Month: March 2012

In the common discourse, Bitcoin is often treated as a revolutionary new concept in how we handle our funds, substituting irreversible finance with reversible, automatic with prepaid, asymmetrical with symmetrical and debt-based with equity-based. Bitcoin promoters often hail these aspects as a necessary shift in our economic culture while detractors bemoan the loss of the consumer protection that reversibility and bank responsibility for fraud normally bring.

Reversibility has become a point of great focus in the Bitcoin community, with a widespread understanding that reversible payment media like PayPal simply cannot interact with irreversible media like WebMoney, Liberty Reserve, various forms of virtual game currency and Bitcoin and that eventually one or the other must win. However, what the discussion often misses is that outside of the American and Western European world the debate is almost meaningless and the issue has already been resolved: reversible payment media are almost nonexistent.

In Russia, for example, outside of some parts of the very wealthy population in Moscow and St Petersburg, credit cards have barely any market penetration, and the economy runs on cash. If you have an Internet or mobile phone service subscription, there are kiosks in nearly every shopping mall that allow you to deposit money into it so that the plan keeps going on a prepaid basis. You get paid in cash, you pay for your food in cash and you pay your bills in cash. Even digital goods work in this way; Valve, as part of its plan to expand into Russia, had to set up 45,000 kiosks across the country to allow people to deposit money into their Steam accounts. And the system works fine. Unlike the Western economy, where in order to buy any kind of online good you have to effectively give the provider unlimited access to your bank account, protected only by the assurance that you have the option of a chargeback and the bank is ultimately responsible for all your losses due to fraud, in Russia you only have to trust people with as much money as they deserve to be trusted with — a value which is often not very high.

In the Middle East, CashU is a popular online payment method for e-commerce and gaming, but it is once again prepaid and non-reversible. In China, systems like Alipay are dominant with similar rules; as Bitcoinica creator Zhou Tong describes it, “the root of all reversibility is the Visa/MasterCard credit card system used by Americans. Chinese banking system is entirely different. Chinese people don’t use Visa/MasterCard for domestic purchases, online payments require strict authentication, banks are usually not responsible for fund losses, etc. Everything is very Bitcoin-like, and non-reversible.” But the issue remains: how do these systems get around the consumer protection issue? It turns out that they use exactly the same solution as that which has been proposed and sporadically implemented with Bitcoin: escrow.
Escrow works by having the buyer, instead of paying directly to the sender, pay to an escrow agency instead. The escrow agency notifies the seller that the funds were received, and the seller sends the product. The buyer, upon receiving the product, says so to the escrow agent, who then releases the funds to the seller. This works well as a solution to combat fraud, and is generally adopted in some form in any low-trust scenario without reversibility. As Zhou Tong points out, “over half of Alipay transactions are escrows.”

Africa is undergoing a banking revolution of its own with so-called “M-banking,” or sending and receiving money through text messages with mobile phones. Mobile phones are surprisingly accessible even to the poorest of the poor; even in Africa, where the majority of the population is still struggling with poverty, there’s on average about one phone per household. Although the local banking systems did attempt to shut down mobile phone banking providers when they first arose, they are now working with them and everyone is benefitting; having one’s money available digitally is particularly important in a world where theft is rampant and physical safety is a luxury.

While for Western economies it’s easy to think of Bitcoin as a fundamentally new form of consumer finance, in the developing world Bitcoin-style finance is already here. And everywhere it’s being implemented its efficiency is creating more and more wealth throughout the world. And as there’s no distinction between consumers and vendors — anyone can send money or accept it — the potential for a decentralized and bottom-up economy is maximized. And there’s plenty of time and opportunity for Bitcoin itself to get involved. Substituting banking with Kenyan shillings through M-Pesa to banking with Bitcoins through MtGox is a simple matter of changing providers, and from there, once smartphones become as ubiquitous as less sophisticated phones are now it’s just as seamless a step to people storing Bitcoins directly on their phones. It’s predicted that in a few years there will be as many as 1.7 billion people in the world with mobile phones and without bank accounts, so Bitcoin will have many years to take its place in the market as the Internet reaches the average Indian, rural Chinese or African before traditional banking and credit cards do. And, as shown by the example of every society outside of the West, the culture to support non-reversible, symmetrical payment media is already there.

