Bitcoin[note 1] is a peer-to-peer payment system introduced as open source software in 2009 by developer Satoshi Nakamoto. Although it does not meet the generally recognized definition of money, the digital currency created and used in the system is alternatively referred to as a virtual currency, electronic money, or cryptocurrency.[6] The bitcoin system is not controlled by a single entity, like a central bank, which has led the US Treasury to call bitcoin a decentralized currency.[7]

Bitcoins are created as a reward for payment processing work in which users who offer their computing power verify and record payments into a public ledger. Called mining, individuals engage in this activity in exchange for transaction fees and newly minted bitcoins.[8] Besides mining, bitcoins can be obtained in exchange for other currencies, products, and services.[9] Users can buy, send, and receive bitcoins electronically for a nominal fee using wallet software on a personal computer, mobile device, or a web application.

Bitcoin as a form of payment for products and services has seen growth, and merchants have an incentive to accept the currency because transaction fees are lower than the 23% typically imposed by credit card processors.[10] The European Banking Authority has warned that bitcoin lacks consumer protections.[11] Bitcoins can be stolen and chargebacks are impossible.[12] Commercial use of bitcoin is currently small compared to its use by speculators, which has fueled price volatility.[13]

Bitcoin has been a subject of scrutiny amid concerns that it can be used for illegal activities.[14] In October 2013 the US FBI shut down the Silk Road online black market and seized 144,000 bitcoins worth US$28.5 million at the time.[15] The US is considered bitcoin-friendly compared to other governments, however.[16] In China, new rules have restricted bitcoin exchange for local currency.[17]

The most important part of the bitcoin system is a ledger that records financial transactions in bitcoins. Recording transactions is accomplished without the intermediation of any single, central authority. Instead, multiple intermediaries exist in the form of computer servers running bitcoin software. These form a network by connecting over the Internet that anyone can join. Transactions of the form payer X wants to send Y bitcoins to payee Z are broadcast to this network using readily available software applications. Bitcoin servers can validate these transactions, add them to their copy of the ledger, and then broadcast these ledger additions to other servers.[18]

Just as a ledger can be used to record transfers of conventional money like dollars, all bitcoin transfers are recorded in a computer file that acts as a ledger called the block chain. Where a conventional ledger records the transfer of actual dollar bills or promissory notes that exist apart from it, bitcoins are simply entries in the block chain and do not exist outside of it.[19]

Maintaining the block chain is called mining, and those who do are rewarded with newly created bitcoins and transaction fees.[20] Miners may be located on any continent and process payments by verifying each transaction as valid and adding it to the block chain.[20] As of 2014 payment processing is rewarded with 25 newly created bitcoins per block added to the block chain. To claim the reward, a special transaction called a coinbase is included with the processed payments.[18] All bitcoins in circulation can be traced back to such coinbase transactions. The bitcoin protocol specifies that the reward for adding a block will be halved to 12.5 bitcoins in 2017 and halved again approximately every four years. Eventually, the reward will be removed entirely when an arbitrary limit of 21 million bitcoins is reached c. 2140, and transaction processing will then be rewarded by transaction fees solely.[21] Fees are optional, but users that pay may have their transactions processed more quickly.[22] Payers have an incentive to include transaction fees because their transactions will likely be added to the block chain sooner; miners can choose which transactions to process[citation needed] and prefer to include those that pay fees.

As of 2013 mining has become quite competitive, and the process has been compared to an arms race as ever more specialized technology is utilized. The most efficient mining hardware makes use of custom designed application-specific integrated circuits, which are much faster and use less power compared to general purpose microprocessors, such as x86 processors.[23] Without access to these purpose built machines, a bitcoin miner is unlikely to earn enough to even cover the cost of the electricity used in his or her mining efforts.[24]

The odds of winning the reward for adding a block to the block chain decrease alongside an increase in the number of miners. Mining is a competitive process, and while many participate, the reward for each block can only go to a single miner. As of 2014 it has become common for miners to join organized mining pools to circumvent this problem.[25] Such pools split the work and the reward among all participants and make mining a less risky endeavor. Even for those who join pools, the cost of the electricity necessary to mine may outweigh the bitcoin rewards from doing so.[24]

The public nature of bitcoin means that, while those who use it are not identified by name, linking transactions to individuals and companies can be done.[26] Additionally, many jurisdictions require exchanges, where people can buy and sell bitcoins for cash, to collect personal information.[27] In order to obfuscate the link between individual and transaction, some use a different bitcoin address for each transaction and others rely on so-called mixing services that allow users to trade bitcoins whose transaction history implicates them for coins with different transaction histories.[28]

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Bitcoin - Wikipedia, the free encyclopedia