To cut through some of the confusion surrounding bitcoin basics, we need to separate it into two components. On the other hand, you have bitcoin-the-protocol, a distributed network that maintains a ledger of balances of bitcoin-the-token.
Both are referred to as “bitcoin. The system enables payments to be sent between users without passing through a central authority, such as a bank or payment gateway. It is created and held electronically. It was the first example of what we today call cryptocurrencies, a growing asset class that shares some characteristics of traditional currencies, with verification based on cryptography. A pseudonymous software developer going by the name of Satoshi Nakamoto proposed bitcoin in 2008, as an electronic payment system based on mathematical proof. The idea was to produce a means of exchange, independent of any central authority, that could be transferred electronically in a secure, verifiable and immutable way. To this day, no-one knows who Satoshi Nakamoto really is.
In what ways is it different from traditional currencies? Bitcoin can be used to pay for things electronically, if both parties are willing. In that sense, it’s like conventional dollars, euros, or yen, which are also traded digitally. Bitcoin’s most important characteristic is that it is decentralized. No single institution controls the bitcoin network. It is maintained by a group of volunteer coders, and run by an open network of dedicated computers spread around the world. In electronic fiat currencies, this function is fulfilled by banks, which gives them control over the traditional system.
With bitcoin, the integrity of the transactions is maintained by a distributed and open network, owned by no-one. With bitcoin, on the other hand, the supply is tightly controlled by the underlying algorithm. A small number of new bitcoins trickle out every hour, and will continue to do so at a diminishing rate until a maximum of 21 million has been reached. Since there is no central “validator,” users do not need to identify themselves when sending bitcoin to another user. In practice, each user is identified by the address of his or her wallet. Transactions can, with some effort, be tracked this way. Also, law enforcement has developed methods to identify users if necessary.
Furthermore, most exchanges are required by law to perform identity checks on their customers before they are allowed to buy or sell bitcoin, facilitating another way that bitcoin usage can be tracked. Since the network is transparent, the progress of a particular transaction is visible to all. Bitcoin transactions cannot be reversed, unlike electronic fiat transactions. This is because there is no central “adjudicator” that can say “ok, return the money. If a transaction is recorded on the network, and if more than an hour has passed, it is impossible to modify.