I’ve been trying to figure out what Bitcoin and Bitcoin Mining is. Articles (like this one) that I’ve looked at online leave me further mystified because they were authored by financial-related sources, and use industry terms of which I am unfamiliar.
What’s “hash” and “public key” mean? I’m guessing “chain of digital signatures” doesn’t mean somebody’s name repeated a bunch of times.
I understand Bitcoin exists only on the web, and is not subject to government regulation. How is Bitcoin considered currency that can be used to buy and sell? How does Bitcoin Mining actually produce money?
Those aren’t financial terms, they’re cryptography terms.
If you start with a block of data, a hashing process will use that to generate a short (typically 64 bytes) sequence of numbers. For example, you can take the text of the book War and Peace and hash it into 64 bytes using the SHA256 algorithm. If you then change a single letter in the whole book, and do the hash function again, the 64-byte hash will be completely different from what it was before. A hash is used to verify that the data sent didn’t get intercepted and changed - the recipient takes what he received, does his own hash using the standard method, and checks to see if that result matches what it’s supposed to be.
A public key is part of public-key cryptography, where one key is used to encrypt data but it takes a different key to decrypt it. Anyone who participates in this system has these two keys that work together, and he publishes one of them for everyone to see, while keeping the other strictly private. If I want to send you a secret message, I encrypt it with your public key, then the only thing that can decrypt it is your private key.
Bitcoins are money because they are hard to come by, and because, or inasmuch, as (some) people have been persuaded to treat it as money, and will trade you actual goods for it.
Mind you, that is true of dollars, pounds, etc. too.
Bitcoins aren’t like gold or precious jewels. They are actually more like electronic scrip. Used as payment for processing work done, that can then be exchanged for other goods and services from people that accept bitcoin.
I thought part of the allure of BitCoin was an anonymous transaction that couldn’t be traced. This sounds like you can trace every transaction from the dawn of time.
The difference being that they are not backed by a government. It’s more like a community currency that has value only because a group of people agreed to treat it as though it has value. If that agreement falls apart you could be left losing a game of financial musical chairs.
Yes and no. While you can trace every transaction, the identities at each stage of the way are part of the encryption. Thus, you have anonymity that can’t be traced to a person. (At least in theory; I’ll leave it to the experts to decide just how safe this is. I’ll just say that if bitcoins were the only thing between me and jail, I’m not convinced they’re safe enough.)
You can if you want; the psuedo-anonymity comes in because the parties involved in a transaction cannot be easily identified. And there are laundering services as well; you give one address a certain set of bitcoins, and a different address gives you a different set of bitcoins. If the launderer is secure, there won’t be any easy way to track the transaction. The drug bazaar Silk Road laundered all of its users’ bitcoins–I recall reading at some point they laundered something like 1/6 of all bitcoins in circulation (sorry, no cite).
But the same thing is true of government currency as well–that’s why they call it fiat money. If everyone decided to stop using it, it wouldn’t be worth anything, and there’s nothing the government could do about it.
I know. That in no way contradicts my assertion that they are hard to come by. They are so by design, and would not be suitable for use as a form of currency if it were otherwise. If you could easily, quickly and cheaply generate bitcoins they would be useless as a medium of exchange because their value would rapidly inflate to virtually zero. The same goes for any sort of scrip (electronic or otherwise). I do not know what the raised eyebrow is for. What I said is perfectly true.
The anonymity thing is misleading. If you only ever use each “wallet” for one transaction, your security is perfect: Anyone can tell what wallet is involved, but nobody can associate any wallet with any person. Unfortunately, a wallet is useless if it’s only used once, since at a minimum, you’ll need to transfer funds into it, and transfer funds out of it.
OK, so if everyone only uses each wallet exactly twice (once in, once out), then security is still perfect. But now the catch is that you need everyone to be doing that. Once anyone doesn’t do that, you can start finding patterns like that wallets X and Y both make transfers to wallet Z, and that people making transfers to wallet W do so in consistent amounts on a set schedule, and so on. Use old-fashioned detective techniques to bust one person for drug-running or whatever, and now you can connect them to other people who might also be drug-runners. Of course, remember in all of this that some portion of the exchanges and laundering services are going to be fronts run by law enforcement agencies, who are deliberately saving all of their information.
