Bitcoin FAQ — What is Bitcoin?
The headline-grabbing crypto currency explained
This is the first in a series of posts where we will explain how Bitcoin and other crypto currencies work. Do you have questions on Bitcoin and other crypto currencies you want answered? Post it here as a note and we will answer it if we can.
What is Bitcoin?
Bitcoin is a decentralized, non-fiat digital cryptographic currency. What that means is that it exists purely on the Internet, as a series of ones and zeroes. The Non-fiat bit means that there is no central authority that runs Bitcoins. Unlike fiat currencies like the US Dollar or British Pound, there is no central bank or organization that creates it, distributes it and backs it. Instead, the currency is run by the people who use it, with computers all over the Internet tracking and monitoring the flow of Bitcoins. The currency is based on cryptography, specifically a cryptographic function called SHA-256 that was developed to encrypt web pages. This encryption is fundamental to Bitcoins: it is how the currency is created and how transactions are authenticated. This is where the name for Bitcoins and other similar currencies come from: they are referred to as crypto currencies.
To create the coins, computers crunch numbers using this function in a process called mining, where each miner repeatedly encrypts numbers using this function, looking to solve a mathematical puzzle. When the puzzle is solved, the miner reports this success, and it is verified by other computers (known as solving the block). When their success is verified, the solver is rewarded with a certain number of Bitcoins. I’ll explain this process more in a later FAQ.
To use Bitcoins, you need a Bitcoin address, which identifies you to the Bitcoin network. This is sometimes known as a public key, as it is one of the keys used to lock Bitcoins (although technically, it is a hash of the public key: don’t worry about that if you don’t know what it means). These addresses are jumbles of numbers and letters that look like this:
1LpHb1vuizy98uMe8xfiq1J2cQWiqF5ae8
These addresses are like your bank account or credit card number, but unlike a credit card, this address can be generated by anyone, online or off. You don’t have to pay to get an address, as they are created automatically by an algorithm. There are plenty of addresses to go around, as the maximum number of Bitcoin addresses is 1,461,501,637,330,902,918,203,684,832,716,283,019,655,932,542,976. This also means that the chance of someone accidentally creating the same address is very, very small.
Each user of Bitcoins has an address, although you can generate as many as you want. To send someone Bitcoins, all you need to know is their Bitcoin address. You don’t need their email or other details, which can make the service pretty anonymous (although not completely anonymous: I’ll discuss that in a later FAQ).
Every address has an accompanying private key, which is a 256-bit number translated into text that looks like this:
5JKDYC2gs8wJpSQ9GRocRCoVbWX7fMLnJqXXuFGT5sqqWiG7wyo
This private key is the important bit: the combination of this and the Bitcoin address allows you to control the Bitcoin address and to send coins. (note that this is the private key for the address shown above, so don’t use this address). If you don’t have the private key, you can’t get at the coins stored at that address. This combination of the address and private key is called the Bitcoin wallet. The reason that Bitcoin works is because of the strange mathematical relationship between these two numbers: although they are generated at the same time, you can’t easily use one to find the other. Because we are dealing with big numbers, experts estimate that it would take about half a billion years of heavy computation to find the secret key for a Bitcoin address by trying every possible number until you guessed the right one. So, it seems that the system is secure, assuming no sudden quantum leaps in computer power (or that the NSA hasn’t built in a backdoor).
There are lots of online services (like Blockchaininfo and Coinbase) that can host a Bitcoin wallet for you, so you don’t have to remember the private key. They store it for you, and you use a password to log into their site and access the wallet. This also means that you have to trust the site, as they could steal all of your coins. This has, unfortunately, happened in the past, but you don’t need to use these services if you don’t trust them: you can create your own wallet with services like Bitaddress and store the secret key off-line. This site can also generate paper Bitcoin wallets, which contain an address and the secret key.
When you spend Bitcoins, your transaction is recorded and verified by many other computers connected to the Internet, and written out to a file that is shared between these computers. Every Bitcoin transaction is stored in this ledger of transactions, called the Blockchain. This information can be accessed by anyone: if you go to the site Blockchaininfo, you can see the transactions scrolling by. This ledger contains the details of every Bitcoin transaction ever made, detailing where it came from, where it went and how much was sent. So, anyone can look up these details and track coins as they move from address to address. Blockchaininfo allows you to do this: just type in a Bitcoin address into their search box and you’ll see every transaction made by this address. You can try this with this link, which shows the transactions for an address used by the Bitcoin Foundation to accept donations for their work in promoting Bitcoins. From this, you can see that they have received 5,855 bitcoins, which is worth about $717,970 at the current $119 price of a Bitcoin. This isn’t really a fair measure of the value of the donation, though: we will talk about the value of Bitcoins in a future FAQ.
This ability to find transactions is fine for a non-profit like the Bitcoin Foundation, but it might be a little unnerving for an organization that wants to keep transactions covert. Transactions can be somewhat masked, though, by generating a new Bitcoin address for each donor. That makes it harder to track, and this is what many non-profits and companies do, as it also allows them to know where a donation or payment is coming from, as they can create a new address for each customer.
Do you have questions on Bitcoin and other crypto currencies you want answered? Post it here as a note, and we will answer it if we can in a future post.
