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In Bitcoin we trust (or at least, in the perceived notion of agreed value). Part 1. - Mike Wilson
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In Bitcoin we trust (or at least, in the perceived notion of agreed value). Part 1.

imageOpen your wallet (yes, your real wallet). What do you see? A few coins, maybe a note or two, some cards, maybe a few receipts or membership cards. Have you ever contemplated what the real value of your money is? If you’re hungry, you can’t eat your coins. If you’re stuck in the rain without an umbrella those notes won’t keep you dry.

If you’re near a sandwich shop, you could exchange some money for a sandwich and if you’ve got a job you regularly do your work in return for these coins, notes or numbers on a bit of paper which in turn you trade with someone else for something you want.

This monetary system that we all know generally works because we all agree between us that that dollar bill, or that pound coin has a certain intrinsic “value” and is worth a such-and-such amount. The coins and notes and numbers-on-a-computer are controlled and distributed by governments and this powerful centralised control of governments and banks has some big disadvantages for the everyday users of the currency. Inflation, means that your money is worth less and less as time goes on; transaction fees, often hidden and excessive bank charges; excessive control, banks & governments can inspect or freeze your accounts without warning.

And in the event of an economic meltdown, a nuclear war, a zombie apocalypse, the-end-of-the-world type scenario, it’s probable that your currency – no matter how wealthy you are in any currency – will be of any value whatsoever. In those situations perhaps gold might have some trade value but food, water, fuel and guns will be what makes one wealthy in such an environment (as is already the case in many dangerous developing countries).

Are you with me so far? Good.

So a few weeks ago I learn about this new currency called Bitcoin. It’s different to most other currencies in that it’s digital, encrypted, peer-to-peer, and it uses relatively anonymous ‘accounts’ which are not tied to addresses or names. I heard about it since an American Senator decided to announce that he was going after the upstart Bitcoin currency as people were using the ‘anonymous’ nature of the Bitcoin to purchase drugs online. (Note: paying with paper notes would be more anonymous than using Bitcoin, but as is often the case with politicians, they’re almost all IT illiterate).

Bitcoin is:

  • A new currency
  • Purely digital, encrypted, anonymised (to an extent), peer to peer/decentralised
  • Simple open-source network supported by voluntary machines (called miners) which receive compensation for the work they do from the network.
  • No (or very low) transaction fees
  • No inflation
  • Private and secure (depending on how cautious the user is!)
  • Risky (new and where there is money, there are scammers)

So I spent a few hours researching the world of Bitcoin and I found out that:

1. Bitcoin was largely an underground experiment in 2010 but started to gain popularity in October 2010.

2. Many early adopters started to purchase Bitcoin with their USD when it was valued around $0.25. Bitcoin’s price rallied over the next eight months to over $30.00 bringing realised profits of up to 12000% for the earliest investors.

3. There are very few shops that accept Bitcoin in exchange for goods and services, although there are many Freelancers who are offering their services (e.g. web design) for Bitcoin.

4. There are various Bitcoin exchanges which will convert between fiat money and Bitcoin

I was intrigued. Since the Bitcoin currency is supported by a network of computers all performing work verifying and securing the transactions, and that these computers receive compensation for their efforts from the network, I thought that it might be a fun exercise to put together a plan to build a machine that would contribute some processing power and in return generate enough Bitcoin currency to pay the running and equipment costs and eventually turn a profit for a while. Sure, this is June – quite late in the game, but this would be an experiment and I had to find out, FOR SCIENCE!

How you use Bitcoin

Using Bitcoin is very simple. Head over to and download the Bitcoin client software (it’s safe, it’s open source and it’s free). This client software creates a wallet for you (wallet.dat stored on your machine) and anyone with access to this wallet has literally access to your coins so keep it safe. The client software allows you to create as many Bitcoin account addresses for sending and receiving funds as you like – there is no limit. So you can create a receiving account address and off you go! To get fiat money (real money) into Bitcoin, you’ll need to use one of the many exchanges who will take your money and attempt to fill an order for Bitcoin for you on their automated markets. Sending Bitcoins takes a few clicks. Although there is a delay of up to a few minutes before a transaction takes effect and is considered “confirmed” by the Bitcoin network.