 

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Differences between Bitcoin-style and credit-card style Finance Explained

• Symmetry – with systems like credit cards and PayPal, it’s much more difficult to get a merchant account than a simple consumer account, and they are not designed to be used outside the context of a formal storefront. With Bitcoin-like finance, anyone who can send money can also receive it just as easily, facilitating more informal economy and lowering barriers to entry for business.
• Reversibility – Credit cards and PayPal have mechanisms for customers to “charge back” any fee in case of fraud, and if a merchant wants to dispute the chargeback they have to deal with a formal dispute resolution process, effectively moving the entire problem over to sellers, which some argue is even worse since while customers can choose not to buy from suspicious businesses, businesses cannot practically evaluate and pick and choose their customers. In Bitcoin-like systems, transactions are final, and other mechanisms are used to deal with low-trust scenarios.
• Debt-based vs. Equity-based – A credit card allows you to buy products first and pay for them later, while Bitcoin-style systems do not and require everyone to maintain a positive balance. While other systems like PayPal are in theory not debt-based, in practice they often are if you get a chargeback after spending the money that you received.
• Automatic vs. Prepaid – In a credit card-based financial system services where you regularly pay the same business money, like subscriptions and online gaming, usually keep your credit card number on file and withdraw from it as needed. In a Bitcoin-style system, a prepaid approach is preferred, where you deposit money into an account and money is deducted from there. Here, from a consumer protection perspective the prepaid approach is actually superior as there is a limit to the unexpected fees that you can incur.

 

  
 

MF Global traces its roots back over two centuries, starting as a sugar trading business in 1783, slowly expanding the range of its activities, but staying within the market of agricultural commodities for almost two centuries. In the late 1970s, they discovered the much more profitable area of futures trading, where they rapidly expanded their business with managed futures, hedge fund products and other financial instruments that they had no competition in. By 2000, they abandoned their roots in agricultural commodities entirely. In the next decade, they would expand to become one of the largest hedge fund managers and brokers in the financial world. However, on October 31, 2011, the unexpected happened: the corporation collapsed like a house of cards over a bad bet on European sovereign debt. Later, it would be found that $1.2 billion, equal to almost 100% of its total net worth, somehow disappeared entirely, and as of the end of January investigators are still just as puzzled as to where it is.

The causes of this are obvious: the company was massively overleveraged, with a debt of $39.7 billion backing assets of $41 billion, and the $7.3 billion that should have been held in a segregated account for its customers actually wasn’t. In our world of fractional reserve banking, where the vast majority of our money ultimately exists only as numbers on a balance sheet, such collapses are inevitable, and some say that it is only a matter of time before the number juggling game cannot be kept up any longer, people realize that they are actually broke, and the system collapses entirely. However, what is more interesting is the complete lack of transparency in the entire system. Regulators and ratings agencies had no idea that MF was exposed to $6 billion of European sovereign debt until October 21, and MF had no idea where its customers’ money was. In this day and age, where supposedly every electronic payment and trade made can potentially be tracked and audited for regulatory, tax and anti-laundering compliance, a billion dollars somehow managed to escape the books undetected.

All this reveals just how little power we have over our money, and just how much power the wealthy financial system does. In order to invest our wealth or insure against unexpected economic circumstances, we are forced to deal not with other fellow investors directly but through cumbersome, unstable, essentially unaudited corporations. Organizations which are supposedly brokers, simply making trades on their customers’ behalf, may in fact be running a fractional reserve scheme behind everyone’s back. Some picture the classic image of evil corporate executives grinning in a boardroom over their new secret plans to skim an extra few percent profit by risking their customers’ savings, but strangely enough it often isn’t like that at all – the web is simply so tangled that financial derivatives become Ponzi schemes entirely by accident.

As for the rest of us, we have no choice but to participate in this process not only to invest but also to use any electronic money at all. In fact, with tax-funded bailouts “socializing the losses” of schemes that do fail and laws already present in Italy – and soon to come in many other countries –  that ban cash transactions over 1000 EUR, participation in the financial industry’s gambling activities is becoming, in every sense of the word, compulsory. This is why reform is needed, and a mere round of regulations that temporarily reduces the maximum leverage and attempts to force segregations of funds like those that MF was required to have in the first place, is ultimately doomed to failure. As long as the current system remains, not in its specifics but in its very essence, tax evasion and blatant theft are not truly illegal – they are simply the exclusive domain of the powerful.

 

  
 

The question of “how to store your bitcoins” is one of the most important decisions for a Bitcoin user to make, and that is why we have done an extremely thorough Bitcoin wallet review for all major Bitcoin wallets.

In this article we will perform bitcoin wallet reviews, including providing the current best option, by looking at ease of use, security and advanced features for the major wallets in each category: Online Bitcoin Wallets, Desktop Bitcoin Wallets and Mobile Bitcoin Wallets.

