So I’ve heard about this strange Bitcoin stuff for ages, but never found the time to look into it, until now. It cropped up at work, s I thought I should get acquainted. And this blog posting is an expression of my level of understanding, so it could well be wrong in places.
Certainly don’t take any of this as financial advice!
Bitcoin is a digital cash currency, but what does that mean?
Well the “cash” bit is understandable; it is normally expressed as a ‘peer-to-peer’ currency but essentially I hand over to you a certain number of bitcoins in exchange some agreed goods or services. Just the same as if I paid you in an ordinary currency in the form of cash.
It is a bit more complex than that as transactions have to be computationally confirmed. Or to put it another way, once you transfer the bitcoins, the transfer has to be independently verified which takes some time. The average seems to be about 8 minutes. So not quite the same as cash then; on the other hand it should be as anonymous as cash – perhaps even more so.
The “currency” bit is a tad more controversial. There’s more than a few governments that declare that bitcoins aren’t a currency but behaves more like a commodity (like gold). Of course they may be speaking with a forked tongue, or simply warning of the dangers of using bitcoins. Fundamentally a currency is a medium of exchange – so if you can find something to buy with your bitcoins, or you are prepared to sell goods or services for bitcoins, it is a currency for you.
Lastly the “digital” bit is where it can get a bit complex, so I won’t be trying. To put it very briefly, a bitcoin is a long string of digits that has been “discovered” (or more accurately mined) according to some complex calculation and then independently verified. It also includes details of all previous transactions that have occurred. The obvious question here is how is it that bitcoins cannot be forged?
There is no answer to that question without getting involved in the details of how bitcoins work computationally, but it is commonly held to be impossible without access to enough computational power to overwhelm the combined computational power of the bitcoin miners.
The Bitcoin “Bubble”?
In conventional economics a bubble is essentially some activity that becomes massively over valued and eventually loses it’s value. Examples include the South Sea Bubble, and the dot-com bubble. There are those who claim that bitcoin shares characteristics with famous historical bubbles, which is a very easy thing to say.
After all, no bubble is a bubble until it has been popped; at least in economics.
The trouble is that bitcoins are essentially worth what people agree they are worth. If everyone turned around tomorrow and agreed that they were worthless, you wouldn’t be able to spend them.
Which makes them the same as practically all modern currencies – the pound, the dollar, the euro. They are all backed not by silver or gold, but people’s confidence. Bitcoins are subject to much larger fluctuations than ordinary currencies which is at least partially a result of the small size of the bitcoins marketplace and the effect of external events such as China banning bitcoins.
The Wallet
To make use of bitcoins, you need a wallet to put them into. This is essentially an application that processes bitcoin transactions and keeps a record of how many bitcoins there are in the wallet. Full-blown wallets (such as one of the earliest – Bitcoin-QT) keep a full record of the bitcoin transactions to fully verify bitcoins; mobile wallets are less capable. Whilst there are still protections in mobile wallets, you may wish to be less trusting with mobile wallets until you know more about this than I do!
Once you have a wallet fully set up – which can take several days due to the large number of transactions it needs to download – you can start using it. Of course initially it will be empty, so you will be unable to buy anything, but you will be able to set up addresses for people to send you bitcoins which will look like 16hQid2ddoCwHDWN9NdSnARAfdXc2Shnoa.
Yes that’s a real address – it’s my “donation” address – and you are more than welcome to send me a coin or two. Or more realistically a tiny fraction of a coin.
Once you have something in your wallet, you can send bitcoins to addresses like the one above … or perhaps another address in return for something useful!
Mining Bitcoins
Previous sections have indicated that there is something called “mining” and that a great deal of computational power is behind the workings of the bitcoin network. Numerous volunteers contrib computer power – almost always using special hardware to do so – in the hope of making money.
Can you make money? Yes, but probably not enough to pay for the increased electricity bill and almost certainly not enough to pay back the initial hardware investment. People who got into mining earlier may have made a bit of money – when you could effectively mine with ordinary computer power, but unless you are prepared to invest many thousands of pounds on a regular basis it is unlikely that you will see anything like a reasonable return.
And this is probably bitcoin’s biggest weakness. The bitcoin network needs miners to validate all of the transactions that go on, and in the future, there may be a lack of volunteers if the return is not reasonable.
But of course I might be discouraging you as I’m mining a bit myself – and the more miners there are, the fewer bitcoins there are for me 🙂