Beginner's Guide to Bitcoin

Bitcoin is an online payment system and currency invented/created by Satoshi Nakamoto. In 2008, Nakamoto published a paper describing the bitcoin digital currency, and in 2009 he released the first bitcoin software that launched the network and the first units of the bitcoin currency (bitcoins). In this beginner's / getting started guide, we'll examine what bitcoin is and how you can use it.

Commercial use of bitcoin as a method of paying for online goods is, as of quite recently, very limited. Slowly though, online merchants are starting to offer bitcoin as a method of payment.

As the value of the bitcoin currency has gradually increased since its inception, there is considerable interest in it from a speculative point of view. This has, however, caused the price of the currency to fluctuate considerably and it's not unusual for its value to go up or down by 10% or more in a single day. As the use of bitcoin becomes more mainstream though, it is expected that these large fluctuations will eventually become a thing of the past.

Bitcoin is sometimes referred to as a digital or Internet currency, but it is probably best to think of its units - bitcoins - as digital or virtual tokens rather than physical notes or coins.

Bitcoin Transactions and Mining

When bitcoins are bought or sold, the ownership of the bitcoins is transferred from one bitcoin address to another - there is no explicit identification of the buyer or the seller. A bitcoin address looks something like "12m1TsxZp7kAdYAGrFjWM89uTmi9D48Y8D" and is used to identify a bitcoin wallet (see below).

Bitcoin transactions

Example bitcoin transactions showing how they appear on the blockchain

Every ten minutes or so, a bundle of transactions, called a "block", is confirmed to a public transaction record called the blockchain. This confirmation process, which is known as "mining", carries a reward of 25 bitcoins per block added to the blockchain.

The 25 bitcoins are distributed amongst the people "miners" who have confirmed the transactions. Acting as an incentive for individuals and groups to maintain the integrity of the bitcoin system by allowing their computers to be used to confirm transactions (and solve mathematical problems), the 25 bitcoins reward is also the way in which new bitcoins enter circulation. It is normal for miners to work in groups - "pools" - for the purpose of confirming transactions, rather than as individuals.

Mining involves a computer solving a difficult mathematical problem with a 64-digit solution. For each problem solved, one block of bitcoins is processed. By rewarding miners with bitcoins, as mentioned above, this provides an incentive for people to provide computer processing power to solve the problems. (The mathematical problem - there is an algorithm to work out what is the next bitcoin to be mined. Solving this requires a number of hashing operations. How many depends on how many coins have been minded previously so it’s an increasing level of difficulty.)

To compensate for the growing power of computer chips, the difficulty of the problems/puzzles is adjusted to ensure a steady stream of about 3,600 new bitcoins a day. There are currently about 11 million bitcoins in existence.

The bitcoin system is designed so that only 21 million bitcoins will ever be created, with the last coin set to be created in 2140 (so some way off yet). After that, there will be nothing more to mine.

How can I become a Bitcoin miner?

Bitcoin mining requires some pretty heavy duty computer hardware, so it's certainly not for everyone. For a good introduction to bitcoin mining, explaining the hardware and software requirements, go to http://www.weusecoins.com/en/mining-guide. Another good article that gives you a roundup of some of the bitcoin mining rigs available can be found at http://www.theregister.co.uk/2014/01/17/ten_bitcoin_miners/.

Can I earn very much as a Bitcoin miner?

Probably not - it is unlikely that you will earn very much money through bitcoin mining. As the mathematical problems become increasingly difficult to solve, the computing power required to provide the solutions increases. So, unless you're willing to spend a few thousand pounds to get a very powerful mining rig, your bitcoin reward will probably be small.

As well as buying a mining rig though, you also have to run it, and powerful rigs use a lot of electricity. There are calculators available that will tell you how much money you are likely to make through bitcoin mining - you can find a good one at http://tpbitcalc.appspot.com/.

So, as an example, for a mining rig that plugs into a USB port on your computer with a Hashrate of 2.6Gh/s (this is effectively the power of the rig - top of the range is something like 1.2Th/s and will cost about £5000 as of Feb 2014), with a power consumption of 2.5 watts, and which costs £170 from Amazon, will earn you about 0.66 of a bitcoin in a year - about £200.

Of course, if the value of bitcoins goes up, your 0.66 of a bitcoin will be worth more than £200 ... but the value of bitcoins could also go down ! As the difficultly of the mathematical problems also increases, the amount of bitcoins you mine will decrease.

If you want to try out a bit of bitcoin mining by just using your computer, you can help the bitcoin community by running what's known as the full Bitcoin client on it. The full client is quite resource intensive and will take a complete day to synchronize. After that your computer will contribute to the network by checking and relaying transactions.

As an alternative to using your own mining rig/computer, you could buy a hosted mining contract such as that available from http://www.butterflylabs.com/landing/slanding.php.

On the whole, and unless you're planning to invest in some serious computing power, it's probably best to regard bitcoin mining as a bit of fun, with the knowledge that you are contributing in a small way to the bitcoin community.

Bitcoin Wallets

To receive a bitcoin a user must have a bitcoin address - a string of 27-34 letters and numbers (see example above) - which acts as a sort of virtual post-box to and from which the bitcoins are sent. Since there is no registry of these addresses, people can use them to protect their anonymity when making a transaction. These addresses are in turn stored in bitcoin wallets which are used to manage savings.

Bitcoin wallets operate like privately run bank accounts - with the understanding that if the data is lost, so are the bitcoins.

