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What Are Bitcoins? How Do Bitcoins Work? (Bitcoins- A Complete Guide- Part1)

What Are Bitcoins? How Do Bitcoins Work? (Bitcoins- A Complete Guide- Part1)

Bitcoins, the currency on the tech world’s lips lately, sounds endlessly fascinating and builds up curiosity as it is supposedly the first time in the history of mankind that people’ve a way to hold and transfer value without any other person involved or having control over it. It gives  complete ownership of money both in storage and transfer. Nobody can prevent you from having it. Nobody can prevent you from spending it.  I was hooked up with the whole premise but was skeptical whether a man of the street like me, who is no cryptography expert, can understand the working intricacies of a concept like Bitcoin which works on cold hard mathematics. However, after reading extensively about it on the internet, I realized that it is fairly easy to understand and an average guy with just basic technical knowledge can  use them.

What is Bitcoin?
A currency.  Just like euros, dollars, yen, pounds, rupee etc.  The beauty of Bitcoins lies in the fact that it is 100% virtual and has no counter-party risk to hold and to transfer.  It allows a direct and immediate transfer of value between two people anywhere in the world. No banks, governments, or organizations control or influence it. Created in 2009 by Satoshi Nakamoto, the Bitcoin network is structured like a guerilla movement. Built on peer-to-peer Internet technology so that no one person, business, or government controls it ; it is literally enabled by the individuals that choose to use it. . Similar to popular file sharing protocols like BitTorrent, clients talk to each other and propagate transactions through the network.  Complex math and strong cryptography are the foundations used to confirm valid, fundable transactions, prevent double spending, and deny inflation.

Bitcoins allow a direct and immediate transfer of value between two people anywhere in the world.

Bitcoins allow a direct and immediate transfer of value between two people anywhere in the world.

How do Bitcoins Work? How do they get rid of governments, banks, and payment companies?
Pretty simple. To use Bitcoins, you download the software from Bitcoin.org. The software acts as your bank account and is called your “wallet.” It stores a secret code on your computer, and this code enables funds to be spent from your bank account. As soon as one has this wallet software, one can receive and send Bitcoins to other wallet-holders anywhere in the world.  You don’t need a name, an address, a Social Security number, or any personal information of any kind. Nobody “approves” you for Bitcoin. It’s free and open-source.

Transactions are sent and accounts are secured using  “public key cryptography.” Every account/wallet has two keys-  a public key and a private key. These keys are long strings of numbers and letters.

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Your private key, which your wallet software knows,  allows you to send money. To send money to someone, you merely need to know their public key (kinda like a bank account number). If you have your private key plus their public key, a transaction can be created and the funds are deducted from your account and credited to the receiver’s account, without anyone else having a say in the matter. Simple as that.

How are Bitcoins generated?
By Bitcoin Mining. A process similar to a continuous raffle draw. Bitcoin Mining secures the transactions to make sure that every transaction (transfer of bitcoins from one computer to another) is verified and
generates new Bitcoins by the aforementioned verification.

What is Bitcoin Mining?
Bitcoin mining is a process where the people who use the Bitcoin system install a software onto their computer.  This software is very advanced and does computationally intensive work (SHA256 decoding) of  verifying  transfer of bitcoins. It collects the transactions on the network (like “A pays B 5 bitcoins” and “C pays D 6  bitcoins”) into large bundles called “blocks.” The software now computes a cryptographic hash of these blocks to verify the integrity of transactions. The people running the mining process get rewarded for completing a block by receiving a certain amount of bitcoins from the system. And  this is the ONLY way that new bitcoins are created. So as a Bitcoin Miner all you need to do is  run computer programs on a very specialised hardware that helps verify earlier transactions made. And get paid for it.

Advantages of using BitcoinsWhat can I buy with Bitcoins?
Video games.
Books.
Servers.
Gifts.
Alpaca Socks.
A detailed list can be found here.

Government Vs Bitcoins
Given the fact that bitcoin could facilitate illegal activities, including the sale of pirated or counterfeit goods, stolen credit card numbers and passwords–even child pornography, there’s a very real chance that the Governments might try to bring down this whole network in future. But, can they? The first step they might take is that they can try to take down Bitcoin websites. Mr. Erik Voorhees, a writer and an entrepreneur, in his recent article described taking down  Bitcoin websites as cutting the heads of a Hydra – for each successful severance, publicity and the profit motive would compel more sites to spring up.

So taking down websites is an inadequate strategy if the government wishes to impede Bitcoin. What else could they do? Can’t the government just “shut down” Bitcoin transfers? Bitcoin is not vulnerable to this risk, because there is no central point of failure. There is no Bitcoin office. There are no central Bitcoin servers. There is no president nor employees of Bitcoin. Bitcoin has no home country, it is licensed nowhere. It is a distributed network, a protocol, that can operate as long as the internet exists (and, in fact, even without the internet per se). Transactions occur peer-to-peer, meaning no governing body approves them. Accounts cannot be frozen, because nobody has the freeze button.

Bitcoin cannot be turned off – it is like a benevolent virus which, so long as a few hosts survive somewhere in the world, can perpetuate itself and regrow at the speed of information.

The Future of Bitcoins
It’s too early to say whether Bitcoin will be a success not. An entirely new global monetary system that Bitcoin is, it faces an uphill battle, both technically and legally. The future depends on the inclination of big organizations towards accepting Bitcoins as a payment option, and they’ve started to do so. Exchanges where you can swap money for bitcoins and vice versa are up and running, and the number of vendors that accept bitcoins for payment continues to expand. Beyond the concerns of acceptance, there’s even a bigger issue. Many economists, including Paul Krugman,  consider Bitcoin’s sudden jump as ephemeral— they  see it as a bubble which will pop once the novelty wears off.  Only time, really, will tell the true potential of Bitcoins. However, there’s an urgent  need for decentralized currency system, and Bitcoin certainly is a step toward censorship-resistant digital currency. And for that reason alone, it’s worth consideration.

This is part 1 of a 3 part series. Links to part 2 and 3, which will elaborate more on Bitcoin Mining and the proper use of Bitcoins, will be updated soon.

The Future of Bitcoins

A Possibility in Near Future?

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  1. Thanks, great article, hope bitcoin can weather the storm!

    Reply

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