What is a Bitcoin?

In its simplest form Bitcoin is just like cash that you can use to pay for goods and services, but electronic. More comprehensively, Bitcoin is a popularly distributed peer-to-peer digital currency that can be transferred instantly and securely between any two people in the world.

What are bitcoins?

If Bitcoin is the name of the currency, then bitcoins are the unit of that currency. “BTC” is the commonly used shorthand to refer to a price or amount of Bitcoin (e.g. “500 BTC”). A bitcoin is basically just a number associated with a Bitcoin Address. We will learn more about this later.

So how can I get bitcoins?

You can acquire bitcoins in a variety of ways:

  • Bitcoins are accepted as payment for goods or services.

  • You can purchase any amount of bitcoins from a number of websites, including Bitit Coinbase, PayBis, Cubits, CoinCorner, BIPS Market, Circle, or Celery.

  • You can also buy bitcoins through Bitcoin Exchanges. This is the most popular today.

  • Bitcoins can also be traded for your local currency.

  • Bitcoin ATMs are a recent development which allows the purchase of bitcoins in certain areas.

  • Several local forums and directories promote trading cash for bitcoins.

  • There is the option of participating in a mining pool.

  • If you a bit more serious and have access to a lot of mining hardware, you can attempt to create a new block (12.5 bitcoins currently).

  • There are also numerous websites that provide free bitcoins and offers.

How can I make money with Bitcoin?

From the beginning, Bitcoin and how it works has been a bit unclear, especially for new users. As a new technology, it has been presented as a variety of things including:

  1. A get-rich-quick scam.

  2. A loophole in the market economy that can be exploited for a steady influx of cash.

  3. An investment platform that almost certainly yields profits.

However, none of these categorizations even comes close. Let’s take a closer look:

So why invest in Bitcoin?

As a new and exciting electronic currency, the value of Bitcoin is not backed by any government or organization. Bitcoin is important today mostly because people are willing to trade it for goods and services. And just like any other currency, its exchange rate fluctuates continuously. However, as a new technology, it lacks wide acceptance and is vulnerable to manipulation by determined parties. The advantage of being a digital currency is also its major disadvantage as security incidents such as website and account compromise will most certainly trigger major sell-offs. This isn’t all bad news, positive feedback loops can also cause a larger exchange rate making it more valuable. It is expected that as Bitcoin becomes better known and more widely accepted, it would stabilize. This is still a future concept and is currently it is quite unpredictable. All Bitcoin investments should be carefully thought out and with a backup plan.

Buying bitcoins with Paypal

You can also buy bitcoins with PayPal but it can be quite difficult and expensive to do so because of significant risk to the seller. Some individuals may be willing to sell Bitcoin to you via Paypal, but the majority of exchanges do not allow exchange through PayPal. As surprising as this may be, there is a good reason. There have been repeated cases where people who pay for bitcoins through Paypal receive their bitcoins, and then complain to Paypal that they never received their purchase. PayPal almost always sides with the buyers in this case, making sellers wary of carrying out transactions using PayPal.

There are also several websites like bitbuy.in and PayBis, which allow you to buy Bitcoins with PayPal.

Bitcoin in-depth

So how are bitcoins created?

Bitcoins are generated through the process of "mining" by the network. The mining process is quite similar to a continuous raffle draw. Mining nodes on the network are awarded bitcoins each time they create a new block by finding the solution to a certain mathematical problem. Creating a block is seen as proof of work and its difficulty varies with the overall strength of the network.

Rewards for creating new blocks are automatically adjusted so that, in every four years of the Bitcoin network operation, half the amount of bitcoins created in the prior 4 years are created. About 10,499,889.80231183 bitcoins were created in its first 4 years from January 2009 to November 2012, and every four years thereafter this amount halves. So it should be 5,250,000 between years 4-8, 2,625,000 between years 8-12, and so on. This is so the total number of bitcoins in existence never exceeds 20,999,839.77085749.

What's the current total number of bitcoins in existence?

There are currently approx. 16,700,000 bitcoins in existence, this is calculated through the number of blocks times the coin value of a block. The coin value of a block is 50 BTC for each of the first 210,000 blocks, 25 BTC for the next set of 210,000 blocks, then 12.5 BTC, 6.25 BTC and so on.

