Bitcoin Basics

What is Bitcoin?

Bitcoin is a decentralized digital money (money being a specific type of currency). The best way to think of it is as a container of value. The lack of tangibility, which is the primary argument against it by those who don't understand it, is actually one of its greatest strengths because it allows one to trade with anyone else in the world without having to rely on middlemen or gateways, aka banks and government. The reason I'm starting with this point is that this is where most people get hung up - they think that if they can't hold it in their hand like cash or gold, it's not real. What they don't understand is that value is never tangible, it's just perception. It's like a hand written letter versus email; the letter is tangible and the email is digital, but they both contain a message, each having their own strengths and weaknesses relative to one another.

As I said, it's decentralized, which is why it's so powerful and such a game changer; it doesn't reside on a single server or set of servers which means that it can't be shut down by regulatory agencies. A decentralized comparison would be like the difference between Napster and torrents. Napster had a centrally controlled system where all the music that was being shared was listed, and all Napster clients had to touch this server in order to communicate with one another. Obviously, if the server gets shut down, Napster won't work, which is exactly what happened. Conversely, torrents are a decentralized way to share files and can't be shut down because, like bitcoin, they're peer to peer. Another benefit of this decentralization is that it is global in nature and completely snubs its nose at borders. This is tremendously powerful for those living in locations where their economic system is collapsing, such as in Venezuela, and they need to preserve their wealth and have the ability to purchase goods that their failing currency is unable to. It also slams the door on government confiscation.

To understand how bitcoin works, you must first understand what the blockchain is. To put it in perspective, the blockchain is to bitcoin what the internet is to email - a connectivity system that applications run on. The blockchain is the global ledger that records all bitcoin transactions. In our current economic system, when you make a deposit into a bank, an entry is made into the bank's ledger, crediting your account and debiting another account, then at periodic intervals, all the bank's ledgers are reconciled to make sure that all transactions zero out. With the blockchain, instead multiple ledgers that need to be reconciled, there is one global ledger that all transactions are recorded on and which resides on thousands of computers simultaneously and is synced in real time. It's also fully encrypted and doublespends and chargebacks are not possible, which is great for retailers.

Another aspect you need to understand is mining. Embedded within the blockchain are all the bitcoins that have not yet been released to the market, and for them to be released to the market, they first have to be mined. Mining is done by solving highly complex mathematical equations and when an equation is complete, a set amount of bitcoin is unlocked and deposited to the miner's wallet. This is just like how gold is put into the market - machines dig into the ground looking for gold, and when gold is found, it's put into circulation. The only difference with bitcoin is that the mining is done digitally. Unlike gold and all other precious metals, we know exactly how many bitcoins there are in existence and the general timeline of when they'll be released. There are a total of 21 million bitcoin with the last of them set to be released in the year 2140. And while 21 million doesn't sound like a lot, it's not a limiting factor because bitcoin is divisible to 8 decimal spots (technically it's infinitely divisible but it is software limited to 8 decimal spots). The smallest chunk of bitcoin (0.00000001) is called a satoshi, named after the anonymous creator of bitcoin, Satoshi Nakamoto.

In order to obtain, hold, and trade bitcoin, you need a bitcoin address. People often call that a wallet but that's not technically true; a wallet is really a collection of addresses. An important aspect of blockchain based currencies to understand is this - your bitcoin does not reside in the wallet, it resides in the blockchain. A wallet is just a gateway to the blockchain and your bitcoin and access to the blockchain is controlled via cryptographic keys.

Wallets essentially fall into one of three categories - hosted wallets, software wallets, and hardware wallets. Hosted wallets are like bank accounts - you pay someone to store your access to bitcoin for you online. Hosted wallets like Coinbase, offer much convenience as you can access them from any internet connection and/or mobile apps, but are also less secure because access to your wallet is controlled by the host and the security of your bitcoin is limited by the security of the host. Exchanges (currency marketplaces which include hosted wallets) have been hacked multiple times so caveat emptor. However, the bitcoin protocol itself has never been hacked and isn’t likely to be, at least not with current or foreseeable technology. Online wallets also generally maintain personal information about you so if you're worried about government meddling, which you should be, I don't suggest keeping the bulk of your bitcoins in an online wallet.

The second type of wallet is a software wallet. A software wallet is a piece of software that resides on your computer that allows you to access your bitcoin. The advantage of software wallets is that you are the only one who can access your coins, there is no need to trust someone else with your wealth. The disadvantage of software wallets is that if someone gains access to your computer, they gain access to your bitcoin. Also, if you lose your keys, you lose access to your bitcoin.

Hardware wallets are the third type of wallet and are similar to a software wallets in that you are 100% responsible for controlling your bitcoin. Where they differ is that unlike software wallets where access to your bitcoin resides solely in the software, a hardware wallet keeps your cryptographic keys on a specialized piece of hardware that looks similar to a thumbdrive and is only connected to the network when you connect the hardware to your computer. Hardware wallets are by far the safest way to store large stores of bitcoin wealth. Obviously, don’t lose your hardware.

Once you've set up a wallet and address and deposited bitcoin to that address (an address consists of 26-35 alphanumeric characters, and while not technically unlimited, there are so many possible combinations that they effectively are unlimited), in order to send bitcoin to someone, all you need is their address, and likewise, to receive bitcoin, you just need to provide them yours. After you've sent bitcoin to someone, the transaction appears in their wallet nearly instantaneously but it still needs to be verified (which is done by the miners) before the recipient can spend the newly acquired bitcoins. Verification usually take minutes to hours unlike the 3+ days of our current financial system (there is also a HUGE debate raging in the bitcoin community that has to do with verification times, but I'm not getting into that here). When you trade with someone, your address, their address, and the transaction amount are recorded on the blockchain. However, there is no personal information attached to the transaction so bitcoin is said to be pseudo-anonymous. Even though all transactions can be traced throughout the blockchain, if the coins you are holding or trading were never attached to a "real world" account like Coinbase, they can't be traced back to you. But if you did purchase bitcoin with an account tied to our current financial system, such as Coinbase, and you need to hide your trail, you can run your bitcoin through a tumbler to mix it with other bitcoins. If you were to do this with dollars, a tumbler would mix your dollars into a bucket with a bunch of other people's dollars and then give back what you put in (minus a fee of course) but what you got back was randomly pulled from the bucket, making it impossible to follow the money trail.

This got longer than I intended so let me wrap it up. If you want to get into bitcoin and be able to acquire it regularly, the easiest way is to create an account at www.coinbase.com and link it either to your bank account or your debit card. Then, if you start developing a bit of a balance, I would move the bulk of it out of Coinbase and use an offline wallet such as Exodus, which is what I use. Also, in regards to buying bitcoin, you don't have to buy a full coin at a time, you can buy it in very small increments. I don't know if Coinbase has a minimum purchase amount, but theoretically you could buy $0.01 at a time if you so desired.

There is obviously a lot more to this, but since this is already rather long, I'm going to end here and let you all ask me any questions you may have.