How do cryptocurrencies such as Bitcoins work?

The first time I heard about Bitcoins was on the radio here in Mauritius. I didn’t pay much attention and reminded myself you need to check it out someday. The word bit combined with coins should create a spark of curiosity for anyone interested in information technology.

Bitcoins

The only news we were getting was negative, that bitcoins are risky as a form of investment. Nothing was said about its impressive engineering.
Then bitcoins also made it on TV if I recall correctly on our local news and the presentator announced that the central bank of Mauritius has announced that bitcoins are risky. That’s the only advertising bitcoins got in Mauritius!

Facebook which so many are dissing at times, sometimes helps you to find like minded people! While posting about areas of interest I got into contact with someone who was at the same school as I was and who is definitely way more savy about crypto currencies than I am. Well thanks to him I got introduced to this subject. The details he was mentioning about crypto currencies was absolutely an alien language and still is. So I decided to dig into bitcoins and learn what is bitcoin in order to understand and to have some comprehension.

Watching a few youtube videos did help to get the overall picture but I still felt more lost! I wanted to know how they work. I checked some bitcoin websites and reading didn’t help much either. I then watched a lot of youtube videos where bitcoins are explained. This kind of started to make more sense to me and then later on, when re-viewing those bitcoin explanatory websites their content was starting to make more sense.

But I have realised, everything about bitcoins is huge. Once you thought OK now I understood this part, you will soon discover HOW LITTLE YOU KNOW… And this makes it even more interesting! I don’t even see bitcoins as a mere currency for buying and selling. It’s way more than that!

While this technological advancement comes with many questions, and to many questions there are also answers, I remain curious wondering how it will evolve in the coming years.
I could list a long list of “maybe’s”…
Maybe bitcoin is the beginning of the future to leave behind the legacy on how the next generation of global currencies will operate… like napster was for peer to peer sharing. If bitcoin dies, it will give birth to new more robust crypto currencies.

The idea of having my own mining rig is tempting but not very lucrative these days. I just would find it awesome to have a whole hall filled with computers with great hashing power!

There is not much that I can teach you about bitcoins that many others have already explained and made whole websites of. They have most likely also structured it way more neater than my blog page. If you are new to bitcoins I hope my post wont confuse you to much and if you don’t get the logic of bitcoins at first shot. Don’t worry, I have been looking at it since 2 months and just one blog post is not enough.

My notes below is the sharing of the first part of my journey of trying to just understand the basics of bitcoins I have listed below various sources and made summaries of various bitcoin presentations. You probably understand way better the technical aspects of bitcoins if you are a programmer or software engineer.

Currently bitcoins are trading above $500 (28.08.14). Here in Mauritius we cannot really do much with bitcoins. If I would buy a bitcoin? Currently I would still hesitate because they aren’t cheap and I also am not yet very familiar with the wallets and keys technology. On my quest of still learning how bitcoins work, it would be nice also to try using some of it in a real life scenario. Maybe some cheaper alt currencies might do.

Maybe each country should make its own alt currency representing the current existing currency. Maybe it could work as a backup currency if the main one collapses. Maybe it could be the start of what in the future will replace the existing one. The list could go on an on… Anyway, herewith I introduce you into the world of crypto currencies!
 
 

Bitcoin is a universal virtual currency.

How were bitcoins born?
By Satoshi Nakamoto

Bitcoin is a run by a peer to peer system.

Mining is performed. Bitcoin application. Hashes per second.

Your office computer might take years to find one bitcoin…
 
 
Bitcoin exchanges
That’s where you can trade bitcoins.
Bitcoin exchange bitfinexUSD Log Scale
Source: http://bitcoincharts.com/charts/bitfinexUSD#tgMzm1g10zm2g25zl
This file is licensed under the Creative Commons Attribution-Share Alike 3.0 Unported license.
 
 
How does the bitcoin model work?
New concept on how you can do money. Not regulated by central banks. Anyone who is using the bitcoin software create a network and form a bit what the central bank is behind a currency. Resilient to censorship and more. Self regulating environment.
 
 
Bitcoin mining hardware

Avalon An ASIC base bitcoin machine

Avalon An ASIC base bitcoin machine

Connected to the bitcoin network and seeing transaction that are flying by.
These transactions are gathered into blocks, blocks of valid transactions.
An algorithm is run that is designed to be very difficult to solve but very easy to check to make sure that your solution is correct.
These bitcoin miners are busy running these checks that the transactions are valid.
Algorithm is run to make busy work, designed to take a while for somebody to discover on the network in finding a solved block or that magical number that makes up the block which has some mathematical properties. And once somebody finds a block they announce it as this is a valid set of transactions and everybody else on the network checks it.
 
