What are Bitcoins?

We had an enquiry on our Twitter account on Bitcoins, and whether it is worth to have some investment in them. Personally I have been skeptical about this Bitcoins thing but I decided to put my biased opinion aside and do a little research so that I can make an informed opinion. After the research what I learnt is that the true honest opinion will be a philosophical one rather than a technical one. The philosophy is purely and ideally the pros and cons of an ideal free market. But before I mention some of these pros and cons of a free market, let’s first introduce Bitcoins.

Bitcoin comes from bit and coin where bit in itself is the portmanteau of binary digits. So Bitcoin is basically someone e.g. Bob coming up with a collection of unique arrangement of bits (several 1s and 0s – to the hundreds or thousands) using a complex mathematical formula (algorithm) and saying OK these 1s and 0s ordered in this unique arrangement represent monetary value. Then Bob approaches Alice and convinces her to accept those 1s and 0s in that particular order as money. That way Bob and Alice and anyone else who agrees with them will always accept the bits and bytes in that particular arrangement as money that they now call Bitcoins.

Background Information

In 2008, an anonymous person or group by the name Satoshi Nakamoto (sounds Japanese) criticized the conventional monetary system and policies citing government regulations,  monetary and fiscal policies, high level corruption, and related vices that contributed to the recent recession in the Western Economies as valid reasons for the society to have a medium of exchange that cannot be regulated by any central government, agency, or institution. To Nakamoto, the solution would only come from the connected computers and the Internet in the form of Bitcoins.

To satisfy the minimum criteria needed for any item to be used as money, there are three basic requirements that Bitcoin had to meet:

  1. Bticoins must be accepted as a medium of exchange
  2. Bitcoins must prevent possibility of double spending
  3. Bitcoins must be secure

1. Bitcoin as a medium of exchange – Generally Bitcoin has been accepted by many people as a medium of exchange. This is what we have from Investopedia, Bitcoin “rocketed to prominence in 2013, when the value of a Bitcoin soared more than 10-fold in a two-month period, from $22 in February to a record $266 in April.” HowStuffWorks adds, “Although pickings were slim when bitcoins first launched, these days there are many merchants that accept these newfangled coins. That includes restaurants, clothing stores, dentists and many others. Some people even use bitcoins for property rental and vehicle purchases.” So yeah thousand of people already accept Bitcoins as a medium of exchange.

2.How double-spending has been prevented – Imagine you had your regular currency e.g. Kshs 1,000 note. You go to a shop to buy some goods worth Kshs. 1,000. Imagine also if you had some magic powers of re-creating that exact Kshs 1,000 note after using it. Now imagine if every other person had the same magic powers. That would mean every single person has unlimited purchasing power for the limited goods and services; meaning within a short time the supply of goods and services will come to an end hence the economy would collapse. The supply will run out as soon as yesterday because no one will want to work as everyone has unlimited supply of money.

This is a potential danger with cryptocurrencies as Bitcoins. Imagine if this exact post in its entirety was one Bitcoin. How many of us can copy paste it? That implies that making copies of a cryptocurrency is very possible. To avoid doing several transactions with one Bitcoin e.g. sending copies of the same Bitcoin to three different individuals, Bitcoin transactions are done publicly in a Peer 2 Peer Network. Your computer becomes part of this network immediately you install a Bitcoin wallet. The Public Network has a Block Chain (Log File or Ledger) which records all transactions in the Network and is accessible to all computers in the network. Each transaction, which must must be stored in the Block Chain, has information on the Bitcoin transacted, the addresses of sender and recipient, and the Bitcoins balances in those addresses. For each transaction to be executed, the network checks whether: 1. the Bitcoin to be transacted is indeed owned by the sender and 2. the particular transaction has not occurred before. This checkup process can take up to 10 minutes.

So basically the only copies you can make is copies of your Bitcoins so that you can save them at different places e.g. in the hard drive, in Flash drive or on a hard copy but you can’t make transactions using the same Bitcoin more than once; you can only use the same Bitcoin if you received it back as payment for goods/services you offered.

3. Security Issues – There are security issues that have been addressed by the way a Bitcoin is generated, transmitted, and stored. But there are other security issues that are entirely up to you and these involve ensuring that your wallet is safe from hackers and your bitcoins are properly backed up in case of computer damage.

Transacting with Bitcoins

To make a transaction using Bitcoin, first you will need to install a virtual wallet. The virtual wallet installed in your computer, smartphone or tablet will be used to generate a Bitcoin address and this address will be assigned Bitcoins Balance that you have purchased. As advised by Investopedia, you can purchase Bitcon “from Bitcoin currency exchange such as Mt. Gox or Bitstamp, or through a service like BitInstant that enables fund transfers between Bitcoin exchanges and supports various payment mechanisms.”

The virtual wallet will generate to you a public address that you will use to receive or transfer Bitcoins. Every time you want to receive Bitcoins, you give out your address to the person who is to send you the Bitcoins. This address will be broadcasted, together with its corresponding public key, to the P2P network. The associated private key remains with the address owner (you). So once I get your address with its public key, I send you the Bitcoins but I must make sure (my wallet will make sure) that I encrypt the transaction with your public key. You are the only one who will be able to receive the Bitcoins as only you has access to your private key that can be used together with your public key to decrypt the message. This transaction will be saved in the Block Chain so the network will know that those particular Bitcoins have been transacted from me to you.

This is the technical background of Bitcoin. Whether to invest in them or not will be covered in the next article.


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