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What is Bitcoin

Most people have heard of Bitcoin by now, but it would be relatively accurate to say that many do not understand what it is or how it started. Essentially, Bitcoin is a payment system - a more-or-less closed loop payment system. This system was invented in 2008 by Satoshi Nakamoto. Unlike traditional currency that is backed by a standard of gold or other precious metals, the standard for Bitcoin is a mathematical equation. The process of buying, selling and paying with Bitcoins is validated by mathematical equations that are proven by users who apply their computing power to verify and record the payments. One of the main points for understanding Bitcoin, though, is the fact that it doesn't rely on a central bank or repository, so as currency it is decentralized and it is virtual - nothing physical is ever produced to "represent" Bitcoins.

Whereas countries that produce currency do so by printing or minting the money and then providing that currency to their citizens through banks, Bitcoin currency is created as reward for payment processing work. The users who verify and record payments use their computing power to accomplish these tasks record the payment information into a public, distributed ledger which is called a block chain. The Bitcoins that are created for their reward on work accomplished are then essentially put into circulation as they make them available for others to "buy". Each action of buying and selling Bitcoins contributes to the total block of currency that is in circulation. This will continue with Bitcoins being created until a limit of 21 million has been reached, per the Bitcoin protocol that was instituted by the inventor. This keeps unlimited Bitcoins from being pushed out into the marketplace. After the ceiling on Bitcoin creation has been reached, those users doing the payments processing work will be rewarded with transaction fees only.

Once Bitcoin was put into production as the first digital or virtual currency that is non-centralized by any one entity, bank, country, etc., it opened the door for other cryptocurrencies to be created. We started seeing these other versions in 2011, but nothing has taken off like Bitcoin has itself. The journey has not been without bumps in the road, most notably with a major Bitcoin exchange going under in 2014 due to hacking (Mt. Gox) which caused Bitcoin to lose half its value, and a technical glitch in March of 2013 that caused the block chain to split. That resulted in two major networks to work on separate versions of the block chain at the same time which should not happen. To resolve the problem, most networks had to downgrade to a previous version and the move forward again.

A deeper dive into the process can highlight some more of the details around the Bitcoin payments process. The main premise of Bitcoin is that it is a completely transparent process. There must be inputs (Bitcoins previously received into the user's account or wallet) and outputs (the payment of Bitcoins to another user). Each of these items must be digitally signed. There can be multiple inputs or one single input that is being transferred to one or more outputs. To talk in traditional currency terms, you might have received a $1.00 payment, a $5.00 payment, and a $10.00 payment and these are inputs - the total in your account is $16.00. If the output you want to enter is $15.50, you would have three of them - you would use all three input payments to reach the total outgoing transaction you need to make with .50 left over. That .50 would be returned to you in another Bitcoin transaction as change.

Each time a transaction is made to a valid owner's Bitcoin address and it is recorded in the public ledger or block chain within a newly accepted "block". Blocks of new transactions are added to the block chain approximately six times per hour. The new block chain with its added new block is immediately distributed to virtual communication or network nodes running Bitcoin software. This is open-source software meaning that anyone can access and run it. Users belonging to these networks or nodes, called miners, do the payments processing work mentioned above by "mining" the block chain. Mining consists of running the algorithms of Bitcoin's mathematical equations against the digitally signed, new transactions. This mining process verifies the origination and amount of the transaction, and proves that the Bitcoin used has not been double-spent. This keeps users from re-spending the same Bitcoins for multiple outputs, and never generating new input.

The process of constantly and repeatedly mining the block chain is really a record-keeping service. It is what ensures that the block chain is whole and unaltered as each new block of transactions is broadcast and verified against the complete record. Each new block has to contain the information that pertains to the previous block that it came from and gives the block chain its name - that information is called a cryptographic hash and it comes from the previous block. In order for the miner to have a successful validation of the new block (and be rewarded with new Bitcoins and/or transaction fees), they have to produce a proof-of-work. This proof consists of a random number used only once (like a check digit) called a nonce and a number called a difficulty target that is provided by the Bitcoin software for the block.

The miner does the tedious work of adding a nonce, one number at a time (as in 1, 2, 3, etc.), until they come up with a hash that is smaller than the difficulty target. Once this new block has been created, validated, and distributed, every network and communication node can easily validate that the work was correct. The work to make the new hash smaller than the difficulty target generated is significant, and it is what proves that the validation was done.

The longer this goes on, the harder it will be to find the correct nonce to create a new hash. There are rules built into the Bitcoin system that will make adjustments for difficulty targets every so often so that the advancements of computer hardware do not significantly reduce the time it takes to mine for the correct nonce values. It should always run around 10 minutes or so. The current reward for this successful work of finding new blocks is 25 Bitcoins and transaction fees. These Bitcoin rewards are also added to the block chain when the miner processes a transaction known as a coinbase.

Users and/or consumers who want to use Bitcoins go online and create a digital wallet for Bitcoins. Since Bitcoins are constantly in motion, they aren't really stored anywhere. So a user's wallet doesn't really store "their" Bitcoins, it more accurately stores their online credentials for what they "own" or hold in Bitcoins. These credentials are what gives a user access to the Bitcoins they haveand allows them to spend those Bitcoins, as well. There are several configurations of wallets such as online or software wallets, but there are also physical, or hardware, wallets that are more highly secure and store a user's credentials offline. Since Bitcoin uses encryption keys when processing transactions - one is a private key and one is a public key and the processing cryptograms are generated from these keys - a user's wallet is really a collection of these keys.

The original wallet was also created by Satoshi Nakamoto in 2009, and was called Bitcoin-Qt. That wallet is also the Satoshi client (or user interface), and it defines the Bitcoin protocol and rules as well as being a standard for implementations of other wallets. It is now called Bitcoin Core to more correctly reflect how it relates to the whole network. There are lots of software Bitcoin wallets available now such as Coinbase or Blockchain.info. Users can buy Bitcoin with currency through online trades (your PayPal account "funds" traded for Bitcoins that are being "sold" by current owners), or for cash trades in a face-to-face exchange. It is highly recommended that when trading cash for Bitcoin, some research into the current owner as to their reputation score should be evaluated.

However one gets into Bitcoin and adds to their holdings, you can see the overall value increase or decrease according to the market - like most every currency or commodity. Buying Bitcoin when the cost is down then selling when the cost is up is one way to increase your own wealth with Bitcoin. The all-time high price for one Bitcoin came in November, 2013 when it hit $1,252 USD. The price dropped last year to around ½ of the previous value and was holding at around $600 USD per Bitcoin as of August 2014. It is worth noting here that Bitcoins are still considered somewhat volatile in the marketplace due mainly to the fact that is new and everyone is still figuring out how it can be useful. But probably one of the most interesting facts to note at this point is the big online names that are now accepting Bitcoin as payment. They include Overstock.com, Amazon, Target, CVS Pharmacy, Virgin Mobile and Virgin Airlines, Expedia, Zynga, Zappos, EBay and TigerDirect to name just a few.

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