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What’s a Bitcoin: How does it work?

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Almost everywhere you look these days, there is talk of Bitcoin and cryptocurrency. This technology, based upon distributed ledgers (blockchains), smart contracts, and decentralized administration, has been adopted mainly by younger audiences but has recently gained traction among more established and traditional financial institutions. This younger demographic adoption can leave parents and family members scratching their heads. 

Bitcoin is the most well-known and was the first cryptocurrency. All cryptocurrencies are designed as a digital medium of exchange. These digital assets are actually just lines of code stored on a highly secured blockchain (think of a giant spreadsheet). When someone wants to use a cryptocurrency to purchase goods or services, they send the user on the other end of the transaction a wallet address that contains the determined value and, in some cases, other contractual obligations (smart contracts). This information is then verified and validated by a global network of computers (miners). Once a set number of computers have validated the information as correct, the transaction is processed. 

The draw and value proposition of cryptocurrency lies in the decentralized nature of the exchanges. There are no middlemen charging fees or making biased decisions about whether a transaction should be processed.  This decentralized approach opens up financial markets globally to populations that may otherwise be left out of traditional financial services. Take, for example, individuals working here in the US that wish to send money to family members in other countries. With conventional financial services, these individuals pay as much as 11% of their hard-earned money to intermediaries and financial institutions for the privilege of sending money to their families. This same exchange in cryptocurrency removes the fees and other obligations - money is sent directly between parties. If you have ever used a service like Western Union, you already know the pain of having to pay on both ends just to use your own money. 

This crypto adoption, blockchain, and smart contract technology is also growing beyond just exchanging digital currency. There are now 1000’s of other applications that are taking advantage of this distributed ledger technology. Supply chain tracking, records administration, loans, medical records, mortgages, banking services, digital content ownership, and even voting are all being moved to the blockchain.  Take, for example, the ownership of your own personal academic records. Why should a student pay a 15 dollar fee for an official copy of a transcript every time they want to verify they have graduated? If that same official transcript is stored on the blockchain behind a smart contract, the graduate owns that transcript. It has been verified as official and can be sent to whoever the student wishes to send it to. 

Bitcoin may be the catchall phrase for cryptocurrencies, but having a general understanding of blockchain technology will serve you well in future conversations. Whether it’s buying a pizza with some bitcoin, providing loans, or creating unique digital content, the blockchain is the real magic behind the transaction. Hopefully, you better understand this after reading this month’s installment of The Money Talk.

 

Until next month,

Dr. Brad Yeckley, MBA CPFC

Assistant Director for Financial Literacy and Well-being

University of North Carolina Charlotte