THE INS AND OUTS OF BITCOIN by James Hill, Software Developer
Since 2008, when the mysterious Satoshi Nakamoto registered the domain name bitcoin.org, awareness of the peer-to-peer currency has steadily grown, and it has been joined by other second generation cryptocurrencies hailing themselves to be the future of money. But are we really close to that being the case when the average Joe is still unclear on what Bitcoin is? Allow us to shed some light.
WHAT IS BITCOIN?
Bitcoin is the biggest and arguably the most well known digital currency in the market. It’s a cryptocurrency; a currency where ownership of money or ‘coins’ is proven mathematically, and last year, the number of global merchants accepting payment in Bitcoin surpassed 100,000.
There are two methods of acquiring Bitcoin, firstly by mining it, or secondly, by purchasing it at an exchange. A miner is a single member of the network, whether an individual trader or a large corporation, as in most cases. Miners spend their time on the network validating transactions to create the next chapter (or block) of the currencies ledger. The network is a huge group of miners, all racing to check transactions and create the next block.
A block is currently around 1Mb of data, or around 1,000 to 2,000 transactions, and there’s one block created approximately every 10 minutes. Each time a block is created, other miners will verify that the submitted block is valid, and all the transactions it contains are also valid. A huge publicly accessible ledger called the Blockchain exists, in which everyone submits transactions ie when Bitcoin changes hands, for miners to read and either accept or reject, depending on whether they can be proven mathematically valid.
If you want to see the public ledger for Bitcoin, it can be viewed at “https://blockchain.info/". On this website you can see every transaction occurring around the world, as well as new blocks as they are created. Mining is a very difficult process as the number of miners you are competing against is huge. It’s very unlikely that over a year an individual miner will successfully mine a single block for Bitcoin, but if they do, the reward for that block is 12.5 bitcoins ($7113.25 USD — 16/08/2016).
Purchasing from an exchange is the easiest method of acquiring bitcoin. Several major exchanges such as Poloniex, BTC-E, Bitfinex and Kraken allow users to associate bank accounts to purchase cryptocurrencies. One off payments can be made to smaller holding companies such as coinbase. And like any other currency, you are able to use an exchange to cash Bitcoin into a more convenient currency, like USD, EUR or GBP. With all exchanges, there will be a small fee associated with transferring the money, but this can be offset, given you’ve made enough profit.
To spend any money in a cryptocurrency network, you need to be able to prove you own the coins you want to spend. In the case of transactions involving very large amounts, the miner will receive a minimum fee, which is a condition built into the underlying algorithm.
To spend Bitcoin, you first need an address to pay money into. Whoever is involved in the transaction will provide addresses to which Bitcoin can be paid. The term address in this context refers to very large numbers calculated using things only the owner of that address knows, and written in a form convenient and secure for users. Running some maths as an owner spending money from an address is how you prove ownership of the address, and therefore the Bitcoin in the transaction. An example of a Bitcoin address is 152f1muMCNa7goXYhYAQC61hxEgGacmncB.
Given to the Bitcoin handler of your choice, in the same way you interact with your high street bank for example, a transaction will be created using money located at addresses you currently own. The transaction will pay the recipient and also pay out to an address you own (for your change). Once money at an address has been spent, it cannot be returned. Instead, money in Bitcoin moves from address to address, and when using the network as it should be used, this recipient shouldn’t be at the same address more than once. This is to protect against potential hackers, as the more you re-use an address, the more information you give to them, in the same way as you shouldn’t use the same password for multiple online accounts.
SO SHOULD I BE TRADING IN BITCOIN?
Bitcoin, while still a small community relative to the countries behind foreign exchange currencies, currently has a $9 billion market cap (correct at the time of writing). It can be volatile to the point where it changes +/- five per cent over the course of a day, with other cryptocurrencies seeing shifts of +/- 30 per cent. Investment in cryptocurrencies can be extremely profitable, albeit very risky. There is a fairly low risk of hackers or any other online threats accessing your money. The danger of losing money to hackers or other threats is greater if you are handling your own private keys and addresses. Giving an exchange the task of calculating and arranging payments reduces the chance of you losing money.
Bitcoin is primarily bought by people who are looking to invest. The highly volatile nature of the currency makes it very profitable for short term investments, albeit very risky, and several high profile names are being heralded as Bitcoin millionaires. There are several websites which currently allow you to pay in Bitcoin and it has become a more popular payment method in recent years.
Recent security breaches in cryptocurrency markets are in no way related to the underlying core blockchain algorithm that forms the basis of all cryptocurrencies. The two largest breaches in recent times are the DAO (Decentralized Autonomous Organisation)hack ($132.7m at the time) and the Bitfinex ($72m at the time). The DAO is a cryptocurrency which runs atop another cryptocurrency network (ethereum). The breach involved exploiting smart contracts which are used to compromise the DAO. These smart contracts are not part of the blockchain algorithm. The breach at Bitfinex did not involve attacking the blockchain, but rather the exchange itself.
In both cases, the underlying blockchain algorithms were not compromised and so remain safe. The basis of blockchain security is a cryptographic function, which to date has not been broken. This makes the currency itself secure; the danger in cryptocurrencies comes from losing your keys which prove you own coins. Most exchanges will handle keys for you, and in the event of hacks, the exchanges have refunded customers who have been victims in the past.
WHAT COULD THE FUTURE LOOK LIKE?
While Bitcoin is currently a hugely volatile market, over the coming years we expect its growth will also provide stability. Right now, it’s a brilliant place to go for a quick return on investments, but its influence is ever expanding, and outside trading there are already potentially huge implications for how the underlying algorithm could be used by different industries, such as healthcare for example. And high street bank Santander has reportedly identified up to 25 potential use cases for the currency.
In the meantime, because the ledger is inherently so secure, very public and so widely distributed, it could inspire businesses to implement their own blockchain to prove purchases and log transactions, minimising the likelihood of human error. So, in the not too distant future, we may see Bitcoin becoming a household term instead of a buzzword that still holds so much mystery.
As a consultancy at the forefront of technology, we’ve set up our own cryptocurrency, Scottcoin, to be used by employees to buy treats at a special ‘snack emporium’ we’ve introduced. The general aim is to bring everyone up to speed with the practical use of cryptocurrencies such as Bitcoin and make it commonplace in the working environment.
It’s a project we’re encouraging widespread participation in, and it would be no surprise if the team found themselves developing such solutions for our financial services clients in future.
If you’d like to know more, why not contact us for a chat at firstname.lastname@example.org.
This content was originally posted at http://smarter.scottlogic.com/insights/the-ins-and-outs-of-bitcoin on scottlogic.com.