WHAT IS BITCOIN?
Bitcoin is a consensus network that enables a new payment system and completely digital currency. It is the first decentralized peer-to-peer payment network that is powered by its users with no central authority or middlemen. From a user perspective, Bitcoin can be considered to be cash for the Internet. Bitcoin can also be seen as the most prominent triple entry book keep in system in existence. While there are or have been at least 110 other digital currencies, Bitcoin accounts for 77% of the market value of all
digital currencies and an even higher percentage of digital currency users.
HOW DOES BITCOIN WORK?
From a user perspective, Bitcoin is nothing more than a mobile app or computer program that
provides a personal Bitcoin wallet and allows a user to send and
receive bitcoins with them. Behind
the scenes, the Bitcoin network shares a public ledger called the “block chain”. This ledger
contains every transaction ever processed, allowing a user’s computer to verify the validity of each transaction. The authenticity of each transaction is protected by digital signatures corresponding with the sending addresses, allowing all users to have full control over sending bitcoins from their own Bitcoin addresses. In addition, anyone can process transactions using the computing power of specialized hardware and earn a reward in bitcoins for this service. This is often called “mining”.
An address is like a bank account into which a user can receive, store, and send bitcoins.
Instead of being physically secured in a vault, bitcoins are secured with public key cryptography. Each address consists of a public key, which is published, and a private
key, which the owner must keep secret. Anyone can send bitcoins to any public key, but
only the person with the private key can spend them. While addresses are public,
knows which addresses belong to which people; Bitcoin addresses are pseudonymous.
After depositing your bitcoins into a “wallet”, the wallet alerts (“broadcasts”) every other
user of bitcoins that it contains bitcoins.
This information is incorporated into the block chain. The wallet generates a public key accessible to anyone and a private key (unless your wallet is on an exchange, such as Bitstamp) or address that authorizes sending bitcoins to other public addresses. If you want to, say, purchase a flight on Virgin Galactic, you contact them, make a user account (e.g., your name), and then tell them that payment will come from your public key. You then go to your wallet or exchange and broadcast the amount from your public key to their public key. This is published on a peer to peer.
Satoshi, in honor of Satoshi Nakamoto, the pseudonym of the inventor of Bitcoin), and potentially even smaller units if more than 21 trillion are ever required. As the average transaction size decreases, transactions can be denominated in sub units of a bitcoin, such as millibitcoins (1 mBTC or 0.001 BTC).
WON’T BITCOIN FALL IN A DEFLATIONARY SPIRAL?
The deflationary spiral theory says that if prices are expected to fall, people will move purchases into the future in order to benefit from lower prices. That fall in demand will in turn cause merchants to lower their prices to try and stimulate demand, making the problem worse and leading to an economic depression.
Although this theory is a popular way to justify inflation among central bankers, it does not appear to always hold true and is considered controversial among economists. Consumer electronics is one example of a market where prices constantly fall but which is not in depression. Similarly, the value of bitcoins has risen over time and yet the size of the Bitcoin economy has also grown dramatically along with it. Because both the value of the currency and the size of its economy started at zero in 2009, Bitcoin is counterexample to the theory, showing that it must sometimes be wrong.
ISN’T SPECULATION AND VOLATILITY A PROBLEM?
This is a chicken and egg situation. For bitcoin’s price to stabilize, a large scale economy needs to develop with more businesses and users. For a large scale economy to develop, businesses and users will seek price stability.
Fortunately, volatility does not affect the main benefits of Bitcoin as a payment system to transfer money from point A to point B. It is possible for businesses to convert bitcoin payments to their local currency instantly, allowing them to profit from the advantages of Bitcoin without being subjected to price fluctuations. Since Bitcoin offers many useful and unique features and properties, many users choose to use Bitcoin. With such solutions and incentives, it is possible that Bitcoin will mature and develop to a degree where price volatility will become limited. When that happens, bitcoins will be valued more for transactions than as a store of value.
WHAT IF SOMEONE BOUGHT UP ALL THE EXISTING BITCOINS?
Only a fraction of bitcoins issued to date are found on the exchange markets for sale. Bitcoin markets are competitive, meaning the price of a bitcoin will rise or fall depending on supply and demand. In additional, new bitcoins will continue to be issued for decades to come. Therefore even the most determined buyer could not buy all the bitcoins in existence. This situation isn’t to suggest, however, that the markets aren’t volatile; it still doesn’t take significant amounts of money to move the market price up or down.
WHAT IF SOMEONE CREATES A BETTER DIGITAL CURRENCY?
That can happen. For now, Bitcoin remains by far the most popular decentralized virtual currency, but there can be no guarantee that it will retain that position. There is already a set of alternative currencies inspired by Bitcoin. It is however probably correct to assume that significant improvements would be required for a new currency to overtake Bitcoin in terms of established market, even though this remains unpredictable. Bitcoin could also conceivably adopt improvements of a competing currency as long as it doesn’t change fundamental parts of the protocol.
WHY DO I HAVE TO WAIT 10 MINUTES FOR A TRANSACTION?
