It is about five years or so now since Bitcoins have been on the market, but lately the prices of Bitcoins have witnessed significant volatility, and this has brought them to the attention of a larger population.
What is Bitcoin?
Bitcoin is a virtual currency and allows users to transfer value anywhere in the world with ease and at a much lower cost compared to other currencies and payment methods. Basically, it is a digital currency which can be used like conventional currencies for the payment of goods or services that you buy. If used correctly and safely, it promises great security features.
Since Bitcoin is a currency, its value fluctuates based on demand supply conditions. Also since this system is in its infancy, volatility is likely to be higher and hence it may not be advisable to convert all your local currency into Bitcoins. Bitcoin acceptance is currently limited and is not accepted by most brick-and-mortar stores and most ecommerce websites also don’t accept it.
If, as a merchant, you have received payment from a customer as Bitcoins, you will be allowed to exchange the same for local currency. But, before you start using Bitcoins, you must keep a few things in mind.
How are Bitcoins created?
There is a limit to how many Bitcoins can be created. There are about 12 million Bitcoins in circulation today and maximum number of Bitcoins that can ever be mined is 21 million. With every passing year, the number of Bitcoins that can be mined each year is halved and hence at the current rate, the last Bitcoin is expected to be mined in the year 2140. You can obtain Bitcoins in a variety of ways:
Receive as Payment: To create Bitcoins, one needs a Bitcoin wallet, which is software to hold Bitcoins and make transactions as well. Getting a wallet is quite simple and all you need to do is register yourself and download the application. Once the wallet is in place, you will be given an address which is 34-36 character long. If you are a merchant, this address can be used to receive payments.
Buy using Cash: If you are not a merchant and want to buy Bitcoins using cash, all you need to do is to visit the blockchain.info home page and enter your address and the number of Bitcoins you need to buy.
An alternate way to buy Bitcoins is through a Bitcoin exchange. In a Bitcoin exchange you can buy or sell Bitcoins in exchange of various currencies. For buying or selling through an exchange you need to put your asking or bid rate and once the transaction is executed you may withdraw the Bitcoins to your Bitcoin address.
Mine Bitcoins: By mining Bitcoins, you essentially create new Bitcoins. The mining process is done to verify Bitcoin transaction and is time consuming. It may even prove to be costly if you are not efficient. It is not just one transaction that miners are expected to verify but multiple transactions.
Each transaction involving Bitcoins is recorded and gathered in boxes, with a virtual padlock on them. Miners need to find the right key that would open the box. It needs millions of iterations to locate the right key for the block chain. Miners need a specialized software and hardware to perform the task.
How are Bitcoins valued?
Just like gold or another precious metal, Bitcoin is available in finite amount. As discussed earlier, there is a threshold to how many Bitcoins will be created. Bitcoin’s value like any other currency depends on demand supply dynamics. Because of the rising demand of Bitcoins in the recent past, the value of Bitcoins jumped to as high as $1000 from as low as $13 in a span of year.
How is Bitcoin different from other currencies?
While fundamentally Bitcoin serves the same purpose as other currencies, there are differences.
- Unlike conventional currencies, there is limit to the amount of Bitcoins that can be issued. Presently the number of Bitcoins that can be issued has been capped to 21million.
- There is no central authority that governs the issue of Bitcoin. Like in case of US dollar, it is the Federal Reserve that has the power to issue US dollar. The issuance of Bitcoins, verification and processing of transaction are managed automatically by the network.
- Bitcoin has very limited acceptance. Many stores and countries do not accept Bitcoins. This is not the case with conventional currencies.
- Bitcoin transactions are irreversible. If for some reason you end up paying an incorrect amount or you end up paying to a wrong recipient, there is no way the system can reverse the transaction, unless the recipient agrees to pay you back. Thus, in case of a fraud, you are likely to loose your Bitcoin value.
- Bitcoins are not insured. If the Bitcoin exchange where you held your balance were to go bankrupt, or your account hacked by a fraudster, you remain liable for the full losses. In case of most conventional currencies, your savings held in a bank account are insured to a certain extent.
- Bitcoin being a complex product and based on digital technology, it is not as well understood by most people.
- Since Bitcoin is not an official currency, many jurisdictions may require the owner of Bitcoins to pay potential applicable taxes in case of any capital gains.
There has also been a lot of criticism of Bitcoin. The biggest problems are related to the volatility of the currency, but at the same time other problems related to processing and tracking transactions are also affecting the Bitcoin users.
How do you make a transaction?
If you want to either pay or receive Bitcoins, you would need to install a Bitcoin wallet on your computer or mobile phone. Bitcoin wallets include a secret data known as private key which is used to sign transactions and ensure that the payment has come from the right wallet and nothing has changed once the transaction has been signed using the private key.
It takes 10 minutes for the transactions to be verified after it is initiated. Transaction verification happens through a process called mining. Every wallet owner is provided with a Bitcoin address which will facilitate payment and receipt of Bitcoins. If you want your friends to pay you Bitcoins, provide them with your Bitcoin address.
Although Bitcoin is in its infancy, its transactions are mostly secure, the only catch being that the Bitcoin wallet that stores the private key has to be safely stored and the user should ensure that these are not deleted, lost or stolen. As we said earlier, if you lose your Bitcoins or it someone steals them, there isn’t much you can do.