The digital currency bitcoin jumped to a fresh high above $11,000 Wednesday before quickly dropping below $10,000 again. Its outsized gains this year however are sparking curiosity. If you’re curious but confused, here’s a brief explainer.
A: It’s a digital form of money, except there is no government or central bank printing it or standing behind it.
Q: So it’s like cash?
A: Well, sort of. Bitcoin is a system designed to allow people to exchange value directly, without any banks or middlemen brokering the transaction. It is global and decentralized and there isn’t any government overseeing it.
What bitcoin is literally, though, is software. It’s a program that is run across an interlinked network of computers and which facilitates those transactions between people.
Q: So you’ve got coins, digital ones, and they ricochet around the world with no one keeping track?
A: There are coins, but they are transferred over a network of interlinked computers. Every one of those computers runs bitcoin’s program simultaneously.
At the heart of that program is an open ledger visible to the public. Every bitcoin transaction is recorded in this. That transaction history is then updated, instantly and constantly, across every computer’s program. This results in a record of bitcoin’s history that can’t be altered or erased. This ledger of transactions, which has come to be called the blockchain, is at the heart of the network.
It sounds exotic, but it’s simply a public spreadsheet that is maintained by a bunch of users. Doing it this way means that no one person controls that spreadsheet. People concerned about inflationary currencies, totalitarian governments, or banks that commit fraud, find it to be an improvement over existing systems.
Q: I hear criminals like it, too.
A: Yes, some do. Bitcoin allows you to have an account without having to identify yourself in any way. This is great if you’re trying to avoid prying eyes. On the other hand, that public ledger means every transaction is fully visible to the world. If a government can connect you to your fraudulent or criminal transactions, they have you caught red-handed. Some criminals have discovered this.
Q: Well, I’m not a crook. How do I get in?
A: You can download the software itself, but that can be cumbersome. If you don’t want to go that far, just get a wallet.
Q: What do you mean, a wallet?
A: It’s a nickname for an online account, like Apple Pay. Some bitcoin wallets are offered by companies like Coinbase, and they are the custodians of the account. Others, like the wallet that comes with bitcoin’s software, are maintained by you.
A service like Coinbase maintains the wallet for you. The others don’t. If you lose your key to the wallet, you can lose access to your account forever. So that is a big risk.
Q: What about problems with security?
A: They’re real. Phishing scams are notorious. Bitcoin wallets can be the target of hackers just like any other online account. Even savvy bitcoiners have woken up one day and found their digital wealth gone.
Q: So no do-overs?
A: Remember what we said about that ledger. Once a transaction is recorded, it can never, ever, be erased. This is the critical aspect of bitcoin that prevents somebody from double-spending the same bitcoin. But it also means every sale is final, so to speak. If you get robbed, that money is as gone as if a mugger took your cash.
Q: Maybe I shouldn’t do this.
A: It’s not for everybody.
Q: Okay, I get the risks. I’ve got a wallet. How do I buy and spend bitcoin?
A: The easiest way is go to an online exchange, which will match buyers and sellers like any traditional exchange. There are hundreds of bitcoin exchanges across the world, some more regulated and some more of an informal bulletin board.
Q: I saw that the price of one bitcoin went to $11,000. That’s a lot of money. I can’t afford that.
A: Every bitcoin is divisible down to the eighth decimal place, so you can buy very small amounts of it if you wish.
Q: So I buy some bitcoin. What do I get?
A: Well, literally, you get some entries in an account in a software program. But right now those entries have a purchasing power of about $10,000 for each full bitcoin among people that accept them.
Q: And I can sell my bitcoin and get dollars or euros or whatever in return?
A: Yep, though it’s a volatile market. In the most recent 24-hour period, bitcoin has traded between $9,300 and more than $11,300.
Q: So is bitcoin a currency?
A: It’s a store of value or a means of making payments. It depends on your point of view. So long as other people believe it has value, it is an asset.
Q: Is it like gold then?
A: Some people call it digital gold, or gold 2.0 since governments can’t control and debase it. That’s why, like gold, some people view bitcoin as a hedge against inflation.
Q: Gold has some nonfinancial uses like for making jewelry. Does bitcoin have any other uses?
A: Since it’s digital, it wouldn’t make very good jewelry. But right now, with the price up so much this year, you could buy some nice jewelry with it.
Q: So why is the price of bitcoin going up so much this year?
A: There’s no definitive answer to that. Some people believe that bitcoin is going to become a global currency and will be widely accepted and used. Indeed, Wall Street is getting more interested in it as an investment. The thinking goes that if it becomes a mainstream investment, the investing hoards will push its price ever higher. Plenty of people also think that it’s all just an investing mania, that people are rushing into bitcoin just because they believe the price will go higher.
Q: That sounds like a bubble. Is bitcoin a bubble?
A: Bitcoin’s price is up about 900% this year. In the past five weeks alone, it doubled. Those are facts. Whether or not that constitutes a bubble is something investors ultimately need to decide themselves.
Q: A 900% gain?
A: It’s not even a record. In 2013, bitcoin jumped more than 5,000%. The next year, though, it lost 60% of its value. Caveat emptor.
Write to Paul Vigna at paul.vigna@wsj.com