An Introduction to Bitcoin: The Open Source Cryptographic Currency

bitcoin-visualBitcoin is the new ‘virtual currency’ that has aroused the interest of millions of people, financial and banking institutions, and government agencies. As it is relatively new, much is not known about it. In this article the author demystifies Bitcoin.

Have you ever wanted to send money to India from a foreign country, or wished for a borderless currency that could easily be spent anywhere?  Open source comes to your rescue here as well. In the always-connected world of devices, you can now use Bitcoin from anywhere with the privacy and anonymity that’s similar to using cash, and in a medium that is very secure.

Bitcoin is an open source peer to peer cryptographic currency, which is quite revolutionary since it is based on a peer to peer protocol. This means that it is not regulated by any government, private body or organisation. Each user forms part of a payment network, which is basically a set of protocols for exchanging currency worldwide without any borders.

The very fact that it can be used and accepted anywhere can change the way our economy works. Moreover, the best part about using Bitcoin is that you can transfer it with little or no transaction fees! Bitcoin had a boom recently when its value spiked suddenly over a short period of time, but it is still not universally accepted in as many places as desired. This is partly due to the fact that the technology is still under development and also because many merchants or developers are still wary of accepting something that could essentially be a risky investment of their time and money.

Figure-1Figure--2
Bitcoin has been of interest to merchants, developers and consumers who are keen to break the boundaries and shackles of the existing payment methods to try something new. These are however niche applications, and its acceptance is at present limited to larger brands and in popular places. Moreover, Bitcoin has also been linked with black markets, money laundering and purchase of illegal goods. This is because of the anonymity and privacy provided by Bitcoin, which makes its use similar to using cash. An important point to note here is that Bitcoin transactions do not come with the kind of fraud protection that conventional platforms like credit cards and PayPal provide. Once completed, a Bitcoin transaction cannot be reversed unless the recipient decides to send you the money back in a new transaction. Many would assume that this is a loophole but it is, rather, a security feature which keeps you in control of your own money instead of interference from some other authority. This is one of the primary reasons why credit card and online payment methods other than bank fund transfers are not accepted even by third party merchants or Bitcoin exchanges in return for Bitcoins.

Bitcoin was launched in 2008 by Satoshi Nakamoto, a person whose true identity is still unknown. However, ever since its launch, Bitcoin’s value has steadily risen from less than a dollar to more than $100 today, where it seems to be relatively stable for the time being. This value is determined by the price at which the Bitcoin is sold at major exchanges like Mt Gox. This has, however, obviously drawn a lot of attention and many of the countries are now trying to find a way to introduce rules and regulations around such innovative technology. The rising value has resulted in day to day Bitcoin transactions being carried out on a much lower numerical scale than normal currency. Divisibility is one of the inherent properties of Bitcoin which, as opposed to normal currency, can be divided up to eight decimal places and can be used in denominations such as uBTC and mBTC.

box--1Figure-3Figure-4Using Bitcoin
Bitcoin can be used from mobile devices as well as desktops. There are clients available for Android, iOS, etc, on mobile devices and for Windows, OS X and Linux on desktop computing platforms. While there are online Web clients also available, these are generally not considered trustworthy or secure despite all security measures, as your Bitcoins are hosted on someone else’s server. Modern day mobile devices now offer innovative ways of using Bitcoin to initiate a transaction between two devices with methods such as a QR code or an NFC tap.

Basically, when you install a Bitcoin client, a wallet is created for you. This wallet is associated with your Bitcoin address which looks like a long string of numbers and letters, for example:

1PC9aZC4hNX2rmmrt7uHTfYAS3hRbph4UN

This address is used to send or receive Bitcoins from another person. Each wallet can be associated with as many addresses as possible. Actually, you should use each address for only one transaction. When this wallet is created, the Bitcoin client will ask you to encrypt it and create an associated password and a private key for accessing the wallet. This private key will allow you to spend Bitcoins from your wallet but anyone can monitor the balance in your wallet.

How it works
One might wonder what it is that gives value to a Bitcoin as opposed to normal currency. Why can it not be simply copied and spent multiple times? Whenever a Bitcoin transaction is intended between two parties, the transaction is broadcast to everyone on the network by the person who is responsible for sending the money to the recipient. This transaction is then verified and validated over the next couple of hours. This process thus avoids double spending, as each verified transaction is then processed and included in the block-chain by the miners (the people who process all this information in return for transaction fees that are allocated to a miner, which may or may not be included).

The block-chain thus acts like a public ledger of all the Bitcoins that have been spent over time and keeps increasing in size.

