Report on Bitcoins

By: Bhavik Bavaria (M706)

Aditya Paliwal (M726)

Introduction
Bitcoin is an online payment system invented by Satoshi Nakamoto, who published his
invention in 2008 and released it as open-source software in 2009. The system is peerto-peer; users can transact directly without needing an intermediary. Transactions are
verified by network nodes and recorded in a public distributed ledger called the block
chain. The ledger uses its own unit of account, also called bitcoin. The system works
without a central repository or single administrator, which has led the US Treasury to
categorize it as a decentralized virtual currency. Bitcoin is often called the first
cryptocurrency, although prior proposals existed. Bitcoin is more correctly described as
the first decentralized digital currency. It is the largest of its kind in terms of total
market value.

Bitcoins are created as a reward for payment processing work in which users offer their
computing power to verify and record payments into the public ledger. This activity is
called mining and is rewarded by transaction fees and newly created bitcoins. Besides
mining, bitcoins can be obtained in exchange for other convertible currencies, products,
and services. Users can send and receive bitcoins for an optional transaction fee.

Bitcoin as a form of payment for products and services has grown, and merchants have
an incentive to accept it because fees are lower than the 23% typically imposed by
credit card processors. Despite a big increase in the number of merchants accepting
bitcoin, the cryptocurrency doesnt have much momentum in retail transactions. Unlike
credit cards, any fees are paid by the purchaser, not the vendor. The European Banking
Authority and other sources have warned that bitcoin users are not protected by refund
rights or chargebacks.

The use of bitcoin by criminals has attracted the attention of financial regulators,
legislative bodies, law enforcement, and media. They listed money laundering, financing
of illicit activities, theft, fraud, tax evasion, and use in black markets as possible. As of
2013, the criminal activities centered around theft and black markets. Officials in
countries such as the United States also recognized that bitcoin can provide legitimate
financial services.

What makes it different from normal currencies?

Bitcoin can be used to buy things electronically. In that sense, its like conventional
dollars, euros, or yen, which are also traded digitally.
However, bitcoins most important characteristic, and the thing that makes it different
to conventional money, is that it is decentralized. No single institution controls the
bitcoin network. This puts some people at ease, because it means that a large bank cant
control their money.

Who prints it?

No one. This currency isnt physically printed in the shadows by a central bank,
unaccountable to the population, and making its own rules. Those banks can simply
produce more money to cover the national debt, thus devaluing their currency.
Instead, bitcoin is created digitally, by a community of people that anyone can join.
Bitcoins are mined, using computing power in a distributed network.
This network also processes transactions made with the virtual currency, effectively
making bitcoin its own payment network.

What is bitcoin based on?

Conventional currency has been based on gold or silver. Theoretically, you knew that if
you handed over a dollar at the bank, you could get some gold back (although this didnt
actually work in practice). But bitcoin isnt based on gold; its based on mathematics

Around the world, people are using software programs that follow a mathematical
formula to produce bitcoins. The mathematical formula is freely available, so that
anyone can check it.
The software is also open source, meaning that anyone can look at it to make sure that
it does what it is supposed to.

What are its characteristics?

Bitcoin has several important features that set it apart from government-backed
currencies.
1. It's decentralized
The bitcoin network isnt controlled by one central authority. Every machine that mines
bitcoin and processes transactions makes up a part of the network, and the machines
work together. That means that, in theory, one central authority cant tinker with
monetary policy and cause a meltdown or simply decide to take peoples bitcoins
away from them, as the Central European Bank decided to do in Cyprus in early 2013.
And if some part of the network goes offline for some reason, the money keeps on
flowing.
2. It's easy to set up
Conventional banks make you jump through hoops simply to open a bank account.
Setting up merchant accounts for payment is another Kafkaesque task, beset by
bureaucracy. However, you can set up a bitcoin address in seconds, no questions asked,
and with no fees payable.
3. It's anonymous
Well, kind of. Users can hold multiple bitcoin addresses, and they arent linked to
names, addresses, or other personally identifying information. However
4. It's completely transparent
bitcoin stores details of every single transaction that ever happened in the network in
a huge version of a general ledger, called the blockchain. The blockchain tells all.
If you have a publicly used bitcoin address, anyone can tell how many bitcoins are
stored at that address. They just dont know that its yours.

