Demystifying BITCOIN
Bitcoin is just like any world currency like Dollar, Pound or
Indian Rupee. But Bitcoin is a digital
currency which means there are no printed notes or coins. Think of it as having
money in an online wallet.
This
unique currency was invented by a
programmer (or group) by the name of Satoshi Nakamoto , no body for sure knows
about the real identity of people behind it. First time it was released in
2009.
It allows for Peer to Peer fast transactions.
It
is denoted by the symbol BTC and are further divided into smaller units (just
like Rupee is further divided into paisa or Dollar is divided into cents)
called –
·
Millibitcoin – Thousandth piece (1/1000) of a bitcoin. It is
denoted by mBTC
·
Microbitcoin – Millionth piece (1/1000000) of a bitcoin. It
is denoted by µBTC
·
Satoshi – 1/100000000 part of a bitcoin. Represented as Satoshi
Dramatic
Rise in Price
Guy named Koch bought
5,000 Bitcoins in 2009 for $27, now worth $886,000. Talk about a
degree that gives you bang for your buck. Kristoffer Koch was writing a thesis
on encryption in 2009 when
he spent about $27 to buy 5,000 Bitcoins.
Who Controls the Bitcoin
This is where things start to get interesting. Currencies around
the world are generated by central banks for example INR is generated by
Reserve Bank of India. Central Banks (along with consultation with governments)
controls the supply of currency.
Bitcoin
is hugely different in this regard. Bitcoin is not controlled by any central
bank or government. It is regulated by the network.
Bitcoin is regulated by the
network
There
are 2 aspects to it.
1.
First is Generation which we will cover in Bitcoin
Mining Second is transaction settlement. Let’s have a look at this one.
In
normal currency transfer, how does a transaction gets recorded? For example I
send money to you, how does the transaction gets recorded at the backend? Here
are the steps involved.
1.
Money is deducted from my account
2.
My bank intimates your bank that such a transfer is going to
happen
3.
My bank credits the money to your bank which in turns credits to
your account
Now
this entire mechanism works on consensus which
means that there is an agreement between all the parties on how would
settlement at each step would happen. And each bank maintains a ledger
where they document the transaction. This ledger is a private
ledger where only that particular bank has the access to.
Now
assume that there are no banks and no private ledgers. There are public
ledgers which is not with any one entity but is available
to thousands of people (servers). And these ledgers are secured by highly
complex keys. There are also well defined rules on how would settlement be
reached hence consensus mechanism is in place.
There are Public Ledgers which is available to
thousands/millions of people (servers). This is called Blockchain. It has 2 key
aspects :
1.
Its public nature which means that no single party has a claim
to it. Everyone can access it albeit is secured by very strong digital
signatures.
2.
Its Distributed Nature – This means that the public ledger is
not kept at one server but is also replicated at different servers. This
ensures that even if one server has any problem, the network doesn’t go down.
It is still up and running.
Both
these aspects are absolute mandatory for bitcoin to work since the network
(which is FREE of any intermediary) has to up and running all the time and has
to be accessible all the time.
It
is the network which regulates bitcoin and an important part of this regulation
is making sure that transactions are settled. This in turn entails these 2
steps –
1.
Verifying whether the transaction was correct
2.
Adding that transaction to the public ledger
But
with so many servers (remember public and distributed nature of the network),
who gets to do it? Hence every server who wants to do it has to solve very hard
mathematical puzzles. The one who does it first gets the opportunity to settle
the transaction.
Since
these puzzles are very computational heavy and sufficient expenses are borne
for it, network rewards the winner. This reward is nothing else but in the form
of bitcoin. And this is how bitcoins are generated.
And
this process is called Bitcoin Mining.
It is something similar the way gold is created. One generates
gold after digging in mines. In the same fashion bitcoins are generated after
digging in computational power to solve very hard mathematical puzzles. Hence
the name Bitcoin Mining.
How it
works
The easiest part to understand is that the Bitcoin system
operates as a peer-to-peer network without centralized servers. The obvious
advantage of peer-to-peer is that it's difficult to shut down.
Supply
and demand creates a market for Bitcoins as per a traditional financial system.
There is no central authority issuing money, and there are no financial regulations
offering any sort of protection to those using or trading Bitcoins. The system
is designed to "drip in" new currency on regular intervals to mimic
the normal action of economic growth within a traditional monetary
system.
Most
articles about Bitcoins talk about the process of "mining". The
Bitcoin network does is indeed made up of a peer-to-peer network of
"mining" servers, but what this "mining" software is doing
is actually running the network itself.
Each
Bitcoin transaction gets recorded in a decentralized transaction log. For
example, if I give you 1 BTC ("BTC" being a non-official, but
commonly used quasi-ISO4217code) that transaction gets recorded in this log
file.
This
recording process is not like a giant distributed SQL database. There is no
"INSERT INTO TRANSACTIONS" and "UPDATE ACCOUNT SET
BALANCE=..." in this arrangement.
