Bitcoin –what you should know about the digital currency

For some time now online payment methods have es­tab­lished them­selves as an al­tern­at­ive to money transfers, direct debit, and credit card payments. The likes of PayPal, Amazon Payments, Skrill, and more, have all begun to rival classic payment methods – in par­tic­u­lar thanks to things like the speed of the trans­ac­tion process and ease of in­ter­na­tion­al payments. Ad­di­tion­ally, online payment services are subject to no­tice­ably cheaper charges compared to those from banks, es­pe­cially for smaller trans­ac­tions. There are further ad­vant­ages too, like buyer and seller pro­tec­tion, as well as account pro­tec­tion for credit cards, etc. One thing that these payment types have in common is that every trans­ac­tion is processed through a central location, be it a bank or the online payment provider. Launched in 2009, the Bitcoin network is breaking with the basic concepts of con­ven­tion­al payment methods. This is happening through the dis­tri­bu­tion of the currency of the same name, as well as the trans­ac­tion databank among all par­ti­cip­at­ing users, who are connected to the system via a client server. Thanks to this de­cent­ral­ised structure, Bitcoin is a currency system without an absolute authority. Though it still reserves the right to collect extensive user in­form­a­tion which includes autonom­ously storing and managing all payment pro­cessing in­form­a­tion. What – and who – is behind this digital currency which is in­creas­ingly gaining pop­ular­ity as a payment method? And how and where can one actually pay with Bitcoin?

On 1 November 2008, a mailing list dis­cuss­ing cryp­to­graphy first proposed the idea of an elec­tron­ic currency system with a network structure in which all par­ti­cipants are equal. This network would operate on a peer-to-peer basis. The post also contained a White Paper, which would then be released the following year and would serve as the basis of the open source software Bitcoin (today known as Bitcoin Core). Both the White Paper and the software were released under the pseudonym ‘Satoshi Nakamoto’, and to this day the true identity of this in­di­vidu­al has not been revealed. The client software code has remained free all along and is visible and change­able to all. Many users have since helped to further develop Bitcoin.

Anyone looking to become part of the currency network needs to install the already mentioned Bitcoin Core or one of the available al­tern­at­ives, like Bither, Armory, or mSIGNA. These function as a so-called Bitcoin wallet; making it possible to send as well as receive Bitcoin, and to this end, also syn­chron­ise with the peer-to-peer network. To fa­cil­it­ate the first syn­chron­isa­tion there needs to be suf­fi­cient bandwidth and storage space available, as the client server downloads files of a total size of more than 65 GB. Contained within these files is the communal public booking system, which forms the core of the Bitcoin network and is also referred to as a block­chain. It is in this chain, whose integrity and chro­no­lo­gic­al order is safe­guarded via cryp­to­graphy, that all confirmed re­ser­va­tions are saved. The client server then cal­cu­lates the status of a Bitcoin account based on this in­form­a­tion. The security concept of the open source system is char­ac­ter­ised not just by the en­cryp­tion of its database, as each in­di­vidu­al trans­ac­tion is also assigned its own special pro­tec­tion in the form of a digital signature. This is generated auto­mat­ic­ally during the sending of Bitcoins via a clas­si­fied data block – the private key (aka. the seed). Each user has their own private key, which can be found in the wallet. On the one hand, the signature acts as proof that the trans­ac­tion being un­der­taken cor­res­ponds to the correct Bitcoin address. At the same time, it also ensures that the trans­ac­tion, once it has been dis­patched, can be modified or amended by other users. For a trans­ac­tion to be confirmed and then dis­sem­in­ated amongst users, specific processes need to take place. These processes are also referred to under the general term mining. What happens during this handling process is that a trans­ac­tion is signed, packaged into a block, and sub­sequently in­teg­rated into the block­chain. This is carried out with the help of special mining hardware and software, which has to be im­ple­men­ted to allow for the creation of a signature cryp­to­graph­ic hash functions (SHA256) and in principle, can be deployed by each par­ti­cipant. As a reward for this mining, the processor receives Bitcoins. At first glance, this might seem to be quite a lucrative reward. However, the hardware and operating costs are nearly on par with the income that can be gained from mining. This can be at­trib­uted to the large amount of com­pet­i­tion in this area. More in­form­a­tion on this topic, which is both in­ter­est­ing and fun­da­ment­al to the Bitcoin network, can be found in this tutorial on weusecoins.com.