Bitcoin clients
The table below gives some popular Bitcoin clients available on various platforms. Some of these are quite heavy due to the large size of the block-chain, while others like Electrum, Mycelium and online clients are relatively easy to use.

Bitcoin-Qt, for example, is the full featured thick client which downloads the whole block-chain using the official Bitcoin code. It requires significant network bandwidth and is quite heavy on system resources. Other third party clients, which keep the private keys on your local machine but use the block-chain that is hosted on a server, provide a relatively manageable compromise between security and speed. While the full featured clients are the most secure, it is not possible for everyone to have the patience and speed to run them on their machines. Each of these clients provides a simple set of instructions for installation on your machine and some of them are quite easy to use, even for those who are non-technical. Installation is similar to any other software. However, detailed instructions can be obtained from the websites of these clients. The official Bitcoin website list links to the websites of these clients.

How can Bitcoins be used?
Bitcoins are accepted in much fewer places than normal currency and conventional payment methods. Online hosting and other digital goods are some of the limited things that you can buy with Bitcoins. In the US, hotels and restaurants have started accepting Bitcoins; however, such popularity is yet to reach India. A few days back, Silk Road, the secret online market place was taken down by the FBI. It was one of those places which allowed you to buy and sell anything with Bitcoin. It was literally a place where people could sell anything, including drugs and weapons.

It is estimated that Silk Road had done an estimated business of more than 9.5 million Bitcoins out of the total 11 million Bitcoins in circulation today. What is surprising is that the closure did not have any significant effect on Bitcoin’s price. This obviously means that people consider it seriously and it is more than just a medium for black marketeers or a method for money laundering. A lot of online merchants today do not even allow you to buy Bitcoins without extensive verification of your documents and identity. They also have an upper limit beyond which you cannot buy any more Bitcoins. Today, Bitcoin is mainly used by many people for trading and investment purposes as they expect its value to only rise over the next few years.

Bitcoin mining
Bitcoin mining is a resource intensive process and is done only on high performance machines with significant GPU and CPU processing power. Some of the methods of mining Bitcoins are CPU mining, GPU mining, FPGA mining and ASIC mining. The last one is the latest and most efficient technology to mine Bitcoins with the least amount of processing power. Mining takes up so much of resources that it is done by many people in a single pool or group, which works towards a common goal of producing a block that fetches them a total reward of around 50 Bitcoins for their efforts. This reward is to be reduced over time to 25 Bitcoins, then to 12.5 Bitcoins, and so on. Eventually, the miners are expected to be rewarded for their efforts with the small transaction fees that is attached to each transaction. This results in the creation of more Bitcoins, which is why it is known as ‘mining’ as it resembles the production of similar limited resources like gold and currency.

Explaining the actual processing that happens during mining requires a more detailed understanding of cryptography and hashing. But, in simple words, it is a process that is intentionally made difficult so that blocks are produced at a rate of around one block every ten minutes for all the miners, which is a total of six blocks per hour.

What actually happens during mining is that miners try to produce the next block by using the hash value of the current block, along with the representation of the next set of transactions shown as a Merkle root, which is added along with a nonce value. The nonce value keeps increasing until the correct solution is produced, which is lower than the target value. Whichever miner solves the problem in the fastest time gets the reward of the Bitcoins, and this process keeps repeating.

Buying Bitcoin in India
While mining Bitcoin is definitely not for everyone, there are some places where you can buy Bitcoins at a value pegged to the US dollar in the popular Bitcoin exchanges like Mt Gox, etc. Some of the places you can buy Bitcoin in India are:

  • BuySellBitco.in
  • Mt Gox
  • LocalBitcoins.com

Of these, BuySellBitco.in is the only exchange in India which accepts payments through Net banking, IMPS and cheques on ICICI Bank, Axis Bank and SBI. Localbitcoins.com is a website that lists traders who are ready to sell Bitcoins in your local area at a specified price. Mt Gox is an American exchange that allows you to specify bids at a specific price, provided you are able to fund your account through international wire transfer, which would prove to be quite expensive and is recommended only if you intend to trade in very large denominations.

I have not covered too many technical aspects of Bitcoin, since this article only aims to provide you with an introduction to it. This is something which is bound to be a part of your future. While the future of Bitcoin is still not secure, one thing is for sure—the idea itself has changed the way we think about money and even if it fails to be as popular as we expect it to be, peer to peer cryptographic currency is bound to be a part of the future economy.

References
[1]    https://en.bitcoin.it/wiki/Main_Page
[2]    http://bitcoin.org/en/getting-started
[3]    www.trybtc.com
[4]    Bitcoin White paper – http://bitcoin.org/bitcoin.pdf

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