How Bitcoins are made

When a Government wants more money it can simply print it at will. This is pretty bad since printing more money while there’s only the same amount of “stuff” to purchase with it in the country simply means that the purchasing power or value of everybody’s money goes down – and prices tend to go up. This is inflation and it doesn’t happen with Bitcoin. The network runs according to programmed rules and one of them is that Bitcoins cannot be manufactured. The Bitcoin economy will eventually have 21 million Bitcoins in it and they are generated by the transaction processing machines that people around the world donate to the Bitcoin network. Randomly (but at a controlled rate), one of the machines working (mining) on the Bitcoin network will find a “block” (or golden ticket if you’ve ever read Willy Wonker’s Chocolate Factory) which contains 50 Bitcoins. This goes to the owner of the machine doing the work as a reward for the work. As these blocks of Bitcoins are very rare, pools of mining machines have evolved in which many machines pool their processing power together and share the rewards based on each individual’s effort – effectively giving more regular, but smaller payouts that will on average reach just less than 50BTC (as the pool administrator wants to be paid) within the equivalent time frame that you would find a single 50BTC block on your own. Luck, obviously has a strong hand to play if you’re mining on the Bitcoin network alone.

What if everybody starts buying Bitcoin?

The Bitcoin exchanges operate as real markets do. As people feel comfortable and confident and make more BUY orders, the value of the Bitcoin compared to the currency being exchanged goes up. As the price goes up the temptation to sell kicks in and more people start to SELL. In the past few weeks since I’ve been investigating Bitcoin the price has averaged between $15 and $20 although it had rallied to $30 and last week there was a temporary crash to $0.01. (Yes, I did say it was risky!).

What’s all this “processing power”?

As I’m writing for a non-technical audience in this post, I’ll keep it simple. Computers working on the Bitcoin network process transactions. Every computer has a database of every transaction ever made – the sending account, the receiving account and the amount. No names or addresses but a full history of every Bitcoin transaction is public and sits on every Bitcoin connected node. A Bitcoin computer that is working on processing these transactions is often called a “miner”, since it toils away at “blocks” of work, checking transactions and confirming them with other nodes on the network. Long story short, the more machines on the network, the stronger the network becomes – the harder it is to hack and the faster it can process transactions. Miners occasionally find a reward block of 50 BTC, which at current exchange rates is $850 (about £500). The more powerful the machine, the more work it can do and the more work a Bitcoin-connected computer does, the more likely it is to find this treasure-chest of coins.

At the heart of your computer is a CPU – a central processing unit. It performs all the mathematical operations that makes your computer work. It’s very good at doing maths. However the type of mathematics that Bitcoin mining requires is not so fast and linear like a CPU – but broad and deep like a GPU – the chip in your computer that powers your graphics processing. Gamers, enthusiasts and other high end users often have these powerful 3D cards powering their displays – you even have a couple in your Xbox 360 or PS3. They’re not so good at the fast mathematics, but they are very good at drawing models in 3D space and twisting and turning them around in real time. This is the type of work that is needed for Bitcoin mining and it is called “hashing”.

My workstation CPU is a fairly high end Intel Core i7 860 processor. It has eight logical cores (like eight powerful CPU’s) and it is capable of processing around 20,000,000 hashes per second, or 20 Megahashes/second = 20Mhash/s. That sounds impressive until you consider the fairly mid range graphics card in the same workstation (Radeon 5850) can process 150 Mhash/s. This one mid-range graphics card manages 7.5 times more work than the high end Intel CPU.

If you know how long it takes to process a block, how often blocks are processed and how you can process a block, you can work out how many Bitcoins you can generate.

There’s one more thing to learn: Difficulty. Clearly, there’s got to be a mechanism to stop people going crazy and buying up server farms to generate all the Bitcoins and thus destroying the viability of the network. There is: the network is programmed to control itself to generating 2016 blocks approximately every two weeks. Every time 2016 blocks have been generated, if it has taken less than two weeks (because there’s lots of new hardware added to the network) the “difficulty” will go up. If it’s taken longer than two weeks, not enough Bitcoins have been added to the network so “difficulty” will go down. Essentially, this is an automatic control over the rate of production of Bitcoins, and difficulty nearly always goes up.

To give you a rough idea, at the current difficulty, 150 Mhash/second will generate approximately 0.11 coins per day which works out to be about $2.19 per day (before electricity costs!). That’s about $66.51 per month. Fairly weedy, I’m sure you’ll agree.

On the 10th June, I made my calculations to try Bitcoin mining… wait for part two if you want to find out how that went (including the hardware choices, building a bitcoin miner and the economics of Bitcoin mining and investing) and I’ll go through the volatile history of Bitcoin (including how one chap lost $250,000, how and why Bitcoin crashed as well as the hacking and leaking of account details from the largest Bitcoin exchange site). Stay tuned!

In the meantime, Rocketboom:

Further reading:

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