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Bitcoins Don’t Exist

March 26, 2013

As the title says, Bitcoins do not exist. They do not exist as something you can hold, as some byte of data on your computer, as some file stowed away in your Bitcoin client, or in any other tangible form. They are not something that you can own, merely something that the collective claims that “you” own. They were invented by a man named Satoshi Nakamoto, who does not exist either.  As it turns out this is a pseudonym, and the true identity of Bitcoin’s creator is a mystery.

So what are Bitcoins? Bitcoins are known as a decentralized digital currency or virtual cryptocurrency that are especially useful for maintaining your anonymity while purchasing certain things online, like VPN subscriptions. The core concept regarding Bitcoins as a decentralized digital currency is the fact that Bitcoins have no (naturally occurring) single, controlling payment processor. Instead Bitcoin transactions are processed by a collective of Bitcoin miners, whom also generate new Bitcoins.

How do Bitcoins work? Bitcoin mining is the process by which Bitcoin transactions are processed by being published to the blockchain—which is essentially a list of every Bitcoin transaction—and by which new Bitcoins are created. To create a Bitcoin transaction, a Bitcoin client is needed. If you do not already possess a Bitcoin wallet, which consists of a public and private key pair, then your client will “generate” one for you. The word “generate” is in quotes because it implies that the wallet did not exist before you generated it, which is incorrect. A public key is merely a string of letters and numbers that is derived from a private key using a cryptographic function. These strings do not require any sort of registration to exist as wallets within the Bitcoin network, and—because they do not require any sort of registration to exist—each and every potential key pair has always existed with the potential to be in use. So your keys are not being generated so much as they are simply being chosen and put into use. Although the odds are incredibly low, it is possible that the private key randomly chosen by your Bitcoin client is already in use by someone else—in which case you will have full access to any and all Bitcoins associated with that particular key pair (as will the original owner so long as they have access to the private key.) The reverse is also possible, where someone else’s Bitcoin client randomly chooses to use your private key. However due to the incredibly low probability of occurring, and the fact that stealing Bitcoin wallets requires the same computational power as Bitcoin mining, it is not a viable method to earn Bitcoins. The private key is the focus of these potential issues for two reasons: It is used to derive the public key and it is used to transfer Bitcoins from your key pair—or wallet—to another. The public key, on the other hand, is used to receive Bitcoins and can be given freely because—due to the nature of cryptography—a public key cannot be used to derive a private key. So by giving out your public key, you allow yourself to receive Bitcoins with no risk of having your private key discovered and your “wallet stolen.” A transaction can only be published to the blockchain by using a private key with a number of Bitcoins greater than or equal to the amount specified in the transaction. There are four steps in publishing a transaction to the blockchain: First by sending a valid transaction to the Bitcoin mining network, then the network includes your transaction (along with many others) in a block, and uses a brute-force attack to solve a cryptographic function derived from the information in that block which—when solved—can be published and accepted by the entire network. On average one block is published every 10 minutes. So it takes at least 10 minutes for any single transaction to be forever written into the blockchain, which is then published to the entire Bitcoin network who must—as a collective—agree upon the number of Bitcoins remaining in all affected wallets. Furthermore it is important to note that—because every transaction is published in the blockchain—the Bitcoins associated with any address can be seen by everyone and anyone. In fact, the entire Bitcoin system can only exist due to several ingeniously implemented systematic incentives—it is self-perpetuating.

These sound like a scam? Bitcoins are a pseudo-fiat currency, meaning that they are not backed by anything like gold or silver (like U.S. dollars.) Bitcoins may seem like a scam because they require one of two things: Either trust or a thorough understanding of cryptography. Unfortunately most people, including myself to a large extent, are not versed enough in cryptography to fully or properly understand the Bitcoin platform, and trust is hard to come by over the internet. However Bitcoins have survived in the open-market since 2009, and as of writing this post they are trading for $74.46 USD apiece. If you cannot trust me as to the legitimacy of Bitcoins, then trust the market.

If everyone can see every transaction, how is this anonymous? Perhaps anonymous is the wrong way to describe Bitcoins; Bitcoins have a strong potential for anonymity. They are pseudo-anonymous. Yes, every transaction (ever) is listed and can be accounted for in the blockchain (which is freely available to anyone), but the transactions only include IP addresses and information concerning the keys involved. While either of these pieces of information could be used to identify a single person as owning a specific wallet, they do not necessarily identify that person. A cash-to-Bitcoin transaction, when combined with a WiFi hotspot or VPN, is essentially untraceable. In fact, this is why the Bitcoin platform has become widely used for money laundering and other criminal activity.

Alright, so why don’t Bitcoins exist and if they don’t exist then why are they worth anything? Bitcoins can best be understood as a collective agreement that you have the money (BTC) in your wallet. In this sense a Bitcoin transaction can be understood as the collective agreement that you have paid an amount, using the funds in your wallet, to another wallet. No physical or virtual transfer or funds is necessary, since it is only the communal agreement that determines that you had any Bitcoins in the first place. Bitcoins have value because they are the perfect currency: They are widely accepted, they never degrade, they are infinitely portable and divisible, they never degrade, they are easily recognizable and exchanged, each Bitcoin is identical, and they cannot be seized by the government. The two caveats to using Bitcoins are their transaction fees: Actual transaction fees for Bitcoins are tend to be relatively small, are optional, and average under 1% (which determines how quickly your transaction is included in a block, since the block’s publisher claims all associated transaction fees in addition to their generation/reward transaction from publishing the block); and the various (much larger) fees associated with currency exchange rates. In fact, firms should prefer their customers paying with Bitcoins rather than credit cards due to the lower transaction fees (excluding exchange fees) and the fact that transactions cannot be reversed after they are published to the blockchain.

Bitcoins may be a niche currency, but they are worth watching. I highly recommend this podcast if you wish to learn more about Bitcoins.

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