BITCOINS: THE
POWER OF DIGITAL CURRENCY
By Theophilus Amenger
The
idea of digital currency is slowing starting to make the rounds, including the
potential for bitcoin, but what many of us don't realize is that's it's here to
stay. Sure, it's had a rough start, but once established and disseminated,
electronic cash will allow for efficient and convenient online exchanges — and
all without the need for banks. Through many of its unique properties, bitcoin
allows exciting uses that could not be covered by any previous payment system.
Despite
the obvious need for a distributed digital currency protocol, the adoption rate
has been relatively slow. Barriers to entry include availability (it's in
limited supply), the cryptography problem (the public still needs to be assured
that it's secure), the establishment of a recognized and trustworthy dispute
system (sensing some opportunities here), and user confidence (a problem
similar to the one that emerged when paper money first emerged).
Bitcoin is a software-based online payment system described by Satoshi
Nakamoto in 2008 and introduced as open-source software in 2009. Payments are
recorded in a public ledger using its own unit of account, which is also called
bitcoin. Payments work peer-to-peer without a central repository or single
administrator, which has led the US treasury to call bitcoin a decentralized
virtual currency. Although its status as a currency is disputed, media reports
often refer to bitcoin as a cryptocurrency or digital currency.
Bitcoins act like cash,
but they are mined like gold. Bitcoins aren't cash, technically. They are virtual
"tokens" that can be exchanged for goods and services from select
retailers, contractors and online trading houses. Rather than going through a
bank or financial institution, though, tokens are exchanged directly from
person to person.
Since bitcoins are not based on any real
world commodity, such as gold or a central bank, investing in them is not for
the cowardly. Their value is based solely on the economic laws of supply and
demand. Currently the value fluctuates between $15 to $20 per bitcoin.
The tokens themselves are generated by
an app that sits on users' computers and that trades the processing power of
those machines (which is used to process transactions) for new bitcoins.
Every four years, the number of coins
that will spring into existence – or be "mined" – will be cut in
half, until the supply (a finite number of 21 million bitcoins) is exhausted
around 2140. About 11 million bitcoins are in circulation now.
How
Does Bitcoin Work?
This is a question that often causes
confusion. Here's a quick explanation!
The basics for a new user:
As a new user, you can get started with bitcoin without understanding the
technical details. Once you have installed a bitcoin wallet on your computer or
mobile phone, it will generate your first bitcoin address and you can create
more whenever you need one. You can disclose your addresses to your friends so
that they can pay you or vice versa. In fact, this is pretty similar to how
email works, except that Bitcoin addresses should only be used once.
Balances - block chain:
The block chain is a shared public ledger on
which the entire Bitcoin network relies. All confirmed transactions are
included in the block chain. This way, Bitcoin wallets can calculate their
spendable balance and new transactions can be verified to be spending bitcoins
that are actually owned by the spender. The integrity and the chronological
order of the block chain are enforced with cryptography.
Transactions - private keys:
A transaction is a transfer of value between Bitcoin wallets that gets included in the block chain.
Bitcoin wallets keep a secret piece of data called a private key or seed, which is used to sign transactions,
providing a mathematical proof that they have come from the owner of the
wallet. The signature also prevents the transaction from
being altered by anybody once it has been issued. All transactions are
broadcast between users and usually begin to be confirmed by the network in the
following 10 minutes, through a process called mining.
Processing – mining:
Mining is a distributed consensus system that
is used to confirm waiting transactions by including them
in the block chain. It enforces a chronological order in the block chain,
protects the neutrality of the network, and allows different computers to agree
on the state of the system.
How
Many Bitcoins Are There?
When the algorithm was created under the
pseudonym Satoshi Nakamoto – which in Japanese is as common a name as Steve
Smith – the individual(s) set a finite limit on the number of bitcoins that
will ever exist: 21 million. Currently, more than 12 million are in
circulation. That means that a little less than 9 million bitcoins are waiting
to be discovered.
Since 2009, the number of bitcoins mined
has skyrocketed. That's the way the system was set up – easy to mine in the
beginning, and harder as we approach that 21 millionth bitcoin. At the current
rate of creation, the final bitcoin will be mined in the year 2140.
How Do You Get
and Spend Bitcoins?
There are three primary ways to obtain
bitcoins: buying on an exchange, accepting them for goods and services, and
mining new ones.
The first thing you do is set up what's
known as a "bitcoin wallet." Here you'll store your coins and keep
your dashboard for any transactions. You can either download the program to
your PC and install it, or get one online (at sites like www.instawallet.com
or www.mybitcoin.com).
In either case, it looks a lot like what
you see when you log on to your bank account via the web.
From there, you'll need to fill your
wallet with bitcoins. If you're the patient type, you can 'mine' them, but most
people buy them with real world cash via online currency exchanges, such as www.mtgox.com
or www.tradehill.com.
Once you've stocked up on bitcoins,
you're free to spend them—assuming you can find a vendor that accepts them
What
Exactly Is Mining?
