Overview

Bitcoin is a global form of digital currency. Unlike traditional currencies, which were frequently backed by gold and silver, bitcoin is based on distributed computing. While traditional currencies are printed by central banks, bitcoins are created or “mined” by distributed computer networks.

Another way bitcoin differs from traditional currencies is that it is decentralized, meaning that it is not controlled by any single institution. As a result, miners around the world create new units of the currency and confirm its transactions.

FXCM does not endorse bitcoin and does not offer bitcoin trading at the present time.

Bitcoin / USD Chart

How does Bitcoin work?

The bitcoin network comprises thousands of computers linked together through a ledger of all bitcoin transactions known as the “block chain” and governed by a uniform bitcoin protocol. Every bitcoin transaction produces a series of letters and numbers, known as a hash, which miners then add to the previous hash to generate a block.1)Retrieved 15 February 2016 http://www.bankingtech.com/415282/blockchain-ushering-a-new-era-in-fintech/

As soon as you start using bitcoin, you receive full access to the block chain. In other words, you will be able to see all the digital currency’s past transactions.

To make a transaction, you provide an amount you want to send and the address you want to send it to, and then sign it with your private key. Both the address and private key are sequences of letters and numbers. While the address’s sequence is broadcast to the network, the details of the private key remain discreet.

After supplying this information, you may have to wait for your transaction to clear. Miners need to verify all transactions, which are combined into blocks in the block chain. Bitcoin protocol dictates that every block requires roughly 10 minutes of mining.

  • Cryptography translates the mass of transaction data into a mathematical problem that the miner computers need to solve — i.e., generate one, seemingly random sequence of numbers and letters—in order to create a block
  • This sequence is called a hash
  • The bitcoin protocol makes it increasingly difficult for miners to solve this problem. Because anyone can create a hash using a collection of data, the bitcoin network has introduced a concept called “proof of work,” which means the bitcoin protocol will only accept hashes that hold certain standards. Finding a hash that works can take several attempts.

Who invented Bitcoin?

The mastermind behind the original concept of bitcoin is Satoshi Nakamoto, who registered the domain bitcoin.org on 18 August, 2008, published the white paper “Bitcoin: a Peer-to-Peer Electronic Cash System” on a cryptography mailing list and launched the first bitcoin protocol in 2009. Satoshi Nakamoto is the pseudonym of a programmer (or programmers) whose real identity has remained unknown.

In March 2014, Newsweek claimed that “Satoshi Nakamoto” was really Dorian Satoshi Nakamoto, a 64-year-old engineer and resident of California.2)Retrieved 15 February 2016 http://www.newsweek.com/2014/03/14/face-behind-bitcoin-247957.html However, Dorian Nakamoto vehemently denied these claims, even sending Newsweek a statement in which he claimed to have no involvement in bitcoin.

Nonetheless, Satoshi shared his work with a community of developers at a very early stage and published the bitcoin protocol in the public domain. An open-source software since its conception, Bitcoin has been available to anybody who wants to improve upon it or design their own cryptocurrency.

After a year of mining and developing, Satoshi Nakamoto moved on to other projects in 2010 and left the work on bitcoin to a trusted group of developers. Today, the core developers are Gavin Andresen, Pieter Wuille, Nils Schneider, Jeff Garzik, Wladimir J. van der Laan and Gregory Maxwell. They actively monitor and improve the network, add new tools and intervene to sort out potential vulnerabilities.

Virtually anyone can contribute tools and know-how to bitcoin’s online repository, GitHub. Tech-savvy users are strongly encouraged to flag any security risk or weakness they detect in the system. However, any modification of the bitcoin software requires a wide consensus among users. Therefore, it does not happen overnight.

How do you store Bitcoin?

