FAQ

Below is an ever evolving list of Frequently Asked Questions about Bitcoin.

Contents:

  1. Isn’t it just fake money? It’s not backed by anything.
  2. Who owns/controls Bitcoin?
  3. Is Bitcoin anonymous?
  4. Isn’t Bitcoin just for criminals and pornographers?
  5. I heard Bitcoin is just a Ponzi scheme.
  6. I heard Bitcoin was a pyramid scheme.
  7. Is Bitcoin in a price bubble?
  8. If there will only ever be 21 Million Bitcoin available, doesn’t that mean there won’t be enough to go around to make it usable worldwide?
  9. So how are Bitcoin created? Who creates them?
  10. What about regulations? Will governments try to shut down Bitcoin?
  11. I’ve heard lots of people have lost their Bitcoin or had them stolen.  Isn’t it insecure or unsafe?
  12. Now that Bitcoin is so expensive, I can’t afford to invest that much.

 

1. Isn’t it just fake money?  It’s not backed by anything.

Bitcoin is backed by a widely distributed network, and a protocol, that is based on the consensus of everybody using it.   In essence, this is not a lot different from how government currencies work.  Bitcoin gets its intrinsic value from the strength of the network and protocol and its ability to solve problems that we haven’t been able to solve before.  Specifically, Bitcoin allows people and companies to send large or small sums of money to anyone, anywhere, without the need for an intermediary party such as a financial institution. This can be done with little or no service fees, and can be done nearly instantly.  Bitcoin also eliminates the need for a typical trust model when transferring funds.  Because each transaction is irreversible, merchants need not worry about fraudulent charge-backs.

2. Who owns/controls Bitcoin?

The answer to that is ‘nobody’ and ‘everybody’.  Bitcoin is based on an Open Source program that is freely distributed. There is no central authority for the Bitcoin network.  It works based on consensus of all those who participate in the Bitcoin network and this network is open to anybody who wishes to participate.

3. Is Bitcoin anonymous?

Not exactly. Bitcoin is referred to as pseudonymous.  It is important to understand the difference between privacy and anonymity.  Privacy means “I know who you are, but I don’t know what you’re doing”.  Anonymity means “I know what you’re doing but I don’t know who you are”.  Bitcoin is pseudonymous because every single transaction on the Bitcoin network is published in a distributed ledger that is open for inspection.  As units of Bitcoin are transferred from one Bitcoin address to another, anyone can see and inspect that transaction. However, it can be difficult (or sometimes even impossible) to link an individual to a specific Bitcoin address. Thus, Bitcoin can behave somewhat anonymously if a person wishes to remain anonymous. However, at the same time, a party wishing to have a high level of transparency like, for instance, a charity organization, can freely publish their Bitcoin receiving address and allow anyone to inspect all transactions into that address.

In short, Bitcoin is as anonymous as you choose to make it.

4. Isn’t Bitcoin just for criminals and pornographers?  

No, not at all.  Bitcoin has received at times a stigma because much of the main stream media coverage of Bitcoin in the past has made mention of illicit websites that trade in drugs, weapons, and other illegal activity.  It is perhaps not surprising that a currency that behaves like digital cash might be used for illicit purposes at times.  However, it is important to distinguish that Bitcoin itself is neutral to its use. It is neither good nor evil in that respect.  Bitcoin as a currency would not be particularly useful if some entity had control over what it could be spent on.  It’s also important to note that illicit trade using Bitcoin, though it does exist, is a relatively small component of the overall Bitcoin economy and is becoming even less so over time.

5. I heard Bitcoin is just a Ponzi scheme.

Unfortunately, several very financially intelligent people who happened to be very uneducated about Bitcoin have expressed this opinion in the past.  A basic understanding of a Ponzi scheme demonstrates clearly that Bitcoin is not a Ponzi scheme.  The basic characteristics of a Ponzi scheme is that current investments are taken to pay dividends to earlier investors, providing the illusion that the investment has real financial merit and is producing real financial returns.

Bitcoin offers no such promise of return, and in fact, behaves much more like a commodity in that respect. Bitcoin is a “thing”, albeit a digital thing, that can be bought or sold freely.  The value of that commodity is based on what an individual is willing to pay, and what another individual is willing to accept – the dictionary definition of value.

6. I heard Bitcoin was a pyramid scheme.

Once again, this misconception demonstrates a lack of understanding of Bitcoin, pyramid schemes, or both.  A pyramid scheme behaves like a Ponzi scheme but with greater transparency.  People getting involved in a pyramid scheme typically understand that it is based on “new blood” alone and that, mathematically, it must fail at some point.

Bitcoin offers none of the promises of a pyramid scheme.  See the next point for greater detail.

7. Is Bitcoin in a price bubble? 

Bitcoin has been, for the whole time it’s been around, in a constantly changing state of price discovery.  It is a very young technology/currency/commodity.  The price of Bitcoin as compared to traditional government currencies has seen substantial, sometimes violent swings both upward and downward.  This is not all that surprising for a new technology.