Mining is the source for new Bitcoins and a possible way to buy and sell Bitcoins. Fur­ther­more, it is possible to acquire currency by offering goods and services – and then allowing others to pay for these with Bitcoin. This then requires you to send your Bitcoin address to buyers. This can be done either by reverting back to the address that was auto­mat­ic­ally generated during the wallet’s in­stall­a­tion, or al­tern­at­ively by gen­er­at­ing a new address code, as an ab­bre­vi­ation of the published key. The latter option is usually the most popular. This address can then be sent in the standard form or in the form of a QR code. Once the buyer has sent the payment, it should usually take no more than ten minutes until the digital coins are in your Bitcoin account

It’s also possible to buy Bitcoins, and here again there are two options available. Loc­alBit­coins.com is a Bitcoin trading website that operates on a person-to-person basis. It allows users across the world to find Bitcoin sellers near them and then pay for them in their local currency. Sellers can post ad­vert­ise­ments, to which potential buyers can respond. Bitcoins can then be paid for in-person with cash or else via online bank transfer. Loc­alBit­coins.com prides itself on the fact that users deal with other human beings, and not just a cent­ral­ised system. Users must sign up, but there is ab­so­lutely no charge for doing so.

Much more common is pur­chas­ing Bitcoins on special Bitcoin mar­ket­places like Bitcoin.com. Based on a regularly updated currency value, re­gistered users can buy and sell Bitcoins. The website itself offers the option of buying Bitcoins with a credit card. Al­tern­at­ively, it also offers a re­com­men­ded list of current online exchanges and brokers, many of whom also offer the pos­sib­il­ity of paying via bank transfer or even PayPal. Con­firm­a­tion of a trans­ac­tion usually take around ten minutes, but due to the growing pop­ular­ity of the Bitcoin network, this time span has been known to increase, sometimes up to an hour. If it so happens that a trans­ac­tion fails to confirm, then the system makes sure the trans­ferred funds are sent back to the original sender’s wallet. Every web page of Bitcoin.com features a live tracker of the value of Bitcoin to the US Dollar in the top right-hand corner. The website also has a ‘News’ section dis­play­ing any recent articles relevant to the currency system, along with a user community forum as well.

To protect the elec­tron­ic currency from the very real pos­sib­il­ity of inflation, the system has a maximum of 21 million Bitcoins that can be in cir­cu­la­tion at one time. Pro­gram­ming has ensured that this limit cannot be exceeded. According to the website block­chain.info, there are currently ap­prox­im­ately 16.2 million Bitcoins in cir­cu­la­tion (March 2017), meaning that there is still some way to go before the maximum limit is reached. On the one hand, this limit means that, through supply and demand, the Bitcoin market can regulate itself on a long-term basis. Up until now this has been the case. At the same time, it also means that the exchange rate of the currency is subject to heavy fluc­tu­ation; something which can quickly become a problem from the seller’s point of view. We have compiled a list of the ad­vant­ages and dis­ad­vant­ages of Bitcoin:

Here you can download the in­fograph­ic on Bitcoin transfer costs.

• Smaller cir­cu­la­tion: Even if it is the case that digital payment methods like PayPal and Amazon Payments have generally es­tab­lished them­selves in the E-Commerce sector, then the Bitcoin system still occupies quite a niche role. There is a lack of both retailers as well as potential customers who have a Bitcoin account and use the digital currency as a method of payment. In order for users to get the most out of what the network has to offer, and to establish a long-term and stable value through Bitcoin, then a growth in the number of clients is necessary.

• Com­plic­ated legal situation: Although not being illegal in any country, decisions and reg­u­la­tions about the use of Bitcoin lies with the legal system of each in­di­vidu­al country. In Vietnam for example, the digital currency can only be used privately and the use of it by financial in­sti­tu­tions is pro­hib­ited. Due to these imposed rulings, it often so happens that Bitcoin exchanges adjust their service for specific countries. The com­plic­ated starting point has made it difficult not just to cooperate with banks, for instance when it comes to something like ex­chan­ging coins, but also regularly leads to sudden slumps in the market. 

• No Plan B for the loss of a key: The de­cent­ral­ised structure only then becomes a problem if you happen to lose your wallet. Wallets are not saved in the Bitcoin network, i.e. in the block­chain, and therefore are not re­cov­er­able. It is also im­possible to access the coins that have been lost, meaning that all that currency can no longer be used for trans­ac­tions.

