Bitcoin - layman's explanation

A plain English explanation of the theory behind Bitcon-like virtual currencies. Some oversimplifications have been made in the interest of clarity and brevity. But if you find outright errors or have suggestions for improvements, let me know!

The perfect currency

Imagine a fantasy society. They have the same exchange problem as us — they can’t barter one tenth of a horse for a mug of beer or half a haircut for a loaf of bread. Our society’s ancestors solved this problem by switching to gold and other precious metals — you can divide it into very tiny units, it doesn’t rot and everybody recognizes its value.

But in this fantasy society, they have alchemy — they can create any metal they want (we’ll get there someday too, through matter transmutation). In this place, a grain of gold is no different from a grain of sand. Yes it’s useful, but nobody will accept it as payment because it’s so abundant. It’s just like you won’t accept air as payment even though it’s technically more valuable to human life than food.

So what do they do? They devise a type of magic coin and a magic wallet (later we will replace this magic with technology). This type of coin is impossible to copy or forge perfectly. It’s not even possible to create it at will, because then everyone will do it and it’ll be about as valuable as sand again. So it has to have a limited supply. The magic works by creating these coins periodically. Who gets the newly created coins? Everybody. Since this is not a finders-keepers scenario like in gold mining, it’s only fair. Newly generated coins periodically appear in everyone’s wallets. And these coins can be neatly split into smaller coins so that they can be spent in any fraction you want.

Now a human being can’t tell whether one of these coins is the real thing or not by just looking at it. The wallet does it for you. If you receive a fake coin from someone and try to put it in your wallet, your wallet will spit it out immediately. Doesn’t that solve this society’s currency problems? Let’s see: