How BitCoin Works

In the previous post I made an introduction to BitCoin, a new digital currency, independent from governments, banks and corporations – maintained by its users. The post was mainly about the good aspects of such an experiment. 

Now it is time to see how BitCoin actually works and what can be done with it.

So, how does BitCoin work?

I tried to simplify this part as much as possible. If it still gives you troubles, gently skip to the next section.

Essence of BitCoin is pretty much the same as the BitTorrent filesharing technology which actually inspired it. There's no central server that keeps all the data. As there is no central bank and server, the data about all the transactions is stored on the computers of the users. Unlike the transactions, data about your amount of money is stored on your computer only. Of course, you can (and should) backup that file (somewhere local, not on a cloud!) or even keep it on your flash drive and take it with you. More about this later. 

Each transaction is encrypted by the same system banks use with credit cards. Except that it's not your name on the card so you have perfect anonymity of what you do with your money. Once the transaction is done, other computers in the system check if those BitCoins weren't spent already. That process takes about 10 minutes to an hour and is called verification.

BitCoin sign photo by freeborn

That's nice, but how does it work from user's perspective?

Luckily, this part is easy.

You download and install BitCoin software. It's available for Linux, Mac and Windows or you can get the source code and compile it for whatever other exotic pile of silicone and wires you are running. Then you run the software (bet you have guessed that, huh?) and let it download the blocks. Thus you became a part of the torrent swarm which makes this system so great. 

Not that you need to know this, but blocks are records of all the BitCoin transactions to the date, so it will probably take a couple of hours. If you want to know how many blocks has been generated so far you can check that here. This huge downloading takes place only the first time you run the software. After that, it only updates new blocks and that goes quite fast. 

You'll probably want to encrypt your wallet (in the Settings menu). Use a good password not the usual shit you put on every mail and Internet account you have. Write the password somewhere safe. You don't want to forget it as there's no password recovery emails nor answering who was your favourite teacher or the name of your first pet. If you forget the password, you burned all the money you had. That's why you should backup the wallet.dat file. Just, please, keep it secure and maybe even encrypted and password protected. 

User interface is quite simple. There is a part of the window showing all your transactions and there is a field with a large string of random letters and numbers. That's your BitCoin address, thing you give people so they can send you the money. You can have as much of those as you fancy and you can assign each of them a label. It's wise to go that way and have different nicely labeled addresses for different streams of income. 

If you want to send money to somebody, you just need their address. System will refuse to send money to non-existing address. It takes just a few seconds for the transfer, but up to one hour to be verified by the community. 

How to get BitCoins?

The very same way you get any other money: by providing the goods and services to other members of the community. In this case, community being the other users of BitCoin.

You can also do the surveys and other Internet stuff to earn small amounts of BitCoins, but before that, be sure to visit BitCoin Faucet, which will give you some peanuts to help you get started. You need Google account and you can use it only once.  

Of course, if you need a large amount quickly, you can buy BitCoins in the exchange office

Beside these, regular, ways, you can also mine fresh new BitCoins.

Mining BitCoins? Come again

Just as you can mine the gold and thus increase the overall amount of money and value in the world, you can mine BitCoins as well. Difference is that you don't have to go in Africa or South America and dig the ore from the ground. To make new BitCoins you have to run computer program. 

I must say that this part is not quite clear to me, but in essence, you use your computer's spare processing power to solve some heavy math. If you hit the solution you've discovered 50 fresh new BitCoins. As I get it, the math has to do with all that encryption needed for safe and secure transactions. 

photo by Olmo Calvo Rodriguez 

Problem is that the math is quite heavy and that you have to be the first to solve the whole block of data. So, as any gold mining, success is one part the size of your mining operation and one part of pure luck. For the first, you need a lot of processing power (read: strong graphic cards, preferably more than one – up to the whole farm). For the later, you might want to join a group of people called pool, thus increasing your chances of hitting the score and then sharing the reward. 

There is also a BitCoin mine that runs directly from your browser (you'll need to enable Java). It doesn't utilize much of your computer's potential, but it seems to have a lot of users. Consequently, it gives steady though quite small revenue. Also, it gives the option to help somebody else mining, so you can put a link on your blog and have your readers tip you in an unusual way. Or you can click here and make me a few cents richer while you are reading this. Thank you. ;) 

Where to spend BitCoins?

Surprisingly to something relatively fresh as BitCoin, list of places and services where you can spend your BitCoins is not short. Take a look at the official wiki list or the map of real-world locations of the shops, hotels and restaurants.

Of course, you can always exchange BitCoins to your local currency, take the paper bills to a bar and do your usual routine. 

I hope I've covered all the important stuff, but if you have any questions feel free to ask. In the next post, we'll take a look on the dark side and problems connected to BitCoin. 


  • To get Bitcoin more easily, just go on and buy them with your phone !!!

  • Thanks again your attention to Buitcoin,
    I have been somewhat curious as to why people speculate on Bitcoin, and I realise it has great potential. This was my understanding when it was $0.79 on an exchange, but my thinking is it is just a bubble because there is no real Bitcoin Economy yet, Bitcoins are not valued for what they do but rather treated as a commodity by speculator. While you can buy things in Bitcoin, it is equivalent to spending in a local currency because the price is pegged that currency.  

    So my conclusion is speculation increased demand and increased demand = increased value, however this is just a bubble if everyone is speculating on it becoming a active currency.

    For me to start accepting Bitcoins I would need to see the Bitcoin wealthy develop something of value, and spend Bitcoin to do it. Taking an example form the textbooks of the Romans.

    Until then, my thinking is this is a tough sell, even tulips have an aesthetic value, the only true value I see in Bitcoin is being eroded by speculation.

  • BitCoin's window of opportunity is in the small transactions on the Internet. First thing that comes to my mind are Linden dollars, internal currency of Second Life. There is a whole micro economy (that is actually anything but micro) that wouldn't be possible if it was based on USD or Euro. It's no surprise that some companies are exploring the possibilities of creating their digital currencies. But if something will be bad for the Internet its Facebook gaining the control of the micro-money that fuels it. 
    I agree that speculation can damage BitCoin. But even private small speculators are better around than one big speculator having all the control over it. 

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