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The purpose of this FAQ is to give general education and information about Bitcoin. It should not be considered financial advice. The great thing about Bitcoin is that you do not need to understand how it works in order to use it. If you are interested in diving in a little deeper, this FAQ is for you.
Virtual currencies are generally tokens issued by a company for near-exclusive use on their site. Examples include loyalty or gift cards, air miles or mobile phone top-ups. In a similar way that email revolutionised the postal service, Bitcoin can revolutionise financial services.
For a broader view at what Bitcoin provides you should watch this video 6min. It is much easier than other online payment systems.
In many cases you simply click a link and confirm that the transaction is correct. On smartphones people tend to use QR codes because it's easier. It's like a barcode but made up of black and white squares. It stores information in a way that is easy for smartphones to read using their cameras. A great example is the Reddit Change Bot. After you've deposited some bitcoins into your tipping wallet you can then transfer those bitcoins to anyone even if they've never heard of Bitcoin just by entering a comment like this:.
Variations of that command are also available for Twitter and GitHub. Bitcoin fees depend on the size of the data to be stored not the magnitude of the transaction involved.
Currently many services offering international remittances charge the person sending money home to their family significant amounts. Bitcoin greatly reduces this. The Bitcoin network has a capital "B", while the tokens that represent value are called bitcoins with a small "b".
It is not owned or controlled by any organisation. There is no government or corporation backing it. It is not patented or copyrighted. Regardless, it now being used by millions of people all over the world to conduct transactions. These people are the Bitcoin community. By reading this you are part of that community.
Think about when you log in to a website. Your user name and password are protected using cryptography - a very advanced branch of mathematics that protects secrets. Bitcoin uses cryptography to prove to others that you, and only you, have the right to spend the funds under your control. All of the cryptography in Bitcoin is well-known and used in countless other applications including banking systems.
There is nothing new or special. You don't even have to know who they are. Also they don't have to be connected to the Internet to receive bitcoins. Obviously, you can receive bitcoins from anyone as well - perhaps as part of a crowdfunded project or a loyal fanbase. When you want to receive money you would typically provide a Bitcoin address. It is a long string of letters and numbers that starts with either a 1 or a 3. The most private way to use Bitcoin is to never re-use an address.
Your Bitcoin wallet will take care of this for you. Also, if you did find yourself actually typing one and made a mistake the wallet software will tell you that it is not valid. Bitcoin is available for everyone. Many Bitcoin wallets are "open source" which means that developers can look at how they work and verify that there is nothing suspicious going on. It is not a requirement of Bitcoin that you reveal your identity.
In fact one of the prime goals of Bitcoin is to avoid revealing your identity to anyone, but still allow you to conduct a transaction. It is very like cash in that sense. It is possible for someone with significant dedicated resources governments, police agencies etc to track your transactions by examining the public block chain. It is the large database that contains all the transactions ever made using Bitcoin.
New transactions are gathered up into a group called a block. Each new block references the one before forming a chain. You don't have to. As a normal user of Bitcoin you are only interested in the parts of the block chain that contain your transactions. That small portion is about 25Mb. Normally people running websites that accept Bitcoin - merchants - would make sure they maintain a complete copy of the block chain to avoid double spends. That is where you get to spend the same money twice with different people.
It was a common problem with digital money before Bitcoin solved it. In the past there have been many attempts at making digital money.
They have all failed because they all required trust in someone. Usually this was a company or government that checked all the transactions going through their system to ensure that no-one was doublespending.
The fundamental problem was trusting the central checker. What if it was cracked and all the transactions rewritten? What if the central checker itself wanted to fake a crack in order to cover something up? That's what Bitcoin does. Everyone who downloads the full block chain is contributing to the overall security of the block chain. Everyone is continuously checking everyone else. Nobody trusts anyone, but everyone trusts the mathematics.
It uses a very similar approach to sharing the big database file that is the block chain. Anyone running the Bitcoin software is known as a node or peer. Anyone can offer up a block for acceptance by the Bitcoin network. To create blocks you simply run some software called a Bitcoin miner.
If your block is accepted you get a reward. To get a block accepted you have to prove that you have checked all the transactions in it are valid and that you have expended a certain amount of effort in securing it.
Bitcoin uses cryptography to create a number that is unique to the block. It is impossible to know in advance what the number will be since even the slightest change in the block will produce a completely different number. The task facing a Bitcoin miner is to fiddle with some settings for the block, without altering the integrity of the transactions, until that number is below a given target. For the technically minded, a Bitcoin miner has to find a SHA hash that is under the target value.
Remember that there are millions of computers out there running Bitcoin mining software. They are all in competition with each other trying to get their blocks accepted so that they can claim their reward. If there was no target then there would be millions of blocks all being offered up and it would be very easy to include double spends.
Once a miner has secured a block, they send it to other nodes in the Bitcoin network for verification. It is trivial to verify that the target has been achieved and that all the transactions have not been tampered with.
This proves that the original miner put some effort into securing the block and qualifies for their reward. This reward is called the "coinbase" and it is the only way that new bitcoins can be minted. The other miners then continue gathering transactions and grouping them into a new block which they will later link to this one.
You could extend it a little to say that Bitcoin is a digital element that is rarer than gold. There will only ever be 21 million bitcoins produced and they only exist here on Earth. It will take until about the year to get them all. Gold is present all over the Universe. All it takes to find more is to go up into space and get it. Yes - it's not exact but near enough.
Bitcoin restricts the number of blocks that can be mined to about 1 every 10 minutes using the difficulty. This results in a controlled release of new bitcoins via the coinbase. Fortunately bitcoins are infinitely divisible since they are merely numbers. At present the Bitcoin network keeps track of them to 8 decimal places.
Thus the total number of units in the Bitcoin system is 2. Since everyone is in competition with everyone else there could be multiple competing blocks being built. The rule is that the Bitcoin network will always accept the longest chain with the highest difficulty level as the final answer. Blocks that are no longer on the longest chain are called orphaned blocks.
The transactions that are contained within them are no longer considered to be valid and are dropped from the Bitcoin network. Yes, in the worst case scenario. However, it is much more likely that the transaction has been copied into a block on the longer chain.