All That You Didn’t Know About Bitcoins

The apex bank of India, i.e. the RBI, recently issued a warning to the general public against the use of virtual currencies (VCs) including Bitcoins. Of course, this is a good example of the maxim ‘all publicity is good publicity’. So far, however, there is very little awareness among the general public regarding this new phenomenon that is yet to complete five years since its inception.

What with all the buzz generated, the lay person is as confused as curious about what Bitcoins are. Here are some FAQs about Bitcoins that will help you to understand this phenomenon, which is fast gaining currency.

What is a Bitcoin?

Bitcoin is a digital currency (cryptocurrency) that is used for peer-to-peer circulation. It is like electronic cash that is used for payments within a network without involving any central authority or bank.

Who created it?

A reclusive Japanese mathematician, Satoshi Nakamoto, introduced the world to this cryptographic digital currency in his whitepaper in 2008. Later, in the year 2009, Nakamoto came out with the concept and specifications of Bitcoins. So, though the concept has caught on in popular imagination only around now, it has been around since 2009.
Theories abound on the web, which is the platform for this currency – in keeping with its trademark spirit of anonymity – about whether Satoshi Nakamoto is an individual, a group or even a larger state entity. It is commonly believed that Nakamoto could as well be the pseudonym for a larger anonymous entity as the name of a single mathematical genius and visionary.

How do Bitcoins work?

Well, they work just like any mobile application or computer programme that executes transactions for a user. A new user has to install a Bitcoin wallet in his/her mobile device or computer. This will generate a Bitcoin address for the user, which can be used for transactions in Bitcoin terms. In a wallet there can be several addresses that users create for specific transactions.

How are Bitcoins minted?

We know that in case of fiat money, there is a central authority or bank that regulates the printing and circulation of money, as we understand it so far. In case of Bitcoins, there is no such central authority involved – so far at least. How it works is that users solve a specific mathematical problem, or algorithm, in return for which they receive a new Bitcoin that is generated in the process.

This process is called as ‘mining’ Bitcoins, and miners use specific software to solve the problems. The level of complexity of these mathematical problems increases as more and more Bitcoins come into existence.

In the process of mining Bitcoins, the miners also serve to secure the network. In turn, they are rewarded with Bitcoins. Thus, these miners control the Bitcoin network in a sense. Any change in protocol of Bitcoin needs to be carried out with a complete consensus of all users.

What is a ‘Blockchain’?

‘Blockchain’ is a shared public ledger that contains all the confirmed transactions that have ever been processed using Bitcoins. This helps in authenticating any transaction processed via Bitcoins.

What are ‘Private Keys’?

Private keys are secret data pieces contained in the user’s Bitcoin wallet, which ensures that the Bitcoin has come from the owner of the wallet. The signature, which connects a Bitcoin wallet with private keys through mathematical logic, prevents any unauthorised alteration of a transaction. 

Once a transaction takes place, it is broadcast to the Bitcoin network. This transaction needs to be verified by at least six Bitcoin miners to complete the transaction. Once this transaction is verified and completed, it gets added as a block in the blockchain.

How can I earn Bitcoins?

There are various ways of earning Bitcoins.

• You can buy from Bitcoin exchanges. Certain fiat currencies can be used to buy Bitcoins at the prevalent exchange rates.
• If you are merchandiser, you can accept payment in Bitcoins.
• You can participate in a mining pool, wherein you can join others in mining Bitcoins.

How is the value of a Bitcoin derived?

Like any other commodity, the value of Bitcoins is determined by the demand and supply. It is also important to note is that new Bitcoins are created at a predictable and decreasing rate. According to back of envelope calculations, the upper limit of Bitcoins that can be created is 21 million, and the last Bitcoin will be generated in year 2140.

There are approximately 12,078,975 Bitcoins currently in circulation, and each Bitcoin has a value of USD 900, probably the most expensive currency. As supply is limited, the value of Bitcoins is determined by changes in demand. For example, we recently saw a bout of volatility in the value of Bitcoins due to a clampdown by the Chinese central bank on the use of digital currency.

Are Bitcoins divisible?

The value of each Bitcoin is currently around Rs 55800 (USD 900). According the current protocol of Bitcoins, one unit of this currency can be divided down to 8 decimal places named after the inventor. That is to say, 0.00000001 Bitcoin equals one Satoshi.

Are there other precedents or imitators around?

Since the success of the Bitcoins (till now), many imitators like Litecoin, Peercoin, Nextcoin, etc. have burst onto the scene. However, Bitcoins are by far the most widely used cryptocurrency. It is estimated that currently there are approximately USD 10 billion Bitcoins in circulation compared to its nearest rival, Litecoins, which have a total market value of USD 500 million. 

Do Bitcoins enjoy the status of legal tender?

Till now, Bitcoins have not been legalised by any country. Far from that, many countries including India have cautioned their citizens against the pitfalls of using such virtual currencies. It is more in vogue with netizens who have a slightly higher degree of tech savviness, whose curiosity has been piqued by this new concept, and who have a risk appetite for this new concept that is so far not backed by established legal frameworks.

What are the tax implications of transacting in Bitcoins?

Unlike any fiat currency issued and controlled by a central authority, Bitcoins are controlled by users around the world and hence do not enjoy the status of legal tender in any jurisdiction. Nonetheless, a tax liability arises when one uses Bitcoins to transact commercially, which is not payable in Bitcoins but in regular currency.