Bitcoin: A Primer

Is this new cryptocurrency the future of digital transactions?

If you’ve been following the news at all, chances are you’ve come across headlines discussing Silk Road. If you’re like most people, chances are you skipped right over it – Miley Cyrus ripping on the US government was far more enticing.

Last week, the FBI took down Silk Road, an underground online marketplace that many people used for drug-related and other illegal activities. In the process, they froze over 26,000 Bitcoins that were being held for customers as they made their transactions. Needless to say, people are not pleased.

Bitcoin, first introduced in 2009, has recently started gaining traction. With the Silk Road controversy raging hard, here’s a primer on the digital currency that may be the new way to conduct transactions online.

What is Bitcoin?

The origin of Bitcoin has been attributed to a pseudonymous developer known only as "Satoshi Nakamoto", who called it a peer-to-peer, electronic cash system.

Bitcoin is a purely digital currency, which means it has no tangible notes or coins. It’s completely decentralised, which means that there is no central authority, only a network of contributors and freedom enthusiasts.

Why is the advantage of using Bitcoin over other, traditional forms of payment?

Let’s say that, for whatever reason, you need to transfer a sum of money to an individual online. Let’s also say that you don’t possess a bank account – according to the Wall Street Journal, close to half of India’s 1.2 billion population don’t – or you do not wish to reveal your financial identity in executing a particular transaction. When dealing with traditional currencies, this would be a serious impediment to your transaction.

That’s where Bitcoin comes in. All you need is an internet connection, and you can complete the transaction using Bitcoin. Also, it’s completely and totally anonymous.

Currently, there is a huge demand for buying bitcoins anonymously due to ever-increasing government regulations, private agency intrusions and discrimination against alternative currencies.

Okay. You’ve got my attention. So how does Bitcoin work?

To put it simply, Bitcoin works a lot like email. Download a Bitcoin wallet, which will generate your unique Bitcoin address (essentially an alphanumeric key that will be the only means to identify you). You can disclose this address to your friends so that they can pay you or vice versa.

Bitcoins are kept in a digital wallet which you can keep in your computer, or on a website online, which will manage and secure your wallet for you.

What’s more, you can use Bitcoin software on top of Tor to prevent anyone from tracking your IP address – total anonymity guaranteed.

I don’t really understand. Can you walk me through how to buy Bitcoins?

The closest thing Bitcoin has to an industry leader is Mt. Gox, a Japanese website that acts as a real-money exchange between bitcoins and more established currencies.

To use the Mt. Gox exchange you have to submit photo ID and proof of residency before you can create an account. Once you have signed up for an account you will be able to wire money directly into the exchange’s bank account. You then need to create an "Ask" or "Buy" order and buy the appropriate amount of Bitcoin (BTC) at the current exchange rate.

Another alternative is using a website such as BlockChain, which offers a simple three-step, anonymous way to begin trading in bitcoins. All you need to get started is an email address and password of your choice. Once you create a free Wallet with BlockChain, you receive your Bitcoin address (the alphanumeric code mentioned above). You can then click the “deposit with cash” button and enter the amount you wish to buy.

However, remember to always be cautious when dealing with online exchanges.

You can also mine bitcoins. Mining, or generating, is the process of adding transaction records to Bitcoin's public ledger of past transactions. Unless you have some pretty intense computer skills, this isn’t easy or recommended.

Okay but what can I buy with Bitcoins? Can I convert them back into tangible cash?

You can send Bitcoins to a person, buy goods on sites like Bitcoinstore, Foodler or Bitcoinwireless, or donate to non-profit foundations who accept it, such as Wikileaks, P2P Foundation, Operation Anonymous etc.

Another way to spend bitcoins is to exchange them for gold, another investment. One important thing to keep in mind: It’s hard to convince someone who has never heard of Bitcoin before to accept it as payment.

In the short term then, the value of bitcoins isn’t driven in any way by the actual use of Bitcoin in trade. It’s driven by speculators who see it as an investment that’s going to rise in value.

Can you convert bitcoins back into cash? Technically, yes. If you can find someone to conduct an in-person transfer with, you can send them your bitcoins while they give you cold hard cash.

If you can’t arrange an in-person exchange however, you’ll need a bank account. And if you’re okay with using a bank account, well why get bitcoins involved in the first place if you aren’t a Bitcoin speculator?

The concept of Bitcoins still sounds awesome. Why aren’t more people using them?

Well, unless you’re a technolibertarian or a Bitcoin opportunist, the appeal of Bitcoin is still revealing itself.

The problem with Bitcoin comes down to why Silk Road was shut down. Complete anonymity under the guise of privacy just doesn’t work, because people take advantage of it to conduct illegal transactions.

There’s also a whole host of other issues – it’s easy to shut down (as exemplified by Silk Road) and widely deflationary (because there is a fixed supply of bitcoins, a lot of people can’t get their hands on it).

It’s also highly volatile (in 2013 itself it was valued at $8 to 1 Bitcoin and as of October 8, the Mt. Gox exchange rate was about $137 a Bitcoin). Your two bitcoins might be enough to buy a cheap laptop today and maybe just a box of cookies the next. Not to mention that most people don’t have much faith in a payment system started by an anonymous hacker.

There’s also one rather glaringly obvious challenge – how do you buy enough bitcoins to make it a stable, usable currency? Unless bitcoins are issued and simply handed out, people will need to buy them. With money. See the problem? It defeats the purpose.

So I just read this entire article for nothing?

Well, no. For one thing, you’re a lot more knowledgeable about bitcoins.

Further, it’s hard to completely dismiss anything that has garnered such a rapid following. Silk Road, just one of many websites that use bitcoins, had 957,079 registered users who did 1.2 million transactions between February of 2011 and July of 2013.

 
Undoubtedly, there are still a number of obstacles to overcome before Bitcoin really catches on. For innovative entrepreneurs however, opportunities abound.