What Are Bitcoins? Virtual Currency Explained (Like You're an Idiot)

Nov. 18, 2013 — -- Members of Congress today will get a crash course on bitcoin, the digital "currency" that allows users to conduct transactions online. In just five years the virtual currency has gone from being worth pennies to nearly $600 apiece. It has funded nascent democracy movements as well as a huge underground marketplace for illegal drugs and weapons.

We set out to answer the question: What Are Bitcoins?

Below is an attempt to answer that and many other questions surrounding the virtual currency. And we promise to speak really, really slowly.

When I was 4, I bit a coin, swallowed it, and had to go to the emergency room. I've had a fear of payphones and gumball machines ever since. Thank goodness Congress has finally gotten around to fixing the scourge of people biting coins. Wait... is this the same thing?

You never have to worry about choking on a bitcoin. Unlike U.S. quarters, Canadian loonies, or, for that matter, the currencies of every country in the world, bitcoins are completely virtual. They exist only online and are not controlled by a central authority like the Federal Reserve.

If hard currency is like a record, then a bitcoin is like an MP3.

That means you can't get them from a bank, or drop them in a wishing well. All transactions take place in an online marketplace, where users are untraceable.

If I can't hide it under my mattress, how can I know my stash is safe?

You hold bitcoins in an online "wallet." This is an account set up on a secure third-party website.

Unlike banks, wallet firms won't invest your money. Nor do they guarantee the same protections afforded banks by institutions like the FDIC.

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If your wallet is hacked and your bitcoins are stolen, there is not much you can do about it.

This sounds a lot like the coins from Super Mario Brothers. Do I have to bang my head against a brick wall to get the money?

New bitcoins enter the market by a process called "mining." Available bitcoins are hidden amid a complex encrypted computer program. Users' computers are working round the clock to solve a complicated mathematical problem in order to release new coins.

The easiest-mined bitcoins have already been discovered. Finding new coins requires huge amounts of computing power. That has led some hackers to take over unsuspecting users' computers to harness their power to mine for more bitcoins.

The system is designed to require more work to get coins as time goes by, that makes the currency's growth rate, also known as inflation, steady and predictable.

About 11 million bitcoins have already been found. But only 21 million exist in total.

How do I use bitcoins? I have a feeling my kids won't be happy when I tell them they're getting virtual currency for Christmas.

You can use bitcoins to buy anything with which you would use any other kind of currency. There's just one huge hitch: the business has to accept bitcoins, and most don't.

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When you want to buy something, you find out the anonymous identification number attached to the seller's wallet, and transfer coins from your wallet to his.

It's this anonymity that has made the currency popular with drug dealers.

Drug dealers? I knew this sounded sketchy. Are these things even legal?

Recently, Silk Road, an online marketplace for illicit drugs, which used bitcoins to facilitate transactions was shut down by the FBI.

Like cash, bitcoins are untraceable, which makes drug dealers like them. Unlike cash, however, bitcoins can easily be transferred anywhere in the world.

For now bitcoins are legal, so long as they're being used for legal purchases.

At today's Senate Homeland Security Committee hearing, a lawyer for bitcoin is expected to ask Congress to "chart a safe and sane regulatory course" without limiting its economic potential.

Patrick Murck, general counsel for the Bitcoin Foundation, is expected to tell the committee that bitcoins are vital for developing economies and developing democracies. They allow users to spend money on political acts that some governments might find threatening and they let users sidestep corrupt practices and punitive taxes.

"Bitcoin can facilitate private and anonymous transactions, which are resistant to oversight and control," Murck will testify, according to released copies of his remarks. "This by no means implies that using Bitcoin can or should provide anyone immunity from the law."

Who came up with this whole idea in the first place?

It's a bit weird. Officially, bitcoins were invented by a Japanese programmer named Satoshi Nakamot, who outlined the process in an academic paper before disappearing in 2009, shortly after the first bitcoins were released.

Satoshi is widely believed to be a pseudonym and given his use of English in some of those papers, many believe he is an American.

What are bitcoins actually worth?

As of today, one bitcoin is worth $568, leading many to believe they are overvalued and the bubble is likely to burst.

The currency is extremely volatile. There's no control over how bitcoins are valued against other currencies and there are no large exchanges that can prevent manipulation and speculation.

Every time bitcoins make the news – like when Silk Road was shuttered, or when the tech investor Winklevoss twins – revealed they owned million of dollars in bitcoins, the value has wildly fluctuated.

So, if they're this invisible, virtual currency, how is it that people keep biting them?

You know what? You're an idiot.