FIGURING OUT HOW BITCOIN WORKS
Bitcoin is changing the way people think about money by planting a seed of doubt in people’s minds — in a positive and thought provoking way. Given the financial crises over the past decade, it’s understandable that some people are trying to come up with new and creative solutions for a better economy. Bitcoin, with its transparency and decentralization, may prove to be a powerful tool in achieving that goal.
One thing bitcoin does is bypass the current financial system and could therefore potentially provide services to unbanked and underbanked nations all around the world. Whereas most people in the Western world find it normal to have a bank account, the story is quite different elsewhere. Some countries in Africa, for example, have an unbanked population of anywhere from 50 to 90 percent.
For a while now, society has been evolving toward a cashless ecosystem: More and more people use mobile money and credit cards to pay for goods and services both online and offline, for example. Mobile payments — paying for stuff with your phone — are now on the rise, which may become a threat to card transactions. Bitcoin has been available on mobile device for years now.
We are slowly starting to grasp the concept of blockchain technology’s potential and future uses: A blockchain can do pretty much anything; you just have to find the right parts of the puzzles and fit them together.
Here are some examples of what bitcoin technology is capable of:
✓ Taking on the remittance market (transfers of funds between two parties) and coming out on top in every aspect.
✓ Sending money from one end of the world to the other end in only a few seconds.
✓ Converting money to any local currency you desire.
✓ Overriding the need for a bank account, making bitcoin an incredibly powerful tool in unbanked and underbanked regions of the world.
What if you live in an unbanked region and have no reliable access to the Internet? There’s a solution for that as well: Some services allow you to send text messages to any mobile phone number in the world in exchange for bitcoin or a few other digital currencies. Once again, bitcoin proves itself a very powerful tool in under- banked and unbanked regions of the world.
Perhaps the most impressive showcasing of what bitcoin can do is the bitcoin network itself. All transactions are logged and monitored in real time, giving users unprecedented access to financial data from all corners of the world. Furthermore, the blockchain lets you track payments’ origins and destinations, even as money is on the move in real time. Such valuable insight will hopefully be adopted in the current financial infrastructure, even though there may be a period of adjustment while that takes place.
Using Bitcoin Anonymously
One of the biggest misconceptions surrounding bitcoin is whether or not digital currency is truly anonymous. The simple answer to that question is “no, not entirely.” But a certain level of anonymity is tied to using bitcoin and digital currency in general. Whether you can label that as “anonymous enough” is a personal opinion.
Whenever you use bitcoin to move funds around, you can essentially hide your identity behind a bitcoin wallet address. These wallet addresses are a complex string of numbers and letters (both lower‐ and uppercase) and provide no insight into who you are or where you are located. In that regard, bitcoin offers a certain level of protection you won’t find in most other payment methods.
But that is also as far as the anonymity goes, because bitcoin wallet addresses are part of a public ledger — the blockchain — which tracks any incoming and outgoing transfers to and from any address at any given time. For example, if I were to send you 0.01 BTC right now, anyone in the world could see the transfer from wallet address A to wallet address B. No one would know whom those addresses belong to, but the transaction itself would be in plain sight.
Once someone knows your public wallet address, they can monitor it at the www.blockchain.info website at any time. In doing so, not only will they see current transactions, but blockchain.info will also display a list of all previous transactions associated with your bitcoin address. As a result, if someone knows your public wallet address, there is no real anonymity when it comes to using bitcoin, as all of your financial transactions are publicly visible.
This story changes a bit whenever bitcoin exchanges are involved. Anyone can see a transfer from your bitcoin wallet to the wallet address of the exchange, as these are publicly listed in most cases. However, if you sell your bitcoin, it becomes a lot harder to track where those coins went to. In that regard, there is a small sense of anonymity, but once again, it depends on your personal opinion as to how secure this is.
Introducing third‐party anonymity
Ways to stay anonymous when using bitcoin do exist, though none of these methods is very user‐friendly at this time.
Generally speaking, those who are interested in anonymity may have something to hide. It could be that they are seeking to avoid paying taxes or that they are purchasing illegal goods or services in their jurisdiction.
Using services such as an online wallet, you can “mix up” coins and extract them from a completely different address, without the addresses being linked together in any way. This technology is developing even as I am writing this. But using such services involves a few risks, and if your coins are lost in the process, there is no way to get them back. Don’t worry too much about losing your coins though — we will explain more on how to manage them and your wallet later in our training.
Always do your own research before using any external service and ask yourself whether or not anonymizing your BTC balance is really that important to you or not.
One of the biggest issues concerning external services is the fact you are relying on a third‐party to anonymize your coins. Bitcoin and digital currency were created to remove any middleman from the equation and put the users in control of their funds at all times. Trusting a third party with your money essentially goes against bitcoin’s core values.
Plus, using an anonymity service for bitcoin raises suspicion of money laundering. Considering that you are already semi‐anonymous by only exposing your public bitcoin address, taking things one step further could raise suspicions around your possible intentions. We will learn more later on how to manage your funds and the most appropriate ways to do this.
Protecting privacy
When it comes to protecting your privacy, the story is similar.
There are ways to protect your privacy when using bitcoin to move funds around, but these require some effort and planning:
✓ You can generate a new address for every individual transaction.
✓ You can avoid posting your public bitcoin wallet address in a public place.
Generating a new wallet
When receiving funds from another user, you can opt to give them a brand new, freshly generated wallet address, which cannot be directly linked to any existing addresses you already own. This type of throwaway address lets users isolate transactions from one another, which is the primary precaution you can take to protect your privacy.
However, depending on how you store your funds — which type of bitcoin client you are using and which operating system you are using it on — you may also be able to generate change addresses. For example, if you install the Bitcoin Core client on your computer or laptop, you can create a new change address every time you send funds to someone else.
A change address occurs whenever you have a certain amount of bitcoin in your wallet balance and are sending less than that total amount to another user. Let’s say you have 3 bitcoin and need to spend 0.25 bitcoin. You need to receive the “change” — 2.75 bitcoin in this case — in your wallet. The Bitcoin Core client (as well as a few other desktop clients) allows you to have this “change” sent to a newly generated address. In doing so, there is no direct link between your original address and the new address, even though you can trace back the steps by looking at the blockchain itself.
Keeping your wallet address secret
Another way to protect your privacy — to a certain extent — is by not posting your public bitcoin wallet address in a public place. Using the address on your website, blog, social media, or on a forum is not a good idea if you want privacy. Once someone stumbles across your wallet address and can somehow tie it to you personally, there is no way to restore privacy other than by using one of the aforementioned methods.
Demonstrating fungibility
The main problem with bitcoin is its fungibility, or more correctly, lack thereof. Fungibility has nothing to do with mushrooms, by the way. It’s just a fancy term for goods being interchangeable or capable of being substituted . . . and that suits bitcoin.
Most governments in the world will stick to their own, controllable system of issuing fiat currency. Local currencies are centralized and issued by a central bank. If they need more money, the central bank can simply issue more money by turning on the printing more money or engaging in quantitative easing as it’s been termed.
Thus, either by order of the government or by acting as an independent authority — a central bank may boost liquidity in the economy by carrying out quantitative easing. With bitcoin, this is not the case, as there is a fixed liquidity cap of 21 million coins. Thus, the cap of 21 million coins essentially means that bitcoin is not fungible as other fiat currencies are.
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