Bitcoin for beginners: how does the digital currency work?
I still really have no idea what bitcoin is, can you explain?
Bitcoin the mysterious crypto-currency that is creating a scene in the online world can be hard to understand at first.
But once you get your head around the key concepts there is no reason not to start using this peer-to-peer digital currency.
What is Bitcoin?
Bitcoin is a global digital currency that you can send through the internet directly from person to person. It is decentralised: there is no central bank controlling it and it doesn't rely upon external banking institutions as other currencies do.
It was designed by a mysterious figure called Satoshi Nakamoto - though that's thought to be a pseudonym - with the code written and developed by Nakamoto and volunteers.
Why do people use Bitcoin?
Bitcoin is attractive to many users because it offers a near instantaneous secure method of currency transaction with minimal or no fees.
As bitcoin operates outside of traditional currency controls of central banks, many users like the knowledge that no bank can take it away from them.
Security is also a big attraction for many users. The bitcoin code is open source so anyone can review it and when making a transaction no secret information about you personally is required, unlike a credit card or debit card transaction.
Similarly, privacy attracts many users. To send someone bitcoin or to receive bitcoin all you need is a bitcoin address or wallet. When sending bitcoin you send funds to a bitcoin address much as you would input an account number when using a bank transfer.
The difference is you only need the bitcoin address of the person you are sending it to, likewise, if someone is sending bitcoin to you, all you need to provide is your bitcoin address.
How do I know a transaction will work safely?
When sending bitcoins to another person or to pay for goods, the transaction is given a digital signature and broadcast to everyone on the network where the transaction is permanently stored.
New transactions are checked against the block chain by the miners to prevent people from spoofing the system with fraudulent transactions.
Two people who tried to come up with a fraudulent transaction alone, when checked against every other copy of the block chain it would be flagged as invalid.
The list holding details of all transactions ever made is a public ledger called the block chain. It can be viewed online at websites such as blockchain.info.
The history of any transaction can therefore be traced back to the moment when those bitcoins were mined. As it takes ten minutes for miners to confirm the latest transaction your transaction may not be added to the block chain for up to ten minutes.
Sounds good, how do I get hold of them?
Any bitcoins you own are stored online in your own digital bitcoin wallet and anyone can get their own bitcoin wallet from bitcoin.org.
Bitcoins can be generated by anyone using a bitcoin mining application on their computer. Part of the design of bitcoin means there will only ever be 21 million bitcoins in existence: the last ones will be mined in 2140.
Mining is a big competition which works by rewarding miners with bitcoins each time they successfully compute a hash - this occurs about once every ten minutes across the entire global bitcoin network. This action also confirms sets of previous transactions called blocks.
While this sounds like a licence to print money, mining is very intensive computational work and becomes harder the more bitcoins are generated. The average laptop would take over three years to compute one hash.
This is why merchants who wish to confirm each transaction may have to wait up to ten minutes.
I don't have time for that... how do I get bitcoins today?
If you don't fancy setting up an expensive power hungry computer to mine bitcoins, you will often hear of people trading them for dollars, sterling or other currencies at regulated bitcoin exchanges such as Mt Gox, Kraken or Bitstamp.
Registering for an exchange is a somewhat arduous process though and an easier method of getting hold of some is to use a service like Bittylicious or BitBargain, aimed more toward the bitcoin beginner and where you can send bitcoin to your wallet directly.
Or if you are selling something you could offer bitcoin as a payment method and receive some that way.
What are the risks?
The value of your holding can go up as well as down.
At present bitcoin is a volatile currency and as such using it as a trading currency on the bitcoin exchanges means while there could be big gains to be made, the risks are equally big.
Bitcoin transactions aren't reversible which means when sending bitcoin you must be absolutely sure you are sending to the correct bitcoin address.
Aren't bitcoins only used by people who want to buy heroin or endangered rhinos?
Although there have been high profile cases of websites such as Silk Road where people traded bitcoin for illegal products like drugs, there are many places to use bitcoin to purchase legitimate goods.
You can purchase anything from web hosting and gold to electronics and houses (well, one man was selling his house in Canada).
More and more places are dipping into bitcoin and offering it as a payment option alongside the traditional credit, debit and online methods.
That's not to say that the shady aspect is trivial, however.
When Silk Road was shut down the FBI said the site had processed 9.5 million bitcoin worth of transactions. There are only about 11.75 million bitcoin in circulation, and there were much fewer during some of that period.