Have you ever heard of Bitcoins?  When Russian developer Alexey Borodin hacked Apple’s In-App Purchase program (by making everything free) with creation of the “Grim Receiper” back in July,  it was amazingly surprising to see many support piracy by making contributions to Borodin through PayPal.  Apple quickly moved to have Borodin’s PayPal account frozen.  This did not stop monetary contributions as Borodin started using Bitcoins – a currency of the future.  The purpose of this article is to look more closely at Bitcoins – finding out what it is, how it works, as well as security issues for using such a system.  Watch the video below for a bird’s eye view on what Bitcoins (BTC) are.

Value is in the eye of the beholder.

Why do we use USD (U.S. Dollars), Euros, Pounds, etc.?  Because it is accepted by the masses to have value.  Before hard currency, there was always bartering which placed value of items and services being traded with value being in the eye of the beholder.  Today, currency is used as the universal medium, but its amount determines the value of the trade for goods and services.  The commonality of what we know and call money up to this point are all currencies that rely on a clearing house or a central authority (usually run by the government) to guarantee and protect the system.  Because of these controls, money can be frozen (making money  or funds inaccessible thereby barring the individual or entity from the economic system).  Transactions through paper money is at times preferred due to anonymity – but the transfer of large quantities of bills can be subject to theft, or even confiscation by government.  Currencies of this type are based upon the full faith and credit in whomever issues the currency.

What are Bitcoins and How Do They Work?

Bitcoins are digital cryptographic currency that is not built upon a system of trust – but a system of distrust and decentralization.  As a fiat currency (money without intrinsic value), Bitcoins have value only because there is a market for them.  And what makes things have value?  Supply and demand.  The oddity of the Bitcoin is that people can get them for “free” by mining for them.  Mining requires CPU power to conduct work for the Bitcoin network by finding new “valid” coins as well as processing transactions.  In reality, this is not free as the cost of mining can be enormous when you take the amount of computational power and electricity that is needed.  However for those who have access to cheap electricity (solar power users or perhaps they have an apartment where electricity is supplied to them), we see some people making Bitcoin mining an actual enterprise.  People can mine solo or in grouped pools in which the amount of CPU “work” contributed will be returned with fractional Bitcoins.  If one goes solo and finds a “valid block”, then the bounty received is 50 Bitcoins or roughly $525 USD.

Bitcoins can also be traded for other currencies similar to the FOREX exchanges.   Current exchange rate as of September 2012 is roughly $10.50 USD to one BTC (Bitcoins). Bitcoins can be fractionalized during transactions so you can give partial amounts.  Coming soon, you’ll also be able to use credit cards to convert BTC to your local currency although many will shy away from this as anonymity will be lost to comply with regulations of financial institutions of the standard currencies.

What prevents people from double spending BTC?  The beauty of the system is that this is distributed computing at its finest.  In order to even try to double spend and use the same BTC for transactions, you’re going to need to have enough CPU power to overwhelm the collective power of every BTC miner and user out there as transactions are sent out to the whole network and must follow very specific rules to be deemed a valid transaction.  A BTC transaction can be verified as in as little as 10 minutes.

A “wallet” is Your Private Encryption Key

If you are ready to try out Bitcoins, you’ll need to get a wallet.  Wallets are free and they will be your personal account number.  A “wallet” is your private encryption key which only you should know.  You also have a public key which is what is visible for the world with which to receive and send BTC.  Because of the way encryption works, if someone tried to mess with your account, the BTC network would immediately know and reject the transaction.  Of course, if someone had your wallet, you’d be toasted as it would be as powerful as a ruler’s signet ring – they can literally empty out your account and leave you stranded.  BTC transactions are permanent and they CANNOT EVER be revoked or reversed once the network has accepted a transaction.  It is cash and once it’s gone, it’s gone.  There are cases where people have been robbed because their wallet was stolen.  A few days ago, an entire exchange lost $250,000 USD worth of BTC because they did not follow the minimal security procedures of keeping a “cold wallet” and a “hot wallet” (these will be gone into in more detail in a future article as I continue my journey with using Bitcoins).  Sadly, the entire BTC network can see the transaction(s) but due to the way BTC was designed, transactions still cannot be reversed.  Because of this, it is imperative that BTC users understand more than the basics of how BTC works as well as basic knowledge in computer security to keep themselves safe.

I Love Finding Pennies on the Street

What ever happens to lost wallets and lost BTC?  Well, as much as I love finding pennies on the street, the closest thing to finding BTC on the street is mining for them.  Sadly, lost wallets remain in the system but will become inaccessible.  This just helps to make BTC more rare and as these problems occur, the value of BTC in circulation will continue to grow in value.  In addition, BTC can never truly go away as the smallest unit for a BTC transaction is 0.00000001 BTC.  That’s a lot of decimal places – considering the smallest unit of USD is a penny or $0.01!

Bitcoins Are a Supplemental System, Not a Replacement

You can’t stop the economy.  Governments hate what they cannot control.  Free speech and free market are wonderful things to be protected.  Because of the Bitcoin project, there will always be ways to do business – even on a global level.  There are risks involved with using Bitcoins.  In some cases, Bitcoins are, in my opinion, less of a risk than holding currency of an upcoming defaulting nation.  Bitcoins have the potential to replace national currencies.  However, I see Bitcoin as more of a supplemental alternative currency.  We’ll see you next time with more of my journey and experiences with Bitcoins as I share my experiences with mining for coins!

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