To save you some time our conclusion to maximize ease of use, security and advanced features is to use the most well rounded Blockchain.info mobile bitcoin wallet (Android or Apple Store) coupled with the ultra-secure and advanced desktop bitcoin client Armory.

Regardless of what kind of electronic payment system you are using if you want to spend digital money then you need to have a digital wallet. Bitcoin differs from every other online payment system. Bitcoin has no central provider and anyone can build a bitcoin wallet. Consequently, there are several dozen bitcoin wallets to choose from and they all vary in terms of ease of use, security and advanced features which makes it important to carefully consider these bitcoin wallet reviews.

DIGITAL WALLETS

The Bitcoin wallets come in many different varieties often with trade-offs between ease of use, security and advanced features. Some are websites that simply offer the basic functions of sending and receiving bitcoins and attempt to make these functions as easy to use as possible. Others are fully-featured online bitcoin wallets that offer the user more power and control including advanced options such as custom transactions.

Then there are bitcoin wallets that are desktop applications which tend to be more difficult to setup but offer higher security and more advanced features across the board. And digital wallets would be incomplete without a mobile strategy and there are plenty of mobile Bitcoin wallets targeted at this huge market.

The list of options to choose from is daunting but we have done the hard work of narrowing the list from dozens to a few in this Bitcoin wallet review. First, ask yourself the question: Do I want a client I can download to my own computer, an online wallet interface, or a client for my smartphone? If you are an avid Bitcoin user then you may wish to have two of the above or even all three. It is extremely popular to have an easy-to-use, medium-security, online and smartphone bitcoin wallet for spending and a highly secure desktop Bitcoin wallet for savings and advanced features.

Once you have narrowed down your use case then look at the options available within each category. Do you want a client that offers more powerful features or do you want something that is easy to use? Perhaps you paranoid and want extra security? In all three of the categories there are different bitcoin clients to suit various needs.

Online Bitcoin Wallet Reviews

Online wallets are the easiest to setup and offer extreme convenience of being able to access your bitcoins from any computer. But generally there is a cost of requiring a higher degree of trust in the provider. Three well known options to choose from among online Bitcoin wallets include:

Blockchain.info

Blockchain is a hybrid between an online wallet and a desktop client and seeks to offer close to desktop-level security with the convenience of an online application. Unlike the alternatives, Blockchain works by storing your wallet encrypted, and running the code necessary to decrypt your wallet and sign transactions in your browser, so the operators of Blockchain have no way to access your funds.

However, there are some security complications with relying solely on Javscript cryptography, so users who want to take full advantage of the increased security that Blockchain has to offer should install either the Chrome or Firefox extension or the wallet verifier addon for Safari.

The client also offers a number of advanced options: the ability to download and backup your wallet to your computer or a printed sheet of paper, private key import and export, brain wallet support and an offline transaction mode are all available.

Coinbase

Coinbase is a step up from Instawallet in terms of both complexity and security. But it is still basic with only standard sending and receiving functionality. Nevertheless, Coinbase has two features which make it a very convenient wallet for the beginning user.

First, the wallet allows you to avoid dealing with Bitcoin addresses entirely and instead send directly to an email address. This makes the transfer internally if both parties have a Coinbase account and if the receiver does not then it sends an email message to the recipient instructing them to immediately create an account to receive the bitcoin payment.

Second, Coinbase includes its own built-in bitcoin exchange which empowers users to convert between bitcoins and US dollars directly through their bank accounts using ACH and they have processed tens of millions of dollars worth of orders. Unfortunately, the bank account integration is only available with banks inside the United States and only a limited amount can be bought or sold at a time depending on verification and other Coinbase policies.

Third, there is a Coinbase Android app. Many wallets are cross-platform compatible.

Coinbase does not claim to be trust-free and all bitcoins are stored in a centralized location controlled by its operators. This means you do not have absolute control over your bitcoins and there have been technical incidents which have left users without wallet functionality, unconfirmed transactions and may have comprised data or personal information. But so far no customer funds have been lost and these appear merely as growing pains for this new startup.

Nevertheless, Coinbase raised $5m of venture capital funding and will likely be around the Bitcoin ecosystem for the foreseeable future and the founder and venture capital investors are unlikely to betray their users by absconding with bitcoins. Their current corporate policy of storing 85% of users’ funds in offline cold storage means that the bitcoins are likely well-protected against third-party theft.

WalletBit

Like Coinbase, WalletBit attempts to create an online wallet that is easy to use but has all of the convenience features that beginning users need. WalletBit allows sending to email addresses as well as a built-in conversion to and from the user’s local currency through the Bitcoin exchanges Bitcoin Nordic and MtGox.

