My husband and I have been looking to buy an apartment over the past few years. This is relevant to bitcoin, I promise. New York City is tough, there’s never enough square footage, never the right views, forget about a modern kitchen – and absolutely no closet space. At least in our price range! A few months ago, we finally came across this amazing apartment. Views CHECK, nice kitchen CHECK, closets CHECK PLUS. We were sold. It didn’t seem like anyone else was bidding on the apartment, but of course, since we are both finance nerds, we were pretty stingy with the negotiating. Unbeknownst to both of us, our broker and the seller’s broker did not get along and hadn’t gotten along for years. We offered 10% below asking and was told there would be no counter offer. We moved up to 6% below asking, still no counter offer. We ended up losing the apartment to someone who paid 5% below asking, a number that we were very willing to pay should there have been a counter all because the brokers did not get along. The inefficiencies here got me thinking how much better off I would have been (in this particular situation) working directly with the seller. Brokers are essentially middle men, controlling which apartments you see or don’t see, negotiating pricing, and charging fees.*
Before you can understand what a bitcoin is and why it matters, you need to first understand the concept of a central bank. Ever heard of “the Fed?” The Fed is the U.S. Central Bank, which is the national bank that controls the distribution and production of our currency – Good ol’ U.S. dollars. When you get that crisp dollar bill that doesn’t even have the slightest crease in it, it came from them.
After my recent apartment hunt, I got to thinking that central banks are sort of like real estate brokers. Our broker controls the listings we see – how many… etc. and negotiates on our behalf. Central banks work similarly – by controlling the supply of the currency to the public. Also similarly to how I can’t speak to any of the sellers of the properties I’m looking at, only my broker can, (stay with me on this one!) wire transfers between two people must ultimately flow through the central bank (or a clearing house, but we won’t get into that today.) In other, simpler, words – like a broker, a central bank is a middle man between the exchange of money.
So what’s a bitcoin!? A bitcoin is a digital currency that eliminates the need for middle men aka banks. Come again? At its core, all currency is, is an accounting system. It’s a means of tracking who owes what, to whom. Right? It’s not an actual U.S. dollar bill that has inherent value (actually it costs the government about 5 cents to create each bill,) its what that dollar bill symbolizes that gives it value. When you hold a dollar bill, you earned it from someone. Bitcoin is essentially a highly technical encrypted digital accounting system tracking who owes what, to whom. By eliminating the need for banks to intervene between the movement of money, you allow for two people even in two different countries (barring regulations) to send currency to each other without crossing paths with any middle men. That’s right, no PayPal fees, no bank fees, no Credit Union fees… and without U.S. dollars.
How is that possible? You’re probably wondering. At the heart of bitcoin is blockchain technology making it all possible. Blockchain is this incredibly secure, digital ledger that I mentioned earlier. It stores information “pseudo-publically” across many many computers, making it impossible to manipulate the data without being detected by other users. Instead of a central power (i.e. a bank) validating transactions, the validation through blockchain technology becomes decentralized across a web of multiple users. Each transaction (i.e. you buy a piece of fruit from the grocery store) gets a unique, time stamped, “block” – which is then sent out and added to the chain of all other transactions (aka blocks) in sequential order.
Although Blockchain was originally created to enable digital currencies, its use is now spanning everything from validating land registries to creating smart contracts. You may not believe that bitcoin is here to stay, but blockchain definitely is.
Hopefully now you understand the basics. Bitcoin is way too dense a topic to fit into one article, so stay tuned for a Part II to talk about the hype, the controversy, and the future of bitcoin.
* There are definitely situations when it makes sense to have a real estate broker! I am by no means saying that real estate brokers are redundant.