Did you read my warning? OK, good. Continue reading then.
If you're reading this article, there is a good chance that you are wanting to learn about Bitcoin because it's something that you've heard about but know little or nothing about. You may have read about it elsewhere before coming across this article but found the information to be either insufficient of too technical.
What is Bitcoin?
what is Bitcoin is the first and most obvious question to answer, so let's start with that. Knowing what Bitcoin is will be a good starting point, but also an important bit of information to evaluate its merits against other things in the same category.
Bitcoin is both a currency and a system for exchanging that currency. As a currency, BTC can be exchanged for goods and services where accepted, just like any other currency. As a system for exchanging BTC, it offers a convenient and secure way of handling transactions.
Because it plays both of these roles, a comparison against just the dollar or just an online payment service would be incomplete. The currency is, however, inseparable from the system itself and not something I'm going to talk much about here.
Bitcoin does have a few terms often used when it is being discussed by those who are familiar with it. While knowing what these means is not essential to using Bitcoin, any introduction to Bitcoin would be incomplete without defining them.
- Exchange: One of many services which trade Bitcoin for other forms of currency. Some even have ATMs.
- Block chain: All transactions using Bitcoin are stored in a public ledger. This ledger is used to determine how much one person has as well as to avoid re-spending. This ledger must be public because in order to spend money, you must first prove that you have enough to cover the transaction by referencing one or more transactions where you were on the receiving end whose sum is at least equal to the amount you are trying to spend. You send the recipient the entire sum of any transactions sufficient to cover the amount you are trying to spend, and the change is automatically sent back to you. The block chain is something used to validate this ledger.
- Block: Transactions over Bitcoin are not immediately available for spending. There is a period of about ten minutes where transactions are queued and await approval. The reason for this is a complicated solution to the problem of determining the order in which transactions occurred (which is something of particular importance in cases of insufficient funds since negative balances are not allowed in Bitcoin). Since there is no central authority behind Bitcoin, all transactions are approved though public computers, and a public computer's record is considered valid by solving a very complicated and unique formula which takes, on average, ten minutes to solve. This is easily the most difficult to understand part of the Bitcoin system. It is an inefficient but ultimately necessary step to validate transactions. The block chain is the entire history of all blocks of transactions.
- Mining: When the next block is ready to be added to the block chain, there is a competition to solve the formula for it. To encourage competition, a reward is offered to the first computer to solve this formula. There may or may not be a transaction fee for any given transaction, so Bitcoin rewards an additional sum on top of any transaction fees. This is how new BTC are created up until the maximum amount (21 million) is in circulation.
- Mining Pools: Because of the competition and incredible amount of computing power involved in trying to solve the next block in the block chain, groups called mining pools have formed to share resources as well as rewards.
Security is one of the most often highlighted features of Bitcoin, and for good reason. One of the core principles in the design of Bitcoin is that it should require no trust. Unlike credit cards and bank accounts, there is zero risk of fraudulent charges outside of a neglectful user or not paying attention to how much you are being charged. Bitcoin is classified as a cryptocurrency, which means that it is able to handle transactions without giving away information which could be used for further charges. It does this using something call asymmetric encryption.
Asymmetric encryption uses a pair of keys (private and public) in order to sign and/or encrypt things. As with all forms of encryption, there is a lot of complicated math going on behind the scenes, but the important things to know is that it allows for things to be encrypted using a public key which can only be decrypted by the private key and it allows for things to be digitally signed by the private key which can be verified against the public key.
That is one built-in benefits of Bitcoin; your receiving address is a public key, and there is no harm in anybody and everybody having this. When you are sending over Bitcoin, you are still not releasing sensitive information because transactions sent are only signed by your private key, but do not include any information which could be used for fraudulent charges.
The only thing which needs to be kept private is your private key and any backups you might keep. If you use an online wallet (not something I recommend, but still an option), you really don't even need to worry about that (but you do have to worry about both the honesty and security of the wallet service itself).
Because there is no bank or central authority behind Bitcoin, this leaves you as the user with the decision of how to store your BTC, and each has its own benefits as well as drawbacks.
- Use an online wallet service
- Use a wallet app on your phone and computer
- Transfer your BTC to a physical medium
Online wallets can be a good option if you are concerned with losing your private key (problems with your phone or computer could case you to lose all of your BTC, and they are nearly impossible to recover). They also have what you might consider the advantage of handling security concerns for you, but the history of Bitcoin has proven them to be unsafe because they make very tempting targets. If you know how to keep your computer secure and keep backups of your wallet, a local app is considered preferable.
If you do keep your BTC stored on one of your devices using an app, you will be at risk to your wallet being compromised by malware or lost to a wide variety of computer problems, including data corruption. Malware will be a security issue for everything that takes place on a computer, however, since passwords to any form of online banking or wallet can be stolen though keyloggers.
Physical media are the one option which I do not know about through experience, but I understand it to involve creating a wallet and transferring BTC to it, and then printing out the private key to that wallet on a piece of paper (there are other options as well). Because the private key is only stored on that, it is unreachable without having that physical object. This means that it may be physically damaged, lost, or stolen. When you want to take the BTC out of storage, you import the private key and have access to all of the BTC which it contains.
We are not used to having these decisions to make, and many would find this choice to be a deterrent to using Bitcoin. Others, such as myself, will find this to be one of the benefits. If you feel uneasy with this choice, your best bet would probably be to use one of the many online wallets. While I have mentioned some security concerns to them, the same risks are involved in any online banking site, and many of the online Bitcoin wallets offer better security features than most banking site.
No computer is immune, no security is perfect, and anyone who says otherwise is either misinformed or trying to sell something.