The
decentralized transaction log --- is a massive hashed and mashed together lump
of data. Putting stuff into the log is very computationally expensive. However,
unlike a SQL server database where you can make transactions disappear with a
quick "DELETE FROM", because everything is so tangled in the Bitcoin
log you can't do this.
The design of the Bitcoin system is to represent in a superdistributed " fashion every
transaction that's ever occurred ever. If you have a wallet on your computer
containing Bitcoins, you yourself have a copy of this log file. Your computer
doesn't partake in the maintenance and distribution of the log -- it just holds
a copy. Also, the log file has superfluous information trimmed out -- i.e. work
is done to make the size manage-able from a systems architecture perspective.
The
actual cryptographic process that goes into the maintenance of this log is not
important. The two things to remember that are is that
a)
putting things in the log requires
considerable computing horsepower, and
b) once a
transaction is there, you can't modify or remove it because all the
transactions are tied into a chain of dependencies.
Two
things conspire to make the system globally reliable. Firstly, "considerable
computing horsepower" means that it's not possible to go back and create a
new, fake blockchain with any improper transactions that anybody so desire. It
would simply take too long to do this. Secondly, the superdistributed nature of the blockchain means that you cannot
attack one part of the system without having to attack the entire system,
including all of the end users.
All
of this is, in fact, pretty cool.
The
log keeping or blockchaining process is so computationally expensive that a
reward for partaking in this work and making the whole system work, the mining
servers are given some Bitcoins for participating in this work. In this sense,
"mining" is a bit of a misnomer -- it's the commission given for work
done, although there is an element of luck to it.
Using
the USD-BTC exchange rate as of the time of writing, about $4,750 of value is
added every ten minutes into the system.
Mining
is now not regarded
as being a decent way of getting into the Bitcoin system -- it requires considerable
effort and specialist hardware to get started. Plus, you will likely spend more
on electricity than you would extract from the process.
The
easiest thing to do -- is transfer some "proper" currency to a
Bitcoin exchange and buy them.
Moving Bitcoins
Once
you have some Bitcoins, you can send them anywhere in the system using an
address.
This
requires a "wallet" -- this being a piece of software that runs on
your desktop or smartphone that connects into the peer-to-peer Bitcoin network.
And as such it's similar to how the various BitTorrent clients work.
So
if you wanted to transfer some money to me, I would give you an address to send
them to. To help increase my anonymity, I would likely create an address just
for that one single transaction. You would instruct your wallet to transfer
money to that address.
That
transaction is broadcast into the Bitcoin system. Eventually that distinct
transaction gets written into the entire blockchain. Because the whole
arrangement is on the basis of assumption that "the more computationally
expensive the better", that process actually takes a long time. There is
little immediacy in this system.
Eventually
that transaction will come down to the receivers wallet, along with the
transaction log. The wallet is then able to report an up-to-date balance,
together with a list of transactions that built up the balance.
Anonymity
The system is designed to
be secure, not necessarily anonymous. It is in theory possible to trace back
any transaction to an actual person. The "problem" with the design is
that all the transactions get mashed up into the entire decentralized blockchain
which is copied everywhere. This stops is being a properly anonymous system --
there is nowhere to hide anything.
Be
careful of this point as I've seen a good number of articles talk about how
Bitcoin is anonymous. It's not.
Fastest and easiest way to buy and sell bitcoins.
People can buy bitcoins
in their own currencies. The seller of the site publishes advertisements for
selling bitcoins and explains the terms of payment and exchange rates. You can
choose direct online transaction or cash transaction bitcoins based on the
content of the AD. Bitcoin is stored in a web wallet at Fastest and easiest way
to buy and sell bitcoins, where you can make a direct transfer of bitcoin.
There
is no
law which says that bitcoin is illegal in India.
One can safely invest in bitcoin from legal perspectives. The main apprehension
is possibility of conversion of black/terrorist money into white
money through bitcoins. Since we would not be involved in any of such
activities, we don’t need to be worried about it.
The
income earned from any profit will get added to your “Income from Other Sources” and
will attract income tax as per your slab.
Bitcoin is a new age digital currency which the world is
slowly adopting. Japan has recently legalized the Bitcoin and there are millions of merchants who
accept bitcoin as a valid payment method. Therefore people and economies are adopting
bitcoin.
Now coming to the question of safety. Whenever an
investment is made, one always run the risk of capital loss (equity is being
talked about in this context). And here bitcoin is no different.
But with bitcoin, there is one additional risk – Risk of
platforms/wallets going kaput. There has been one very infamous instance in the
past where the biggest bitcoin exchange Mt GOX filed for bankruptcy when it
reported that some 850,000 bitcoins worth $450 Million have been stolen.
Since exchanges are more prone to hacker attacks, it is
best advised to keep your bitcoin in wallet apps like blockchain.info rather
than with exchanges.
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