You’ve probably heard mention of the term Bitcoins in the media lately, most likely with little to no explanation as to what they are or why you would want to own them. I fell into this same boat so decided to investigate for myself. Bitcoins it turns out, are a digital currency (i.e. electronic only – no paper or physical coins) that are completely independent of any government and untied to any physical commodity. These coins can be used for online purchases with those (very few at the moment) vendors who accept them, and they can also be sent to any other individual who has a Bitcoin wallet.
At first this sounded dangerous to me – a currency that exists only online, with no regulation whatsoever?? It seemed to me that this would attract nothing but hackers and other individuals who would make the entire system unusable… much like most other unregulated peer to peer systems on the internet. The first question that entered my mind would be how to prevent someone from gaming the system and creating millions of virtual coins for themselves. It turns out the answer to this question is the heart of the system itself:
New coins are generated by Bitcoin users who setup their computers as Bitcoin miners. These computers solve a very computationally intensive mathematical problem in an attempt to generate a solution. Each time a solution is found, it is broadcast to all other computers on the Bitcoin network and the miner receives a reward of 50 Bitcoins for finding the solution. The rate of coin generation is automatically adjusted by the network by changing the difficulty in solving the mathematics by setting a more difficult target (hence requiring more computational time to solve). The goal of this system is to allow for the solution of a new block every 10 minutes on average. Each new block generated must contain the signature (or hash) of the previous block in its solution – and this is the key to preventing tampering with the system. In order for someone to artificially create new blocks, they would need to surpass the computing power of the entire rest of the network combined and not only catch up, but also surpass the rest of the network in new block generation — at least that’s my current understanding of the process.
There are some interesting aspects to using the currency itself as well. First, there is no central bank that keeps track of everyone’s account. Instead, all computers on the Bitcoin network maintain a record of every Bitcoin ever created and the full transaction history for every coin. These transactions are somewhat anonymous since they only refer to the Bitcoin addresses of both the sender and receiver. These addresses are essentially the same idea as an email address, except they are used for Bitcoin transfers only. Users can create as many addresses as they want within their wallet, making it very difficult to tie Bitcoin ownership to any other personally identifying information. The wallet itself is simply a file on your computer that contains information on the addresses you have created and the keys required to access them. For this reason if you lose your wallet, you lose the Bitcoins they reference as well. For this reason it’s important to backup your wallet to a secure drive, or even print a hardcopy of it so that you can recreate your wallet in the event of a computer crash.
In all, I find the technology quite interesting, and it will be interesting to see whether or not it really takes off as a true, usable currency. The exchange rate of $US/Bitcoin as of today’s writing is $104. I am going to create a wallet myself and possibly a miner to see if I can generate some coins – check in later for updates. If you want to give it a try yourself, just follow the instructions at the Bitcoin website.