Receiving a payment is almost instantaneous with Bitcoin. However, there is a 10 minute delay on average before the network begins to confirm your transaction by including it in a block and before you can spend the bitcoins you receive. A confirmation means that there is a consensus on the network that the bitcoins you received haven’t been sent to anyone else and are considered your property. Once your transaction has been included in one block, it will continue to be buried under every block after it, which will exponentially consolidate this consensus and decrease the risk of a reversed transaction.
Every user is free to determine at what point they consider a transaction
confirmed, but six confirmations are safer than waiting three months on a credit card transaction.
HOW MUCH WILL THE TRANSACTION FEE BE?
Most transactions can be processed without fees, but users are encouraged to pay a small
voluntary fee for faster confirmation of their transactions and to remunerate miners. When fees are required, they generally don’t exceed a few pennies in value. Your Bitcoin client will usually try to estimate an appropriate fee, when required.
Transaction fees are used as a protection against users sending transactions to overload
the network. The precise manner in which fees work is still being developed and will
change over time. Because the fee is not related to the amount of bitcoins being sent, it
may seem extremely low (0.0005 BTC for a 1,000 BTC transfer) or unfairly high (0.004
BTC for a 0.02 BTC payment).
The fee is defined by attributes such as data in transaction
and transaction recurrence. For example, if you are receiving a large number of tiny
amounts, then fees for sending will be higher. Such payments are comparable to paying a restaurant bill using only pennies. Spending small fractions of your bitcoins rapidly may also require a fee. If your activity follows the pattern of conventional transactions, the fees should remain very low.
WHAT IF I RECEIVE A BITCOIN WHEN MY COMPUTER IS POWERED OFF?
Bitcoins will appear the next time you start your wallet application. Bitcoins are not actually received by the software on your computer; they are appended to a public ledger that is shared between all the devices on the network. If you are sent bitcoins when your wallet client program is not running and you later launch it, it will download blocks and catch up with any transactions it did not already know about, and the bitcoins will eventually appear as if they were just received in real time. Your wallet is only needed when you wish to spend bitcoins.
WHAT DOES “SYNCHRONIZING” MEAN AND WHY DOES IT TAKE SO LONG?
Long synchronization time is only required with full node clients like Bitcoin
speaking, synchronizing is the process of downloading and verifying all previous Bitcoin
transactions on the network.
For some Bitcoin clients to calculate the spendable balance of your
Bitcoin wallet and make new transactions, it needs to be aware of all previous transactions. This step can be resource intensive and requires sufficient bandwidth and storage to accommodate the full size of the block chain. For Bitcoin to remain secure, enough people must keep using full node clients because they perform the task of validating and relaying transactions.
WHAT IS BITCOIN MINING?
Mining is the process of spending computing power to process transactions, secure the network,and keep everyone in the system synchronized together. It can be perceived like the Bitcoin data center except that it has been designed to be fully decentralized with miners operating in all countries and no individual having control over the network.
This process is referred to as “mining”as an analogy to gold mining because it is also a temporary mechanism used to issue new bitcoins. Unlike gold mining, however, Bitcoin mining provides a reward in exchange for useful services required to operate a secure payment network. Mining will still be required after the last bitcoin is issued.
HOW DOES BITCOIN MIN
Anybody can become a Bitcoin miner by running software with specialized hardware. Mining software listens for transactions broadcast through the peer to peer network and performs appropriate tasks to process and confirm these transactions. Bitcoin miners perform this work because they can earn transaction fees paid by users for faster transaction processing as well as newly created bitcoins issued into existence according to a fixed formula.
For new transactions to be confirmed, they need to be included in a block along with a
mathematical proof of work. Such proofs are very hard to generate because there is no
way to create them other than by trying billions of calculations per second. This requires
miners to perform these calculations before their blocks are accepted by the network and before they are rewarded. As more people start to mine, the difficulty of finding valid blocks is automatically increased by the network to ensure that the average time to find a block remains equal to 10 minutes. As a result, mining is a very competitive business where no individual miner can control what is included in the block chain.
The proof of work is also designed to depend on the previous block to force a
chronological order in the block chain. This makes it exponentially difficult to reverse
previous transactions because this requires the recalculation of the proofs of work of all
the subsequent blocks. When two blocks are found at the same time, miners
work on the first block they receive and switch to the longest chain of blocks as soon as the next block is found. This allows mining to secure and maintain a global consensus based on processing power.
Bitcoin miners are neither able to cheat by increasing their own reward nor process
fraudulent transactions that could corrupt the Bitcoin network because all Bitcoin nodes
would reject any block that contains invalid data as per the rules of the Bitcoin protocol.
Consequently, the network remains secure even if not all Bitcoin miners can be trusted.
ISN’T BITCOIN MINING A WASTE OF ENERGY?
Spending energy to secure and operate a payment system is hardly a waste. Like any other
payment service, the use of Bitcoin entails processing costs. Services necessary
for the operation
widespread monetary systems, such as banks, credit cards, and armored vehicles, also
use a lot of energy. Although unlike Bitcoin, their total energy consumption is not transparent and
cannot be as easily measured. Also, Bitcoin doesn’t require an expensive Federal Reserve System ($5.1 billion), Secret Service ($1.4 billion), or Bureau of Engraving and Printing ($0.8 billion).
