Bitcoin is a digital payment system and quasi-currency. It allows people to send payments anywhere in the world directly--without an intermediary like a bank. The network makes the transaction public yet keeps identities private.
Understanding Bitcoin can quickly get complicated and involve lots of technical jargon including nodes, hashes, and nonces. One way to make sense of Bitcoin is to understand its ecosystem--the companies that have surrounded Bitcoin to make it easier to use or useful for activities other than transmitting bitcoins within the network. Looking at the Bitcoin ecosystem helps to understand its benefits, limitations, and potential.
The following is brief exploration of the Bitcoin ecosystem and examples of companies that are a part of it. Links to specific companies are only for illustrative purposes and do not constitute an endorsement.
Creation. Like government-backed currencies, the number of bitcoins in circulation can increase over time. "Mining" bitcoins takes place when someone solves specific mathematical problems on the Bitcoin network and gets rewarded with bitcoins. However, the more bitcoins are mined, the more difficult it becomes to mine additional ones. This is why over time miners have combined their efforts into pools or adopted specialized hardware. But unlike government currencies, the absolute number of bitcoins is limited--to 21 million.
Buying and Selling. One way to get bitcoins is to purchase them with government currency. For that, you'll have to employ the services of an exchange. Exchanges allow you to get onto the Bitcoin network in the first place; that is, to own bitcoins. Ultimately, Bitcoin transactions are verified by the network itself through the work of bitcoin miners.
Storage. Once you have bitcoins, they'll be stored in a digital wallet. A wallet is an account made up of unique digitial addresses. A wallet permits you to send or receive bitcoins from someone else's wallet, but not to buy or sell them into other currencies. For that, you'll need an exchange.
Security. One of major advantages of the BItcoin network is the inherent security it provides for transactions. Buying something with bitcoins does not require the buyer to reveal any information that someone else could use to steal their bitcoins. Buying something with credit cards, by contrast, does, and explains why merchants go to such lengths to protect their customers' financial information. Bitcoin transactions are also irreversible, which eliminates the possibility of fraudulent charge-backs to merchants. Accessing a wallet requires a private key, and it's impossible for anyone to figure out someone else's private key by hacking into it directly--the underlying encryption technology is just too strong.
Nonetheless, there is a real need for security with Bitcoin wallets. It is possible for a thief to obtain bitcoins by, for example, stealing someone's computer or smart phone that has access to their wallet. A thief may also obtain the private key to a wallet just like gaining improper access to someone's ATM pin numbers; that is, if someone writes it down or otherwise displays the private key in front of the thief.
Unsurprisingly, numerous services have emerged to protect wallets (or their associated private keys). These range from services that simply provide random password generators to software that encrypts hard drives to third-party applications like Armory that manage and encrypt wallets. A major advantage of using full-service type exchanges like Coinbase or BitSimple is that they take care of protecting one's wallet (which in principle should be very safe), including by using offline wallet systems.
Of all the Bitcoin services to outsource, wallet security seems like the most important.
Protecting Against Price Swings. Perhaps the weakest aspect of Bitcoin is the extreme volatility in its price so far, including the fact that it may currently reflect a speculative bubble. In 2013, the price of a single bitcoin skyrocketed from $13 to just over $1200. Since December 2013, the price has settled down, but has still fluctuated between $1100 and $700.
To protect against price changes, merchants that accept bitcoins can just price everything in dollars, and leave the price risk on the buyer. But companies are also helping to provide bitoin users with more general methods of guarding against price volatility. One way is by using derivatives contracts, a method of lowering price risk that has been used for centuries. ICBIT is a Bitcoin derivatives market that uses futures contracts. BTC Oracle, by contrast, provides Bitcoin options. One can also bet on the direction of Bitcoin using BTC.sx or through a prediction market like the one offerred by Predictious.
None of these hedging services are likely to be easy or cheap to use for ordinary consumers. They may also come with some large risks. This means that Bitcoin will not be very widely adopted until its price becomes more stable or companies provide hedging services as part a seamless package of exchange, wallet, and security services.
Business Usage. For businesses that want to be able to accept payments in bitcoins, there are numerous companies that assist with accepting Bitcoin payments. Some companies provide bitcoin escrow services that help ensure that a seller is not paid until the buyer actually receives and inspects their product. Others specialize in assisting financial institutions in using Bitcoins. For companies that want to set up a bitcoin exchange or other business directly involving Bitcoin, they may need to hire the services of a lawyer or other specialist in Bitcoin regulatory compliance. Bitcoin exchanges, for example, may have to comply with federal money transmitter and anti-money laundering regulation or risk prosecution.
Investing, Borrowing, and Giving. A host of other companies allow people treat bitcoins more like cash. Alternative ways to invest in Bitcoin other than just buying them are to invest in vehicles like SecondMarket's Bitcoin Investment Trust or a pending Bitcoin exchange-traded fund. In addition, services like BTCjam and Bitbond let people borrow bitcoins using crowdfunded loans. Other services allow people to give Bitcoin gift certificates, or even tip in Bitcoin.
The foregoing is just a snapshot of the Bitcoin ecosystem. A relatively comprehensive list of companies making up the Bitcoin ecosystem is maintained here.
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