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Thursday, 1 December 2016

What Are Bitcoin and How Does it Work? Here is All You Need to Know

Bitcoins are electronic currency, otherwise known as 'cryptocurrency'.  Bitcoins are a form of digital public money that is created by painstaking mathematical computations, and policed by millions of computer users called 'miners'.


 
How Do Bitcoins Work?
Bitcoins are, in essence, electricity converted into long strings of code that have money value. Bitcoins are completely virtual coins designed to be 'self-contained' for their value, with no need for banks to move and store the money. Once you own bitcoins, they behave like physical gold coins: they possess value and trade just as if they were nuggets of gold in your pocket.
 
You can use your bitcoins to purchase goods and services online, or you can tuck them away and hope that their value increases over the years.
 
Bitcoins are traded from one personal 'wallet' to another.  A wallet is a small personal database that you store on your computer drive, on your smartphone, on your tablet, or somewhere in the cloud.
 
How Much Are Bitcoins Worth?
 
One bitcoin is currently worth around $450 US dollars . There are approximately $1.9 billion USD worth of bitcoins in existence, with approximately $2 billion more to be created.
 
Bitcoins will stop being created when the total number reaches 21 billion coins, which will be sometime around the year 2040.   As of 2016, just over half of those bitcoins have been created.
 
What Is a Bitcoin Made of?
 
A bitcoin, at its core, is a very simple data ledger file called a 'blockchain'. A blockchain's file size is quite small, similar to the size of a long text message on your smartphone.
 
Each bitcoin blockchain has three parts, two of which are very simple: its identifying address (of approximately 34 characters), and the history of who has bought and sold it (the ledger).
 
The complex part of the bitcoin is its third part: the private key header log.  This header is where a sophisticated digital signature is captured to confirm each and every transaction for that particular bitcoin file. Each digital signature is unique to each individual user and his/her personal bitcoin wallet.  
 
These signature keys are the security system of bitcoins: every single trade of bitcoin blockchains is tracked and tagged and publicly disclosed, with each participant's digital signature attached to the bitcoin blockchain as a 'confirmation'. These digital signatures, when given several seconds to confirm their transactions across the network, prevent transactions from being duplicated and people from forging bitcoins.
 
Note: while every bitcoin records the digital address of every bitcoin wallet it touches, the bitcoin system does NOT record the names of the individuals who own wallets.  In practical terms, this means that every bitcoin transaction is digitally confirmed but is completely anonymous at the same time.
 
Your bitcoins are stored on a computer device of your choice, but the history of each bitcoin you own or spend is publicly stored on the bitcoin network, and every user will be able to see every bitcoin's history.
 
Who Makes Bitcoins?
 
Bitcoins can be 'minted' by anyone in the general public who has a strong computer. Bitcoins are made through a very interesting self-limiting system called 'mining'.  It is self-limiting, because only 21 million total bitcoins will ever be allowed to exist, with approximately 11 million of those Bitcoins already mined and in current circulation.
 
Bitcoin mining involves commanding your home computer to work around the clock to solve 'proof-of-work' problems  (computationally-intensive math problems). Each bitcoin math problem has a set of possible 64-digit solutions. Your desktop computer, if it works nonstop, might be able to solve one bitcoin problem in two to three days, likely longer.  
 
For a single personal computer mining bitcoins, you may earn perhaps 50 cents to 75 cents USD per day, minus your electricity costs.
 
For a very large-scale miner who runs 36 powerful computers simultaneously, that person can earn up to $500 USD per day, after costs.
 
Indeed, if you are a small-scale miner with a single consumer-grade computer, you will likely spend more in electricity that you will earn mining bitcoins.  Bitcoin mining is only really profitable if you run multiple computers, and join a group of miners to combine your hardware power.  This very prohibitive hardware requirement is one of the biggest security measures that deters people from trying to manipulate the Bitcoin system.
 
How Secure Are Bitcoins?
 
They are as secure as possessing physical precious metal.  Just like holding a bag of gold coins, a person who takes reasonable precautions will be safe from having their personal cache stolen by hackers.  
 
Your bitcoin wallet can be stored online (i.e. a cloud service) or offline (a hard drive or USB stick).  The offline method is more hacker-resistant, and absolutely recommended for anyone who owns more than 1 or 2 bitcoins.
 
More than hacker intrusion, the real loss risk with bitcoins revolves around not backing up your wallet with a failsafe copy.  There is an important .dat file that is updated every time you receive or send bitcoins, so this .dat file should be copied and stored as a duplicate backup every day you do bitcoin transactions.
 
Security note:  the collapse of the Mt.Gox bitcoin exchange service is not due to any weakness in the Bitcoin system.  Rather, that organization collapsed because of mismanagement and their unwillingness to invest any money in security measures.  Mt.Gox, for all intents, had a large bank with no security guards, and they paid the price of their human error.
 

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