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How to use Bitcoins - the peer-to-peer Internet currency

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frenzy has written a nice little introduction to bitcoin , focusing on the mining side of Bitcoin .

But not all users mine for bitcoin. This 'ible will focus on what Bitcoin is, how to get it and how to use it.

The following video gives a brief general introduction into Bitcoin. A fuller explanation is given below.

 
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Step 1: What is Bitcoin?

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What BitCoin is : Bitcoin is an Internet currency.
Unlike fiat currency, no central authority can print money at will. The total number of Bitcoin in existence at any time is known to the Bitcoin community and controlled by a known algorithm. 
Because it is based on military-grade cryptography, Bitcoin is impossible to counterfeit.
One Bitcoin (or BTC) can be divided into as small of pieces as you want (down to 0.00000001 BTC) and they can be transferred instantly across great distances via a digital connection such as the Internet.

This is accomplished by the use of powerful cryptography many times stronger than that used by banks. Instead of simply being "sent" coins have to be cryptographically signed over from one entity to another, essentially putting a lock and key on each token so that bitcoins can be securely backed up in multiple places, and so that copying doesn't increase the amount you own.

Because bitcoins are given their value by the community, they don't need to be accepted by anyone else or backed by any authority to succeed. 

What problem BitCoin solves : Mathematically, the specific implementation of the bitcoin protocol solves the problem of "how to do all of the above without trusting anyone". If that sounds amazing, it should! Normally a local currency has to trust all kinds of people for it to be able to work. So does a national currency. And in both cases, that trust is often abused. But with BitCoin, there's no one person who can abuse the system. Nobody can print more money, nobody can re-use the coins simply by making a copy, and nobody can use anyone else's coins without having direct access to their keys. People who break its mathematical "rules" simply end up creating a whole different system incompatible with the first. As long as these rules are followed by someone, the only way BitCoin can fail is for everyone to stop using it.

This marvelous quality of not having to trust anyone is achieved in two ways. First, through the use of cutting-edge cryptography. Cryptography ensures that only the owner of the bitcoins has the authority to spend them. The cryptography used in BitCoin is so strong that all the world's online banking would be compromised before BitCoin would be, and it can even be upgraded if that were to start to happen. It's like if each banknote in your pocket had a 100-digit combination lock on it that couldn't be removed without destroying the bill itself. BitCoin is that secure.

But the second way of securing the system, called the blockchain, is where the real magic happens. The blockchain is a single, authoritative record of confirmed transactions which is stored on the peer to peer bitcoin network. Even with top-notch digital encryption, if there was no central registry to show that certain bitcoins had already been "paid" to someone else, you could sign over the same coins to multiple people in what's called a double-spend attack, like writing cheques for more money than you have in your account. Normally this is prevented by a central authority, the bank, who keeps track of all the cheques you write and makes sure they don't exceed the amount of money you have. Even so, most people won't accept a cheque from you unless they really trust you, and the bank has to spend a lot of money physically protecting those central records, whether they are kept in a physical or digital form. Not to mention, sometimes a bank employee can abuse their position of trust. And, in traditional banking, the bank itself doesn't have to follow the rules you do--it can lend out more money than it actually has.

The blockchain fixes all these problems by creating a single master registry of the already-cryptographically-secured bitcoin transfers, verifying them and locking them down in a highly competitive market called mining. In return for this critical role, the BitCoin community rewards miners with a set amount of bitcoins per block, taken from the original limited quantity on a pre-agreed schedule. As that original amount gradually runs out, this reward will be replaced by fees paid to prioritise one transaction over another--again in a highly competitive market to ensure the lowest possible cost. The transactions are verified and locked in by the computational work of mining in a very special way so that no one else can change the official record of transactions without doing more computational work than the cumulative work of all miners across the whole network.

In conclusion : All this mathematical technology may be a bit of a mouthful, but what it means in practice is that BitCoin works just like cash. Bitcoin transactions are intentionally irreversible--unlike credit cards or PayPal where chargebacks can invalidate a payment that has already been made. And there are no middlemen. Transactions are completed directly between the sender and the receiver via the peer to peer network.