There are measures that people can take to make their activities more opaque on the
bitcoin network, though, such as not using the same bitcoin addresses consistently, and
not transferring lots of bitcoin to a single address.
5. Transaction fees are miniscule
Your bank may charge you a 10 fee for international transfers. Bitcoin doesnt.
6. Its fast
You can send money anywhere and it will arrive minutes later, as soon as the bitcoin
network processes the payment.
7. Its non-repudiable
When your bitcoins are sent, theres no getting them back, unless the recipient returns
them to you. Theyre gone forever.
So, bitcoin has a lot going for it, in theory. But how does it work, in practice? Read more
to find out how bitcoins are mined, what happens when a bitcoin transaction occurs,
and how the network keeps track of everything.

Block chain of Bitcoins

The block chain is a public ledger that records bitcoin transactions. A novel solution
accomplishes this without any trusted central authority: maintenance of the block chain
is performed by a network of communicating nodes running bitcoin software.
Transactions of the form payer X sends Y bitcoins to payee Z are broadcast to this
network using readily available software applications. Network nodes can validate
transactions, add them to their copy of the ledger, and then broadcast these ledger
additions to other nodes. The block chain is a distributed database; in order to
independently verify the chain of ownership of any and every bitcoin (amount), each
network node stores its own copy of the block chain. Approximately six times per hour,
a new group of accepted transactions, a block, is created, added to the block chain, and
quickly published to all nodes. This allows bitcoin software to determine when a
particular bitcoin amount has been spent, which is necessary in order to prevent
double-spending in an environment without central oversight. Whereas a conventional
ledger records the transfers of actual bills or promissory notes that exist apart from it,

the block chain is the only place that bitcoins can be said to exist in the form of unspent
outputs of transactions.

Mining of Bitcoins
Relative mining difficulty chart. Vertical axis: relative mining difficulty, the scale is
logarithmic. Horizontal axis: date ranging from 2009-01-09 to 2014-12-31.
Obsolete bitcoin mining hardware called ASICMiner Block Erupter USB common in mid
and late 2013.
Mining is a record-keeping service. Miners keep the block chain consistent, complete,
and unalterable by repeatedly verifying and collecting newly broadcast transactions into
a new group of transactions called a block. A new block contains information that
"chains" it to the previous block thus giving the block chain its name. It is a
cryptographic hash of the previous block, using the SHA-256 hashing algorithm.
A new block must also contain a so-called proof-of-work. The proof-of-work consists of a
number called a difficulty target and a number called a nonce, which is jargon for "a
number used only once". Miners have to find a nonce that yields a hash of the new
block numerically smaller than the number provided in the difficulty target. When the
new block is created and distributed to the network, every network node can easily
verify the proof. On the other hand, finding the proof requires significant work since for
a secure cryptographic hash there is only one method to find the requisite nonce:
miners try different integer values one at a time, e.g., 1, then 2, then 3, and so on until
the requisite output is obtained. The fact that the hash of the new block is smaller than
the difficulty target serves as a proof that this tedious work has been done, hence the
name "proof-of-work".

Bitcoins Wallet
A wallet stores the information necessary to transact bitcoins. While wallets are often
described as a place to hold or store bitcoins due to the nature of the system, bitcoins
are inseparable from the block chain transaction ledger. Perhaps a better way to
describe a wallet is something that "stores the digital credentials for your bitcoin

holdings" and "allows you to access (and spend) them". Bitcoin uses public-key
cryptography, in which two cryptographic keys, one public and one private, are
generated. At its most basic, a wallet is a collection of these keys.
There are several types of wallet. Software wallets connect to the network and allow
spending bitcoins in addition to holding the credentials that prove ownership. Internet
services called online wallets like Blockchain.info, Circle, Snapcard, or Coinbase offer
similar functionality but may be easier to use. Physical wallets also exist and are more
secure, as they store the credentials necessary to spend bitcoins offline. Examples
combine a novelty coin with these credentials printed on metal, wood, or plastic. Others
are simply paper printouts. Another type of wallet called a hardware wallet keeps
credentials offline while facilitating transactions.

Privacy in Bitcoins
Privacy is achieved by not identifying owners of bitcoin addresses while making other
transaction data public. Bitcoin users are not identified by name, but transactions can be
linked to individuals and companies. Additionally, bitcoin exchanges, where people buy
and sell bitcoins for fiat money, may be required by law to collect personal information.
To maintain financial privacy, a different bitcoin address for each transaction is
recommended. Transactions that spend coins from multiple inputs can reveal that the
inputs may have a common owner. Users concerned about privacy can use so-called
mixing services that swap coins they own for coins with different transaction histories. It
has been suggested that bitcoin payments should not be considered more private than
credit card payments.

Bibliography
https://bitcoin.org/en/how-it-works
http://en.wikipedia.org/wiki/Bitcoin
http://www.coindesk.com/information/what-is-bitcoin/
https://www.weusecoins.com/