How do Bitcoins work?
It seems that every time you turn on the news you hear a lot of buzz words such as: Cryptocurrencies, Coinbase, Bitcoins, Ripple, and Ethereum getting thrown around a lot. No one ever seems to explain what they are, how do cryptos compare to cash, how they work, how to invest, and most importantly how to use them in our every day life. Here at Latino Tax Pro, we stay on top of everything tax related, make sure to sign up for our newsletter, so you don’t miss out on important topics that matter to you and your business.
What are Cryptocurrencies
Cryptocurrencies are considered digital currencies, they are a form of exchanging goods and services.
Right off the bat it is important to distinguish the difference between cryptocurrencies and bitcoins. Bitcoins are a type of cryptocurrency. There are many different types of cryptocurrencies and new ones are being created daily.
Before we dive into the world of cryptos it is important to understand how physical currencies work, lets look at how the United States Dollar (USD) operates.
The USD is the official currency of the United States of America, it was created through the coinage Act of 1792. In the act it was stated that one USD would equal between 371 and 416 grains of silver. An Eagle which was worth around $10 USD would equal between 247 and 270 grains of gold. Coins made of gold with equivalent weights were used, during this time the purchasing power of a dollar would equal the purchasing power of the gold or silver which it was based from. In 1975 the U.S. dollar was no longer part of the gold standard and could be free on the international currency markets.
The USD is owned and controlled by the Federal Reserve System, but it is up to the U.S treasury to decide if more physical money should be printed. We have all heard the saying “the Fed is printing money”, they are not actually creating physical currencies, they are crediting bank deposits. Think of it as direct deposit, no physical cash was exchanged, there was only a credit to your bank account from the employer. Since the feds can credit all they want, and the U.S treasury can print more cash on demand, the USD supply is theoretically unlimited.
In 2009 an anonymous programmer, or a group of programmers known as Satoshi created and introduced Bitcoin. Satoshi described Bitcoin as a peer to peer electronic cash system that is completely decentralized. Decentralized means that there are no servers involved, and no central authority. You may be asking if there is no central authority, how are the transactions accounted for. This is where the blockchain technology comes into play, we will talk about that and coin mining in a future article.
A quick explanation; every transaction is a file with public keys (the recipient) and the amount that is being exchanged. The transaction also needs to be signed off by the sender with private keys, this is done through cryptography. For the transaction to be valid, the cryptocurrency network must have consensus that the transaction is valid. Again, this will be discussed in more detail in a future article.
Since most cryptocurrencies are decentralized, the amount of coins circulating is stated from the creation of the coin; some are finite, and some aren’t. It is important to remember if a digital currency has a finite amount of coins, no more will ever be created after the final coin is mined, which means the value of the coin cannot be lowered or altered by a third party.
In the next article we will go more in depth about various topics: different types of cryptocurrencies, blockchain technology, protocols, and the safety and security of the blockchain.