Because of BitCoin's intricate design, the network remains secure no matter where or how you process bitcoin transactions. Which is incredible--no one else has ever tried to create a system that worked this way! All previous monetary systems have relied on trusting somebody, whether it was the king, town hall, the federal reserve, or banks. BitCoin doesn't. It's guaranteed instead by the laws of mathematics, and that's why it has everyone from technologists to economists very excited.

Step 2: Is it anonymous?

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Bitcoin developer Gavin Andersen notes that "bitcoin transactions are more private than credit card or bank transactions, but less private than cash transactions". The system relies on all transactions being verified by the p2p network, so in effect anyone can view all Bitcoin transactions that have ever been made. However, as each transaction is linked only to a hash (long string of characters) rather than a name, it provides a degree of anonymity. But, if any of the addresses in a transaction's past or future can be tied to an actual identity, it might be possible to work from that point and figure out who owns all of the other addresses. This identity information might come from network analysis, surveillance, or just Googling the address. Using a new address for every transaction is designed to make this attack more difficult.

The Bitcoin Wiki contains advice on precautions to take to help protect your anonymity. 

Step 3: Getting a Bitcoin wallet

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Bitcoins are stored in Bitcoin wallets, which contain a series of sets of private and public cryptography keys. The public keys are shared to allow other to send you Bitcoin, and function in a similar way to a (Swiss?) bank account number. The private keys are your password to proof that you are the owner of those Bitcoins. You can get a wallet with an online Bitcoin eWallet provider, or you can download a client to host the wallet on your owner computer.

Online wallets

MyBitcoin is a popular online eWallet provider. Using an online provider means you have no program to install and you don't need to worry about your computer crashing and losing your entire saving. If you have an Internet enabled mobile phone, your wallet is also portable. However, you do need to trust the provider not to lose your money through fraud or computer malfunction and not to run off with your savings. [Update August 2011: Highlighting the dangers of online eWallet providers, MyBitcoin experienced fraudulent transaction and went into self-imposed receivership. Users are able to place claims for 49% of their bitcoin balance before the attack. Thus, they lost over half their funds.]

Setting up the client on a Windows computer

First you need to download the program from http://sourceforge.net/projects/bitcoin/  The current version is 0.3.24.

The first time you run Bitcoin, it needs to download all the blocks to set up. This may take half an hour to a few hours.

Your public receiving Bitcoin address is shown in the bar at the top. This is the address you give to someone to make a payment to you. It is a good idea to create a new address for each transaction by clicking on the new button. You can give each address a descriptive name by editing it in the address book so you can identify what the transaction was for, but this is not mandatory.

Your balance is shown below your address bar.

Step 4: Getting Bitcoins

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When you first install the client, your Bitcoin balance will be zero. A wallet is not much good when it's empty, so you need to know how to get bit coin.

Mining

New Bitcoins are created by a process known as "mining". By running a series of calculations to solve a difficult computational problem, which are used to secure the Bitcoin network, miner computers have a chance of being allocated a block of 50 Bitcoin in return. New blocks are formed around every 10 minutes. Frenzy's 'ible describes how to set up the client to mine, so I won't go into that here. These days, because so many computers are doing it, mining is hard work, and it's unlikely to be profitable unless you have a high-end graphics processing unit.

So how else can you get Bitcoin?

Free Bitcoin Faucets

There are a couple of Bitcoin faucets, which can be used to get your first bits of Bitcoin to play around with. The original Bitcoin faucet has run out of coins lately. There's another faucet that currently gives out 0.01 BTC if you enter in a mobile phone number (to stop people using it multiple times).

Enter you receiving address in the form (you can click "Copy to Clipboard" in the client and then paste the address in the form). Once you submit the form on the faucet successfully, you should see a new transaction in your client within seconds. But you can't spend your Bitcoins just yet. Under status, the transaction will be listed as unconfirmed and it would show in you Balance. This is a security feature to stop Bitcoins being able to be spend more than once in quick succession. Once your transaction has been confirmed by 6 nodes on the network (those mining computers), the status will change to confirmed and you will be able to spend your coins.