You can store your bitcoins online, on your computer or on your smartphone, and there is a huge variety of software programs available for setting up either type of wallet. You may also combine different storage options. For example, those interested in keeping their bitcoins offline might consider cold storage, which will keep their digital currency out of the reach of hackers.3)Retrieved 15 February 2016 http://www.coindesk.com/information/how-to-store-your-bitcoins/

  • Online storage means that you trust the operator of a web server to keep your bitcoins safe.
  • You can protect your access to the keys and addresses with strong passwords.
  • Online storage makes access convenient and independent from your hard drive.
  • The security risks are the same as in the case of online banking (hacking, for example).

Cold Storage

Those wary of storing their bitcoins online might consider cold storage, which will ensure their digital currency is not vulnerable to online hackers.4)Retrieved 15 February 2016 http://www.coindesk.com/information/how-to-store-your-bitcoins/ Cold storage is an option available with many software bitcoin wallets.

Physical form

You can also stash your bitcoins in physical form. A paper wallet is a paper snippet containing two QR-codes: one for the address and another for the private key. A paper wallet might come as a good option to backup an offline wallet. Physically minted bitcoins appeal mostly to collectors, but they also contain an address and a private key under a hologram sticker.

What is Bitcoin Mining?

Bitcoin is based on the principle of public verification of transactions: if many users see that a certain number of coins have been given by A to B, then this transaction is verified and recorded in a general ledger.

Bitcoin miners have two crucial roles:

  1. To maintain the security of the system
  2. To create new bitcoins

Each bitcoin transaction is encrypted into a mathematical problem that the miner needs to process. This work involves millions of calculations per minute, and therefore requires strong mining hardware. Also, these calculations become increasingly difficult over time, which helps ensure mining speed does not surge along with the constant expansion of computing power.

  • Within the context of one transaction, mining means finding the mathematical proof of a bitcoin transfer and bundling it up with other transactions into a block.
  • One block contains several transactions (all those completed in the past 10 minutes). When all these transactions are confirmed as valid, we say that “a block is mined.”
  • A new block is the result of the decentralized computing effort of many rigs operating around the world.

Miners do this work for two types of reward:

Block Reward

The block reward is a fixed number of bitcoins created with the mining of a new block. The first miner (or mining pool) to find the block reaps the reward. To date, block rewards are the main income source for miners.

Transaction Fees

Transaction fees are fees that a party of the bitcoin transaction may pay to miners for processing a payment. Transaction fees are low and apply mostly in cases of urgent transactions. Most BTC payments are still free of charge because miners work for the block reward.

Anyone can become a miner if he is prepared to buy a mining rig; join a mining pool; and dedicate some time, money (energy bill) and effort to mining bitcoins.

Transaction data

Besides transaction data, miners also use the hash of the latest existing block, which means that fraudsters would need to do all the computing work associated with all previous blocks if they wanted to manipulate a block. This feat would require astronomical computing power and would be quickly noticed by other users.

Miners

Once a miner (or mining pool) has created a new block, all the transactions in that block get confirmed and permanently recorded in the block chain. The successful miner is rewarded with the fixed amount of new bitcoins created in the process.

Which countries accept bitcoin as a currency?

While governments may acknowledge bitcoin as a legitimate alternative to state currency, and will allow its usage within their sovereign domain, it does not mean the state will accept them as payment.

This means that, categorically, governments do not accept bitcoin as a transactional currency between an individual and the state. For example, you cannot pay your taxes in bitcoins, but must instead convert them to the state currency.

  • Bitcoin is an unregulated peer-to-peer digital currency, whereas state currencies are issued and regulated by a centralized national authority.
  • Because of this, many governments have been hesitant to take a public stance on bitcoins accept their usage. Some critics believe that the currency is merely a bubble.5)Retrieved 15 February 2016 http://www.telegraph.co.uk/finance/currency/10521471/Bitcoin-governments-should-tame-it-not-ban-it.html More specifically, they refuse to recognize bitcoin as a legitimate currency, considering it an “imaginary” currency used to make illegal purchases of guns and prohibited substances.
  • Some critics contend that hackers, terrorists, and money launderers all pose a threat to bitcoin.6)Retrieved 15 February 2016 http://www.telegraph.co.uk/finance/currency/10521471/Bitcoin-governments-should-tame-it-not-ban-it.html Further, they assert the odds that the digital currency will fail are high.