Because of the benefits of asymmetric encryption as mentioned above as well as the fact that transactions using Bitcoin are carried out as requests for funds which you must approve instead of a forced transaction, these requests can take on many forms. Though not all would make much sense, it would be possible to request payments over anything capable of presenting a Bitcoin link, which makes paying though Bitcoin extremely easy.
When generating QR codes or links (as seen above) requesting payments, you may also include the requested amount, custom labels, as well as messages to these requests.
If you found an ice cream stand that accepted Bitcoin, when they charge you for the ice cream they would create a QR code which you would scan with your phone. Your Bitcoin app would automatically enter whatever information was included in the request, and you would only have to approve the transaction.
If your cell phone or electric company accepts Bitcoin for payments, they could send you a link in an email. When you click on this link, your Bitcoin app would open, and the rest would be the same as with the ice cream.
- Setting up a new wallet can be done without hassle - no forms necessary. Online wallets might require signing up or even proof of identity, but this does not need to be required for local apps.
- No distinction for merchant accounts. The wallet I created on my phone is capable of accepting payments in any amount from anywhere in the world. Integration in eCommerce sites can be as easy as generating QR codes or payment links for a Bitcoin app. There are, however, third-party services for merchants.
- Transaction fees are very low, if they exist at all. Because transactions are handled by mining, which currently has its own rewards, transaction fees are not always required and are very low when they are.
- Because Bitcoin itself is decentralized and open source, developers are free to innovate when creating apps. This means that users can pick whichever app best fits what they want. This also means that users should be careful to not install a Bitcoin app that will just steal from them.
Criticisms & Concerns
Despite its advantages over other payment systems, Bitcoin is not perfect. It is still vulnerable to our own gullibility as well as anything which could affect the device being used. Also, like all code ever written, vulnerabilities in Bitcoin itself will be found. It is my opinion that all of these vulnerabilities are a significant improvement over existing services, but any decision made should be as well informed as possible, and that must include opinions which are negative.
Bitcoins are not real money/have nothing backing them
There is certainly some truth to this criticism, but isn't this true of everything (I would even say gold)? The only reason anything has value is because people agree that it is worth something.
Do you know what the money in most of our (physical) wallets is backed by? Debt! The US dollar is created by the government borrowing money from the Federal Reserve which, despite having "federal" in its name, is privately owned and operated.
Bitcoin, on the other hand, at least has additional value for being innovative. Aside from the value we perceive it to have, it is also valuable because of the payment system behind it.
Bitcoin prices are unstable
Like all investments, you have to accept that you might lose instead of gain money. Because it is fairly new (a few years old now, but it was unheard of until fairly recently), market prices are fluctuating quite a bit. These prices are expected to stabilize with maturity, but if your interest in using Bitcoin is profiting from investing in it, it is a risky investment. As with many investments, however, its value is dependant on demand, and it will be worth more if more people begin to use it.
Nobody accepts Bitcoin
A valid argument, though many large online retailers are starting to accept it. While this is a limitation to its usefulness as an alternative currency, the same would have been true when credit cards were first introduced. It would be foolish to promise the same outcome (becoming a widely accepted and perhaps even the preferred method of payment), it is reasonable to expect that it will be accepted more places if consumers demand it.
Bitcoin can be used illegally
That's not really a valid issue if you think about it. Bartering hand-knitted sweaters could be used to fund illegal activities.
Also, as you will see in the next issue with Bitcoin, it is extremely difficult to remain anonymous. Because it is a cryptocurrency, all transactions using Bitcoin leave a
Bitcoin is not anonymous
It can be used to remain anonymous, but that can be extremely difficult, if not impossible. Since all transactions contain the sending and receiving address as well as a reference to a transaction in which you received whatever BTC are being used to cover the payment, any transaction which is not perfectly anonymous could possibly be used to identify you, whether that transaction occurred before or after yours. If anywhere in the history of references to one of your transactions, either before or after you, provided information which identifies them, it will be possible to identify you.
This does not mean that tracing a transaction back to you would be easy though. You can use Tor to hide your IP address, and the further you are from a transaction containing personally identifiable information (such as buying/selling at an exchange) the safer you are.
Bitcoin Core contains the Heartbleed bug
Congrats to you if you knew this. Bitcoin Core (a popular Desktop Bitcoin app) uses an outdated version of OpenSSL (1.0.1e) which was released prior to the discovery and patch for the Heartbleed bug.
If you aren't familiar with Heartbleed, it could be explained by saying that OpenSSL (the most popular method of encryption in the world) contained a bug in its coding which allowed an attacker to get random information from a computer.
While this is certainly a major security concern, I do not expect that it would be a problem if you are behind a firewall. Since it only allows an attacker to read random information and the block chain is public to begin with, your only concern would be on your own device. Unless Bitcoin Core is exposed on your network, your private key should be safe.
Any Bitcoin app using OpenSSL 1.0.2 or greater will have this fixed.
Bitcoin Core requires downloading the entire block chain
Yep, its true. This can be a real limitation to computers with limited resources or disk space because the block chain is well over 20 gigabytes!
Not all apps require downloading the block chain though. You may have other options, and (as far as I know), no mobile apps have this requirement.
There are many pros and cons to using Bitcoin. Despite it not being commonly accepted and the security precautions required to use it safely, I consider it to be overall much better as a form of payment than anything else (perhaps with the exception of competing cryptocurrencies).
While I do not expect it do replace any established currency anytime soon, I think that it provides an excellent alternative to all of the existing payment methods. I believe that, if it were to replace credit cards, fraudulent charges would nearly cease to exist. I also think that if and when prices stabilize, it would be useful for securely storing funds
for a rainy day.