If you want to use bitcoins, perhaps to buy products or services, or perhaps you just want to trade in bitcoins, you will need to set yourself up with a bitcoin wallet before you can sensibly do anything. There are three types of wallet:

Where can I get a Bitcoin wallet?
This is what a wallet looks like on blockchain.info

This is what a wallet typically looks like on blockchain.info

There are plenty of websites from where you can obtain a bitcoin wallet and, as mentioned above, you can opt for a web-based solution, or you can download and install wallet software on your computer or mobile device. Here are a few options:

Desktop (Software) Wallets

Mobile Wallets

Web Wallets

Hardware Wallets

How can I add money to my bitcoin wallet (buy bitcoins)?

Adding money to a bitcoin wallet is not as straightforward as perhaps it could be - maybe due to anti money laundering measures - but there are several ways in which you can add bitcoins, and it is something that is getting easier all the time. Here, we'll examine a few ways in which you can get bitcoins.

How Can I Spend/Sell Bitcoins?

So far in this beginner's guide to bitcoin we have looked at a few ways in which you can obtain bitcoins ... but how can you spend/sell them once you have them. Here are a few possibilities.

Buy goods on the Web

Although the number of sites on the web that accept payment in bitcoins is still small, this is slowly changing as more and more sites offer it as a method of payment for products or services. Here is a (non-exhaustive) list of places where you can spend bitcoins: https://spendbitcoins.co.uk/places/... and a couple of bitcoin-specific shops/stores: https://www.bitcoinstore.com/ and http://www.bitcoinshop.us/?ref=blockchain.

Withdraw/spend money using a bitcoin debit card

There are quite a few bitcoin debit/gift cards available; you can get a list here: https://en.bitcoin.it/wiki/Trade.

An example of such a card is the RAXcard Bitcoin debit card (http://www.raxcard.com/home.html), which can be used to withdraw cash (in local currency) from an ATM as well as for buying goods at high street shops, websites, service stations, restaurants and so on.

There is a daily limit of $1000/day per card on cash withdrawals, and there is a 3% fee on any spending or withdrawal. There is also a $50 initial fee for the card itself.

Sell your bitcoins at an online market place or exchange

There are plenty of online markets and exchanges that enable you to sell bitcoins. What looks like a fairly comprehensive list is given at https://en.bitcoin.it/wiki/Selling_bitcoins.

How Safe/Secure Are Bitcoins?

The security of bitcoins is certainly something that needs to be considered when trying to decide how much money you should hold in the bitcoin currency, and there have been some high profile cases where bitcoins have been stolen. For example, in February 2014, the anonymous online marketplace Silk Road 2 was hacked resulting in the loss of all its customers' bitcoins - all $2.7m (£1.6m) worth. You can read about it on the BBC website here: http://www.bbc.co.uk/news/technology-26187725.

You should probably regard your bitcoins in the same way as you would a pile of cash stored in a showbox under your bed ie if someone steals the shoebox, that's it, your cash is gone. Similarly, if someone hacks into your bitcoin wallet and steals your bitcoins, they're gone. As mentioned above, some bitcoin wallets are more secure than others, so bear this in mind when deciding what type of wallet to use.

Are There Physical Bitcoins?

physical bitcoins

Some Physical Bitcoins

Although bitcoin is a digital (crypto) currency that exists on the Internet, you can get physical bitcoins, for example, see https://www.casascius.com/ and http://buyphysicalbitcoins.com/.

When you own bitcoins, what you really own is a private cryptography key that lets you spend, move or send them to someone else. With physical bitcoins, this private key (along with a bitcoin address) is embedded into the coin in some way. When you go online and enter the bitcoin address (see here: http://blockexplorer.com/) of the physical bitcoin, you can see how many bitcoins the coin is worth.

There is a mathematical relationship between the bitcoin address and the private key inside the coin. The digital bitcoin is actually located on the public blockchain stored on the Internet, but it is completely inaccessible to anyone unless the private key from the coin is loaded into a bitcoin wallet. The embedded private key code is all a bitcoin client (for example, Armory or blockchain.info) needs to find and claim the digital Bitcoins from the peer-to-peer network.

Physical bitcoins can be either pre-loaded with bitcoin funds or not. What this means is that when you buy a physical bitcoin, it might have a value in bitcoins that have been pre-loaded onto it, or it might have no bitcoin value at all. For a coin that os not pre-loaded, you will need to transfer bitcoins to the address of the coin.

References and Resources

General

https://bitcoin.org/en/ - A great place for information and resources to do with bitcoin. If there's an aspect of bitcoin that you're unsure about, this is a good place to look for the answer.

http://en.wikipedia.org/wiki/Bitcoin - Wikipedia's bitcoin page - gives a good overview of bitcoin.

http://www.weusecoins.com/en/ - Contains clear information about bitcoin, including a mining guide and how to accept bitcoin payments if you're an online merchant.

https://en.bitcoin.it/wiki/Getting_started - A getting started guide for bitcoin.

http://www.afr.com/p/boss/beginner_guide_to_bitcoin_4io70koOKxNP61fHaY29wL - A very good beginner's guide and video to bitcoin.

Bitcoin Mining

http://www.theregister.co.uk/2014/01/17/ten_bitcoin_miners/ - Roundup of bitcoin mining rigs.

http://www.weusecoins.com/en/mining-guide - An introduction to bitcoin mining.

http://tpbitcalc.appspot.com/ - Bitcoin mining calculator.

full Bitcoin client - allows you to contribute to the bitcoin network by checking and relaying transactions.

http://www.butterflylabs.com/landing/slanding.php - buy hosted mining contracts.

Trading

https://en.bitcoin.it/wiki/Selling_bitcoins - List of exchanges and markets where you can trade bitcoins.

https://en.bitcoin.it/wiki/Trade - List of exchanges and markets where you can trade bitcoins.

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