Are bitcoins divisible?

A single bitcoin can be divided down to 8 decimal places. This means that 0.00000001 BTC is the smallest amount that can be used in a transaction. However, the protocol and related software can be modified to handle even smaller amounts but this is quite rare.

What are the various bitcoin denominations?

Bitcoin was created to be highly divisible and necessitated the creation names for smaller denominations of bitcoin amounts. This is quite necessary because transactions involving whole bitcoins are no longer quite so common. However, as Bitcoin is decentralized, there is no organization with the power to set official names for its units. Therefore, there are many different unit names with varying degrees of popularity. The most commonly used units are bitcoins, bits, and Satoshi: 1 bitcoin = 1 000 000.00 bits = 100 000 000 Satoshi.

By popular consent, Satoshi (sat), is the smallest value that the Bitcoin network supports sending, (0.000 000 01) of a bitcoin. The unit was named in honor of Satoshi Nakamoto its creator, after he left.

The bit, one millionth (0.000 001) of a bitcoin, is another commonly used unit. This unit is often regarded as a microbitcoin (μBTC). Bits are considered logical as they have two-decimal like most local currencies.

SI prefixes are also fairly common:

  • 0.01 BTC = 1 cBTC = 1 centibitcoin (bitcent)

  • 0.001 BTC = 1 mBTC = 1 millibitcoin (mbit (em-bit) or millibit or bitmill)

  • 0.000 001 BTC = 1 μBTC = 1 microbitcoin (ubit (yu-bit) or microbit)

When will all bitcoins be generated?

The last bitcoin block to be mined has been calculated to be block #6,929,999 which should be generated at or near the year 2140. The maximum number of coins in circulation will remain static at 20,999,999.9769 BTC.

Even amounts greater than the normal 8 decimals, the total BTC in circulation will always be slightly below 21 million. For example, even with 16 decimals, the end total would be 20,999,999.999999999496 BTC.

Will more blocks be created after all bitcoins are generated?

It sure will! More blocks will be created because of the use of transaction fees. This will make creating new blocks more valuable from the fees than the coins being created. When all the coins have been generated, these transaction fees will sustain the ability to use bitcoins and the Bitcoin network. The number of blocks that will be mined in the future is limitless.

What happens when Bitcoins are lost when creation stops?

As per the law of demand and supply, when fewer bitcoins are in circulation the ones that are left will be in higher demand, and will have a higher value. Therefore, as Bitcoins are lost, the remaining bitcoins will increase in value to compensate. As bitcoin value increases, the amount required to purchase an item eventually decreases. When this happens, transactions will probably be denominated by less used sub-units of a bitcoin such as millibitcoins ("Millies") or microbitcoins ("Mikes").

The original Bitcoin protocol uses a minimum unit of a Satoshi (0.000 000 01), but unused bit units are available in the protocol fields that can be used to denote even smaller subdivisions.

Economy

Why is Bitcoin valuable?

Bitcoins are valuable because they are useful and scarce. Most local currencies are backed up by gold, this means that there's a promise in place that you can exchange the currency for gold. However, Bitcoins operate just like dollars and euros, it is not backed up by anything except the variety of merchants that accept them.

So is Bitcoin a currency?

Very much so, in the same way as the euro and dollar are. Their value lies in acceptance in exchange and they have no inherent value. If everyone suddenly stopped accepting dollars, euros or bitcoins, the "currency" would burst and value would drop to zero. However, this is unlikely to happen.

Doesn't Bitcoin unfairly benefit early adopters?

The early adopters of Bitcoin took a substantial risk and invested resources in an unproven technology. They are the reason Bitcoin became what it is now and they will also make it what it will be in the future. It is only fair they will reap the benefits of their investment.

All generated bitcoin will probably change hands dozens of time as a medium of exchange. This more than balances out the profit made from the initial distribution compared to the total commerce enabled by Bitcoin.

Can the loss of wallets and the finite number of Bitcoins create excessive deflation?

It is the general belief that Bitcoin will be destroyed by deflation, unlike most currencies, which experience inflation as more and more units are created. Bitcoin will most likely experience gradual deflation with the passage of time. As Bitcoin is created to be unique, only a small amount of units will ever be produced, this number has been the principle since the project's inception, and units are being created at a predictable rate.

