You may have heard the term Bitcoin recently, maybe while surfing the Internet, from a friend or read about Bitcoins somewhere in the newspapers. So what is Bitcoin and how do they work? Who is a Bitcoin miner or what is Bitcoin mining? How is the Bitcoin investment market? This post tries to touch upon these questions in brief.
What Is Bitcoin
For those who do not know about Bitcoin, it is an electronic currency – not related or dependent on the currency of any country. Bitcoin (BTC) is a digital currency first described in a 2008 paper by pseudonymous developer Satoshi Nakamoto, who called it an anonymous, peer-to-peer, electronic payments system. It uses the Blockchain Technology.
What makes this Cryptocurrency more volatile is that unlike printed coins and bills, there is no physical entity to back it. For example, in many countries, bills are printed only up to a certain ratio of total exchangeable gold (or any other precious) metal available in that country. The image displayed is just for representation purpose; Bitcoins are not physical.
Bitcoin Mining: Needs Dedicated Resources
Bitcoin can be created as and when necessary. That said, they are backed up by intangible computer resources in terms of both processor and storage. The method of encryption used to secure bitcoin transactions employs heavy and lengthier encryptions and thus consumes considerable computer resources. It would not be wrong to say a transaction initiated using bitcoin or parts thereof depend upon the number of servers (or bitcoin miner as they are called) and the computing capacity of these servers.
Bitcoin Mining: Needs Dedicated Hi-End Software
A new Bitcoin is relatively easy to handle compared to bitcoins that were already used for transactions. Each transaction adds a good amount of hashing, etc, related to previous transactions, to the bitcoin. Each new transaction would require the miners to first decode the coin and then append a larger sequence to the bitcoin. Thus, it becomes heavier.
Considering it gold, assume that each time a bitcoin miner (server) receives a gold block (for example purpose) and decodes it, it also adds another layer of gold plating to it – thus making it heavier to an extent where the servers cannot handle the weight. Bitcoins too pass from the phase and at this point – where they become too large – the initial data is erased and the last ones are kept to consider previous successful transaction and then to work based on that.
The aim here is to keep the “weight” of bitcoins under a specific unit so that it does not crash the software engaged in mining. To casually define bitcoin mining process, it is the process of understanding whether the bitcoin is genuine i.e. being used legally – by decoding the previous transaction and comparing it to the log to see if they match. If they don’t, chances are: 1) either the server missed the log report broadcasted upon previous successful transaction or 2) the same bitcoin is being used for two different transactions at a time – in other words, an attempt to hack into bitcoin mining.
All the above requires complex software. These are all open source software – the only requirement is that each of the bitcoin mining server should have compatible software to decode previous transaction, validate it and create a new, long hash for completing the current transaction. I used the word “long” here as in some cases, two or more miners may create hashes at same time and broadcast it to logs. In this case, the coin having longer hash is considered – the one with shorter hash is discarded. It means that the transaction goes through and only the small hash is discarded.
Bitcoin Miner: What Are The Incentives?
You may ask me about the incentives for people managing the TOR network. They do not get anything except a little satisfaction towards contributing to user privacy. But in that case, the system resources used are pretty low. If you use your computer as a TOR node, your computer will not slow down. It will simply receive a packet and forward it to another node in the TOR network. That’s all.
Coming to bitcoin mining, special software and good amount of computing resources are required. As long as there are new bitcoins being generated, the bitcoin miners get a good incentive for decoding and logging the transaction. In some cases, the people (users) who initiate transactions, also add transaction fee for the miners. Anything above the transaction value is kept by the bitcoin miner. This is good until a stage.
There is a limit to the number of bitcoins that can be generated and to the rate of bitcoins generation. It halves every four-year and ends at 2140. As of now, each ten minutes see 25 new bitcoins. Four years later, it will be 12.5 and again four years later it will be 6.25 and so on. This is something they’ve calculated based upon the current protocol and technology. 21 million is the maximum number of Bitcoins that will be mined. Currently, there are only 17 million Bitcoins in existence.
Thus, the only incentive for miners is the amount they mine plus transaction fee if any. Considering this with gold again, you can mine and sell only up to whatever the mine holds. After you extract the complete mine, the only way you can make money is by using the fluctuations in the gold rates.
That is why I said if you are a day trader, you can go for some quick profits. The rate of bitcoin is highly volatile dependent on several factors and one can make good money if she or he understands how it works. Unfortunately, like with other stocks, you cannot create a predictable graph that will trigger alarm to buy and sell. Some stock exchanges have incorporated bitcoin exchange as well so you might get a ticker on your computer that alarms you when the value of bitcoin goes up a little. This bitcoin value monitoring software may be provided by the bitcoin exchange or you’ll have to create a custom one. It is easy – you just manipulate existing tickers and add bitcoin to it as you add any other currency.
Bitcoin Investment: Possible Hurdles
Right now, some entities are accepting bitcoins as valid currency to trade their goods. According to a few reports, most of such entities are gambling points and illegal drug selling entities. Some reputed institutions such as Wikileaks also accept bitcoins so that contributors can stay anonymous. There is no way any agency can track the sender unless the sender leaves a trail of similar sounding origin addresses.
As of date, there are few bitcoin exchanges that convert bitcoins into real currency and a recent law has made such bitcoin exchanges accountable for registration and taxation. This trend can grow – creating easy conversion as well as good amount of taxation to discourage trading in bitcoins. If there are sufficient reasons to prove that a majority of bitcoin users are doing it for illegal reasons, such bitcoin exchanges may completely be closed in any country at short notice.
Taking into account:
1. The fact that miners will earn less and less as more bitcoins are in the network,
2. That the value of BTC will only go down as the number of users increase, and
3. That the laws can change anytime against exchange of bitcoins into real currency,
I would say be careful if you want to experiment and make some money while it is still in its heydays. Whatever you do, trade in bitcoins or use them to buy items, stay safe! If you fall into the category of day traders, yes – you go ahead and play! But if you are looking for long-term investments, you may want to wait and watch for a while.
I’ve eliminated several Bitcoin related terms from the article to replace them with easily comprehensible words. For full details of how it works and possible dangers plus benefits, visit bitcoin.org.
- Microsoft and University of Maryland, have developed a Bitcoin called Permacoin.
- Microsoft starts accepting BitCoins as a mode of payment
- Citigroup’s own Bitcoin, Citicoin may be coming soon.