Currency Exchange

The Bitcoin you received from the faucet won't get you very far. There are a number of exchange website on which you can convert your fiat currency cash (e.g US$) into BTC.

Mt Gox
is by far the most popular by turnover at the moment. You can wire in US dollars, Australian dollars or Euros to fund your account or use Dwolla. Funds deposited in EUR or AUD will be converted into USD in your account, and may take a few days to get in there. Once your account is funded, you can then trade on the market with people willing to sell BTC for US dollars. You can either accept the best current market rate, or set a price you are willing to pay and wait for someone willing to sell at a price you enter. Mt Gox charges 0.65% commission on the exchange. [Update: As at September 2014, Mt Gox is undergoing bankruptcy proceeding and its reopening is questionable.]

Tradehill is a relatively new exchange that is growing fast in popularity. If you join using a referral code, you get a 10% discount on commission to 0.54%, and also receive 10% of the commission from everyone who joins using your referral code.[Update September 2014: Tradehill is no longer operational.]

Bitcoin7.com is a very new, but flash looking exchange. Probably the most professional looking exchange yet. It currently does't have the same market depth as Mt Gox or TradeHill though. While they are in start up mode, they have very low commission.[Update September 2014: No longer operational.]

Camp BX is a new US-based exchange, accepting Dwolla deposits and will soon allow trading on margin. Like Bitcoin7, it doesn't yet have much liquidity and is currently only useful to those with US accounts, but if you are concerned about dealing with non-US exchanges, then this one could be for you.

Coinjar is an Australian exchange and wallet service showing promise [as at September 2014].

Once you have exchange your fiat currency for BTC, you can withdraw it your Bitcoin address.

Sell goods or services for BTC

Don't have the cash to buy Bitcoin. Maybe you ahve a marketable skill or service you can provide in return for Bitcoin. Post it on Forbitcoin.com .

Step 5: A note about security

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You take care of your physical wallet so you don't lose it or have it stolen. You need to take certain precautions with your bitcoin wallet too! Bitcoins work by a combination of a public key and a private key. You give your public key to people for them to pay you, and your private key allows you to send those bitcoins to others. If you lose your private key, those bitcoins are lost forever!

Backing up: Protecting against wallet loss

Each time you make a transaction, a new set of keys is produced in your wallet file. By default, your wallet also contains 100 sets of unused keys, so if you backup your wallet, and then spend and receive Bitcoins, you can still restore from your backup so long as you have not made more than 100 transactions. The file you need to back up is "wallet.dat". Your wallet.dat file is not encrypted by BitCoin. Anyone who can access it can easily steal all of your coins.

Encryption: protecting against wallet theft

If you are using Windows XP or Windows 7, you can keep your wallet on an encrypted disk image created by third-party software, such as TrueCrypt (open source) or Jetico BestCrypt (commercial).

To mount the BitCoin data directory on an encrypted drive: 
1. Use the third-party disk image encryption program of your choice to create and mount an encrypted disk image of at least 100 MB in size.

2. Locate the BitCoin data directory, and copy the directory with all contents to the encrypted drive.
Your BitCoin data directory is usually located at C:\Documents and Settings\YourUserName\Application data\BitCoin (XP) or 
C:\Users\YourUserName\Appdata\Roaming\BitCoin (Vista and 7).

3. Create a Windows shortcut that starts BitCoin with the -datadir parameter and specifies the encrypted drive and directory.
For example, if you installed Bitcoin in the default directory, mounted your BitCoin encrypted drive as E:\, and stored your BitCoin data directory on it as Bitcoin, you would type the following command as the shortcut Target:
C:\Program Files\Bitcoin\bitcoin.exe -datadir=E:\Bitcoin

4. Open BitCoin's settings and configure it NOT to start automatically when you start Windows.
This is to allow you to mount the BitCoin encrypted disk image before starting BitCoin.