Bitcoin users are also faced with the danger of loss of account. If a Bitcoin user loses his wallet, his money is gone forever, unless he finds it again. This doesn’t affect that user alone, the Bitcoin is gone completely out of circulation, rendered utterly inaccessible to anyone. As people will lose their wallets, the total number of Bitcoins will slowly decrease.

Whereas most currencies inflate over time, Bitcoin will most likely do just the opposite. Over time there will the irretrievable loss of an ever-increasing number of Bitcoins. The already small number of Bitcoins available will be whittled down further and further. As there become fewer and fewer Bitcoins, the laws of supply and demand suggest that their value will probably continually rise.

That being the case, this was thought about from its inception so there is a mechanism in place to combat the consequences. Although extreme deflation would render most currencies highly impractical, Bitcoin offers a simple and stylish solution: infinite divisibility. Bitcoins can be divided up and trade into as many small pieces as one wants. This way, no matter how valuable Bitcoins becomes, one can trade them in ever smaller quantities. In fact, even if only a single Bitcoin, or a fraction of one, remains, Bitcoin should continue to function just fine.

What happens if someone buys up all the existing Bitcoins?

The chances of this happening start at difficult and rise all the way to next to impossible. As a competitive marketplace, the price of a bitcoin will rise or fall depending on supply and demand. Also, only a fraction of bitcoins generated is found for sale on the exchange markets. So, if a buyer with lots of money surfaces he couldn’t buy all the bitcoins available unless their owners offer them for sale. Even the wealthiest, most determined buyer can't get at them.

Additionally, new Bitcoins are being issued daily and will continue to do so for decades. The miners are also not obligated to sell their bitcoins so not all bitcoins will even make it to the markets. However, this doesn’t mean that the markets aren't vulnerable to price manipulation. With enough money, it is possible to move the market price up or down, and thus Bitcoin remains volatile.

Will a new blockchain, or a new digital currency render Bitcoin obsolete?

One of Bitcoin’s central security mechanisms is that the blockchain cannot be easily forked. When given the choice between two blockchain, a Bitcoin miner will always choose the one with a more complex hash (usually the longer one). This ensures that users can only spend their bitcoins once, so no user gets ripped off.

As a consequence of the blockchain structure, a new blockchain would leave the network vulnerable to double-spend attacks. The process of creating a viable new chain is considered difficulty, and the possibility does not present much of a risk. This is because Bitcoin will always choose the longer Blockchain, determining the relative length of any two branches by the complexities of their hashes. As each new block makes its hash from the preceding block, one must be prepared to do more computation that has been done by the entire Bitcoin network. Right from the fork point up to the newest of the block one is trying, to supersede to create a block with a more complex hash. Such an undertaking would require an enormous amount of processing power. More still, since Bitcoin is continually growing and expanding, it will require more with the passage of time.

The more serious threat to Bitcoin is the development of other, superior virtual currencies. These could become advanced enough to supplant Bitcoin and render it obsolete and valueless. Even though a great deal of careful thought and ingenuity went into the development of Bitcoin, it still remains the first of its kind, a prototype, vulnerable to highly-evolved competitors. As of now, rivals are yet to rear their heads and Bitcoin remains the number one private virtual currency, for now. According to the way the internet is structured this seems inevitable. Messenger and Myspace suffered this very same fate at the hand of Facebook and popular Napster was eventually ousted by Limewire,

Sending and Receiving Payments

Why wait 10 minutes?

The average time it takes to find a block is 10 minutes. It can, however, be significantly take more or less time, 10 minutes is simply the average.

The confirmations seen in wallets are actually “Blocks” and they are how Bitcoin achieves consensus on ownership exchange. A block signifies that everyone agrees that the coins have been exchanged, so they can be spent again. By rule of thumb, the more confirmations a transaction has, the less risk there is of a reversal. Typically, only 6 blocks or 1 hour is enough to make reversal impractical.

Must I wait until my transactions are confirmed to use my Bitcoin?

Yes, you do! It takes a minimum of two block confirmations before the Bitcoin reference software displays a transaction as confirmed. The longer transactions go on, they increasingly become non-reversible, however, they are very reversible before the first confirmation. Two to six block confirmations are recommended depending on the value of the transactions involved.

My bitcoins haven't arrived yet! Where could they be?

