What are Bitcoins?

On this past week’s broadcast/podcast of The Motley Experience on WRSU, the topic of Bitcoins was discussed.

The use of bitcoins has been highlighted in the news recently and will most likely continue to do so due the controversy surrounding the subject.

To ensure that readers of The Motley Experience have a better understanding of what bitcoins actually are, I have put together a basic overview.

Bitcoin is a digital currency and software

Bitcoin is often referred to as a new kind of currency. But it may be best to think of its units being virtual tokens rather than physical coins or notes. However, like all currencies its value is determined by how much people are willing to exchange it for.

To process Bitcoin transactions, a procedure called “mining” must take place, which involves a computer solving a difficult mathematical problem with a 64-digit solution. For each problem solved, one block of bitcoins is processed. In addition the miner is rewarded with new bitcoins. This provides an incentive for people to provide computer processing power to solve the problems.

Blocks create 25 new bitcoins at present. This amount, known as the block reward, is an incentive for people to perform the computation work required for generating blocks. Roughly every 4 years, the number of bitcoins that can be “mined” in a block reduces by 50%. Originally the block reward was 50 bitcoins; it halved in November 2012. Any block that is created by a malicious user that does not follow this rule (or any other rules) will be rejected by everyone else. In the end, no more than 21 million bitcoins will ever exist. There are currently about 11 million bitcoins in existence.

Because the block reward will decrease over the long term, miners will some day instead pay for their hardware and electricity costs by collecting transaction fees. The sender of money may voluntarily pay a small transaction fee which will be kept by whoever finds the next block. Paying this fee will encourage miners to include the transaction in a block more quickly.

To receive a bitcoin a user must have a Bitcoin address – a string of 27-34 letters and numbers – which acts as a kind of virtual post-box to and from which the bitcoins are sent. Since there is no registry of these addresses, people can use them to protect their anonymity when making a transaction. These addresses are in turn stored in Bitcoin wallets which are used to manage savings. They operate like privately run bank accounts – with the proviso that if the data is lost, so are the bitcoins owned.

There are a variety of ways to acquire bitcoins. One way is to accept bitcoins as payment for goods or services. The most common way to buy bitcoins are the Bitcoin Exchanges. There are also several services where you can trade them for traditional currency. Another way is to use “mining” software to unlock blocks.

So this has described the basic idea behind bitcoins.

There has been a lot of hype concerning the potential uses for bitcoins, however those considering investing in Bitcoin software and acquiring bitcoins should be wary.

Recently, bitcoin’s value dropped sharply after one of the largest trading exchanges said there was a flaw in the virtual currency’s underlying software. An investigation had revealed it was possible for thieves to fool the transaction process so that double the correct amount of bitcoins would be sent.  Bitcoins fell from $700 to $540.

Also in the news, the use of Bitcoin for alleged money laundering led to the arrests of two men in the US just last week.

Bitcoin is still very new. Despite safeguards in place, it is still possible for manipulation and other issues to disrupt transactions. Although there are positives, such as a universal instrument for anonymous transactions, there are dangerous negatives to consider.

 

For a more in depth look into Bitcoin, please see the below links that were used for information to write this article:

US makes Bitcoin Arrest – http://www.bbc.co.uk/news/technology-25919482

Introdution to Bitcoin – https://en.bitcoin.it/wiki/Introduction

Bitcoin FAQ – https://en.bitcoin.it/wiki/FAQ#How_can_I_get_bitcoins.3F

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