An agreement amongst a community of people to use 21 million secure mathematical tokens, "bitcoins", as money - just like everyone agrees that the paper currency issued by Central Banks is also money.
Bitcoin is the first decentralized electronic currency not controlled by a single organization or
government. It's an open source project, protected by the Blockchain Protocol and is used all over the world. People are trading hundreds of thousands of dollars worth of bitcoin every day with no middle man and no credit card companies. It's a startup currency which has never happened before.
Bitcoin is the first digital currency that is completely distributed. The network is made up of users like yourself so no bank or payment processor is required between you and whoever you're trading with. This decentralization is the basis for Bitcoin's security and freedom.
From a user perspective, Bitcoin is nothing more than a mobile app or computer program that provides a personal Bitcoin wallet and enables a user to send and receive bitcoins.
Behind the scenes, the Bitcoin network is sharing a massive public ledger called the "block chain". This ledger contains every transaction ever processed which enables a user's computer to verify the validity of each transaction. The authenticity of each transaction is protected by digital signatures corresponding to the sending addresses therefore allowing all users to have full control over sending bitcoins.
Thus, there is no fraud, no chargebacks and no identifying information that could be compromised resulting in identity theft.
The first Bitcoin specification and proof of concept was published in 2009 by an unkown individual under the pseudonym Satoshi Nakamota who revealed little about himself and left the project in late 2010. The Bitcoin community has since grown exponentially.
Everyone has access to all the source code all of the time any developer can review or modify the software code. As such, the identity of Bitcoin's inventor is probably as relevant today as the identity of person who invented paper.
Nobody owns the Bitcoin network much like no one owns the technology behinds email or the Internet. As the heart of the system, the block chain fixes all the problems by creating a single master registry of the already cryptographically-secured bitcoin transfers, verifying them and locking them down in a highly competitive market called mining.
New bitcoins are generated by competitive and decentralized process called "mining". The process involves that individuals are rewarded by the network for their services. Bitcoin miners are processing transactions and securing the networks using specialized hardware and are collecting new bitcoins in exchange.
The trust is accomplished by the use of powerful cryptography many times stronger than that used by banks. Instead of simply being "sent" coins have to be cryptographically signed over from one entity to another, essentially putting a lock and key on each token so that bitcoins can be securely backup in multiple places, and so that copying doesn't increase the amount you own.
Bitcoin user are in full control of their transactions; it is possible for merchants to force unwanted or unnoticed charges as can happen with other payment methods. Bitcoin payments can be made without personal information tied to the transaction. This offers strong protection against identity theft. Bitcoin users can also protect their money with backup and encryption.
Bitcoin is designed to allow its users to send and receive payments with an acceptable level of privacy as well as any other form of money. However, Bitcoin in not anonymous and cannot offer the same level of privacy as cash. The use of Bitcoin leaves extensive public record. Various mechanisms exist to protect users' privacy.
The Financial Crimes Enforcement Network (FinCEN), which is an agency within the USA Treasury Department, took the initiative to regulate Bitcoin activities. It published guidelines about the use of virtual currencies. Since then, Bitcoin has been deemed legal in most countries, and is awaiting a proper legal status in just a few countries. Jurisdictions such as Argentina and Russia severely restrict or ban foreign currencies. The legal status of Bitcoin has not been challenged in Pakistan so far.
The price of Bitcoin is determined by supply and demand. When demand for bitcoin increases the price increases, and when demand falls, the price falls. There is only a limited number of bitcoins in circulation and new bitcoins are created at a predictable and decreasing rate, which means that demand must follows this level of inflation to keep the price stable.