Here are a number of reasons why your bitcoins have not shown up yet, and the ways to diagnose them.

You can hover over the icon in the bottom right corner of the client to learn your client's status. This tells you how far it has yet to go in downloading the blockchain. If it still yet to catch up then it's possible that your transaction hasn't been included in a block yet.

Even better, you can check pending transactions in the network and if the transaction is listed then it's a matter of time until it gets included in a block before it can show in your client. A coin that was involved in a recent transaction may be considered a low priority transaction. Transfers may also take longer if the transaction fee paid was not high enough.

My Bitcoin address keeps changing, is that normal?

Bitcoin addresses are designed to be used for a single transaction only, unlike postal addresses. Wallets originally only displayed a single address at a time, this address changed whenever a transaction was received. Recently, an increasing number of wallet upgrades now allow you generate an address for payments.

This is considered a bad practice, with the most important concerns including misuse, loss of privacy and security. Which can be put into jeopardy when addresses are used for more than a single transaction.

Why are transaction fees so high?

Bitcoin often requires a transaction fee to confirm transactions between two parties. This transaction fee is payment given to the bitcoin miner who mines the block containing the transaction; this is considered as a confirmation. The exact fee to be paid depending on the size (in bytes) of your transaction, how fast you want the transaction to be confirmed, and on current network conditions. This makes using a fixed fee, or even a fixed fee per kB, is a very bad idea. Bitcoin wallets generally use a system to estimate an appropriate fee for you, though some methods are better than others.

The major determinant is the transaction data size not on the amount of BTC being sent. A 0.01 BTC transaction may require a higher fee than a 1000 BTC transaction.

How do Bitcoin transactions work?

If for example, you receive BTC in three different transactions of 1, 4, and 15 BTC, you can assume your wallet now contains three gold coins with sizes 1, 4, and 15 BTC. So, if you decide to transfer 5 BTC, you can dissolve the 1 & 4 BTC coins together and cast them as a 5 BTC coin, or melt down the 15 BTC coin and recast a 5 BTC coin for the recipient and a 10 BTC coin for yourself. These objects are known as input and output coins. “Coin” here denotes these objects and not the amount of BTC.

Transaction fees, are proportional to the number of input and output coins in a transaction, not its value. Input coins are normally more expensive than output coins. This means that if your wallet estimates a very high transaction fee for you, it may be that your wallet is full of a bunch of tiny coins, making your transaction to take very many coins as inputs, increasing the cost.

Network conditions also influence transaction fees. In the Bitcoin system, unconfirmed transactions compete with each other to be picked by miners. So, if there are a lot of high-fee transactions being sent at a certain time, you will need to pay a higher fee to out-bid them. However, if speed isn’t important to you, you can pay a smaller fee, and your transaction will be paused until there is a period of reduced network usage.

Can I receive Bitcoins when my computer is powered off?

The term “sending” is actually incorrect, Bitcoins are not actually "sent" to your wallet; the software only updates the system. Even if your wallet client program is not running, when you eventually launch the wallet client program, the coins will appear as if they were just received in the wallet. Your wallet is only needed when you wish to spend coins that you've received.

Why do I need to "synchronize" take when the Bitcoin client is first installed?

The most used Bitcoin client software can be accessed at bitcoin.org. It implements what is known as a full Bitcoin node, this means it is able to carry out all the duties of the Bitcoin P2P system. This is unlike a "client" software. One reason for using the full Bitcoin nodes is that they don't automatically assume that the all participant follow the rules of the Bitcoin system.

Therefore, during synchronization, the software processes the Bitcoin transactions history and makes sure that all of the rules of the system have been correctly followed. Normally, after synchronizing, the software should use little of your computer's resources.

However, during the first installation, the initial validation can be quite tasking for your computer's hard disk. The amount of time depends mainly on your disk and CPU speed. This can take anything from a few hours to a day or two. It is still possible to use the Bitcoin software during synchronization, but you may not see recent payments until the client program has caught up.

Mining

What is Bitcoin mining?

What we call “Mining” is the process of using enough computation power to secure Bitcoin transactions against reversal and introducing new Bitcoins to the system.

