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Bitcoin: just what the heck is it?

A screenshot from the explainer video on the Bitcoin website.

Don't feel bad if the news surrounding bitcoin is confusing. Even financial experts are trying figure out what the rise of bitcoin means in the context of currency markets.

Bitcoin currency could either wind up replacing money as we know it, or it could be a huge investment bust—and people aren't really sure who even created it in the first place.

Bitcoin has been rocketing upwards in trading value. It's worth more than McDonald's Corp., according to Bloomberg Technology.

Bitcoin is a form of cryptocurrency that exists solely in cyberspace. The "crypto" in "cryptocurrency" comes from the fact that bitcoin and other cryptocurrencies use cryptography.

How does bitcoin work?

"This is a question that often causes confusion," according to the Bitcoin.org website itself.

Specifically, the transactions use a digital code, which allows currency exchanges to be tracked within the bitcoin system even while being almost completely anonymous.

The system works by having digital wallets for each user, which store bitcoins. To have someone put bitcoins in your wallet, you'll need to give them your bitcoin address—but each address is intended to be used just once. Think of James Bond burning the paper his code word is written on after he memorizes it.

The transactions are tracked using an ever-evolving cryptographic stream called a blockchain. Private computer owners can use their machines to process the transactions for strangers, which grants them bitcoins created out of thin air, or "mined."

You can try and figure out the details for yourself by going to bitcoin.org/en/how-it-works. Good luck.

Bitcoin first came on the scene in 2009, when a person under the name Satoshi Nakamoto published a white paper outlining the bitcoin system. It's unclear who Nakamoto really is.

"Satoshi left the project in late 2010 without revealing much about himself," the bitcoin web page explains.

Shadiness also surrounds just what people are buying with their bitcoin. Its anonymous nature lends itself well to criminal activity—for example, perpetrators of the WannaCry ransomware attack in May got their ransom money in bitcoin. That's not the only nefarious activity connected to the currency.

"Mysterious spikes and drops in the price of bitcoin since its birth helped build an early reputation for the currency as a tool for selling drugs and laundering money," another Bloomberg article said.

Bitcoin is different than conventional money in the latter is fiat currency—that is, currency which is authorized by a federal government, like U.S. dollars or pesos or yen. Fiat currency has no intrinsic value except for what the market and/or the the government places upon it. Bitcoin goes one step further into abstraction, however, by having a currency that has no intrinsic value whatsoever and is not connected to a central bank, such as U.S. dollars are connected to the Federal Reserve.

The bitcoin system isn't impervious to hacks, however. The latest was announced earlier this month, wherein a related company called Tether lost $31 million to computer theft.

"Saying bitcoin is un-hackable is of small comfort to those who've lost money through cracks in its ecosystem of exchanges, intermediaries and money-raising schemes," columnist Lionel Laurent wrote for Bloomberg. "The latest theft in cryptoland is a reminder that the promise of security and liquidity is only that—a promise."

But within a matter of hours, bitcoin's market gains erased the entire trading slump caused by the hack. It later went on to achieve $11,000 in value.

Plus, bitcoin argues, the hacks actually make the system stronger.

"Like any other form of software, the security of bitcoin software depends on the speed with which problems are found and fixed," the bitcoin FAQ states. "The more such issues are discovered, the more bitcoin is gaining maturity. There are often misconceptions about thefts and security breaches that happened on diverse exchanges and businesses. Although these events are unfortunate, none of them involve bitcoin itself being hacked, nor imply inherent flaws in bitcoin; just like a bank robbery doesn't mean that the dollar is compromised."

Appearing on Bloomberg Television Wednesday, economist Joseph Stiglitz of Columbia University said bitcoin should be illegal, and if the government decides to ban it, the bitcoin system would financially collapse.

"It's successful only because of its potential for circumvention, lack of oversight," he said. "So, it seems to me it ought to be outlawed. It doesn't serve any useful social function."

FACTBOX

What is bitcoin?

• A digital currency created and exchanged independent of banks or governments.

• A maximum of 21 million bitcoins can be created, a limit that probably won't be reached for several more decades if the currency survives.

• Transactions typically are completed anonymously, making the currency popular among people who want to conceal their financial activity.

• The currency can be converted into cash when deposited into accounts at prices set in online trading.

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