Jinbo Lin - Murray State Information Systems



Jinbo Lin

CSC 530

April 20, 2014

Bitcoin

Introduction: In cash, there are always more than one notes that indicate the government office which issue this kind of currency. Take a deeper look, you can find these phrases “The United States of America”, “Federal Reserve Note” and “This note is legal tender for all debt, public, and private” on U.S. Dollar. These phrase means, this note is legal tender issued by the Federal Reserve, it can be used in United States and it is guaranteed by Federal Reserve.

Currency is always issued and regulated by government or bank that people who use this currency would trust. Is there a kind of currency that has the same function of currency but is not issued and regulated by government or bank? The answer is “yes”, the virtual currency, or digital currency.

Virtual currency, is defined by the European Central Bank, it is “a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community” (European Central Bank). Either success or failure boils down to the same reason, since it is not regulate by government, virtual currency is convenient for the virtual community who use it, but it also carries out many trouble especially this virtual currency becomes more and more effective in the internet. Bitcoin is the famous virtual currency in the world, it dominates the virtual currency market.

What is Bitcoin?

Bitcoin is a peer to peer payment system and digital currency carried by open source software. Cryptography is used once there is a transaction or creation of bitcoin, hence, Bitcoin bring out the concept of “cryptocurrency” and it is the first cryptocurrency. Users can use their wallet software in personal computer, mobile device, or web application to manage their own bitcoin. Even though Bitcoin is virtual currency and does not rely on any bank, business association, or government, users can use it for exchange or purchase products and services.

How to get start with Bitcoin?

Since Bitcoin is carried by open source software, in order to get start with Bitcoin, a new user should download and install the Bitcoin wallet on his/her computer or mobile device first. Once the wallet is installed, it will generate the first bitcoin address; this address is for the transaction of bitcoin, its recommended to use new bitcoin address after each transaction for the purpose of protecting security, user would be able to use their wallet to regenerate a new bitcoin address.

Bitcoin Address

Bitcoin address represent the destination of bitcoin payment, it start with the integer number 1 or 3 and followed by twenty-six to thirty-three alphanumeric characters. Here is the sample bitcoin address that consist of thirty-four characters: “3B74t1WpEZ73CNmQviecbaciWRnqRhWNLy”. For the purpose of preventing visual ambiguity, uppercase letter “O”, integer “0”, lowercase letter “l” and uppercase letter “I” will not be used in generating the address. Those characters are case-sensitive and randomized, so it is very easy for user to enter the desired bitcoin address incorrectly, which in case nearly Bitcoin users use copy and paste function to enter the desired address in transaction.

Address is not generated completely randomly, the bitcoin wallet use their own algorithm to generate the address. When the bitcoin wallet try to validate a bitcoin address, rather than just check the first digit, string length and allowed character, bitcoin wallet would use their own function (Bitcoin Address Validation Source Code). Indeed, the address must have at least one certain private key that can access to the funds that assign to that address. This private key is stored in the wallet file in users hard drive, if the hard drive is crashed or lost, user lose those bitcoins that associate with that private key forever.

Balance

Bitcoin is a decentralized peer to peer payment system, in other words, there is no center server that can record and regulate each bitcoin transaction. Hence, in order to record bitcoin transaction, Bitcoin developers decide to use block chain. Block chain is like a public shared ledger on every single client of Bitcoin network, all confirmed transaction is record in the block chain. That way, every client can be run like a server. When a user tries to make a transaction, the system calculates the balance of payer first, then it verifies the spending bitcoins are actually owned by the payer, finally system will broadcast this transaction in form of “Payer A send X amount of bitcoins of Payee B” to all block chain. Each time a user start the wallet software, it will automatically synchronize the block chain data first.

Transaction

In each transaction, bitcoin wallet use user’s private key to sign the transaction and provide the mathematical proof that those bitcoins involved in this transaction are come from the owner of this bitcoin wallet. The signature by the private key also prevent the transaction being changed from anyone include the payer. So after the transaction being confirmed, there is no way to cancel this transaction or take certain amount of bitcoins back. The only way to get those bitcoin back is let the payee start another transaction, so users suppose to be extremely careful when making a new transaction.

After the transaction is confirmed by the system, system will broadcast the transaction information between users through a process called mining. Mining is a distributed consensus system to confirm the waiting transaction and including them to the block chain. Since there are many transactions possible in the same moment, the mining system need to decide the processing order in order to enforce the chronological order of block chain. To be confirmed, transactions must be packed in a block that fits cryptographic rules that will be verified by the network.

