Bitcoin has been heralded as both the internet's premier currency and as a conduit for malware. It's been in the news this year as the ATO says it will be classed as an asset, not a currency, for taxation. Keen proponents looking to cash in have launched Australian Bitcoin ATMs and an EFTPOS debit card, but stories of spectacular crashes and disappearing funds also abound.
So just what is Bitcoin, and will you be paying for your coffee in bitcoins anytime soon?
What is Bitcoin?
- Bitcoin is a web-based payment system.
- Bitcoins have value and can be used for payment.
- Individual bitcoins are sent and received through users.
- Bitcoin is unregulated and inherently risky.
Bitcoin works as a peer-to-peer payment system where payments are delivered as transactions from one person to another over the internet. The cyber currency is based on bitcoins, which have a value and can be bought, sold and exchanged. The recently opened Bitcoin ATMs let you convert real currency for bitcoins that are stored on your phone to make payment from an e-wallet app, sell and buy bitcoins.
Bitcoin payments don't go through traditional financial systems and can be sent directly through the internet using a Bitcoin wallet, which is a program that stores, sends and receives payments. A Bitcoin wallet can be used on a computer, smartphone and tablet.
Bitcoin is a bit of a frontier currency because it isn't controlled by a central bank and its use is unregulated. The US has been considering regulating Bitcoin trading to formalise it and provide some safety for trading in the e-currency. Recently, the US IRS (tax office) announced that bitcoins should be treated like property and federal taxes should apply.
Where did Bitcoin come from?
The idea of Bitcoin was developed by Satoshi Nakamoto in a 2008 paper outlining how to create a peer-to-peer payment system. The following year, the first Bitcoin program was created and bitcoins released.
No one owns the Bitcoin network as such, and anyone can download the Bitcoin "wallet" program to join the network. There is a Bitcoin Foundation, whose mission is to promote Bitcoin as a viable, safe currency. It wants to standardise Bitcoin so it's robust and ensure it's safe from being hacked.
How does the Bitcoin system work?
Bitcoin works a bit like email. No one single entity owns or controls email, and there are lots of programs to send and receive email that you can use.
- Bitcoins are bits of computer code that match a formula.
- Bitcoins are created by using computers to carry out huge volumes of computations to try different combinations and eventually find one that matches the Bitcoin formula.
- The process of creating new bitcoins is called mining.
The bitcoin computing the code was developed from Satoshi Nakamoto's paper on a peer-to-peer payment network. The Bitcoin network relies on a database, which is a kind of public ledger that records all the transactions in the system and who owns the individual bitcoins. It is known as a "block chain" because a block or bitcoin record is added to the database every time there's a transaction. The Bitcoin block chain is a complete historical record of all Bitcoin exchanges.
Bitcoin is known as a 'crypto currency' because the order and number of transactions stored in the blockchain is protected by cryptography. The bitcoin code was written so that individual bitcoins are 'unlocked' or created by the computers processing the bitcoin code. The cryptography ensures that the number of coins designed in the original code is fixed and they are authentic and extra, fake, bitcoins can't be created.
How do I get bitcoins?
There are several ways to acquire bitcoins:
- Earn bitcoins on your computer by mining.
- Transfer bitcoins with another user.
- Buy bitcoins on an exchange.
- Accept payment in bitcoins.
Bitcoin mining is where people use their computers to take part in processing and can eventually earn bitcoins for themselves. Bitcoin mining on your computer will earn bitcoins using special software to solve equations. To do this, you use mining software to which you devote some of your computer's processing capacity to work towards bitcoins.
Bitcoin transfers can be carried out using a Bitcoin e-wallet to send and receive payments over the internet through a computer, smartphone or tablet. It's like sending payments via PayPal or electronic bank transfer. To create a Bitcoin wallet, you need to install a Bitcoin wallet program on your computer.
Buying bitcoins is possible from one of the many Bitcoin exchanges. A Bitcoin exchange is an online marketplace for buying and selling bitcoins. In Australia, you can start on howtobuybitcoins.info. This site links to local bitcoin exchanges such as Bit Trade Australia, Btc Markets or Bitcoin Australia.
Bitcoin payments can be made at certain online merchants as well as some cafes, restaurants and other shops. It hasn't yet taken off in Australia, but the introduction of bitcoin ATMs may spur along bitcoin payments.
What's the value of a bitcoin?
As of September 2014, it costs US$533 to buy one bitcoin. So as you can see, they don't come cheap. You might not want to buy them until you know exactly what you're going to do with them. You'll also need to pay a commission to buy and sell bitcoins like you do when exchanging foreign currency.
The creation of individual bitcoins is pre-defined by the original Bitcoin code and cannot exceed 21 million. As of October 2014 there were more than 13 million bitcoins in the system according to blockchain.info, which tracks transactions in real time.
What's the risk?
Bitcoin has been accused of being a convenient front for money laundering and cybercrime and a way to pay for illegal items such as drugs. Critics say it's not properly regulated and values are volatile. There are two main risks with Bitcoin – losing your money and infecting your computer with malware.
On the financial side, Bitcoin isn't controlled by a central bank to manage value fluctuations. Sceptics also argue the currency is vulnerable to theft from hacking. The Japanese Bitcoin exchange Mt Gox suffered a theft of some 650,000 bitcoins in 2014 and has ceased trading.
On the security side, getting viruses and malware onto your computer can compromise your bitcoin stash. For example, a recent malware attack on Mac used a fake Angry Birds game to infect Apples and steal bit-coin related login details.
Bitcoin wallets for cloud, computer and mobile
There are three types of bitcoin wallets that can be used to store and transact Bitcoins:
- Cloud-based wallets that use a web browser
- Software wallets that run on your computer, and
- Mobile wallets that use an app on a tablet or smartphone.
A Bitcoin program sends and receives transaction to other users in the network. Each user has an address – an alpha-numeric string of between 27 and 34 characters, a bit like an email address that identifies you and the destination for your bitcoins. You can get an address within your Bitcoin program by clicking "New Address".
Some Bitcoin e-wallet programs will download the list of blocks when you first start up as a reference point to add your transactions to this record. Each time a transaction is made, it's broadcast to the Bitcoin network and each payment is digitally signed to verify it and prevent double-dipping of bitcoins. Bitcoin uses cryptography to protect transactions so they can only be locked and unlocked by right sellers and buyers to prevent theft.
Bitcoin isn't the only cyber currency. There are many other types, including Litecoin, Peercoin and Dogecoin to name a few, but they haven't (yet) gained the notoriety of Bitcoin. Some are derived from Bitcoin but may use slightly different ways to mine coins or verify coins.
The cost of coins in these rival e-currencies is lower than bitcoins. Whether we'll eventually see a raft of different cyber currencies used in the mainstream or if two or three develop and exist alongside traditional currencies remains to be seen.