It's more complicated than I can simplify in a short post. I have probably invested in about 4 hours total of research to understand the whole system. But I'll try to make it simple...
There is a controlled process set up to limit the total Bitcoins that can actually be put in electronic circulation (Capped at 250K). They are created when someone sets up a support site with a program that interacts with others to validate transactions (currently 50 Bitcoins). A person that writes the program/algorythm necessary for the system is rewarded and new Bitcoins are created. There are currently something like 125K in circulation. The system that support Bitcoins will not take more than 250K. So once the magic number is reached, all of the infrastructure (alledgedly) will be in place to support all transactions. And all transactions are are regulated and approved independently and by private consensus through the software that was set up by each of the users.
Pros - It is solid as long as there remains confidence, government doesn't regulate, demand stays consistent and acceptance expands. Cons - If you lose your wallet (figuratively and literally per the system), it's gone. There is no paper or value to hold for proof. If you lose a decryption code.... Also, trading is all speculation at the moment. The designers have tried to set it up to closely resemble the price fluctuations of precious metals. But, best I can tell, there is nothing tied to those values. The value of a Bitcoin is all confidence and speculation driven by the trading price.
Disclaimer: I am no where near an authority on this and only started researching it a couple weeks ago. So far, unless the price drops back to $1/Bitcoin, I'll not be investing. And as far as I am concerned, it is only viable as an investment. Trading them for goods would require timing purchases and sales just right to validate the value of any barter for the seller and buyer.
.... My cap numbers are way wrong. It’s 21 million not 250K. Had something else on my mind. Sorry.
Value is also reflected to a large degree by supply and the cost to produce them. The cost to produce Bitcoins has risen substantially and now requires expensive and limited ASIC miners to generated profit beyond even what the electricity would cost using the most efficient GPUs, and forget using CPUs - even for mining Litecoins.
Bitcoins are vapor...
Total bitcoins in circulation as of December 2013 12 Million Plus...