How to get Bitcoin?

When user install their bitcoin wallet in his/her device, the account initial balance is always 0. There are three ways to get bitcoins: working, mining, and exchanging. Obviously, people get paid when they work for another person or group, so the first way to get bitcoin is provide mathematic, computational, or software related services or sell products to other people who agree to pay with bitcoin.

The second way to get bitcoin is exchanging. Since Bitcoin is a decentralized, there is no Bitcoin official organization that offer bitcoin exchange service. Hence, the only way to get bitcoin through exchanging is communicate with those individual or organization who held large amount of bitcoins such as Coin Cafe, Cash into Coin and , etc. Customer pay them with the currency they want and they will transfer bitcoins equivalent to the amount of money customer paid according to the bitcoin market price to the bitcoin address which customer provided.

The last way to get bitcoin is mining. As I mention above, mining is the process to maintaining the chain block. Because maintaining the chain block is a complicated job and every Bitcoin user can be Bitcoin miner by running a software with specialized hardware, the miner who complete this job will be rewarded with bitcoins and transaction fee. After users try to make a transaction, the transaction information is broadcast to peer-to-peer network, the transaction is ready to be confirmed and added to the block chain. Mining software will listens to these transaction and performs appropriate tasks to confirm transaction.

In order to confirm a new transaction, it need to be included in a block with a specialized mathematical proof of work. Such proof is extremely hard to generate so miners need to try billions of calculations per second. Meanwhile, there might be multiple individuals or groups working on same transaction since it is broadcast in the network, the bitcoins reward will goes to the first miner who complete the process and the block is accepted by the block chain. As the result, no individual or group can dominate the mining job. Since this job is so complicated and competitive, so miners do the massive amount of calculation but don’t get any reward at most of times, so mining is a risky task. Miners often work as group and split the work, they also split the bitcoin to all participants if they get rewarded. Even though mining as a group let mining becomes less risky, the cost of electricity and energy still outweigh the bitcoin rewards from doing so sometimes.

Bitcoin Advantage

Payment freedom. Since Bitcoin is a decentralized currency, no central organization will regulate the transaction, it is possible for user to transfer any amount of their bitcoin to any bitcoin address in this world at anytime as long as this transaction is confirmed. Bitcoin user have full control of their money.

Low transaction fee. While a transaction of bitcoin draw coins from many different bitcoin addresses, a large sized of data involved in this transaction therefore a small transaction fee is expected. Otherwise, the transaction fee is expected to be zero. While miners confirm a transaction, they will get reward with bitcoin from system and few transaction fee. Payer can setup the transaction fee they want to pay in each transaction in their own wallet. The default transaction fee is zero, if payer want to spend less time to wait for this transaction to get confirmed, payer can raise the transaction fee so that the priority of this transaction is raised. In comparison, the transaction fee of Paypal is 1.8% - 3.4 % of the payment plus 0.35 Euro flat fee.

High security. It is impossible for any merchants or third party to impose any unwanted or unnoticed service charge as some company with other payment method. Since bitcoin transaction is irreversible, payee does not need to worry about payer can draw the money back by any pretext without payee’s will and permission. Bitcoin transaction can be made without user’s personal information because transaction only require bitcoin address and payment amount, meanwhile user always generate and use new address after each transaction. This offers strong protection against identity theft and provide high security.

Bitcoin Disadvantage

Low Degree of Acceptance. Virtual currency is defined as currency that used and accepted among those members of specific virtual community, Bitcoin is not a exception. Every day, more and more businesses accept bitcoin because its advantage, however, most people in this world are still unaware of Bitcoin. As the result, payee or payer may not accept bitcoin in the transaction.

Immature. Bitcoin software is still in beta with many incomplete features. The wallet is a low user friendly software compare to software of other payment methods like Paypal. In other words, user may make some mistakes in transaction. For instance, Since the bitcoin address does not contain user’s personal information and user always change to a new address after each transaction, payer cannot check whether the address entered is right or wrong until the transaction is confirmed and payee says he/she actually get those bitcoins. If payer enter wrong amount of bitcoins or payer enter the wrong address, there is no way to get the money back after payer click the button “send”.

