Bitcoin for Beginners (like me)

Bitcoin is a fresh virtual currency or as my mate Dmitri puts it:

So I set out attempting to understand it a bit better and see if and how this could be a solution to the “Paypal Problem” 1) …

Technology

I wasn't so much interested in the entire technical details on how Bitcoin works. I'm no crypto experienced and Bitcoin got a lot of whirr in the latest months, the entire protocol and clients are open source and I trust that many people more clever than me have analyzed how it works and that the system itself is secure Two) .

However it turned out that some basic technical understanding is needed to understand why certain things work as they do. So lets put down some (very likely oversimplified) basics very first.

BitCoin is decentralized using Peer-to-Peer technology. This means there is no real central authority, similar to popular filesharing protocols, clients talk to each other and propagate transactions through the network (pretty much like Gnutella did). However BitCoin usually uses some IRC channels to find knots to connect to (similar to a Torrent Tracker).

BitCoin clients are called wallets. Like a real wallet they store your coins. If you liberate your wallet, that is the file your client stores the data, you liberate your money. Of course Bitcoins aren't real coins, instead plain transaction statements (“Address A sent five BTC to Address B”) are stored. These transactions use public-key mechanisms (think SSH), so you send a coin with your private key to the public key of someone else. Your wallet contains the private keys for your coins. Without that key the coins can't be spent anymore Trio) .

To verify the integrity of all transactions and make counterfeiting unlikely, transactions are verified and signed by miners by creating so called blocks. Mining is a very (computational) expensive process involving lots of hashing. A block contains many transactions and the BitCoin clients will use these blocks to verify transactions. People running the mining process get rewarded for completing a block by receiving a certain amount of bitcoins from the system Four) and from fees affixed to the transaction (more on that later).

In fact the entire mining/block business is the most complicated part about the BitCoin technology Five) . But to just use Bitcoin you don't need to think about it much. You just need to know that there are knots in the network doing expensive work to verify transactions and keep the system working.

Getting began

The very first thing you need to use BitCoins, is a wallet. I did my very first steps with an Android app called Bitcoin Wallet. You can also use the official client available at bitcoin.org.

Once embarked, the wallet will create an address for you. This is basically a private/public key pair with the shown address being the public part. Now people can send bitcoins to this address.

To get began I asked around at my followers if someone could donate a petite amount to me for playing and @fabsh from Linux Outlaws was kind enough to send me one BTC 6) . It took about ten minutes to go from his wallet to mine.

If you don't have a acquaintance to get you began, there's also the Bitcoin Faucet that gives away 0.001 BTC 7) for free.

BTW . you can also create an account at some eWallet provider – which is most likely a bit more convenient but also a bit closer to the initial Paypal problem again.

Sending Coins

Now like with a real wallet, you shouldn't keep all your money in one place (like on your phone). Instead you should have a savings account. To have that, I set up a bitcoin client at my computer and then sent money from my Android wallet to the address generated by my home wallet. This is the same as if I'd be sending money to someone else's wallet.

Now the dialog looks effortless enough. It expects the target address and an ammount. But what is it about the optional fee? I wasn't so sure but it said optional, so I used a zero and hit send. The BTCs vanished from my wallet, but on the other side nothing displayed up. Not after ten minutes and not an hour later.

I was confused. I triple checked that my client was working, that the UPNP option of my router forwarded bitcoin traffic to my client and that I didn't misspell the address. Everything was alright but my BTC didn't display up on my home computer.

Only several hours later my one BTC eventually arrived.

To understand this we have to look at the tech again. As wrote earlier, transactions have to be confirmed in a mined block before they are valid. Creating these blocks is expensive – it takes a lot of CPU and thus electric current to calculate them. To encourage people to running miners, the system presently gives some free bitcoins to the miner who calculated a fresh block, but this will stop once twenty one million bitcoins are in circulation 8) . But blocks then still need to be created to verify transactions. To give people an incentive you can fasten a puny fee to your transaction. This fee goes to the miners who can prioritize the inclusion of transactions with fees.

If I had added a petite fee to my transaction it would most likely have been picked up much swifter.

Trading

The idea of a currency is that you can use it to buy or sell stuff. Unluckily the list of sites accepting Bitcoin isn't that tremendous presently. This means to give the currency real value it has to be convertible to other currencies.

And that is exactly what happens. The fattest trader for Bitcoins is Mt. Gox who is said to treat Bitcoins for about half a million US Dollar daily. Like with a real currency, the exchange rate can vary and the following graph shows how the interest in Bitcoin during the latest months switched its value massively:

For attempting if I could lightly convert bitcoins in anything of “real world” value without going through any bank transfer hassles, I determined to attempt BTC Buy which sells Amazon.com bounty codes for bitcoins. I bought a three USD bounty code for 0.25 BTC 9) . Thanks to the 0.0005 BTC transaction fee I used this time, my order went through in just duo of minutes.

Summary

I now know how this bitcoin thing works and I have to admit I'm intrigued.

The fattest problem is the adoption of course. A currency is only as good as is its acceptance rate. Unless it is backed by some thicker players Ten) I fear that it will remain a rather geeky payment option only.

This is especially true if you indeed consider to use it as a Paypal alternative – the one thing Paypal makes effortless is to let people add “real” money to buy something. My mom might be able to use her credit card to paypal me money, but buying bitcoins?

Anyway, if you like to donate for one of my projects or this article, feel to send bitcoins to 15B8b5yCB5sK7hSwbhyQQZpHrRYzvmxrAA .

I’m a Web, Wiki and Open Source enthusiast living in Berlin, Germany. Love your stay here.

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