Ask LH: How Does Bitcoin Work And Is It Safe?

Dear Lifehacker, I have seen Bitcoin as a payment option on some websites recently. Can you please explain exactly what it is? And is it safe to use? Thanks, Bitcoinfused

Photo: zcopley

Dear Bitcoinfused,

It's not entirely surprising that you're confused by bitcoin, because there's quite a bit to wrap your head around. Bitcoin is a mostly digital currency that, unlike the theory behind regular currencies, isn't backed by any kind of standard value agreement; this used to be gold for many currencies but is far more complicated these days. Instead, it's a currency that kicked off in 2008 after the work of a pseudonymous developer (or developers) called Satoshi Nakamoto; in honour of his or her work, the smallest current unit of bitcoin is a Satoshi; one hundred millionth of a bitcoin.

Bitcoins are a computationally derived currency with a finite limit. The maths involved is complex; a fixed amount of bitcoins will be released ("mined") each year set within the open source code of the bitcoin project. There's a hard total limit of 21 million bitcoins that can be produced based on the current specifications; while that limit hasn't been reached it is dependent on the currency being actively used; without that no new bitcoins would be produced. It's feasible to mine for bitcoins yourself, but the processing power involved is intense and the probability factors involved mean that it's unlikely to be a profitable venture at a solo level.

The other important issue to consider with Bitcoin is that it is intended as an experimental currency. This isn't like using, say, PayPal, where you're trading in currency you understand and most likely hold. The value of a bitcoin is essentially whatever somebody will give you for it (the same as other currencies) but the value of bitcoin can vary by quite a bit; at the time of writing one exchange rate suggests that a bitcoin is worth around 18 Australian dollars. Bitcoin values have been incredibly variable over its short life, especially as certain events relating to Bitcoin fraud have seen the wider bitcoin market lose a lot of faith in the currency.

So are Bitcoins "safe" to use? It's an interesting question with no absolute answer. The encryption within bitcoins make them theoretically impossible to forge, and you can always turn some of your hardware power towards "mining" new bitcoin addresses, although that isn't an easy way to riches per se — and as one ABC employee found out last year, it can be an easy way to get into serious trouble at work.

Bitcoin transactions are made at a peer-to-peer level but should be secure, although the open nature of the transaction may concern you. While there's nothing specific to tie you to the peer-to-peer address used for a bitcoin transaction within what's broadcast, it's an open channel, and in theory if you chose to (or accidentally) made your bitcoin address public, it would be feasible to track all your transactions. There have been cases of bitcoin fraud, most notably last year when the bitcoin exchange at bitfloor was hit for around $US250,000 worth of bitcoins.

If you're looking at a service that offers to sell you goods and services in bitcoin, you're most likely looking at this stage at smaller level transactions, and for that, it seems a reasonable proposition. As an overall currency, if you were interested in trading, investing or harvesting large quantities of the currency, I'd be wary. Despite its rapid acceleration, Bitcoin is still a relatively immature currency.

If readers have their own bitcoin experiences, positive or negative, we'd love to hear them in the comments.

Cheers Lifehacker

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Comments

    http://www.grc.com/sn/sn-287.htm

    Steve Gibson has a great breakdown of the tech behind it. He also brings it up continually on the Security Now podcast, giving details on its ups and downs.

    If you are interested in Bitcoins and want to stand a chance of finding a coin, look into Litecoin, it uses memory hard problems that can't be crunched through using arrays of video cards, making every computer with a half decent CPU good enough to solve the problems and generate currency.

    Bitcoin was a great idea, but sadly implemented using tech unfit for the purpose.

      Does using memory hard algo make Litecoin less suitable for a potential portable hardware wallet? I get that memory hard is good for making it hard to crack passwords, but I don't think that's a problem for bitcoin.

      Do not follow charlatans.. You better read Bruce Scheneir

      www.schneier.com/

      As for Steve Gibson.... well read for yourself....

      http://attrition.org/errata/charlatan/steve_gibson/

      http://grcsucks.com/

    Time to go to the Silk Road and get some DMT!

      Yep thats it, help bring attention to the road. After all just like usenet they need all the publicity it can get (I'm sure it wont affect the service in the long run, just like it hasnt for usenet.. oh wait)

        Someone should probably tell this guy then...

        http://www.theage.com.au/victoria/secret-website-harboured-drugs-smorgasbord-court-hears-20130131-2dlw3.html

    "So are Bitcoins “safe” to use? It’s an interesting question with no absolute answer"

    That right there answers the question simply by using common sense.

