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5 Essential Bitcoin Questions Answered

What is Bitcoin, and where does it come from?

Earlier this month, Paypal announced that their subsidiary company Braintree, will accept Bitcoin transactions. The platform, which facilitates online and mobile payments, will work with the Bitcoin online wallet and payment site Coinbase, to allow Bitcoin transactions to be made. Despite the adoption, there is (as yet) no indication that eBay or Paypal will also adopt the currency, although it’s likely that this development will nudge the two in that direction.

Despite its growing adoption, Bitcoin is still a bit of an enigma for some people. If this is you, we’ve covered the 5 most essential questions you’re likely to have about Bitcoin.

1) What is Bitcoin?

Bitcoin is the world’s first decentralised digital currency; because Bitcoin is “the currency of the internet”, it can be used worldwide both online and in shops that accept it as a means of payment. Bitcoins are exchanged directly from user to user through the internet, so there is no bank, institution or central authority that holds your money - something that distinguishes Bitcoin from traditional ‘physical’ currencies.

By and large, Bitcoin works like any other currency. You can buy products, trade and exchange it with other currencies, gamble, tip, invest, and even receive regular income with it (though few organisations actually do this). All you need is a Bitcoin wallet, basically a digital wallet stored on your computer or mobile device. From there, you can start trading on Bitcoin exchange sites and buying products using the Bitcoins in your wallet.

2) Who created Bitcoin?

Bitcoin (or its ideology) was allegedly first conceived by Satoshi Nakamoto in 2008, publishing a paper describing a digital currency, its code and the mathematics behind it on a cryptography mailing list. Mysteriously however, there is speculation as to the real identity of Satoshi Nakamoto with some suggesting the name is a pseudonym, representative of an individual or a group of people have been fluttering around for the last few years. There have been several attempts to unmask its creator, but none have been successful so far. Interestingly, of all Bitcoin ‘accounts’, there are a few which stand out for holding a substantial amount of Bitcoins (around 100,000). At one stage earlier this year, this was equivalent to around 1 billion US dollars. It’s believed that one of these accounts might belong to its creator.

3) How does Bitcoin work?

Each Bitcoin transaction has its own unique code (a transaction ID) consisting of a long string of digits. While there’s no single central authority that controls Bitcoin transactions, the transactions are overseen by thousands of individual regulators called Bitcoin ‘miners’. These miners download Bitcoin’s complex computer code (created by Nakamoto) and use their computers to confirm payments, identifying and wiping any false codes or attempts to use the same transaction ID twice. Once confirmed, the transaction ID is stored on a transparent public ledger that holds every single Bitcoin transaction ID in history known as a ‘blockchain’. If the payment is not confirmed on this blockchain, it does not exist.

In return for this (lengthy) validation work, miners are rewarded with a small amount of newly generated Bitcoins (though the rate-of-return per transaction verified is very small), as well as transaction fees that are added to Bitcoin payments. Transaction fees are optional for the payer, though the incentive is that their transaction is more likely to be confirmed sooner. This is because miners can choose which transactions to confirm and are thus more likely to choose those that have a transaction fee (at the moment, the average transaction confirmation time is 8 minutes).  

Otherwise, Bitcoin is like any other currency. It has its own exchange rate and ties in with other currencies around the world. Google and Yahoo added Bitcoin’s conversion price to their financial tools in June this year, so it is evidently becoming increasingly recognised as a legitimate currency and method of payment.

4) Where do Bitcoins come from?

In conjunction to confirming payments and earning newly generated Bitcoins, miners can also specifically ‘mine’ for new Bitcoins by solving complicated mathematical problems. In its early stages when the volume of Bitcoins in circulation was small, the problems were easier to solve. Now, these problems are very complicated and time-consuming due to the number of users and miners. As the mining-rate increases, so does the difficulty of the mathematical problems being solved.

As a result, many opt to use specialised Bitcoin mining technology - ‘application-specific integrated circuits' (ASICs). ASICs are not only more time-efficient but also economically-efficient. This is because they outperform ordinary CPUs and also use much less electricity. If you do it on a normal computer, the cost of the electricity is more than the value of the Bitcoin. Another method some miners adopt is working in groups known as ‘mining pools’, essentially sharing the workload and the Bitcoins they mine (proportionate to the amount of work each puts in).

There is a finite amount of Bitcoin units (21 million) and these will eventually have all been mined, though this won’t be for quite some years; decades, maybe even next century.

5) What are some of the pros and cons of Bitcoin?

Pros

  • You could pay anyone, anywhere at anytime as long as they use Bitcoin and you have an internet connection.
  • Personal information isn’t tied to the transaction - so it’s somewhat protected against identity theft. While anyone can view people’s payments, your personal information is hidden.
  • There are very low and very few fees with Bitcoin. Transaction fees are low, and Digital Currency exchange sites generally charge lower fees than Paypal or credit card companies.
  • It’s projected that as more and more businesses adopt the currency (which is the case at the moment), its volatility will decrease.

Cons

  • Despite its online circulation and worldwide base, there are still relatively few users. While companies like Expedia and Braintree do accept the currency, the figure is still small.
  • There is also a small amount of Bitcoins in circulation. As a result, small activity, trades and business transactions can cause massive fluctuations in price. Therefore it is ill-advised to invest your savings with Bitcoin.
  • Its anonymity and low-traceability means that it is ideal for criminal activity. Black markets like ‘Silk Road’ (an online drugs market) have given the digital currency some bad publicity and heavy associations with crime (at one stage, 4.5-9% of all Bitcoin transactions were for drug trades on Silk Road). It was shut down by US law enforcement in 2013, though alternative sites are still running.
  • Although anonymous, Bitcoin theft is quite common; Bitcoin-related malware can be harnessed to steal wallets. Furthermore, because transactions are irreversible, you cannot undo unauthorised transactions and get your money back. Having said this, there are some built-in features that can help prevent theft.


This is a guest blog for Spektrix by Robin Sheffield.

Image credit: Perfect Hu