Finance

BitCoin for Dummies

bitcoin - digital look

Digital Records Instead Of Real Money

There are three friends: John, Bill and Tom. John has a jacket, but he doesn’t like it and wouldn’t mind to sell it. Bill likes the jacket and would like to buy it. He has the necessary amount of money in his money-box, but he left it at home and cannot pay right now. So, John and Bill take a scratch-pad and write down the terms of their deal. And they ask Tom to witness the deal, promising him some revenue for his participation in this transaction. And they write down the revenue, too.

Do they need any financial institutions or other authorities to make or to record this commodity-money exchange? No! And do they need to hand over any real money in order to fulfill their obligations under the deal? Not at all! They can review their notes and check that John has, let’s say, $100 (the money he has got from selling the jacket) and Tom owns $5 (his revenue). And then they can ask Bill to mow their lawns instead of giving them the real money. He agrees to do the job for $50, and the corresponding record is made into the scratch-pad. From this point, our friends can enter into any transactions between themselves, just introducing the corresponding notes – they will always be able to calculate the balance on their “accounts” by reviewing the records. Transform this idea into digital environment and you will get BitCoin.

How Does This Work?

So, BitCoin is a kind of record describing transactions and those records are stored in a distributed database. This means that there is no main server for storing, processing and controlling the system – anyone can get their server connected to the system and use it.

The database is open to public and unencrypted, so if you join our Tom, Bill and John, you will be able to see the history of all their transactions and they will get access to yours. Um, and what about anonymity and security? In fact, all transactions are “tied” to encrypted addresses, which serve as identification means in the BitCoin system. Thus, looking into the imaginary scratch-pad you can only learn something like “5PreshX6QrHmsWbSs8pHpz6kLRcj9kdPy6 sent $100 to 2PreshX6QrHmsWbSs8pHpz6kLRcj9kdPy6” – but no one can track Tom or John, since no other identification is required. And you are allowed to generate a unique address for each transaction (but it is not necessary if you are not crazy about your anonymity).

As for the security of transactions in the system, it is provided by verification through a certain combination of user’s BitCoin address, his digital signature and data on his previous output. Sounds scarily, but it is really simple:

  • When you join the system, you create your digital wallet via services represented on the official web-site.
  • Then your personal secret key is generated that can be stored in encrypted files of your wallet, on your computer’s hard drive or on servers.
  • Based on the key your BitCoin address is generated (or several of them).
  • When you want to make a transaction, you specify the previous output (bitcoins that were received on your address) and a payee’s address, while verifying the transaction through your digital signature generated by your key.
  • If the output, address and signature match together, the transaction is accepted by the system.

How to Use?

The system is decentralized and absolutely independent of governments, banks and corporations: there is no authority, which can block your BitCoin account. Using the system, it is easy to accept donations and payments for goods and services, as well as to pay via the Internet and to convert bitcoins into many currencies (about 5000 BitCoin businesses are listed here). You can build your business on mining, buying and selling bitcoins, or even make your life savings – in 2009 New Liberty Standard set a rate of $1 for 1.309.03 bitcoins, while in 2017 the price of bitcoin reached $1460!