I was avoiding the topic of bitcoins fearing it would take too long to wrap my head around it. But it’s time I bit the bullet.
Like everyone else, I want to be able to answer questions like: ‘Are crypto currencies a good thing? What are the risks and are these being adequately addressed?’ How do crypto currencies other than Bitcoin fit in to the picture?’.
But before you can form an opinion on these matters, you need to know what Bitcoin is and how digital currencies work. The problem for people who are new to the conversation is that the discussion is filled with vocabulary and concepts that are unfamiliar to many of us such as:
Bitcoin is not the only crypto currency; there are many others but this article will focus on Bitcoin for simplicity. Furthermore, this post is an introduction to the topic and will not explore in detail the opportunities represented by Bitcoin or the security concerns.
I wasn’t sure how to start this post and then decided to begin in the middle with a massive oversimplification; and then explain as I go along. Be patient.
Here is how it works:
You decide to pay somebody in bitcoins.
You identify the person you’d like to pay; you’ll need their public encryption key.
You make your payment and sign it using your private encryption key; this identifies the payment is from you.
You don’t have to go through an intermediary.
The recipient will use your public encryption key to identify you as the payment sender.
The recipient accepts the payment and signs for it using their private encryption key.
The transaction is recorded publicly for all to see and your respective account balances are adjusted accordingly. This public ledger is also referred to as the block chain.
The block chain only shows the transaction i.e amount transferred as well as the respective public keys for the sender and receiver. It does not publicly display each account balance.
Each bitcoin has it’s own serial number that identifies it as unique so the same person cannot spend the same bitcoin twice.
The system is designed to make it difficult to send the same bitcoins to multiple people by
making it mathematically complicated for this to occur,
making it very machine-energy intensive to do this (you’d need a great deal of processing power),
making transactions public and asking the community to verify these; a reward of 25 bitcoins goes to the miner who confirms a valid transaction
Here are some things you’ll need if you want to own and spend bitcoins:
Private & public encryption key-pair
You’ll need a wallet. This is a program where you’ll keep your bitcoins and which will allow you to transact with other users: https://bitcoin.org/en/choose-your-wallet
You can ask your wallet to generate a bitcoin address.
Private and public encryption key
When you wallet generates a bitcoin address for you it will also provide you with a public-private encryption key pair.
Your private encryption key will be used to sign any payments you make.
Your public key is your bitcoin address.
Now that you have your wallet, how can you load it up with juicy bitcoins?
The easiest way is to just buy them. You can get these via a bitcoin ATM machine. These are cropping up all over the world. Singapore, my current city, had it’s first last month. UK opened its first this month in London. Or buy them on a bitcoin exchange platform. Use this site to see how to buy bitcoins in the country you’re in.
Apparently you can earn them online doing menial tasks like completing CAPTCHA forms, entering specific Google search terms, looking at online ads. Probably not the best way.
You can ‘mine’ for bitcoins. This involves using your computer to validate transactions. For each block of transactions you validate you will earn 25 bitcoins. But it takes a great deal of computer processing power to do this.
Hmm, I still have some questions:
How many bitcoins are there? Who controls supply?
There will be a finite supply of bitcoins in circulation due to the mathematical formula used to create them. The supply reduces by half every 4 yrs and by 2140 no more will be generated. The total number in circulation at that time will be 21million.
How are they made or found?
A bitcoin is a complex bit of code that fits a mathematical formula; so complex that you need huge amounts of computer processing power to try gazillions combinations to find code to fit that specific formula. This process is called mining and it is also how bitcoins are created.
What does mining for bitcoins mean?
Mining is the name given for processing and validating transactions. The miner who validates a block of transactions gets rewarded with 25 bitcoins. This is the incentive that allows everyone in the system to be involved in verifying transactions. It used to be 50 bitcoins. Every four years, the reward is halved.
Who came up with bitcoin?
Satoshi nakamoto who?
You will never know
Where does Bitcoin’s value come from?
As one silicon valley investor says, bitcoins don’t have an arbitrary value. It’s value comes from the fact that it’s a money transfer system that can be used by anyone, anywhere, with no fraud and low or no fees. The more it is used, the more valuable it becomes. If everyone were to stop using it, it would be worthless.
What is the minimum unit of a bitcoin?
10-8 (it’s called a satoshi).
What is a block chain?
A block chain is a permanent record of all Bitcoin transactions; it’s available for all to see.
How can we trust the blockchain/ public ledger as a source of transaction information?
Bitcoin uses a proof-of-work system called Hashcash. Each block in the block chain has a unique hash (a small, random series of letters and numbers). Think of this thing called the hash as a wax seal that cannot be tampered with without EVERYBODY knowing about it. Any tampered blocks would then be ignored by everyone.
What are the benefits of using Bitcoin?
Anyone can use it; you don’t need to go through a 3rd party; there are no or low transaction fees; every transaction can be viewed on the blockchain; supporters say there are no or minimal opportunities for fraud unlike with credit cards.
Is there a bank?
There is no bank. Everybody in the system is collectively a bank. Bitcoin works as a peer-to-peer network i.e there is not central server; each client receives and sends information to other client servers. As mentioned above, anyone can make a payment to anyone else directly and all transactions will be publicly available. You don’t have to go via a 3rd party and therefore pay any 3rd party fees.
Bitcoin as a protocol – why are people so excited about this?
It isn’t the currency but the underlying Bitcoin platform that is the source of excitement. The platform is expected to disrupt the economy and society. This Wired article talks about how tomorrow’s apps will be based on Bitcoin code.
Some useful links to Bitcoin related articles
These articles were helpful to me as a Bitcoin newbie.
- I like this article by entrepreneur and investor, Mark Andreessen, because it was one of the first I’d read that helped me understand the promise of Bitcoin; it gave me a baseline understanding.
- This post by Michael Nielsen, writer, programmer and scientist talks you through the Bitcoin protocol in stages.
- This qz.com article also explains quite well how Bitcoin works and touches on the issues of privacy and security.
- I really liked this article which compares bitcoins to digital apples. Bitcoin simplified.
- In this article, a silicon valley investor and entrepreneur talks about how Bitcoin will be great for the ‘unbanked’ people of the Philippines
- The first 2-3 paragraphs here talks about setting up your wallet and client
- A simple description from bitcoin.org covering basics for the new user.
- I liked the section on the use of the hash in this article. Talking about each block having a wax seal helped me understanding this a bit better.
- This article talks about the risk to Bitcoin of miners working together and forming a collective with a large enough processing power to manipulate the record of future transactions.
- The original paper on Bitcoin.
Some questions that I can’t answer yet:
What do events like the Mt Gox bankruptcy due to loss of the bitcoins on its exchange platform mean?
What protection is available to anyone who has had their bitcoins stolen?
What additional security measures exist to safeguard the bitcoins in your wallet?
If you’ve gotten this far down and spotted any mistakes, please do let me know and I’ll update this post. I’m off to a Bitcoin event this week; hopefully I’ll come back with a better understanding of the topic!