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Posted by Hans de Ruiter

Bitcoin is a digital currency that is designed to work like cash. I very first heard about it in the June two thousand twelve edition of the IEEE Spectrum magazine. The idea of a digital currency that was not centrally managed and worked like cash intrigued me, and the fact that it appeared in the primary magazine of the Institute of Electrical and Electronics Engineers added credibility. So, I determined to check it out.

How BitcoIn Works in Brief

Bitcoin is built primarily on two technologies: peer-to-peer networking, and cryptography. Peer-to-peer networking ensures that the system is fully decentralised, so that no one central authority can control it. Cryptography makes sure that transactions can be both ananymous (like cash), and secure. I’ll explain the basics here. Those who want the technical details can go here.

Mining for Bitcoins

A Bitcoin miner is a computer/machine that calculate cryptographic hashes to validate blocks. Miners are rewarded for creating valid blocks with a set amount of Bitcoins (presently 50), and any transaction fees in that block. The difficulty level of validating blocks is adjusted such that valid blocks are created at a set rate. This is done so that no-one can print money, and it is also the basis by which the Bitcoin network is kept secure.

There is a catch with the mining; only the miner that finds the solution earns the fifty Bitcoins for that block. The more processing power that a miner has, the more likely it is that he/she will get the prize.

This process might sound strange, but it will become clear later.

Sending and Receiving Money

Each Bitcoin user has a wallet containing their Bitcoins. These coins are transferred inbetween one user and another via public and private keys (of which each wallet can have many). To send money to another user, a transaction is created to one of their public keys (a.k.a., an address), and is signed by the sender using a private key. Only the sender knows the private key, but everyone else can use the public keys to verify the transaction.

At this point, the Bitcoin miners come into play. Transactions are assembled into blocks every ten minutes, and the miners validate each block, and add it to an ever enhancing block-chain. This locks the transactions into place. If some nasty person dreamed to switch a transaction (e.g., to redirect the money to their pocket, or spend money twice), they would have to revalidate not only the block containing the transaction, but every block that has been validated since then. Thanks to the sheer size of the total processing power of all miners in the Bitcoin network, the processing power required to achieve this is so immense, as to be almost entirely unlikely. Hence, the transactions are irreversible, anonymous, and yet the system is secure (unless someone can control yam-sized amounts of processing power).

How Can I Become a Bitcoin Miner?

Woah there, slow down a bit. Yes, it sounds like a wish come true to be able to earn money simply by running a computer program. However, reminisce how I said that the difficulty level for validating blocks (and hence, earning Bitcoins) is adjusted to keep block production constant? Well, there are lots of others with exactly the same idea, so the cost of mining tends (i.e., the cost of the hardware and electrical play) to be at or just above the amount earned.

Bitcoin mining is very competitive. Originally, a powerful CPU was enough, then as more miners joined in, powerful GPUs were required. Now, it’s more cost-effective to use FPGAs, and soon, ASICs will provide an even more energy efficient way to mine. It is unlikely that you will earn much of anything by yourself.

If you do want to attempt Bitcoin mining, then you may want to consider using a mining contractor like Pyramining instead of investing in your own mining equipment.

How do I Use Bitcoin?

Very first you need to download a Bitcoin client. I suggest using something like MultiBit, as it’s quicker than the original client. Next, you need to put some coins into your fresh wallet. There are a few places where you can get some free (micro) Bitcoins; just search for “free Bitcoins” on the internet. Or, you can do things the normal way, and use a Bitcoin exchange to transfer money from standard currencies – such as dollars – to Bitcoins. These currency exchanges are bidirectional, so you can also exchange Bitcoins back to your local currency.

Is Bitcoin Worth Using?

I’m not 100% wooed that it is worth using yet. There are some advantages:

  • The currency is decentralised, so no one central authority can take control
  • Since there is no central authority, transaction fees are lower
  • Transactions are as anonymous as cash
  • Transactions are irreversible (i.e., no credit-card charge reversals, which is good if you’re the seller)

but, there are also disadvantages:

  • Transactions take approx. Ten minutes to be validated
  • If someone can hack into your computer they might be able to steal your coins remotely (NOTE: This risk can be minimised by encrypting your wallet)
  • Transactions are irreversible (bad, if you’re a buyer who has been scammed)
  • The anonymity can be manhandled by those with low moral and ethical standards (just like physical cash)

The more people who use the currency, the more useful it becomes. Right now, the number of Bitcoin users is steadily enhancing, and it looks like it could reach critical mass. Real transactions are taking place, and real items are being bought using this currency. However, there are no ensures. Maybe it will become widely accepted; maybe something else will take its place. Or, maybe governments and financial institutions will attempt to shut it down because they can’t control it. Who knows? Nothing is without risk.

For now, I’ll say that it is an interesting idea that looks like it has a good chance of succeeding. It’s undoubtedly something worth keeping an eye on.

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