 
Why would people do that?
Each of these transactions create bitcoins out of thin air. This is the motivation behind why people mine. That’s the only way bitcoins are created.
 
 
When a block is found and solved, a bitcoin gets created.
Transactions must be valid and verified so that a bitcoin cannot be spent twice.
Bitcoin Block Data
By Matthäus Wander (Own work) [CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons
 
 
Transactions that happen and get collected in these blocks?
One entity paying another.
To pay creates a transaction broadcast over the network. It’s gathered into a block by a miner and that’s when it becomes confirmed. It’s also a guarantee that the transaction took place and is valid. Miners do the important work of confirming of YES that the transaction is valid and creates a history.
 
 
What is the other way of getting bitcoins?
By trading.
A system like Bitcoin cannot by hyper inflated.
 
 
Technical issues?
How easy is it to keep your bitcoins safe?
It’s risky.
Should be getting fixed over the years to hold on bitcoins more securely.
 
 
Taxing bitcoins?
Could be applied on the transaction like VAT.
 
 
Security of bitcoins?
Bitpay – has been so far very secure.
The loosing of your wallet if its not properly secured.
Bitcoin security is not a solved problem yet!

You are responsible for holding your private keys. You need to keep a backup of these.

Transactions where more keys are needed can be applied to make paying your bitcoin more secure or requiring more steps. This can also depend on your wallet settings which will allow a transaction to go through.

A transaction is a public record but it requires a key to access them.

Hardware Bitcoin Wallets – to use a dedicated piece of hardware that is more secure to just process bitcoins.
 
 
Bitcoins on paper or a paper wallet?
It’s more about the keys. The key pairs.
Take a brand new computer.
Generate some bitcoin adresses then also generate bitcoin key pairs and then print out those private keys on paper and put them somewhere safe and destroy these computers – no possibility for the private keys to be anywhere else than on those papers.

Then you can send bitcoins to the public keys associated with those private keys. Now basically you have bitcoins on paper.

You could even make a brain wallet…
 
 
How to buy bitcoins?
Coinbase
Bitcoin, safe and easy.
Coinbase is an international digital wallet that allows you
to securely buy, use, and accept bitcoin currency

Localbitcoins.com
Buy and sell bitcoins near you (they also list Mauritius)

Learn here: https://bitcoin.org/en/
 
 
References:
Bitcoin Architect: Everything You Need To Know About Bitcoin | Presenting Gavin Andresen

https://www.youtube.com/watch?v=7gndSZVMbTY
 
 


 
 

More regarding to the block chain or public ledger


Ref: https://www.youtube.com/watch?v=IFj84lp_4ko

Satoshi Nakamoto (No clear data available who he or she exactly is!)

A public ledger. Every transaction in the bitcoin world is recorded in this public ledger. And this public ledger is referred to as a block chain.

Every 10 minutes all transactions in the world that happened are compiled, processed and recorded into this block chain. The bitcoin system allows another 10mins each time for all processors in the world to compile the data to create the next blocks.
 
 
How does this digital virtual electronic money crypto currency eliminate double spending? How to make it more safe?
Let’s say you want to send a dollar. You will not be able to create dollars out of thin air and just send unlimited dollars as digital or electronic money.

Satoshi solved the double spending issue by recording all transactions in the public ledger.
When you spend, you have -1$ and someone else has +1$.

The bitcoin system can check the previous block chain to also verify if you do have 1$. And this is where autentication occurs and then authorising the transaction.

The bitcoin system is based on proof! So when you do a transaction it gets recorded in the next block and added to the block chain – it’s a chain.

The whole past history can be scanned for proof if you really do have the $ to pay.

This is how the double spending gets eliminated.

Reference:
Explained plain and simple by Tai Zen

https://www.youtube.com/watch?v=4nTdbyS9A28
 
 
Is there any privacy on the block chain?
How did Satoshi solve that?
You can have some anonymity but its not 100% anonymous. It’s pseudonymous!
Just have a look at a bitcoin account address. It consists of lots of characters. No one knows to whom that string address belongs to. Unless if you say so. If there is no info of the one sending you a payment then you won’t know from whom its coming.


Reference: https://www.youtube.com/watch?v=8RVGpHZUKpw
 
 
Why would people process bitcoin transaction via a peer to peer network?
Banks just charge you a fee when you do a transaction. Therefore only banks benefit and make money over your transaction.

