The payments industry is abuzz with excitement as one topic continues capturing headlines, with profound implications for community banks: Bitcoin.

As the original digital currency, Bitcoin has steadily climbed from obscurity to reach a total market capitalization of over $1 trillion. However, the lofty valuations often come with steep declines — it is not uncommon for Bitcoin’s value to rapidly plummet in a matter of hours.

With digital currencies reshaping the U.S. payments system that community banks and their customers depend on, what exactly is Bitcoin, and from where did it arise?

Origins of Bitcoin

The story of Bitcoin started in the murky corners of the internet on November 1, 2008. On that date, a person or group called Satoshi Nakamoto uploaded the original white paper that laid out the vision for a “purely peer-to-peer version of electronic cash” that would permit people to send payments without using financial institutions as intermediaries.

This new form of digital money depends on cryptography to secure transactions — thus, the word cryptocurrency was born.

Bitcoin launched on Jan. 3, 2009, when Nakamoto created the first transaction block, now known as the genesis block. The block contained a message reading “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks” that serves as a timestamp and criticism of the traditional financial system and the Great Recession.

Shortly thereafter, the first transaction occurred on January 12 when Nakamoto sent ten bitcoin to Hal Finney as a test.

Nakamoto continued to support the development of Bitcoin until posting a final entry on the Bitcoin Forum on Dec. 12, 2010, and final communications to the crypto community in April 2011. Nakamoto, whose identity remains a mystery, has estimated holdings of 1.1 million bitcoin that have never been spent or transferred.

How Does Bitcoin Work?

Unlike the electronic payments that bank customers initiate with ACH or cards, Bitcoin transactions do not flow over traditional payment rails or require processing financial institutions to complete the transactions.

New Bitcoin is not created by any central bank but generated through a process called mining.

Bitcoin does not exist as a physical object. Images of golden coins stamped with various Bitcoin symbols are artistic representations to help viewers understand or visualize the abstract concept of cryptocurrency.

Miners are engaged in a 24/7 race to bundle unprocessed transactions into blocks to add to the public ledger of all Bitcoin transactions, known as the blockchain, to receive transaction fees and newly minted Bitcoin as compensation for their efforts to maintain the network. The network relies on miners to process and validate all pending transactions and, most importantly, prevent users from spending the same bitcoin twice.

Nakamoto devised a clever solution to achieve consensus across the decentralized network and ensure that transaction processing requires enough resources to disincentivize miners from confirming false records. Miners must complete challenging proof-of-work calculations that consume tremendous amounts of electricity to sustain sufficient computing power.

The proof-of-work equations become increasingly complex over time, necessitating more powerful computers and more electricity. Bitcoin’s electricity use is now controversial with many critics, including Treasury Secretary Janet Yellen, calling it wasteful and harmful to the environment.

To initiate a Bitcoin transaction, an owner needs access to a Bitcoin address and a private key. The Bitcoin address, a hashed version of the public key, is similar to a publicly shared bank account number. The private key is comparable to an exclusive password.

These are critical elements of a process called public-key encryption that cryptographically secures all transactions. All the “electronic coins” associated with a particular address are a “chain of digital signatures” because the number of bitcoins contained within any address always derives from the outputs of previous transactions.

A new transaction occurs when the owner digitally signs a transaction message with their private key, proves ownership of bitcoin associated with the address, and secures the directive before broadcasting into the network for confirmation.