BITCOINS: THE POWER OF DIGITAL CURRENCY

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