Oh I entirely agree. I certainly have a hugely greater faith in government backed currencies than I do in bitcoins, and indeed, I remain baffled as to how anyone was ever persuaded to ever start treating bitcoin as currency, and to agree to exchange real goods (or established currency) for them. However, it remains the case that, for government issued fiat currencies quite as much as bitcoin, it has value only so long as people continue to believe that it has value.
Well it’s not quite that simple because there are ways to break the blockchain. And you don’t need every person in the network to be using disposable wallets, only the people involved in the transaction. Consider that wallet X transfers to wallet Z (a launderer), which then transfers wallets A and B to wallet C (the user’s wallet) in twenty parts. There’s no blockchain to follow here. Wallet Z and wallets A and B are then used for the next transaction. And the thing is, transaction fees are usually zero, so that simple transfer could actually have consisted of thousands of wallets and transactions.
That is a really good analogue. It is really good if you imagine a situation where people keep signing over the cheque, and cease to think about the intrinsic value - the redeemability - it has. Bitcoins have no intrinsic redeemable value. It is as if the cheque continues to be signed over, and no-one has bothered to care if the account the cheque is drawn on has any funds. So long as no-one cares, the cheque remains valuable. Now imagine if there are millions of such cheques circulating, all drawn on the same account. You may get to a situation where the account the cheques are drawn on has no funds, everybody knows this, and still doesn’t care. That is Bitcoin.
How does Bitcoin Mining work? I’ve read explanations that it’s a process that involves a lot of computing power and puzzle solving, but they don’t address how and where this money exists or how Bitcoin Miners can claim it.
Walton Firm’s post explains that Bitcoin mining is kind of a self-regulating process that prevents single ownership of a list of transactions (also called a “blockchain”). I understand there’s some web programming method that shares transaction information without the need of a centralized bank, but I don’t see how money can be made from “mining” that data. Are they grabbing the fractions that got dropped when money amounts are rounded to the nearest cent (or whatever the base unit of Bitcoin is)?
I think the simplest way to look at it is that Bitcoin mining is solving a series of complex puzzles. When someone solves a puzzle, everyone else verifies it and agrees that they deserve a bitcoin (or 50, I think). Because everyone agrees that they have a bitcoin, they get one. In the process of solving these puzzles, bitcoin miners also process and verify transactions in the network. Hopefully someone else can give a better summary.
Bitcoin mining certainly creates bitcoins. It may or may not create money. The fact that new bitcoins are continually being created naturally has an inflationary effect on bitcoins: The more coins are mined, the less each of them is worth. I think that in the simplest economic models, the total value of all bitcoins would remain constant, but of course the real world is more complicated, and the inflation might be more or less efficient than that.
Not exactly, IMO. There are always two pressures on a money which determine the value per unit: how much money is being created or destroyed (i.e. the rate of change in the supply of money) AND the rate of change in how many people are using the money to buy & sell how many goods how quickly.
Assuming a closed economy with no change in population or goods or services being bought and sold, then yes, any creation of new money such as bitcoin mining would produce inflation. And any withdrawal of money would produce deflation.
Conversely, if the number of bitcoins is fixed, but more people start trying to use more and more of them to buy & sell more & more stuff, then that too would cause inflation. And if folks slowed their use of the currency to buy & sell then deflation would ensue.
Only when these two forces are in equilibrium will there be neither inflation nor deflation.
One of the IMO smarter ideas at the core of bitcoin was the idea that mining would produce a slow increase in supply as the bitcoin economy grew. And the rate at which mining would mathematically succeed was tied to the volume of money already created. So balance between the two forces was supplied more or less automatically. Or at least it would be for the moderate growth & everything’s going smoothly scenario; there’s no safety net for what happens if everybody abandons the currency en masse.
So BC miners aren’t actually finding money. They’re performing services and getting paid in Bitcoin. The terminology led me to think they were actively searching for data bits and somehow using them as online currency.
OK, that puts me a few steps closer to solving this mystery. What are these “puzzles” they’re solving?
They’re not so much puzzles and complex mathematical calculations whose sole purpose is to regulate the availability of Bitcoins. Solving them has no other usefulness.