A lot of press has been made of Bitcoin in the last few years, but what exactly is the phenomenon and how could or would it affect the way that we handle transactions?

Background

For the uninitiated. Bitcoin is a form of cryptocurrency … or more plainly stated, it’s a form of digital currency that relies on cryptography and also involves a process known as proof-of-work to create and manage the currency. The Bitcoin model is a unique form of cash system in that it is highly distributed by use of a peer-to-peer system that uses a ledger and the ledger is updated by p2p file sharing technology. It’s also unique in the fact that, unlike paper currencies, there is a total limit to the number of Bitcoin that will ever be produced and further that the currency can be subdivided down to eight decimal places… Strange I know but once you get past formulas and the scientific blah blah blah.. it is really quite a simple process.

  1. Bitcoin servers are the responsible entities for handling transactions.
  2. Transactions are collected up into what is known as a block
  3. The servers now “work” on finding a  solution to a complex computation on the block.
  4. Once a solution is found, the Bitcoin server finding the solution broadcasts that to the collective and also get paid with some newly created “coins”
  5. Rinse and repeat…

Consumers

The one main advantage that people look at when using something like Bitcoin is the ability to process transactions anonymously. You have a Bitcoin wallet client running on your PC and you can send and receive Bitcoins from anyone on the planet. The ledger doesn’t record the IP address of the user so it is somewhat anonymous. I say that because I have done research and there are other more published works on the ability to run large numbers of Bitcoin clients and deduce where transactions are coming from. For that you can refer to Dan Kaminsky’s excellent Black Hat talk in 2011 ( Black Ops of TCP/IP ) which reached the same conclusions that I did. Also when you are using a Bitcoin client it is up to the user to back up their key or risk losing all of their assets. Sure there have been some online wallets and such, but that also undermines the cause of anonymity. However, if the user is diligent in their backups then they can be fairly confident that their currency is secure and the likelihood of someone hacking the ledger is fairly remote.

Miners

Bitcoin servers or miners have a reward for putting forth raw computing power to solve these blocks. In the early days of Bitcoin, the reward was fairly substantial in terms of amount of coins and the difficulty of solving the block was such that you could use CPU power in order to garner a decent reward. However, as more and more miners have entered into the ecosystem and some have started to pool their resources by using pooled mining systems this has raised the complexity to an extent were you need to process using GPUs with OpenCL. The reason for using GPUs is fairly simple and I have explained it before in my talks on cryptography and brute force computations, a CPU is made to do a LOT of stuff… therefore although calculations can seem fast to you they are not fast enough. GPUs on the other hand are made to do basically one thing and that is to compute the hell out of some mathematical equations. Not just 1 or 2 times as good but your talking about hundreds of times per second better. So anyone who’s making any kind of coin out there is normally doing it using a fairly decent rig setup.

Exchanges

Exchanges are online entities that deal in the trading of Bitcoins , or whatever other cryptocurrency floats your boat, just like a brick and mortar bank would exchange currency. You can pretty do everything here: but Bitcoin, sell Bitcoin, transfer to another account…again just like a bank. AND just like a bank they take a percentage of your transaction total for facilitating that trade. Some of the large exchanges are making not millions but sometimes Big B as in Billions on the transfers that occur, especially recently. Of course, as cryptocurrency has gained prominence they have also been subject to attack and scrutiny. Japanese exchange MtGox one of the largest online exchanges has gone through a previous large scale hack ( MtGox HACK ) and also is in a spat with the government (Government problems for MtGox ). Other rivals such as the popular Liberty Reserve have been totally shut down by the U.S. government ( Liberty Exchange Shut Down! ). To be fair though, other companies like CoinLab  have made sure that they are well within FinCEN guidance and are trying to do things on the up and up.

What’s it worth?

Intrinsically, Bitcoins are worth what you consider them to be worth …it could be nothing or quite valuable depending upon your “belief”. Just like the dollar bill in your pocket is worth something because everyone believes that it has a worth to it because the government says that they back it. The worth in dollars for Bitcoin is something of a roller coaster over the last few years. In 2011, Bitcoin had raised up to the mid $20s before the MtGox attack and then it wallowed for a long time below $5. In the last year however, it has rebounded and gone as high as $200 and recently has settled around $120 or so. This may seem like a lot but again the coins are actually traded in fractions upon fractions. You rarely see 1 BTC transactions too much anymore.

Come’on AJ Can You Make Money?

Well, yes and no. As more and more people get into the “mining” biz the network self adjusts the complexity involved in finding a solution. So it gets harder to find a solution to a block. Additionally, every so many Bitcoins produced reduces the reward by half…so it has gone from 50 BTC –> 25 BTC –> 12.5 BTC.  This presents a two-fold problem:

1. “Smaller” miners simply do not have enough computing power to efficiently process the work. This means that their PCs put out more $$$$ in electricity and wear and tear on components than the Bitcoin that they get out of it.

2. Power is consolidated into the larger players. Those with more GPU computing power. This consolidation is a problem because now the ones processing the transactions and holding onto the ledgers are a few big time players which defeats some of the security aspects of having the system distributed.

Can you make money? Sure … I will share with you a screen shot from ONE of my wallets. Never mind, the small amounts .. that’s me “pinging” the Bitcoin network with small transactions gathering information for research. It’s my version of Bitcoin sonar.

 

Multibit

 

Now you can see that I am making money but I also already have the proper rig and other things in place to facilitate this. For someone starting out you may go out and get two fairly decent video cards for maybe $500 or so and be able to make 1.5 BTC/month if you are mining in a pool. Yep that’s right! A huge-a-mongous 1.5 BTC/month ! And that’s if you are having those babies spinning 24/7. So it is definitely not going to be a get rich quick scheme.

So Why Do You Do It?

Two reasons:

  1. FOR THE MONEY, SILLY!! Far be it from me to allow my disbelief in something to come between me and some cash. That’s right, in my heart of hearts I believe that this whole cryptocurrency thing is a flash in the pan. The governments are already starting to make the exchanges play nice with a bunch of regulations. This is turn causes the  network of cryptocurrency to start to lose their luster as an anonymous exchange source. While more online sources may be starting to accept them, I believe that the anonymity factor is such a huge draw that once it is removed from the equation then the whole thing comes crumbling down. Plus, you have some upcoming changes that are making some people a little angry https://bitcointalk.org/index.php?topic=196138.0 
  2. The totally AWESOME RESEARCH!!!!!! This is probably a bigger factor. The ledger is open to everyone. Anyone can set up a Bitcoin Server. Anyone can set up any number of wallet accounts. It’s like a big wonderland of puzzles to solve. Imagine being able to look into the worldwide account transactions of Visa without the user information and trying to find out whom is processing which transactions and when. This is the kind of stuff that I like. I have programs and procedures written like in the previous mentioned article that use ledger data and strategically placed servers and databases and algorithms to figure out IP addresses of accounts (not that hard) … Also, you notice things…. like how the network feeds on transactions and it doesn’t do miners any good to not have transaction blocks to mine….so what if they created a pool of accounts. A big maze that leads to a final destination account and you know that you have plenty of computational power to solve a number of blocks. You could write code that would take a percentage of your block rewards and “distribute” it down your leviathan maze of accounts to be finally deposited in the end account. This creates a large amount of transactions, essentially self-feeding the network to create more blocks. Hell, if you don’t have enough traffic then just create the traffic yourself! 

 

Well, there you have it in a nutshell. What are your thoughts on Bitcoin? Are you mining right now and making any money? What about the changes coming down the pipe limiting micro-transactions? Let me know in the comments!

 

Cheers!
AJ