5. Shut down BitCoin, and then restart it from the new shortcut.

After doing this, any time you want to use BitCoin, you must first mount the BitCoin encrypted disk image using the same drive designation, and then run BitCoin from the shortcut that you created, so that it can find its data and your wallet. :-)


Photo by Darwin Bell .

Step 6: Spending Bitcoins

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Buying or earning bitcoin is not much use if there is nothing to spend it on. Although the bitcoin economy is still in its infancy, more merchants and services providers are appearing each week. Bitcoin gained notoriety as the payment method for an anonymous online drug website. However, there are legitimate things you can spend your Bitcoins on:

Grass Hill Alpacas  are now the stuff of legend in the Bitcoin world as one of the first merchants to accept Bitcoin as a payment method. They are even featured in the Bitcoin promo video shown in the introduction. So as a rite of passage into the Bitcoin world, I had to buy some Alpaca socks! I will use it to demonstrate how to make a payment with the Bitcoin client.

How to send a payment

Buying Alpaca Socks

I ordered some Alpaca Socks from Grass Hill Alpacas. After confirming the current price (including shipping) with the seller, I clicked on the "Send Coins" button at the top left, which brings up a Send Coins window. I copy and pasted the address I got from Grass Hill in the Pay To box. Then, I entered the amount in the amount box. I clicked send and the seller is instantly notified of my payment. After the transaction has enough confirmations, my new socks were sent and I received them a few days later!

Other places to spend Bitcoins

* Bitcoin World Market and Bitcoin Classifieds  are a couple of emerging market places where you can buy goods for bitcoin.

* You can spend Bitcoin on services from Forbitcoin.com .

Bitcoin seems to be an ideal match for online gaming sites.

Strike Sapphire  is the first online casino to accept Bitcoin as a payment method. They have a range of innovative games on offer.

* You can play Texas Holdem poker at Betco.in  or host your own poker (or other) game at BitBetter .

BitcoinGamer  has various casino style games.

* There's even a bitcoin lottery at BitLotto .

* Play Darts .

Buy a newspaper

* The Bitcoin Sun is an informative weekly newspaper covering general Bitcoin news and current affairs and is a good source for gaining a better understanding of Bitcoins. The pdf version costs a few Bit cents. [Update August 2011: The Bitcoin Sun does not appear to be publishing any new articles. Old articles are still available]


Tipping

As a micropayment system without mandatory transaction fees, Bitcoin is perfect for small value transactions, or micropayments. You can use these micropayments, for example, as tips to give a small token monetary incentive to content producers, rather than just the feel-good karma or a "like" or a "reddit".

I created a Youtipit  jar for a musician friend of mind. Please tip him if you enjoy it.

Step 7: Advanced topics and final notes

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There is a whole Bitcoin economy developing with features resembling those found for regular financial systems. In future 'ibles, I may cover:

* the use of options contract to protect from wild fluctuations in the BTC/USD exchange rate;
* the Bitcoin stock exhange;
* the use of escrow services to provide more trust when performing transactions.


If you found this info helpful, please consider leaving me a tip at my address at: 15QQiR7CqpyMwTn9nmnZAsMUqW6vdAFSqr

Tipping with Bitcoin is easy because there are no transaction fees and you do not reveal any personal details. On the Bitcoin Forum , tips are regularly given to users who provide helpful information.

Attribution: Parts of this instructable were derived from the Bitcoin Wiki and weusecoins.com, which are licensed under the Creative Commons Attribution 3.0 Unported Licence .

Photo by Muy Yum .

In Brazil you may spend Bitcoins at www.MercadoViagens.com - Brazil's first Bitcoin-powered travel and tourism marketplace!

Spendbitcoins.com allows you to spend your bitcoins on Amazon, New Egg, Fishpond, Bitcoin Classifieds, and soon, Barnes & Noble. Rates are better than btcbuy.info.
brendio (author) 4 years ago
Another method to get some free bitcoin to start testing is at the website FreeBitcoins.org.
sgaltsev4 years ago
There is also a new service on www.btcbuy.info, where you could exchange bitcoin for amazon of newegg gift card. They also allow putting custom value on a gift card, so you can make one which equals to order.