Bitcoin has been generating plenty of column inches recently – but how does the P2P digital currency work in practice? Vitalik Buterin gives the lowdown
This article first appeared in issue 239 of .net magazine – the world's best-selling magazine for web designers and developers.
Bitcoin, the startup online digital currency, has been making waves in the media. But what is it, and what makes it so special? Bitcoin is the first method of payment truly made by the internet, for the internet.
The most basic level of the internet’s architecture is client and server protocols. There is no centralised ‘server company’ to ask permission and register an account before you can start operating your own website. As long as you have a static IP address, you can simply plug in and do it. Email is similar: anyone can run their own SMTP server to send and receive mail. True, in many cases, we opt for centralised web hosting and email providers like Google, as well as additional services like Facebook. But we have a vibrant, competitive marketplace giving consumers options to choose from to suit their needs and start their own - at rock-bottom prices.
In contrast, to be able to accept payments, you must sign up for a merchant account with an established provider, pay high fees and risk your account getting closed and your funds locked at a moment’s notice. Starting up your own processor costs millions of dollars getting deals with established banks, worming your way through a federal government and 50 states’ worth of money laundering regulations. Even if you do succeed, good luck getting any users; unlike email there’s no common protocol your service PayPal can interact with.
Decentralised Bitcoin is changing things. There are no central parties managing the system, anyone can start up their own Bitcoin node (or use a free third party provider), and the process of maintaining the network’s security is similarly delegated out to the community in the form of a protocol called ‘mining’. Transactions happen directly from sender to receiver without intermediaries.
To receive bitcoins, ask your wallet application for a Bitcoin address; you’ll be notified of the payment within seconds, and be able to spend it within about fifteen minutes. To prevent you sending money into the abyss if you make a typo, the addresses have a checksum included so any attempt to send a transaction to an invalid address will fail. It’s easier for a smartphone client: scan a QR code and the address will appear automatically.
Bitcoin has numerous benefits. There are no mandatory fees. Even businesses paying optional transaction confirmation charges report average fee rates below 0.03 per cent. Bitcoin’s privacy is almost as strong as that of cash. International payments are simple, too; sending money to Kyrgyzstan or Guatemala is as instant and free as making a payment to your neighbour.
To accept Bitcoin as a merchant you need to automatically generate a payment request for each customer, keep track of all addresses and send a confirmation when the customer has paid – and do so privately and securely. BitPay allows merchants to start accepting payments online and in a brick-and-mortar operation. WalletBit is another popular alternative, and technically inclined users have an even wider array of options. As a US customer, Coinbase allows you to buy bitcoins directly from your bank account with a one per cent fee (and sell in the same way). If you want to pay cash, BitInstant and BitMe allow you to do so at any Walmart, 7/11 or Chase bank branch. And, the Bitcoin community is a great place to earn the digital money by freelancing or starting an online business yourself.
Bitcoin has grown a lot in the past few months. You can now use bitcoins to pay for premium services for WordPress. In December, Bitcoin Central finalised an agreement with a payment processor in France enabling them to integrate their Bitcoin exchange into the banking system directly. Once everything is set up, Bitcoin Central users will be able to have their salary sent to a bank account that converts everything to Bitcoin automatically.
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