Mining involves the calculation of a hash of the block header, this includes among other things a reference to the previous block, a hash of a set of transactions and a nonce. If the computation is carried out and the hash value is found to be less than the current target, a new block is formed and the miner gets the newly generated Bitcoins. If the calculated hash is more than the current target, a new nonce is tried, and a new hash is calculated. These calculations are done millions of times per second by each miner.

Is mining useful?

The computations serve the purpose of securing the Bitcoin network, which is very useful.

How can we stop miners from including transaction fees?

Transaction fees are an incentive for miners to include transfer transactions. It would be ordinarily trivial for a miner to create and include transactions merely to surpass thresholds placed on transaction size. Also as the network matures and blocks reward drops, miners become more dependent on transaction fees to pay their costs.

How does the proof-of-work system work?

Bitcoin uses the proof of work protocol, to give a general idea of how this works in the mining process, let’s use this setup:

  • Payload = < data related to transactions on the Bitcoin network>
  • Nonce = 1
  • Hash = SHA2 (SHA2 (payload + nonce) )

Miners are responsible for repeatedly increasing "nonce" until the hash function yields a value, which has the rare property of being below a certain target threshold. The mining process doesn't compute anything special. It consists of finding a number (nonce) which produces a hash with special properties.

This makes it very easy to check results. As the hash has a specific nonce, a single call to the hashing function is needed to verify that the hash has all the required properties. This feature then allows the Bitcoin network to come to a consensus on the history of transactions.

Security

The major security questions are twofold;

1. Could miners come together to give themselves money?

2. Could miners fundamentally change the nature of Bitcoin?

Let's look at these separately.

Could miners come together to give themselves money?

We have explained mining to be the process of creating new blocks in the blockchain. Each block on the chain contains a list of all transactions that have taken place across the entire Bitcoin network since the last block was created. New Bitcoin blocks are generated, by Bitcoin clients correctly guessing sequences of characters in complex codes called 'hashes, using information from previous blocks. Miners may download specialized software, which allows them to dedicate their processing power to guessing at strings within the hash of the previous block. Whoever makes the right guess first creates a new block and receives a reward in Bitcoins.

Bitcoin security hinges on two structures, one is the blockchain network and the other is the public-key encryption system on which Bitcoin is traded. Blockchain assures users that every single transaction that ever takes place in the Bitcoin network is recorded. This record is readily available on the computer of anyone who chooses to store this information. Lot’s of users have complete records of every transaction in Bitcoin’s history available to them. The best part is that this information can be obtained with ease, making Bitcoin very hard to fool.

It takes considerable processing power to run the Bitcoin network. Basically, those with the most processing power are able to make the most guesses and therefore earn the most currency. At present, each correct guess yields twenty-five Bitcoins, and every miner who earns any number of Bitcoins makes money. Most miners join or form mining pools where they all contribute to earning a share of the profits while some miners are able to pull in Bitcoins on their own

So the answer is yes! Bitcoin is actually designed to encourage miners to come together to make money. These mining pools are a communal affair, and there is nothing dishonest or underhanded about them.

So can they rip off the network and make loads of money dishonestly?

Like any other currency, Bitcoin isn't invincible. It can be manipulated, but doing so is extremely difficult. Bitcoin was designed to be unlike other modern currencies which are is controlled by large institutions who keep track of what's done with it, and who can manipulate its value. Bitcoin, on the other hand, doesn't ask that its users trust any institution.

It depends on the cryptography that is an integral part of its structure for security. So instead of one institution or entity being responsible for tracking transactions, the entire network does. This makes Bitcoins really difficult to steal, or double-spend. In terms of security, Bitcoin is designed to withstand the shortcomings of modern currencies, it is inflation-proof, double-spend-proof and completely distributed.

Could miners fundamentally change the nature of Bitcoin?

No, they can’t. As changes implemented to the Bitcoin system must be accepted by all users, anyone trying to change the way Bitcoins are generated would have to convince every user on the network to download and use a particular software. So only mutually beneficial changes are allowed.

It is regarded impossible for anyone to change Bitcoin functions to their advantage. The fact that changes are so difficult to make testifies to the fully distributed nature of Bitcoin. Modern currencies having a central authority can be modified by the central agency without its adherents consent. Bitcoin changes only at the behest of the whole community as it has no central authority. The concept of Bitcoin represents a collective form of evolution, the first of its kind among currencies.

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