WHAT IS BITCOIN AND HOW DOES IT WORK?
Bitcoin is the Internet’s version of money. It is also known as crypto-currency, because at it’s core, it has a cryptographic protocol. Unique pieces of digital property which can be transferred from one person to another is created by the protocol. A Bitcoin can’t be spent twice, the protocol ensures that.
Bitcoin is not just a token of value it is also a method of transferring that value. Bitcoins are generated using an open-source computer program to solve complex math problems in a process known as mining. Bitcoins are defined by a public address and a private key, which are long strings of numbers and letters that give each a specific identity. Bitcoins also have a unique digital fingerprint.
Bitcoins are characterized by their position in a public ledger of all Bitcoin transactions which is known as the blockchain. Hence, buying a Bitcoin can be thought of as buying a spot in the blockchain, which then records your purchase publicly and permanently.
A distributed network of computers around the world maintains the block chain. This means that no one entity, such as a government, controls it. Transactions happen digitally from person to person, without middlemen such as banks or clearinghouses. The official record for all of these transactions is the public Bitcoin network. Bitcoins can be transferred personally.
This direct approach greatly reduces the fees involved with transferring traditional money. And makes sending and receiving money across the globe is made much easier and faster. Bitcoin gives an efficiency increase relative to banking transactions which can be compared to the efficiency of email versus physical email.
People primarily buy and sell Bitcoins through online exchanges. To trade, sell, and spend Bitcoin, the public address and private keys are both required.
Even though the transaction is recorded publicly, the identities of the buyers and sellers are veiled to each other. This is because transactions are done using the public keys.
Bitcoins are more pseudonymous than anonymous.Transactions are currently quite difficult to trace, which explains why Bitcoin has been associated with illicit activity, such as buying and selling drugs on the now-defunct Silk Road market.
Bitcoins can be saved in a wallet just like paper money. They store the public and private keys needed to identify the Bitcoins and execute a transation. These can be digital wallets that exist in secure cloud environments or on a computer, or they can take physical form. If a wallet is hacked or you lose your private Bitcoin key, you no longer have access to that Bitcoin. Possession of the public address and private key amounts to possession of the Bitcoin.
Bitcoin can either be used to buy things online from merchants and organizations that recognise and accept Bitcoin, or it can be cashed out through an exchange, broker, or direct buyer.
WHERE DO BITCOINS COME FROM?
With paper money, a government regulates when and how much cash to print and distribute. Bitcoin on the other hand, doesn’t depend on a central bank or government — people create Bitcoins through mining.
Mining is the process of solving complex math problems (also called “hashing”) using computers running Bitcoin software. This requires more computing power than regular PCs have, so people buy specialized Bitcoin machines or form groups that chain multiple computers together to mine.
When the program solves one of these problems, it creates “blocks,” or encrypted Bitcoin transactions. When you (or your pool) solve a block, you are rewarded with Bitcoins.
These cryptographic puzzles get increasingly harder as more Bitcoins enter circulation. Also, the rewards are cut in half at regular intervals. Put in another way, there’s a gradual slow-down in the rate at which new Bitcoins enter circulation. There is a built-in limit of 21 million Bitcoins, meaning when this many have been mined, production will stop completely.
A single Bitcoin can be divided down to 8 decimals, and people can transact with fractions of Bitcoins, known as satoshis, so even if one Bitcoin is worth a lot, the system is still useful for very tiny transactions.
The blocks created by mining make up the transaction record of the Bitcoin system. Every block contains a hash of the previous block, which creates a transaction database — the previously referenced blockchain. The blockchain is a public ledger and records all transactions in chronological order.
A new block is added to the blockchain an average of once every ten minutes. Rather than being maintained by a central body, it is distributed across all the mining computers.
HOW DO YOU BUY OR SELL BITCOIN?
People commonly buy and sell Bitcoins through exchanges. In order to make transactions on an exchange, you must have a Bitcoin wallet to keep your currency in.
The most well known and one of the largest Bitcoin exchanges is Japan-based Mt. Gox, which is a market exchange — meaning buy orders are matched with sell orders. (Editor’s Note: Mt. Gox filed for bankruptcy and shut down in late February.)
Other exchanges considered reputable are BTC China, Bitcoin.de (Germany), VirtEx (Canada), Bitstamp (Slovenia), BTC-e (Bulgaria), CampBX (U.S.), and Bitcurex (Poland). There are also fixed-rate exchanges and brokers, such as Coinbase, that will trade for you.
Remember, you have to be very careful about where you place your trust and your money: Bitcoin exchanges are not highly regulated. While this is part of the appeal for many, it does make it easier to get cheated.
Once you have settled on a broker or exchange, you create an account with a user name and password and link your bank account. Mt. Gox (and others) ask for personal information and photographic scan of a drivers license, passport, or national ID card. Coinbase asks for your phone number, and some exchanges even require a recent utility bill to confirm your identity and location.
Now you can start buying.
Coinbase and Bitstamp make it pretty easy to buy Bitcoins, exchanging real-world money from your bank for the virtual currency, or vice versa. For first time buyers, there is usually a delay of a couple days to a week for orders to go through.
When you want to sell, you make sure your wallet is loaded with your Bitcoins, and all you have to do is click “sell.”
Some people prefer to conduct Bitcoin transactions offline. As mentioned above, every Bitcoin has a private, unique, and long numerical ID. If you write this key down or store it on a local drive, you can trade a Bitcoin simply by passing that key off to someone else.
LocalBitcoins.com is a platform that connects people looking to buy and sell locally with trading partners around the world in more than 4,500 locations. This approach can actually be faster than going through a centralized exchange, and it offers more flexible payment options, such as PayPal, cash, and Western Union.
A relatively new method is a Bitcoin ATM made by Robocoin. The first machine opened at a coffee shop in Vancouver, Canada, in October. It allows you buy, sell, and trade Bitcoin in exchange for cash and checks in 60 different currencies.