What is Bitcoin?
Bitcoin is a virtual or digital currency also known as a cryptocurrency created by the mysterious (and unknown) Satoshi Nakamoto. Bitcoin is like other currencies: it can be used to purchase items locally and electronically. However, Bitcoin differs from conventional money in that it is decentralized and fully independent. No institution controls the Bitcoin Network and it is not tied to a country like the US Dollar. The entire network is maintained by individuals and organizations referred to as Bitcoin Miners. Bitcoin miners process and verify Bitcoin transactions through a mathematical algorithm based on the cryptographic (hence the name cryptocurrency) hash algorithm SHA256.
Bitcoin is Decentralized
No central authority such as a government controls Bitcoin or its network of transactions. A community of Bitcoin miners makes up the network, processing the transactions. If any changes are made to Bitcoin by a developer or developers using GitHub, a 51% majority of the miners hashing power must agree upon it. This ensures that, in theory, no individual can steal your bitcoins or print (create) more. The beauty of this network setup allows for transparency and an open forum for ideas. Bitcoin can be seen as a democratic currency where the majority always decide what will happen next with the Bitcoin source code.
Bitcoin Transactions Can not be Reversed
When you send bitcoins to a Bitcoin address, you can’t reverse the transaction. Unlike credit cards where a transaction can be disputed or reversed, bitcoins are nonrefundable. Bitcoin can’t be replaced either. If your wallet is stored on your hard drive and not in a cloud storage, you could lose your bitcoins if you are hacked, get a virus or if your computer dies. These lost bitcoins can never be retrieved.
Furthermore, merchants can’t initiate charges on you as they can and do with credit cards. Each transaction must be initiated by the wallet holder, further underlining the advantages of the Bitcoin system.
Bitcoin is Secure
Proponents of Bitcoin praise it's impressive security and with good reason. In theory, unless 51% of the system is controlled by one party, Bitcoin is practically unhackable. For instance, in cc or double spend a Bitcoin, they would have to obtain majority control of the system and modify every miner in this majority. When there is a disagreement in the blockchain, the system overrides the minority with the data agreed upon by the majority.
How are Bitcoins Created?
Bitcoins are created through a process known as mining. Mining is the term used by those who contribute to processing transactions. People who do the mining are referred to as miners. Miners process and secure the network using specialized hardware that “mine” for new bitcoins. Bitcoin mining requires a computer and a special program. Miners will use this program and a lot of computer resources to compete with other miners in solving complicated mathematical problems. About every ten minutes, they will try to solve a block that has the latest transaction data in it, using cryptographic hash functions. As “payment” for their contribution, they are awarded new bitcoins. This is how new bitcoins are created.
New coins are created at a fixed and decreasing rate that is predictable. The number of coins created each year is halved over time until 21 million bitcoins is in circulation. At this point, Bitcoin miners will be rewarded by transaction fees. This has led to many speculations on the future of Bitcoin and Bitcoin Miners.
When a miner has successfully created a new hash, the block is sealed off and added to the blockchain. 25 bitcoins are awarded to the miner who discovered the new hash. The number of bitcoins rewarded per block is cut in half every four years. Blocks are solved an approximate rate of 6 per hour.
How Are Hash Functions Useful For Bitcoin?
Because it is practically impossible to predict the outcome of the input, hash functions can be used for proof of work and validation. Bitcoin miners will compete to find an input that gives a specific hash value (a number with multiple zeros at the start). The difficulty of these puzzles is measurable. However, they cannot be cheated on. This is because there is no way to perform better than by guessing blindly.
The aim of mining is to use your computer to guess until it comes up with a hash value that is less than whatever the target may be. If you are the first to do this, then you have mined the block (normally this takes millions and billions of computer-generated guesses from around the world). Whoever wins the block will get a reward of 12.5 bitcoins (as long as it becomes part of the longest blockchain). The winner doesn’t technically make the bitcoin, but the coding of the blockchain algorithm is set up to reward the person for doing the mining and thus helping to verify the blockchain.
Each block is created in sequence, including the hash of the previous block. Because each block contains the hash of a prior block, it proves that it came afterward. Sometimes, two competing blocks are formed by different miners. They may contain different transactions of bitcoin spent in different places. The block with the largest total proof of work embedded within it is chosen for the blockchain.
This works to validate transactions because it makes it incredibly difficult for someone to create an alternative block or chain of blocks. They would have to convince everyone on the network that theirs is the correct one, the one that contains sufficient proof of work. Because everyone else is also working on the ‘true’ chain, it would take a tremendous amount of CPU power to beat them. One of the biggest fears of Bitcoin is that one group may gain 51% control of the blockchain and then be able to influence it to their advantage, although thankfully this has been prevented so far.
Why use Bitcoins?
Bitcoins are appealing to a large number of people for an equally large sum of reasons. Bitcoins can be anonymous, near instantaneous and offer a level of control over your money that can’t be found in other traditional currency. There is no central bank or middleman that can take away your money, and Bitcoins are deflationary in nature, while e.g. USD is inflationary where your money depreciate over time. Bitcoins are also speculative in nature due to their potential to shake up the entire financial industries, which has sprung the attention of investors.
For practical reasons, merchants are drawn to Bitcoin because of the low fees associated with a transaction. Merchants typically pay 2-3% + $0.30 per transaction to credit card processors, whereas many types of transactions are free with Bitcoin. Transactions are free if several conditions are met. Any transactions that don’t meet the requirements are charged 0.1mBTC (0.0001 BTC) per 1,000 bytes. Typical transactions are 500 bytes but do not meet the priority requirement and thus are charged a 0.1mBTC fee regardless how many coins are transferred. You can view the live Bitcoin price here.
How to Obtain Bitcoins
There are several ways to obtain bitcoins. The most common way is to purchase them on a Bitcoin exchange.
Bitcoins can also be obtained by becoming a part of the Bitcoin network and start mining for bitcoins. Before the days of ASIC miners, individuals could set up their computers to mine and earn bitcoins easily. Those days are long gone due to the difficulty to mine Bitcoin, the difficulty level of Bitcoin has risen enormous making it harder and harder to earn bitcoins with the same equipment. Becoming a miner and seeing positive ROI would mean a substantial investment and is now left to the big companies and wealthy investors. For most individuals, purchasing your Bitcoin through a Bitcoin Exchange is the best option.