Ask LH: How Does Bitcoin Work And Is It Safe?



Dear Lifehacker, I have seen Bitcoin as a payment option on some websites recently. Can you please explain exactly what it is? And is it safe to use? Thanks, Bitcoinfused

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Dear Bitcoinfused,

It’s not entirely surprising that you’re confused by bitcoin, because there’s quite a bit to wrap your head around. Bitcoin is a mostly digital currency that, unlike the theory behind regular currencies, isn’t backed by any kind of standard value agreement; this used to be gold for many currencies but is far more complicated these days. Instead, it’s a currency that kicked off in 2008 after the work of a pseudonymous developer (or developers) called Satoshi Nakamoto; in honour of his or her work, the smallest current unit of bitcoin is a Satoshi; one hundred millionth of a bitcoin.

Bitcoins are a computationally derived currency with a finite limit. The maths involved is complex; a fixed amount of bitcoins will be released (“mined”) each year set within the open source code of the bitcoin project. There’s a hard total limit of 21 million bitcoins that can be produced based on the current specifications; while that limit hasn’t been reached it is dependent on the currency being actively used; without that no new bitcoins would be produced. It’s feasible to mine for bitcoins yourself, but the processing power involved is intense and the probability factors involved mean that it’s unlikely to be a profitable venture at a solo level.

The other important issue to consider with Bitcoin is that it is intended as an experimental currency. This isn’t like using, say, PayPal, where you’re trading in currency you understand and most likely hold. The value of a bitcoin is essentially whatever somebody will give you for it (the same as other currencies) but the value of bitcoin can vary by quite a bit; at the time of writing one exchange rate suggests that a bitcoin is worth around 18 Australian dollars. Bitcoin values have been incredibly variable over its short life, especially as certain events relating to Bitcoin fraud have seen the wider bitcoin market lose a lot of faith in the currency.

So are Bitcoins “safe” to use? It’s an interesting question with no absolute answer. The encryption within bitcoins make them theoretically impossible to forge, and you can always turn some of your hardware power towards “mining” new bitcoin addresses, although that isn’t an easy way to riches per se — and as one ABC employee found out last year, it can be an easy way to get into serious trouble at work.

Bitcoin transactions are made at a peer-to-peer level but should be secure, although the open nature of the transaction may concern you. While there’s nothing specific to tie you to the peer-to-peer address used for a bitcoin transaction within what’s broadcast, it’s an open channel, and in theory if you chose to (or accidentally) made your bitcoin address public, it would be feasible to track all your transactions. There have been cases of bitcoin fraud, most notably last year when the bitcoin exchange at bitfloor was hit for around $US250,000 worth of bitcoins.

If you’re looking at a service that offers to sell you goods and services in bitcoin, you’re most likely looking at this stage at smaller level transactions, and for that, it seems a reasonable proposition. As an overall currency, if you were interested in trading, investing or harvesting large quantities of the currency, I’d be wary. Despite its rapid acceleration, Bitcoin is still a relatively immature currency.

If readers have their own bitcoin experiences, positive or negative, we’d love to hear them in the comments.

Cheers

Lifehacker

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