Recently I have had various questions asked about BitCoin. My favorite is my wife’s typical “How’s the money laundering going?” — Which always makes me chuckle. But let’s take a Q & A approach to some general questions that the not-so-familiar will ask about BitCoin.
Where does the money come from?
A: In VERY general terms, the money is awarded from the network. Think of it as similar to the federal mint printing money and shipping it to banks. Just take away the Federal Reserve, and central banks, and you have a form of currency which is more like BitCoin.
BitCoin is electronic money. As such, the currency is tracked through transactions which are verified by the BitCoin network. All recent transactions (typically over the last 10-15 minutes) are included in a block, which is a publicly distributed ledger. The block is downloaded by each BitCoin client, and is verified to ensure it contains the correct hash and thus is valid.
BitCoin mining is the process of searching for the correct hash value of the next block. It involved specialized software running on computers typically overloaded with ATI graphics cards capable of performing incredible amounts of calculations per second. Once a miner finds the correct hash for a block, and the block is verified by the network, that miner is awarded for its efforts with BitCoins. That’s where the currency comes from.
The value of BitCoin, in regard to other currencies, comes from its acceptance as a form of trade. The value varies over time due to the constant flux of supply and demand. Since it hit the news it has drawn interest by investors which seek only to buy low and cash out high. The speculators can be a dangerous mix into BitCoin. But when it all comes down to it, its value is determined by what someone will trade for BitCoin, and similarly the value is linked to cash.
There are similarities to BitCoin and government issued fiat currencies, but at the end of the day, neither are backed by gold.
The largest difference is that you really can’t hold your money in your hands like cash. You keep your BitCoins in your wallet.dat file, which keeps track of how many BTC you have and also tracks your transactions.
The Wallet.dat file keeps track of all of your transactions– What about anonymity?
A: BitCoin is PSUEDO-anonymous. There is a level of anonymity which is inherited by the way the BTC are sent through the network. Don’t be mistaken either. You can spend your coins to a brand new wallet file, and $shred your last wallet.
Other best practices are to use a new address for EACH and EVERY transaction. Also, NEVER PUBLISH a BTC address in a public forum. If you were to publish your address, your transactions can be tracked through BlockExplorer.