The price of Bitcoin is, in part, based on the most basic laws of economics: Supply & Demand.  The overall supply of Bitcoin is limited in that there will only ever be roughly 21 Million Bitcoin in existence (more on that later).  At the time of this writing, there are approximately 12.5 Million Bitcoin in circulation and Bitcoin units are created (or, more accurately, ‘discovered’) at a relatively fixed rate of 25 every 10 minutes.  This means a consistent and predictable supply of Bitcoin – unlike traditional government fiat currency which can be ‘printed’ at the will of the government.

The demand side of Bitcoin is driven in part by its utility – your ability to use it functionally to transmit money – and in part by speculation on the future value of Bitcoin.  Because the supply of Bitcoin is limited and ultimately fixed, there is the sense amongst many owners of Bitcoin that “if this thing catches on” the demand will increase sharply and the price will be driven up to substantially higher prices than we currently have.

This may in fact happen.  However, it is very important to recognize that Bitcoin is a worldwide social experiment and “we’ve never done this before”.  For that reason, treating Bitcoin like an investment can only be viewed as highly speculative and risky.  It is not advisable that an individual should invest life-changing amounts of money into Bitcoin with an expectation of future return.  Bitcoin might be worth a lot some day.  It might be worth nothing some day. Both are very real possibilities.

8. If there will only ever be 21 Million Bitcoin available, doesn’t that mean there won’t be enough to go around to make it useable worldwide? 

Individual Bitcoin units are divisible to the 8th decimal place.  In essence, there are 100 Million units in each Bitcoin.  These smallest units are commonly referred to as a Satoshi (a nod to the pseudonymous Satoshi Nakamoto, the original developer of the Bitcoin code).  So there are 21 million x 100 million individual “units” of Bitcoin when divided to its smallest unit of currency. This is plenty to go around.  Part of the brilliance of Bitcoin is that it can be both scarce (there will only be 21 Million) and nearly unlimited (because you can slice them so thinly) at the same time.  If Bitcoin demand ever increased so sharply that it drove the price up to some outstanding value (say, $100,000 per Bitcoin), it is important to understand that Bitcoin would still be highly tradable in smaller denominations.  In this example, one Satoshi would be worth 10 cents, so you might buy a cup of coffee for 20 Satoshi. However, this divisibility does not hinder the “scarceness” of Bitcoin because no matter how thinly you slice the pie, there’s still only the same amount of pie and the more people who want pie, the more a pie is worth.

9. So how are Bitcoin created? Who creates them?

The Bitcoin source code that everybody runs has all of the code necessary to allow people running the program the opportunity to discover new Bitcoin.  This process is called “mining”. It is analogous to someone digging in the dirt to discover gold. The gold was already there, but someone had to do work to find it and get it out of the ground.

In the same vein (if you’ll pardon the gold pun), Bitcoin are discovered by solving very difficult math problems.  This gets complicated, and if you want more technical detail on how this work, check out this great video on the subject.  But in simple terms, individuals running Bitcoin software on computers participate in a  “guess and check” mathematical problem solving exercise trying to find an answer that meets specific criteria.  They then publish the proof of that answer (called the hash in cryptography terms) demonstrating that they have done the work to solve the problem and they are rewarded with Bitcoin.  This process is called “solving a block” and the current reward for solving a block is 25 Bitcoin. This happens roughly every 10 minutes somewhere.  This is sometimes referred to as the “Bitcoin lottery” because it is impossible to predict which computer will “get lucky” and solve the next block.  When Bitcoin was first released, the reward for solving a block was 50 Bitcoin, and the reward is cut in half every 4 years, thus slowing the production rate of new Bitcoin into the network. This means that every 4 years, one half of all remaining Bitcoin will be mined and become part of the Bitcoin economy.  Most of the total number of Bitcoin will be mined by the year 2040, though it is estimated that it will take until the year 2140 to mine the very last Bitcoin.

This process ensures a gradual and predictable “printing of money” within Bitcoin, and a specified maximum total supply.  This makes Bitcoin inherently “deflationary”, in that its value, assuming people continue to use it, naturally goes up along with the spending power, having the effect of causing deflation of other goods that can be purchased in Bitcoin.  Traditionally we are used to currencies being “inflationary”, meaning that the overall supply of money is increased driving down the value of the currency, and driving up the relative cost of items purchased with the currency.

10. What about regulations?  Will governments try to shut down Bitcoin?

The Bitcoin network and protocol would be very difficult for any government to try to regulate or shut down without shutting down the Internet.  Because it is a decentralized, distributed network, there’s no single point of failure to go after.  There’s no door to kick in or bank of centralized servers to seize.

However, because of the potentially disruptive impact that a technology like Bitcoin may have on financial systems and capital controls, as well as the potential for evasion of other financial regulations such as Canada’s FINTRAC Proceeds of Crime (Money Laundering) and Terrorist Financing Act it would not be surprising to see regulatory bodies attempt to regulate Bitcoin at the point of exchange to Canadian currency, or on the merchant side.

