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What you need to know about bitcoin

Every bitcoin transaction is recorded in a public ledger that is distributed across a network of computers.

Its rise to mainstream prominence has been riddled with drama and controversy, but after eight years, bitcoin is still the top dog in the cryptocurrency world

What is bitcoin?

Bitcoin emerged in early 2009, in the wake of the near-collapse of the global financial system, as a digital platform carrying programmable money with no links to governments, central banks or financial institutions.

Every bitcoin transaction is recorded in a public ledger with the identities of individuals obscured using cryptography – hence, the term cryptocurrency. But unlike a ledger operated by a bank, the bitcoin ledger is not stored in any one central place. Instead, it is distributed across a network of participating computers. Those computers – referred to as miners – contribute their computing power by recording bitcoin transactions and solving complex mathematical problems. The computers and their owners are paid for those tasks in bitcoins, which can be sold for cash or used to purchase goods.

Bitcoin's initial value was zero. But within two years, it was being derided as a bubble that would soon be punctured by governments unwilling to give up their money monopoly and worried about the digital currency's adoption by terrorists, drug traffickers and money launderers eager to hide their financial dealings.

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Yet eight years, a couple of major scandals and plenty of roller-coaster rides in price later – and despite the emergence of rival payment platforms such as ethereum and litecoin – bitcoin remains the top dog in the cryptocurrency world.

How is it created?

The process has come to be known as "mining" because it is slow and intensive, reaping a gradual reward in the same way that minerals such as gold are mined from the ground.

Computers solve complex, automatically generated mathematical puzzles to help secure each block of transactions and keep the bitcoin network safe from hacking or manipulation. For bitcoin users, that security is one of the currency's main attractions.

After the first miner secures a block of transactions, its work is verified by the other miners in the network, and that block is added to the " blockchain" – a shared record of all the transaction data – which is virtually impossible to tamper with. The mining, therefore, keeps the whole system going.

Specialized computer farms are set up to solve the equations, with the first network to actually solve the equation rewarded with new bitcoin. In the early days after bitcoin was launched in 2009 this could be done by hobbyists from personal computers, but the increased complexity of the blockchain means it now requires more energy and computing power to solve the equations and produce new coins.

The energy being used to power the network is enormous. Bitcoin-focused website Digiconomist calculates that bitcoin uses more than 32 terawatt hours of power a year, or about the same power as Denmark uses in a year. Digiconomist says that with much of the network powered by cheap coal electricity in China, each transaction has a footprint of about 122 kilograms of carbon.

An employee checks power supply units and cooling fans used in cryptocurrency mining machine systems at the SberBit mining ‘hotel’ in Moscow, Russia, on Dec. 9, 2017.

How many bitcoins are there?

One of the features of bitcoin that has made it appealing to early adopters is its finite supply. While fiat currencies (like the dollar or euro) can become inflated by central banks printing more money, the algorithm that governs bitcoin caps the total supply at about 21 million. The website blockchain.info indicates that there are about 16.735 million bitcoins in existence today, up from 16 million last December.

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Written into bitcoin's code when it was invented in 2008 was a rule dictating that the prize for mining it would be halved every four years, in a step designed to keep a lid on bitcoin inflation. The last bitcoin is expected to be mined around the year 2140.

Who invented it?

The story of bitcoin begins with a mysterious founder who calls himself Satoshi Nakamoto. To this day, no one has been able to find Mr. Nakamoto, whose only interactions with the programmers who helped him create bitcoin were via online chat. (There is a man named Satoshi Nakamoto living in Japan but he denies having had anything to do with bitcoin.)

The founder's absence has prompted various theories about his whereabouts. Some hypothesize that Mr. Nakamoto has died, while others claim the moniker may be a pseudonym for a group of individuals.

According to a white paper posted to a cryptography mailing list in August, 2008, Mr. Nakamoto was aiming to build a peer-to-peer version of electronic cash – one that, because of its lack of a central authority, could not be manipulated by any one person or entity, including a central bank.

The meteoric rise of the value of bitcoin has caused a number of people to label it a bubble.

What can you use it for?

Bitcoin's rise to mainstream prominence has been riddled with drama and controversy. Soon after its adoption, it gained a reputation for being a convenient method for laundering money, hiding from the taxman and purchasing all sorts of illicit goods – from drugs to weapons to child pornography – on the dark web. However, industry insiders say criminals have grown wary of bitcoin ever since the 2013 bust of an online black market called Silk Road proved that bitcoin transactions are traceable.

The currency's reputation took another hit the following year when Mt. Gox – then the world's largest bitcoin exchange – was hacked and lost hundreds of thousands of its users' bitcoins. The Tokyo-based exchange promptly filed for bankruptcy.

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Although bitcoin was created to be a medium of exchange, a number of factors make it ill-suited for the job. While some retailers – including Expedia and a number of Shopify stores – accept bitcoin payments, most major retailers do not. Secondly, its wildly fluctuating value makes spending it a gamble.

Residents of several Latin American countries – including Venezuela, Brazil and Argentina – are reportedly turning to bitcoin as a reprieve from their currency woes. In Venezuela, for instance, hyperinflation has made the local currency virtually useless. Such a situation can make bitcoin – whose supply cap prevents excess inflation – appealing.

Because of its scarcity and its independence from banks, some users consider bitcoin a safe haven, similar to gold. A number of cryptocurrency proponents attribute bitcoin's red-hot tear to rising political tensions around the world. For instance, the price hit a new record just after news broke that North Korea had launched a missile over Japan.

The first bitcoin futures started trading on Sunday, Dec. 10, on an exchange run by Cboe Global Markets Inc.

How do you buy it?