Volatility. Bitcoin has an extremely volatile exchange rate. The total value of bitcoin in circulation and the number of bitcoin user business are relatively small compare to other currency, therefore, small business event, trade, or decent amount of buying and selling bitcoins can affect the price significantly. According to Mark T. Williams of Boston University, bitcoin exchange rate volatility is over seven times that of gold. Hence, the value of bitcoin which user have is unstable, it may goes incredibly high or drop to unacceptably low. In 2012, a bitcoin was sold for $10 USD. In January 2013, the bitcoin exchange rate went up to $40 USD for 1 bitcoin. Further more, in December 2013, a single bitcoin was selling for $1100 USD. Soon after that, the bitcoin exchange rate started to drop, and 1 bitcoin is worth about $505.8 USD today.

Bitcoin Ethic Issue

Illegal use of bitcoin. Since bitcoin transaction can be done without the personal informations of payer and payee, even though the bitcoin amount of transaction is public and everyone can see it in block chain, nobody know whether this transaction is legal or not. That way, many people can spend their bitcoin in some illegal way such as online gambling, drug, and black market.

According to a news wrote by Megan Guess in , almost one half of bitcoin transaction are bets placed in online gambling website. Satoshi Dice, as one of the biggest online gambling website that support bitcoin bets, reported that they have 33,310 bitcoins which equivalent to $596,231 USD at that time and $17,020,000 USD nowadays in profits in 2012 (). In 2013, Non-drug transactions were thought to be far less than the number involved in the purchase of drugs, even some online gun dealer can use bitcoin to sell arms without background check.

The famous black market using bitcoin is the Silk Road. Silk Road is a online black market website, user are able to browse it anonymously and securely without potential traffic monitoring. Silk Road was launched in February 2011, it provides illegal goods typically drugs as underground website, indeed, sometimes users of Silk Road call this website “ of illegal drugs”. Buyers and sellers conduct all transaction with bitcoins. On October 2013, the FBI shut down the silk road and seize 144,000 BTC that belongs to the founder and operator of the website. In the report, there were approximately 1,229,465 transactions made by bitcoin in Silk Road from February 6, 2011 to July 23, 2013. The total revenue generated from these sales was 9,519,664 Bitcoins which about $885 millions at that time, and the total commissions collected by Silk Road from the sales amounted to 614,305 Bitcoins worth $55 millions at that time.

2. Public Concern of Ponzi Scheme.

Ponzi Scheme is a fraud investment operation, the operator as a individual or group that tell investors to turn in large amount of money for a big investment then get paid with some certain percentage of that amount of money every fixed time period like month. Operator use the first few investors as advertisement to attract those investors family, friends, or neighbor to join this scheme. Operator take the money from new investors, pay older investor back with the money collected from the new investors instead of the profit earn by operator’s investment. More and more people will fall into this scheme because the operator actually do pay those investors back well before the scheme collapse. Like a pyramid, operator sit on top of the pyramid, and investors get benefit from the money came from the investors that just one level below them. If operator cannot find more investor to join them, this scheme will collapse.

Since Bitcoin is a decentralized digital currency, the bitcoin wallet will show users the balance of bitcoin associated with the private key. Bitcoin balance is not even stored in any server or hard drive, all users have is the private key and the balance is nothing more than digital data stored in public ledger - the chain block. Most bitcoin users spend their real currency to buy bitcoins as initiate funds, similar to investors in Ponzi Scheme. Every time a user sell his/her bitcoins, another user spend their money to buy it which just like new investors in scheme or old investors who want to invest more. Thus the balance is just a digital data on the chain block, the public community start to concern about whether Bitcoin is a Ponzi Scheme or not. Many journalist, U.S. economist Nouriel Roubini, and the head of Estonian central bank said that Bitcoin may be nothing more than a Ponzi Scheme, but Bitcoin supporter disagree. No court has judged the Bitcoin system to be a Ponzi scheme.

Conclusion

Overall, Bitcoin is a very convenient digital currency in the internet, more and more people and business use Bitcoin because of its advantage compare to other payment method. Either success or failure boils down to the same reason, since bitcoin transaction can be done without users’ information, it benefits a lot user who want to hide their information in transaction, but many people use bitcoin in a illegal way also. It is the user who can decide how to use the tool!

Work Cited:

European Central Bank (October 2012). Virtual Currency Schemes. Frankfurt am Main: European Central Bank. p. 5. ISBN 978-92-899-0862-7. 15 April 2014.

Bitcoin Address Validation Source Code. . Private Internet Access. 13 Sept. 2010. 20 April 2014.

Geuss, Megan. Firm says online gambling accounts for almost half of all Bitcoin transactions. . 24 Aug. 2013.

17 April 2014.

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download