Bitcoin mining has been designed to become more optimized over time with specialized
hardware consuming less energy, and the operating costs of mining should continue to
be proportional to demand. When Bitcoin mining becomes too competitive and less
profitable, some miners choose to stop their activities. Furthermore, all energy expended
mining is eventually transformed into heat, and the most profitable miners will be those
who have put this heat to good use. An optimally efficient mining network is one that isn’t actually consuming any extra energy. While this is an ideal, the economics of mining are such that miners individually strive toward it.
HOW DOES MINING HELP SECURE BITCOIN?
Mining creates the equivalent of a competitive lottery that makes it very difficult for anyone to consecutively add new blocks of transactions into the block chain. This protects the neutrality of the network by preventing any individual from gaining the power to block certain transactions. This also prevents any individual from replacing parts of the block chain to roll back their own spending, which could be used to defraud other users. Mining makes it exponentially more difficult to reverse a past transaction by requiring the rewriting of all blocks following this transaction.
WHAT DO I NEED TO START MINING?
In the early days of Bitcoin, anyone could find a new block using
their computer’s central
processing unit (CPU). Next, miners used video game graphic cards and then to pin grid array
As more and more people started mining, the difficulty of finding new blocks increased greatly to
the point where the only cost effective method of mining today is using specialized hardware.
Adoption of application specific integrated circuits (ASIC) customized for bitcoin mining has recently had a noticeable increase in the speed of bitcoin issuance.
IS BITCOIN SECURE?
The Bitcoin protocol uses the strongest algorithms used by the NSA for encrypting Secret level documents. Anyone can generate as many addresses as they want for free. There are approximately as many possible Bitcoin addresses are there are atoms in the Earth, so generating duplicate addresses (and thus having access to someone else’s funds) practically impossible.
Most Bitcoin users maintain a number of addresses, stored in a digital wallet.
The Bitcoin technology the protocol and the cryptography has
a strong security track record,and the Bitcoin network is probably the biggest distributed computing project in the world. Bitcoin’s most common vulnerability is user error. Bitcoin wallet files that store the necessary private keys can be accidentally deleted, lost, or stolen. This is pretty similar to physical cash stored in a digital form. Fortunately, users can employ sound security practices to protect their money or use service
providers that offer good levels of security and insurance against theft or loss.
HASN’T BITCOIN BEEN HACKED IN THE PAST?
The rules of the protocol and the cryptography used for Bitcoin are still working years after its inception, which is a good indication that the concept is well designed. However,security flaws have been found and fixed over time in various software implementations. Like any other form of software, the security of Bitcoin software depends on the speed with which problems are found and fixed. The more such issues are discovered, the more Bitcoin is gaining maturity.
There are often misconceptions about thefts and security breaches that happened on diverse exchanges and businesses. Although these events are unfortunate, none of them involve Bitcoin itself being hacked, nor imply inherent flaws in Bitcoin; just like a bank robbery doesn’t mean that the dollar is compromised. However, it is accurate to say that a complete set of good practices and intuitive security solutions is needed to give users better protection of their money, and to reduce the general risk of theft and loss. Over the course of the last few years, such security features have quickly developed, such as wallet encryption, offline wallets, hardware wallets, and multi signature transactions.
On the whole, the crypt-graphic and game theoretical foundations behind the Bitcoin system have proven to be rock solid, and the fact that no one has yet claimed the $140 million reward for breaking these foundations is a testament to this. To the average user, there are only two ways to
lose one’s bitcoins to malicious activity: entrust the bitcoins to a third party service that turns out to itself be insecure or fraudulent, or have your own computer get hacked by a computer virus both of which are problems in the traditional financial system as well, costing the U.S. economy $50 billion per year.
COULD USERS COLLUDE AGAINST BITCOIN?
It is not possible to change the Bitcoin protocol that easily. Any Bitcoin client that doesn’t comply with the same rules cannot enforce their own rules on other users. As per the current specification, double spending is not possible on the same block chain, and neither is spending bitcoins without a valid signature. Therefore, it is not possible to generate uncontrolled amounts of bitcoins out of thin air, spend other users’ funds, corrupt the network, or anything similar.However, a majority of miners could arbitrarily choose to block or reverse recent transactions. A majority of users can also put pressure for some changes to be adopted. Because Bitcoin only works correctly with a complete consensus between all users, changing the protocol can be very difficult and requires an overwhelming majority of users to adopt the changes in such a way that remaining users have nearly no choice but to follow. As a general rule, it is hard to imagine why any
Bitcoin user would choose to adopt any change that could compromise their own money.
IS BITCOIN VULNERABLE TO QUANTUM COMPUTING?
Yes, most systems relying on cryptography in general are, including traditional banking systems. However, quantum computers don’t yet exist and probably won’t for a while. In the event that quantum computing could be an imminent threat to Bitcoin, the protocol could be upgraded to use post quantum algorithms. Given the importance that this update would have, it can be safely expected that it would be highly reviewed by developers and adopted by all Bitcoin users