This is different with the bitcoin peer to peer network. Satoshi was concerned about this.
Very brilliant idea! Anyone can volunteer and come in with their computers to process transactions. It started at around 2009. When you process transactions you get rewarded In bitcoins and BTC is the symbol for bitcoin.

Every period of time the bitcoins that get rewarded is halved. In 2009 it was at 50 bitcoins for each block of informtion, in 2013 at 25, in 2017 it will be 12.5 until someday 21 million bitcoins have been rewarded which is the limit.


Reference: https://www.youtube.com/watch?v=LrYu5P1tTug
 
 
What is bitcoin mining, miners and mining pools?
A pool of people put together their computers to process transactions to get the next block of information to get the bitcoin rewards. The first group that gets a block correct gets the reward. It’s complex mathematics… There is a lot of information out there on how to mine but this video made it clearer to me regarding the competition of being the first to figure out the next block of information for getting the bitcoins reward.

The word mining really does confuse people who try to learn about bitcoins. You can also replace it with the word “processing”. People that process transactions are called miners and a group mining together are called mining pools.
 
 
What is a bitcoin account or wallet?
Armory Bitcoin Client
https://bitcoinarmory.com/

Mentions unfairness in regards to opening a bank account and that Satoshi didn’t like this. Not every person can benefit from the banking system. Satoshi had the brilliant idea that everyone should be able to open an account and have banking services.

You only need a device that can store a wallet, this is your bank account! This can have revolutionary effects for billions of people who cannot have access to banking.
http://www.Bitcoin.org you can download your wallet. Then you will have a bank account on your computing device.

The wallet term can be misleading or not really make sense. You cannot touch the wallet. It’s more a digital account.

You get a private key when you open an account. The private key needs to be extremely well safe guarded!
Wallet.dat contains your private key.
There are different types of wallets. And these also vary according to security.

Security issues such as your PC gets hacked and the wallet.dat file gets exploited.
Suggestions are to store your private key on paper. This is called cold storage.
If you store your key on your PC it’s called a warm/hot storage.

Satoshi made sure that cryptography is extremely tight.

You can also use your brain as a wallet. Also called a “Brain Wallet”!
There is a brain wallet software where you can input for example a quote or a saying and the software will process this quote to generate the key.


Reference: https://www.youtube.com/watch?v=GzldR0XjKBU

Also visit the website of Tai Zen
Prison or Freedom
 
 

What is a blockchain?

A block contains recent transactions and they get appeneded therefore creating a block chain only after validation! This is the job of the miners. Blocks get added to a permanent database. All these details are spread out. The block chain contains ALL transactions that have been done.

Reference:
Explained short and plain simple by Yan Huang

https://www.youtube.com/watch?v=BsUj9f58mGc
 
 
A 3D Visualization of the Bitcoin Blockchain Over Time by John Ratcliff

https://www.youtube.com/watch?v=3ujUIz9hQ7c
Also read the description of the visualisation.

How to Parse the Bitcoin BlockChain by John Ratcliff
http://codesuppository.blogspot.com/2014/01/how-to-parse-bitcoin-blockchain.html
 
 

The Truth About Bitcoin by Stefan Molyneux

A bitcoin address has 32 characters.
http://weusecoins.com
http://btc.com | Dietmar: Is it still actual or has it been bought by Gawminers? Yes it has, just found the news here → Bitcoin Domain BTC.com Acquired for 1.1 Million USD by Josh Garza of GAWMiners :Update 1Million
Example given of fees for transferring $6.5m in BTC which cost only 6 cents and would have cost with PayPal $188,500 and via Bank Wire Fee $227,500 and it can take 3-5 days to clear.

Escrow services can be used.

Other bitcoin currencies can be created as this software is open source and these are called “alt-coins”. This creates currency competition. If Bitcoin gets into trouble users can switch to a new or existing altcoin.

Crypto currency could be a new standard instead of gold.

FinCEN regulations… (Financial Crimes Enforcement Network)

Money laundering?
Standard Chartered Bank – the 5th largest bank in the UK was caught laundering $250 billion and only had to pay fines. | Dietmar:
http://online.wsj.com/news/articles/SB10000872396390444318104577589380427559426

“The total number of Bitcoins that will ever exist is hard coded into the software at around 21 million BTC. These 21 million BTC are divisible down to 8 decimal places, providing for about 2.1 quadrillion transact able units of the currency.”

Currently Bitcoin is above 56% its maximum. (Compared to 21 million BTC)

Bitcoin will be a deflationary currency.

