Bitcoin explained: How it works and what it is good for

Bitcoin is thought of as a digital currency because it exists only virtually, without any physical coins or notes. It resides in a decentralized, encrypted network that is independent of commercial or central banks. This allows Bitcoin to be exchanged under the same conditions all around the globe. It's also a cryptocurrency, because it uses encryption to conceal users' identities and activities.

The cryptocurrency was first publicly described in 2008 by an unknown person — or group of people — who used the name Satoshi Nakamoto. Its implementation began in January 2009, when it was released as open-source software.

There are three different ways to acquire Bitcoin: First, you can buy the cryptocurrency with legal tender (e.g. dollars and euros) at online exchanges such as Coinbase or Bitfinance. Second, you may accept Bitcoin as a payment in exchange for your products and services. And third, you can create your own Bitcoins in a process known as mining.

Before you can buy Bitcoin you have to install so-called wallet software onto your computer. It contains a public key (your address) as well as a private key that allows only the owner of the wallet to send or receive cryptocurrency. Smartphones, USB sticks or any other digital hardware or cloud-based data storage can serve as wallet. Without the digital wallet, no Bitcoin for you.

To see how the process of paying with Bitcoin works, let's imagine Mr. X wants to buy a hat from Ms. Y. First thing Ms. Y needs to do is send Mr. X her public wallet address, which is like her Bitcoin bank account.

After Mr. X has received the public wallet address of Ms. Y, he signs off the transaction with his private key to verify that he is indeed the sender of the digital currency. The transaction is now stored on the Bitcoin blockchain with thousands of other transactions that are made with Bitcoin every day.

Now Mr. X's transaction is broadcast to all other participants in the peer-to-peer blockchain network, which are also called nodes. Essentially, they are private computers, or "miners," which verify the validity of his transaction. After that, the Bitcoin gets sent to Ms. Y's public address, where she can now unlock the transfer with her private key.

Theoretically, everyone can become a "miner" in the blockchain network. But most of it is done in huge computer farms that boast the necessary computing power. Bitcoin processing keeps transactions secure by chronologically adding new transactions (or blocks) to the chain and keeping them in the queue.

The Bitcoin transaction between Mr. X and Ms. Y is finally included in a vast public ledger, the blockchain, where all confirmed transactions exist as blocks. As each block enters the system, all users are made aware of each transaction. Who has sent how many Bitcoins to whom, however, remains anonymous.Once confirmed, a transaction can't be reversed — by anybody.

Miners generate new Bitcoins when they process transactions, which they do using special decryption software. Once solved, a new block is added to the chain and the miner is rewarded with Bitcoins. China is the biggest miner in the Bitcoin network. It's cheap electricity from coal gives it a competitive edge over rival miners, mainly in the US, Russia, Iran and Malaysia.

Due to the massive computing power needed for crypto mining and processing, the Bitcoin network consumes vast amounts of energy — about 120 terrawatt hours of power per year. University of Cambridge's Bitcoin Electricity Consumption index, has calculated the cryptocurrency requires more energy than each of the countries shown in blue on the map above. Graphics: Per Sander Text: Gudrun Haupt