• Deflation danger: As the number of potential new Bitcoins steadily decreases, at the same time the demand for them increases – and with that so does the price. The natural decrease in coins, which occurs as a result of the loss of personal wallet keys and the coins contained within. This en­cour­ages investors to buy Bitcoins, keep them for a long time, and speculate about higher market rates.

• Highly fluc­tu­at­ing value: The small number of in­di­vidu­als, retailers, and companies involved are the deciding factor for the highly fluc­tu­at­ing Bitcoin market price. Even minor events, activ­it­ies, or trans­ac­tions can have a big influence on the price, and up until now, this has made the market very un­pre­dict­able. For this reason, entering into the market on a business level is ac­com­pan­ied by risk.

• Con­tinu­ous de­vel­op­ment process: If the state­ments of the de­velopers involved are to be believed, then the Bitcoin software is still in the Beta phase. New and un­fin­ished functions, tools, and services are re­l­at­ively common, and the network wishes to make these more widely and securely available. It regularly happens that various minor pro­gram­ming errors occur, but thanks to the engaged and very vigilant community, these are always fixed quickly.

To allow customers to pay with Bitcoins in your online shop, you will first need a wallet, which can be acquired through in­stall­a­tion of the software. Once the digital coin col­lec­tion has been installed, you have two pos­sib­il­it­ies for obtaining coins from customers:

1. Through the use of an external dealer service like BitPay or Coinbase, which function as a link between you and your customers. In some cases, these providers will also offer to convert the Bitcoins into another currency. The fees charged for these services are specific to the in­di­vidu­al vendors.
2. Or you impart the address of your Bitcoin account yourself and then check yourself that the customer then transfers the agreed amount to the account. While this does save the expense of an external dealer, it does require a lot of effort and co­ordin­a­tion. The money that is saved from not paying for the external pro­cessing of the trans­ac­tions can then be spent in other areas of your business.

If you decide to opt for the latter option, you should create an in­di­vidu­al Bitcoin address for each trans­ac­tion, to avoid com­plic­a­tions later when assigning and or­gan­ising payments. This will allow you to assign invoices to the cor­res­pond­ing address. To help with this, there is also a separate in­form­a­tion page, where you can list the Bitcoin addresses that cor­res­pond to the in­di­vidu­al account numbers. This list can then be copied by the buyer and pasted into the client server. In addition, it is also your re­spons­ib­il­ity to determine the Bitcoin price for the goods and/or services on offer. Usually it makes sense to use current exchange rates as the basis for coming up with these prices. But it is also re­com­men­ded that you include an extra clause in the sales contract, which allows for a price ad­just­ment if there is a large fluc­tu­ation in the market price of Bitcoin. This should then clearly outline who will pay for the trans­ac­tion fees (usually the buyer). The receipt of a payment can then be reviewed and verified in your own wallet or on block­ex­plorer.com. Given that Bitcoin does not have an in­teg­rated buyer pro­tec­tion system, the option of an escrow service might be worth offering, es­pe­cially for larger trans­ac­tions.

The fun­da­ment­al principle behind every currency is the assurance that there is someone else that wants to have it. It doesn’t matter if it is paper money, gold bars, or digital coins. The deciding factor for the future of Bitcoin is a more wide­spread ac­cept­ance.

There are two major factors that can be seen as being behind the general re­luct­ance of many potential Bitcoin users: a lack of trust in the security, and the in­con­sist­ency of the payment network. Es­tab­lished exchange platforms have in the recent past often fallen victim to cyber-attacks, wherein several million dollars’ worth of coins have been stolen. These attacks are just one of the reasons for the fluc­tu­ations in the value of the digital currency. Ad­di­tion­ally, the low level of cir­cu­la­tion, uncertain legal situation, and the not yet complete de­vel­op­ment process are all reasons for hes­it­a­tion in embracing this currency.

The Bitcoin software itself can certainly be seen as secure. Any changes to the un­der­ly­ing protocol can only be made with the agreement of all users. On top of that, the steady growth of available coins should in the long term have a calming effect on the price and also prevent extreme fluc­tu­ations in the future. Anyone who decides to add the option of this aspiring payment method to their online shop is only really taking a risk if, overnight, a huge part of their total turnover is suddenly trans­formed into Bitcoin form. With smaller, in­di­vidu­al trans­ac­tions, Bitcoin may mean an ad­di­tion­al expense, but at the same time, also the op­por­tun­ity to access a whole new customer base.