What Is Bitcoin?

What are bitcoins worth?

The value of bitcoins in real world dollars fluctuates wildly—often as much as 8 percent per day. As little as two months ago, the exchange rate was $1 USD per bitcoin. That was before the mainstream world learned about them, though—which sent their value through the roof.

Speculators quickly saw potential in this new currency and began buying them through Mt. Gox and other sites. Given the currency's instability, that led to rapid inflation and the currency value peaked at nearly $28 on June 9.

These days, you can expect to pay somewhere between $15 and $20 per bitcoin.

How do bitcoins work?

Because they're virtual, bitcoins aren't backed by any real world commodity, such as gold or a central bank. Instead, they rely on the economic laws of supply and demand, making them something of a roll of the dice for investment-minded speculators—the same people who bet on penny stocks for a big payoff.

Most people who use bitcoins buy them from an exchange or trader. It's the fastest, easiest way to get the currency.

Others, though, dedicate a portion of their computer's power to run a transaction-validating software app, which helps police the system. As a reward, they can earn new bitcoins when they are released.

Doing so is a very complicated and very slow process, though. It's called mining—and the comparison to diamond or mineral miner is apt, since both groups are looking for a material that is not inexhaustible. The bitcoin system is designed so there will never be more than 21 million bitcoins in existence.

Every four years, the number of new coins that will spring into existence—or be mined—will be cut in half, until the supply is exhausted in approximately 2030. After that, the only way to get bitcoins will be via exchanges. (At present, there are about 6.6 million in circulation.)

One other important note: Those previously mentioned complicated transaction addresses (the ones comprised of long strings of numbers) have fooled some people into thinking all bitcoin purchases are completely anonymous. That's not necessarily true.

The system records every transaction, so it can trace the movement of coins and avoid counterfeits. The Bitcoin dev team says law enforcement officials already monitor that log (which is made available to the public), so anyone using the currency to conduct illegal transactions is rolling the dice.

Are bitcoins safe?

Because it's a currency that's based solely in the online world, bitcoins are subject to the same threats as anything else on the Internet, specifically hackers. And that's when the lack of a backing commodity shines through.

On June 19, Mt. Gox, the most popular bitcoin exchange, saw the value of the currency drop from $17 to nearly zero in just a few minutes after hackers gained access to an account with a large number of bitcoins, and sold them all off. The site suspended trading for six days, as it upgraded security and "rolled back" exchange prices to the pre-hack level.

The hack and others like it underscore the problem with the unregulated nature of bitcoins. The unnamed owner of that Mt. Gox account, as well as the owner of another unrelated account who saw 25,000 bitcoins (worth roughly $500,000 at the time) stolen, has little to no chance of recovering his or her investment.

The FDIC doesn't guarantee virtual currencies.