Sunday, December 15, 2013

Bitcoins - The way I understand them.

I recently read a really good article on Bitcoin.  Here is that URL: 

"http://www.michaelnielsen.org/ddi/how-the-bitcoin-protocol-actually-works/".  

When I shared the URL with some friends I got a "tl;dr" response and some questions.  Here are my responses to the questions: 

1. "... 
What gives the bitcoin a fluctuating value? ..."
Its fluctuating value is a result of the fact there is absolutely no organization that underwrites the value of Bitcoin.

I think a good analogy to Bitcoin is:  Suppose some new mineral was discovered that was not good for anything on its own but was very difficult to obtain.

Because the difficulty of obtaining it would make it rare then it could be used as money.  (For example gem diamonds.)

If the difficulty of obtaining this mineral was uncertain and at any time some breakthrough could occur that would make it very easy to get more of it or if at any time the process of obtaining it could be taken over by some arbitrary group then its value would fluctuate.

2. "... What is the underlying value? ..."

Zero.  

These days (perhaps excepting gold and such) there is no underlying value of any money, except the trust we have in the countries that issue that money. 

3. "... How are bitcoins purchased/traded ? ..."

You can do it yourself by setting up your own e-wallet then putting some bitcoins in it.  To put some bitcoins in your wallet you find someone to transfer some of their bitcoins to your e-wallet.

There is another way to get bitcoins yourself, you can e-mine them. The computing power necessary to e-mine bitcoins is probably beyond the grasp of normal computers.  After, and perhaps even before all the Bitcoin is mined there is a provision in the Bitcoin protocol (not currently in use) called transaction-fee so you could become a Bitcoin banker and get bitcoins that way.  How this would work has not yet been invented. 
 
4. "... What if you lose your bitcoin serial # ? ..."

If you really lose it and can not recover it then the bitcoin no longer exists.  

Well sort of no longer exists:  You can still see the bitcoin in something called the block-chain but it can not be accessed by you or anyone else.  NOTE: There is a cryptographic assumption here that applies to everything about Bitcoin.

5. "... Is there a benefit to using bitcoins for consumer services ? ..."

No.  However, the answer is yes if the particular service you need is only available for purchase using Bitcoin.

6. "... Any audit trail for taxation reasons? ..."

Yes:  There is a complete trail of all bitcoins.  

Not only that but a bitcoin is its transaction trail.  If you follow the transaction trail back you get to either the 'bitcoin-genesis-block' or some 'e-mine' event that created it.  

The database of all Bitcoin transactions is called the 'block-chain'.

The act of exchanging Bitcoin involves not just the bitcoins themselves but also the IP address of the 'e-wallets' of the parties who did the exchange.  So the trail is very complete. Currently there are Internet protocols that attempt to anonmize the locations of the e-wallets but they have been shown to be breakable.