Why does the pound in your pocket have value? Why can you take it to a shop and expect the owner to accept it – or an electronic version of it – in exchange for a couple of pints of milk? It’s not because it’s backed by gold. Those days are long gone. Yet nor is the pound backed purely by force of habit or faith.
Ultimately, the pound is worth something because the UK government says that it has value. In effect, the pound is backed by the strength of the UK’s economy and institutions, and in the ability of the government to tax the populace.
This may seem like a reasonable bet. The risk is that, across history, plenty of governments have collapsed, and their currencies have gone with them. And even those countries which are still successful today have had plenty of hairy moments.
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What if there was a form of money that didn’t rely on the backing of any one entity? This is the core idea behind bitcoin.
Bitcoin is a form of digital currency called a cryptocurrency. There can only ever be 21 million bitcoins in existence. They are created (or “mined” in the jargon) by computers competing to do very hard sums.
The technology that underpins bitcoin is the blockchain. Put simply, the blockchain is just a big database. It records who currently owns each bitcoin, as well as the entire transaction history of each individual coin.
The key thing about the blockchain is that unlike a typical database, it isn’t controlled centrally. Instead, it’s what’s known as a “distributed ledger”. It’s entirely public – anyone can see it – and every transaction is verified, not by one central body, but by the computers that form the entire bitcoin network. In other words, bitcoin is a form of money that does not depend on the solvency or trustworthiness of any central authority at all.
Will we ever use bitcoin for day-to-day transactions? It’s unlikely. Governments would rather create their own centrally-controlled digital currencies, rather than cede this power to a truly independent currency.
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