Bitcoins are sold in a variety of ways, including at a specialty bank machine or through a cryptocurrency exchange – an online marketplace that matches buyers and sellers. Meanwhile, the first bitcoin futures started trading on Sunday, Dec. 10, on an exchange run by Cboe Global Markets Inc. The pro-futures contracts, which trade under the ticker symbol XTC, are based on the Gemini exchange auction price for bitcoin. CME Group will also be launching bitcoin futures contracts next week.

What happens if you lose your coins?

When Matt Lefebvre first started mining bitcoin in 2010, he had no clue what it was for. By the end of the year, the Richmond Hill, Ont., resident had amassed roughly 13,000 bitcoins – the equivalent of nearly $300-millioncdn at recent bitcoin prices – on a USB stick.

But the following year, Mr. Lefebvre made a disastrous mistake. He accidentally wrote over the data with Windows 8 – "arguably the worst possible operating system since Windows ME," he said.

It has taken him years to get over the loss, while the price of bitcoins has continued to climb.

"I tried literally everything to get the data back," says Mr. Lefebvre, who is now a professional YouTuber who creates videos about technology. He often daydreams about what he would have done with the money. Home ownership is at the top of his list.

"I had a winning lottery ticket, didn't know it was a winning lottery ticket and set it on fire," he said.

There is no recourse for people like Mr. Lefebvre who lose access to their coins, which will likely sit dormant in cyberspace forever. And unfortunately, tales like his are not uncommon. Perhaps the most famous of such stories is that of British resident James Howells, who in 2013 accidentally tossed away a hard drive containing roughly 8,000 bitcoins. Today his virtual fortune – currently worth more than $180-millioncdn – sits in a landfill the size of several football fields.

Mr. Howells has visited the landfill but was unable to get permission to search the site – despite offering the local council a 10-per-cent cut and having numerous financial backers willing to finance the venture. But the Newport man has not given up. Bitcoin's rapidly accelerating price in recent months has buoyed his hopes.

"As the price continues to rise, I'm confident I will be given permission to search for the hard drive at some point in the future," he told The Globe and Mail via e-mail. "Even at current prices, the value of the drive is too high for the council to keep ignoring."

Is it regulated?

Like many of their global counterparts, Canadian regulators are failing to keep pace with the change brought on by these technological advancements. A staff notice issued by the Canadian Securities Administrators last August left some ambiguity as to whether new cryptocurrency offerings constitute securities or not.

Cryptocurrency transactions occur outside the mainstream financial system and the purview of regulators, making them vulnerable to money laundering and tax-avoidance schemes. FinTRAC, the federal anti-money laundering agency, has introduced new rules governing cryptocurrency exchanges. But the rules, which would require the exchanges to register as money-services businesses, report suspicious transactions and identify their clients, have not yet come into force. Meanwhile, criminals have reportedly moved on to other cryptocurrencies, such as Monero and Zcash, which offer a higher level of anonymity.

A Bitcoin sign on display at a bar in central Sydney, Australia. Some critics say bitcoin is not an actual currency because it doesn’t reliably hold value and cannot be spent easily.

Is it a bubble?

The meteoric rise of the value of bitcoin has caused a number of people to label it a bubble. Mark Kamstra, a professor of finance at York University's Schulich School of Business, says that bitcoin is a classic bubble because its value is based on nothing more than the expectation that its price will continue to climb. There is nothing tangible – no bar of gold, no promise from a central bank, not even a tulip bulb – backing the currency.

"It will burst," Dr. Kamstra said. "I couldn't tell you when. That's the thing about bubbles – they're driven by this irrational exuberance over future price gains. And when does that stop? When do people stare at the naked man walking down the street and say the emperor has no clothes? I don't know."

Bank of Canada Governor Stephen Poloz used a recent speech to issue a warning to people who may be piling into high-flying bitcoin and other so-called cryptocurrencies, insisting they are not currencies at all.

"The term ' cryptocurrency' is a misnomer – 'crypto,' yes, but 'currency,' no," he said. "For something to be considered a currency, it must act as a reliable store of value, and you should be able to spend it easily. These instruments possess neither of these characteristics, so they do not constitute 'money.'"

The central bank has said previously that it is exploring the possibility of eventually issuing its own digital currency for retail transactions.

What is an ICO?

Similar to crowdfunding, initial coin offerings help early-stage companies avoid venture capitalists and the highly regulated stock markets and raise money directly from investors by selling digital tokens or coins. The coins are similar to equity in an initial public offering, but without the regulatory oversight or backing of financial institutions.

Some companies have managed to raise millions of dollars very quickly this way. What's troubling, however, is that many of the ventures being financed this way have little more behind them than a brief white paper outlining their business plans. There have been more than 230 ICOs in 2017, raising roughly $3.68-billion (U.S.), according to ICO tracker Coinschedule. But regulators are starting to get wise to the existence of a shadow market that flouts the normal practices and rules for raising capital. The U.S. Securities and Exchange Commission has cautioned that many such coin offerings look like securities, suggesting the agency will start regulating ICOs.

Are they risky?

Even early adopters and cryptocurrency proponents, such as Andreas Antonopoulos, are speaking out about the frothiness of the ICO market. Mr. Antonopoulos – a self-professed "digital nomad" and well-known figure in the bitcoin world – calls it an "absolute flood of scams and money grabs."

While issuing a digital token or coin may be a legitimate way to finance a project, many have cautioned that the sector is rife with fraud and pump-and-dump schemes – coins that offer little value besides the opportunity to make a quick buck by reselling them in the secondary market. Earlier this year, the SEC took regulatory action against two ICOs that were purportedly backed by real estate and diamonds; the regulator alleged the coins being peddled by REcoin Group Foundation and DRC World didn't really exist.

With reports from Brian Milner, The Canadian Press and Reuters

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