    So, I'm a Bitcoin user. I heard about it in Summer 2011 from a buddy working at a computer retailer. At first, I was very skeptical, and of all the many thoughts that entered my mind at the time, the following were hardest to ignore:

    1) This sounds like it could be a pyramid- or get-rich-quick scheme.
    2) This sounds both unnecessary and impractical.
    3) This sounds like it could be illegal.

    There were other thoughts too, but out of curiosity I 'Googled' it and came across the technical white paper (which can be found at www.Bitcoin.org). It's probably a difficult read for most people, but fortunately I've been blessed with a knack for learning things quickly and I began to understand why, even in 2011, Bitcoin was beginning to slowly take hold.

    Here's the thing -- Bitcoin is probably the most sound form of money on the planet, and almost any and all risk you may incur while using it generally arises from user error.

    User error arises because Bitcoin forces users to take responsibility for their money. Users must maintain their own Bitcoin wallets, and this differs from the average citizen who entrusts a 3rd party (bank, PayPal, etc.) with the responsibility to care for his money. Bitcoin, in a way, teaches financial responsibility, and if you don't practice it you'll get burned. Those who have gotten burned using Bitcoin deferred responsibility to various others (exchanges, investors, hosted wallet companies, etc.) that failed to protect users' bitcoins.. And so, sites were hacked, scams were performed, and many people lost some or all of what they had. But, there has not been a single case of failure within the Bitcoin protocol itself. Bitcoin has never been hacked. Instead, people lost money because they made dumb mistakes...just like often do with cash and credit cards and such.

    But, I like to be safe with my bitcoins. I encrypt them with a (very) strong password, create multiple backups and secure them safely, and I don't trust anybody else to do it for me. I took the time to learn about Bitcoin both technically and in practice using small amounts of money until I felt confident using it. To date, I've successfully made about 2600 Bitcoin transactions and I haven't lost a thing.

    Things I've bought with bitcoin include the following: computer hardware, gold, silver, jewelry, video games, a bhut jolokia pepper (!!!), condoms, a months-supply of gourmet survival food, and even rhodium. Other times, I sell bitcoins for cash. I even operate a couple 'mining rigs' to generate bitcoins while simultaneously contributing to the strength of the entire Bitcoin network. And if you were wondering, yes, I did report all of this to my tax agent (the IRS told H%R block to tell me that it was a hobby). And no, I've never purchased anything illegal with bitcoins.

    All in all, expect a steep learning curve at first, but after the initial hurdle you'll quickly realize that the effort was worth it. It's rare (like gold). it's convenient (like cash), it's fraudproof, it's pseudoanonymous, and, most importantly, it's decentralized. And, it's pretty damn cool to send a confirmed payment to someone in Korea at 2 a.m. for that hot item you just had to have. And the cost for said transaction? Nada.

      computer hardware, gold, silver, jewelry, video games, a bhut jolokia pepper (!!!), condoms, a months-supply of gourmet survival food, and even rhodium.

      Sounds like a hell of a weekend.

      would there be a limit for when BTC income would be no longer classed as a hobby?

    this is all very interesting. BUT........I still don't know how to actually buy bitcoins. Can anyone give me a hint?

    A gentler primer is:

    How Bitcoin Works: A Guide for the Digitally Perplexed

    At the website where it all began, time stands still. There is the feel of a deserted ghost-town in a Western, desolate and abandoned, with only the occasional tumbleweed or dust devil drifting by. At the top of the page is the name of a small New York City computer security firm. Underneath, some unstyled text reads: “This web site does not yet have content. Please come back later.”, but the page hasn’t changed in at least a year. Beneath that there’s a link, “Click here for the Cryptography mailing list”. Below that, just empty space.

    Subscriptions to the mailing list are handled automatically. Anyone can join, but the overall sense of neglect helps ensure that only specialists and the cryptographic cognoscenti ever actually sign up. Traffic is generally light, and in 2008 October ended as slowly as it had begun. A little after five in the afternoon someone posted a message with the abstruse subject heading, “Who cares about side-channel attacks?” Apparently nobody; no-one posted anything else that Friday, and the month finished with an average of less than two posts a day.

    For the rest of the world, of course, October had not been so quiet. On October 1st the Dow Jones Index had begun its descent towards terrifying lows. On the 15th, it set a new record, dropping 733 points in a single day. Economies around the world plunged into the worst financial crisis since the Great Depression of 1929. But as October drew to a close with the old financial system in ruins, a new one slipped softly into the world on the cryptography mailing list.

    Continued at http://unscramblings.blogspot.com/2014/03/how-bitcoin-works-guide-for-digitally.html

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