We in the Bitcoin community tend to advocate for less restrictive regulations that will not stifle the tremendous innovation that is happening within the Bitcoin ecosystem.  Most companies participating in the Bitcoin economy by operating Bitcoin Exchanges have chosen to voluntarily comply with FINTRAC Anti-Money Laundering (AML) and Know Your Customer (KYC) requirements even though it is not clear, at present, whether these regulations should apply to Bitcoin businesses.

Canada Revenue Agency issued a statement on November 5, 2013 clarifying its position on digital currencies (ie: Bitcoin) stating that it treated trade of goods for Bitcoin the same way it treats barter.   If you are a merchant conducting business in Bitcoin, it is advisable that you consult an accountant familiar with barter for clarification on the accounting and tax implications.

11. I’ve heard lots of people have lost their Bitcoin or had them stolen.  Isn’t it insecure or unsafe? 

Yes and no.  Just like Bitcoin is as anonymous as you choose to make it, it’s also as secure as you choose to make it.   In all things, there is a balance between usability (convenience) and security.  A physical safe, for instance, might be more secure by having a 10 number combination but would be difficult and cumbersome to use.  So we have to decide how much security we’re willing to give up for convenience and usability.

There are highly secure ways to store your Bitcoin.  Long term storage of Bitcoin can be done using paper cold storage wallets  (here or here).  Perhaps one of the most reputable and respected Bitcoin wallet services is Armory.  Both of these methods of storing Bitcoin can provide users with a high level of security, but cause inconvenience when attempting to use Bitcoin for simple transactions.  The Bitcoin client download offers a reliable wallet that you control yourself, but remember that it’s only as safe and secure as your computer is.  Ask yourself how much money you wish to gamble on your ability to protect your computer from catastrophic crash or malicious software.

Many of the instances of people losing large sums of money have come from their storage of substantial quantities of Bitcoin on online wallets (hot wallets) or in exchanges.  There are countless stories of Bitcoin services that have shut down, been hacked, or even seized leading to the loss of individuals’ Bitcoin.  These services act something like banks by giving you a place to store your Bitcoin but they are unregulated, are sometimes run in distant countries by people who you could not ever hope to track down if something went wrong, and are relying on the administrator’s ability to keep malicious hackers out.  All this can spell disaster if you allow yourself to be overexposed to risk.

There is a place for these services.  In truth, even the most reputable exchanges are run by people in a largely unregulated environment. You must determine individually how much risk you’re willing to expose yourself to.   If giving your personal information to an exchange service to get verified and be allowed the opportunity to trade directly on an exchange isn’t for you, then don’t do it.  If storing more than $30 worth of Bitcoin in an environment that could be compromised is outside of your comfort zone, then don’t do that either.

It is generally a good practice to store any large amounts of Bitcoin (and only you can decide what’s large to you) on cold storage paper wallets or using a service such as Armory.  For day-to-day transactional amounts of Bitcoin, Blockchain.info offers a generally-thought-to-be-trustworthy and reliable hot wallet that makes receiving and sending Bitcoin quick and simple, while offering such protections as 2-Factor Authentication to help secure your Bitcoin.

One of the challenges with Bitcoin currently is that most people aren’t knowledgeable enough of the potential risks to properly protect their Bitcoin and are, in fact, far more exposed to losing their Bitcoin than they think.  There’s a tendency to take the “it won’t happen to me” approach to securing Bitcoin and this can prove to be tragically incorrect thinking. It’s important to remember that the entire Bitcoin ecosystem is still very young, and new innovations are regular.  There are many bright people working on developing tools to make Bitcoin storage more secure without hampering convenience.

When in doubt, seek the advice of someone knowledgeable about Bitcoin and security.

12. Now that Bitcoin is so expensive, I can’t afford to invest that much.

This is a very common misconception.  People tend to think of the price of Bitcoin as analogous to the price of a stock.  What’s important to understand is that you needn’t be concerned with buying a whole Bitcoin.  You can literally buy ANY amount of Bitcoin you like.  You could buy $3.26 worth, or millions of dollars worth, or any value in between.  Other than the psychic satisfaction that seems to come from possessing one full Bitcoin (1 BTC), there’s no appreciable benefit to holding Bitcoin in round number values. Remember that when you buy 1 BTC, you are buying 100 Million Satoshi.  Would it really be that tragic if all you could afford to purchase was 46 Million Satoshi? Or 643,000 Satoshi?

Since the price of Bitcoin took a sharp rise starting around October of 2013, it’s become more commonplace to speak in terms of Millibitcoin (or mBit, or mBTC).  This is 0.001 Bitcoin.  So if someone wanted to buy 0.035 BTC you could equally say they were buying 35 mBTC.   So if buying 1 Bitcoin is too rich for your blood, how many mBTC would you be interested in?