A major issue facing widespread adoption of bitcoin continues to be the regulatory environment. While some jurisdictions have either regulated the digital currency or banned it entirely, others have taken no action at all. At any rate, there is no consistent stance on regulating the currency. For instance, China has barred its financial firms, including banks, from “dealing in” bitcoins.7)Retrieved 15 February 2016 http://www.europarl.europa.eu/RegData/bibliotheque/briefing/2014/140793/LDM_BRI(2014)140793_REV1_EN.pdf Russia outlawed the currency.8)Retrieved 15 February 2016 http://www.cnbc.com/2014/12/17/russians-move-into-bitcoin-as-ruble-tanks.html

However, in the United Kingdom and the United States, the countries with the highest proportion of bitcoin merchants, bitcoins continue to thrive despite the continued absence of an official government stance by the latter.

Where can I spend Bitcoin?

Many online businesses already accept bitcoin for transactions. Bitcoin can be used online for a wide array of legitimate transactions with household name brands.

Examples include:

  • Amazon
  • CVS
  • Target
  • PayPal
  • Subway

In 2014, the online retail giant Overstock.com suddenly announced that it would accept bitcoins as payment from now on.

However, it’s not just online businesses that accept bitcoins.

Here to Stay

At the time of writing (Feb. 2016), the largest proliferation of Bitcoin-friendly merchants remain in the US, although several European nations are making progress in this area. There is a wealth of sites dedicated to cataloging and updating the lists of businesses that accept Bitcoin, such as http://spendbitcoins.com/, which allow you to see which local businesses will accept your bitcoins. As the digital currency develops and becomes more clearly defined by government regulation, we can expect to see this list of companies expand.

Accepting Bitcoin

There is also an ever-increasing number of ‘brick and mortar businesses’—i.e. businesses with a physical presence—that accept bitcoins as payment for a wide variety of goods and services. Examples include hotel accommodation, take-out food, taxis, restaurants and even gaming arcades. A notable example is a Lamborghini dealership in Newport Beach, Calif., which announced in 2013 that it had recently accepted $103,000 worth of bitcoin in the purchase of a Tesla. The company also wrote that it quickly picked up its second customer using bitcoin.

Legal Concerns

While it holds many advantages over traditional currencies, bitcoin comes with risks of its own, and every prospective user should be aware of these risks and how to manage them. Just like the cash in your wallet, the safety of your bitcoins depends upon your own vigilance.

One of the benefits of virtual currencies like bitcoin is that every transaction and individual bitcoin is tagged and traceable. This means that your money simply cannot disappear without a trace.

However, transactions issued with bitcoin cannot be reversed; they can only be refunded by the recipient. Bitcoin is not anonymous. All bitcoin transactions are stored publicly and permanently on the block chain, which means that anyone can see the balance and transactions of any bitcoin address. However, the identity of the user behind an address remains unknown until information is revealed during a purchase or in other circumstances.

Small market

For this reason, it’s good practice to ensure that individual bitcoin addresses are only used once. Because bitcoin is still a relatively small market, the market price of bitcoins may go up or down in response to relatively insignificant changes in demand.

Highs and Lows

This means that bitcoin’s price fluctuations can be quite volatile. Although it is becoming less experimental as usage grows, bitcoin is still a relatively new phenomenon that reaches into new territory. As such, its future cannot be predicted by anyone.

Finally, bitcoin users must pay close attention to the tax and revenue regulations provided for the digital currency by government agencies. Jurisdictions can potentially tax income, sales and capital gains, and this extends to bitcoins.

The information provided herein is for educational purposes only. This is not a solicitation or an offer to buy/sell. Site users should conduct their own due diligence before deciding to make an investment.

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