
Something like that. Fundamentally, bitcoin is a secure system for storing and exchanging money anonymously on the internet. In some contexts, it works like untraceable money (for, say, buying drugs on the dark net); in others, it works like a safety-deposit box without a bank (like when it’s used to store money away from the prying eyes of governments); in still others, it’s a tradable financial asset like a stock or bond (you could use bitcoin to become a millionaire). But each of these metaphors has limitations, too. Unlike most currencies, bitcoin is not supervised or endorsed by any government; it has incredible price volatility, which makes transactions complicated and undermines the safety-deposit-box approach; and, unlike the stock market, where valuations are based at least theoretically on expectations of future company value, there is no “fundamental” basis of speculative value for bitcoin.

Wait: Is bitcoin … real?
No, but then again, neither is the dollar.
But the dollar is backed by the U.S. government.
Who needs a central government when you’ve got an unhackable, unfoolable currency?

I’m already lost. Why would anyone buy a bitcoin?
For the same reason you’d buy anything: Because you think a bitcoin is worth something. And there are a few different reasons to think it is. Maybe what’s valuable to you is bitcoin’s anonymity: A lot of people really like operating anonymously on the internet. Plus, if you want to move your money out of an economically or politically unstable country without being hit with taxes or currency controls, converting your fortune to bitcoin might help. Or maybe what’s valuable to you is bitcoin’s whole philosophy — you believe it will someday be widely adopted as a day-to-day currency, and you want to buy in early. But those are the reasons people originally got into bitcoin — the true-believer stage. Now people are getting in because they think they can make money — the investment stage. In that case, what’s valuable is, well, the fact that everyone else is buying bitcoin and you think its price will keep rising.

I mean, will its price keep rising?
That depends. Unlike most regular currencies, whose purchasing power declines over time, bitcoin was designed to be deflationary: There are a limited number of total bitcoins, and new ones are added to the market slowly. What drives the price up is if more and more people show up hoping to buy the existing coins, thereby bidding up their value. But that’s a big if — if bitcoins never reach widespread adoption, or if they’re too difficult to convert into more usable cash, their value will go down.

This seems pretty risky.

Well, yeah. And even setting aside the long-term case for bitcoin, in the short and medium term the currency is terrifyingly volatile. On paper, 2017 was very good to bitcoin — this time last year, one bitcoin was worth about $900; it’s now worth about 15 times that — but also very stressful to bitcoin investors. Within one week in December, Bitcoin hit a high above $19,000, dropped to as low as $10,400, and then climbed back up above $15,000 24 hours later.