M-Pesa: pay via mobile phone, popular in many african countries. | Dietmar:
http://www.economist.com/blogs/economist-explains/2013/05/economist-explains-18
http://www.bbc.com/news/business-11793290

Expect attacks on Bitcoin from governments.


Reference: https://www.youtube.com/watch?v=w4HGVJjqDVk
 
 
Questions:
What will happen when the 21 million bitcoins have been mined? Will there be still reward blocks?
This questions is nicely answered here:
Bitcoin Myths

Miners will benefit from transaction fees. But it also states that the security of the network might be at stake. Quote: “However unlike the block reward, there is no coupling between transaction fees and the need for security, so there is less of a guarantee that the amount of mining being performed will be sufficient to maintain the network’s security.”
And also check here:
http://bitcoin.stackexchange.com/questions/876/how-much-will-transaction-fees-eventually-be/895#895
 
 

What do you think is the future of bitcoin and cryptocurrencies?

 

What is your vision of the future how these should be used and deployed?

 
 
so what ya thinking of crytpocurrencies aka bitcoins

How do cryptocurrencies such as Bitcoins work? by

7 thoughts on “How do cryptocurrencies such as Bitcoins work?

  1. Arturo

    Great post! I will comment on one thing: you said that bitcoins are not cheap right now… but remember you can buy in any amounts, you don’t need to buy a whole bitcoin!

     
    Reply
    1. Dietmar Reigber

      Thanks Arturo! THIS is definitely an eye opener what you just said! Hi5 for this! You see, with the banking system here, we have been kinda of brainwashed to think in numbers without decimal places. The only decimal places I get to see is all those small fees the bank is subtracting all the time… Bitcoin reminds a bit of my time when I switched from Windows to Ubuntu, the transition phase required lots of coffee and around 6 weeks! But afterwards I really loved my new way of using the computer.

       
      Reply
  2. Arturo

    Thanks, Dietmar! What you say is quite true. Especially with Linux 🙂
    All changes require some transitional effort, but we do it because the overall return of value to our life is supposed to be greater. I’ve seen many in my years in the tech world that won’t switch to something better because they don’t want to “re-learn”. It will take time to “re-learn” new ways of doing business, like bitcoin. And people like us who take the first step can help those who are weary of their first step.

     
    Reply
    1. Dietmar Reigber

      Hi Arturo, well said! I like it how you “coined” it down mentioning the transitional effort! I wouldn’t have come up with such a simple yet deep explanation! It’s like this saying, don’t touch a running machine… But we need to! You cannot relax on the status quo – once you do, the train starts rolling backwards. And the crash will be hard. A friend of mine used to say, learning hurts, that’s why many abstain trying to remain in their zone of comforts. Hope to visit your great country someday! The closest I got was at Foz do Iguacu on a Brasil trip. The only Argentinian contacts I had was when I was in Germany. Now am back on my small island here in Mauritius which is so far from all the main lands. I will circle you on Google+ !

       
      Reply
    1. Dietmar Reigber

      Hi Jean!

      thanks for raising this question. I’m sure a lot of people would ask similar. The only info we got in Mauritius was once in the radio and news that we should simply be careful if we trade with bitcoins.

      There are several ways to answer this question and this question also shows that Bitcoin isn’t well understood. It took me also quite sometime to understand the basics of it. If you read my whole article and watch all the videos, which will actually take quite sometime, you will find the answer yourself as there is some logic behind it 🙂 I’ll spare your time and answer you this in short form but I do advise you, if you are interested in this subject, to do some research.

      Bitcoin isn’t attached to a country, this is what makes it so unique! This would be my first aspect to say, NO it’s not illegal in Mauritius. Even if it was, the gov would be wasting their time looking for bitcoins 🙂 Secondly, Bitcoin offers privacy, meaning you could be the only one knowing how many bitcoins you have in your wallet and memorize it in your head.

      But on the other hand you also have to ask yourself, what are you going to do with Bitcoins? In Mauritius you will not find much use for it as there are no shops that accept bitcoin. Even though this currency could have been very interesting even for a marchand roti for example because you could pay them through mobile phone. But there are other competitive technologies that offer similar that are being offered by local banks.

      For me personally I find Bitcoin in its technological aspect amazing and the possible future outcomes that it holds. I’m only following up on this technology. I haven’t used it and do not find any use for it in Mauritius. Also the price is currently dropping and am still wondering when the price of Bitcoins is going down if the networks or people that are mining for coins will still be finding it an incentive enough to continue. If any persons knowledgeable about Bitcoins know more about this aspect, it will be great to read your comments!

       
      Reply

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