"Mining" is lingo for the
discovery of new bitcoins – just like finding gold. In reality, it's simply the
verification of bitcoin transactions.
For example, Vivian buys a laptop from David
with a bitcoin. In order to make sure his bitcoin is a genuine bitcoin, miners
begin to verify the transaction.
It's not just one transaction
individuals are trying to verify; it's many. All the transactions are gathered
into boxes with a virtual padlock on them – called "block chains." Miners
run software to find the key that will open that padlock.
Once their computer finds it, the box
pops open and the transactions are verified. For finding that hidden key, the
miner gets a reward of 25 newly generated bitcoins.
The current number of attempts it takes
to find the correct key is around 1,789,546,951.05, according to
blockchain.info – a top site for the latest real-time bitcoin transactions.
Despite that many attempts, the 25 bitcoins
reward is given out about every 10 minutes. In 2017, the bitcoin reward for
verifying transactions will halve to 12.5 new bitcoins and will continue to reduce
by half every four years.
How
Do You Mine On A Budget?
Bitcoin mining can be done by a computer
novice – requiring basic software and specialized hardware. The software
required to mine is straightforward to use and open source – meaning free to
download and run.
A prospective miner needs a bitcoin
wallet – an encrypted online bank account – to hold what is earned. The problem
is, as in most bitcoin scenarios, wallets are unregulated and prone to attacks.
Late last year, hackers staged a bitcoin heist in which they stole some $1.2
million worth of the currency from the site www.inputs.io. When bitcoins are
lost or stolen they are completely gone, just like cash. With no central bank
backing your bitcoins, there is no possible way to recoup your loses.
The second piece of software needed is
the mining software itself – the most popular is called GUIMiner. When
launched, the program begins to mine on its own – looking for the magic
combination that will open that padlock to the block of transactions. The
program keeps running and the faster and more powerful a miner's PC is, the
faster the miner will start generating bitcoins.
When mining began, regular off-the-shelf
PCs were fast enough to generate bitcoins. That's the way the system was set up
– easier to mine in the beginning, harder to mine as more bitcoins are
generated. Over the last few years, miners have had to move on to faster
hardware in order to keep generating new bitcoins. Today, application-specific
integrated circuits (ASIC) are being used. Programmer language aside, all this
means is that the hardware is designed for one specific task – in this case
mining.
New faster hardware is being created by
various mining start-ups at a rapid rate and the price tag for a full mining
rig – capable of discovering new bitcoins on its own – currently costs about $12,000.
But don’t let the figure scare you, there is a way around such a hefty
investment: joining mining pools.
Pools are a collective group of bitcoin
miners from around the globe who literally pool their computer power together
to mine. Popular sites such as Slush's Pool (http://mining.bitcoin.cz/)
allow small-time miners to receive percentages of bitcoins when they add
their computer power to the group.
The faster your computer can mine and
the more power it is contributing to the pool, the larger the percentage of
bitcoins you will receive. Bitcoins can be broken down into eight decimal
points. Like wallets, pool sites are unregulated and the operator of the pool –
who receives all the coins mined – is under no legal obligation to give
everyone their cut.
Joining a pool means you can also use
cheaper hardware. USB ASIC miners—which plug into any standard USB port—cost as
little as $20. "For a few hundred dollars you could make a couple of
dollars a day," according to Brice Colbert, a North Carolina-based miner
of cryptocurrencies and operator of the site http://www.cryptojunky.com.
"You're not going to make a lot of money off of it and with low-grade
ASICs you could lose money depending on the exchange rate."
The other way you could lose money when
it comes to mining is power consumption. Currently, profits outweigh money
spent on the energy needed to mine. Again, that could quickly change due to the
volatile price of bitcoin.
Due to the anonymous nature of
transactions, people are also using bitcoins to buy illegal drugs via
well-hidden websites, something that put them in the national spotlight in the
first place.
Assuming you find a place that takes
them, you'll then open up your bitcoin wallet and digitally transfer the amount
to an address the merchant provides. The transfer address will be an illegible
string of 30-40 randomly generated numbers and letters – eliminating the need
to know who, exactly, you're doing business with – and giving users a limited
form of anonymity.
Perhaps because of the limited number of
establishments recognizing bitcoins, most people who mine or invest in them hold
on to the currency rather than spend it. A study in October 2013 found that 78
percent of the active bitcoins in circulation are dormant.
The danger with that is if hackers
target an account – or a wallet provider – it’s very difficult for users to
recover their investment, since bitcoin transactions are generally
irreversible.
In early April, Instawallet, which
branded itself as an "anonymous" bitcoin wallet site, was forced to
suspend operations indefinitely after hackers stole nearly $4.6 million in the
currency. The site later said it would open a claims system, refunding amounts
of under 50 bitcoins within 90 days, assuming it received only a single claim
on the account.
with
excerpts from www.bitcoin.org and www.cnbc.com