These options are less convenient than Coinbase’s bank account integration with ACH but they have much higher deposit and withdraw limits and are more widely available around the world. WalletBit is also a merchant services provider. If you are interested in accepting bitcoins for your business, whether online or brick-and-mortar, then WalletBit has a wide variety of integrated supplementary tools to assist you.

WalletBit’s security model is similar to that of Coinbase but their operators are neither more established and prominent than Coinbase’s nor have they raised the same amount of venture capital. So you should consider the staying power of the developers in the bitcoin wallet reviews.

Desktop Bitcoin Wallet Reviews

Desktop clients are simply software programs that you download onto your computer. They offer increased security and control but at the expense of being more difficult to set up. Hence the trade-off in these bitcoin wallet reviews. There are three main clients to choose from:

Armory

Armory is the most advanced and secure Bitcoin client available and has been developed by Alan Reiner who is one of the world’s premier experts in Bitcoin security. If your use case requires safely storing large value in bitcoins then Armory is the only practical choice.

Armory offers a range of features even larger than either Blockchain.info or the Satoshi Bitcoin client. However, all of these tremendous benefits come at a price: convenience. There are three modes a user can choose: Standard, Advanced and Expert. But even the Standard mode requires some serious study to become competent.

Of course, there is standard bitcoin wallet functionality like storing encrypted wallets, managing an address book, changing or removing a passphrase, backing up either individual private keys or via paper or digital methods, deleting or removing wallets and creating watching-only addresses.

However, beyond the standard functionality expected from any Bitcoin wallet client, Armory pays attention to small details like having a graphical keyboard to protect against keyloggers and other features empower users to manage multiple wallets, import or sweep private keys, sign messages (although this functionality is not compatible with the Satoshi client), perform your own elliptic curve calculations using secp256k1 elliptic curve to supply values as 32-byte, big-endian, hex-encoded integers and most importantly Armory has seamless integration for signing transactions completely offline.

This offline transaction signing can greatly reduce potential attack vectors and there is no other wallet which offers this type of security in as easy to use implementation. This feature should not be underestimated!

The Armory client has no networking functionality and requires the Satoshi client to be running at the same time to interact with the blockchain. This can put strain on an older computer and even with the latest hardware there is significant startup time because it uses the Satoshi Bitcoin client for transaction data and therefore needs to download the entire blockchain.

But this is the only major downside we could find in this particular bitcoin wallet review of the Armory client. And if your use case requires storing significant amounts of bitcoins that you do not want compromised then the Armory client is the best choice.

BitcoinQt

Originally developed by Bitcoin founder Satoshi Nakamoto in 2008-2009, and continuously worked on by the core Bitcoin development team since then, this is the first Bitcoin client ever created. The client is a fully fledged node of the Bitcoin network, meaning that it can connect to other nodes and help verify and relay transactions, although it cannot mine.

Because it is a full node, the client must download the entire (currently 6 gigabyte) blockchain to operate, which can take up to a few days the first time you start the client and several minutes to an hour every time you start the client afterward if you do not keep it running constantly. Your private keys, the mathematical data that makes it possible for you to spend the bitcoins that have been sent to one of your Bitcoin addresses, are stored in a “wallet.dat” file on your computer (which users are encouraged to back up), and the client offers the option of keeping your wallet.dat encrypted.

This client is arguably the most trustworthy, since its development is certainly the most heavily scrutinized and is overseen by very well-known and established members of the Bitcoin community. So the probability of it having security holes is pretty low and one reason for it being so popular in the bitcoin wallet reviews.

Its features include the basic sending and receiving functionality, as well as a feature that allows you to digitally sign a message with one of your addresses, allowing anyone who knows that the address belongs to you to verify that the message was not modified or forged (the verification functionality is also present in the client).

Electrum

Electrum is a solid lightweight desktop client, meaning that it does not download the full blockchain. Instead, it relies on servers to do much of the work. It performs well in the bitcoin wallet review because it empowers you to send and receive transactions, but also has some advanced features: it can generate wallets deterministically from a seed, create and sign transactions offline, sign and verify messages (compatibly with the Satoshi client’s implementation), export a “root public key” that allows applications like AcceptBit to monitor, but not spend from, the wallet, and it can import and export private keys.

Unfortunately, these advanced features are only accessible through the command line. Those who only wish to send and receive bitcoins, however, need not worry about the advanced features. If one wishes just to send and receive bitcoins, Electrum offers the most simple, easy-to-use and minimalistic interface of all the online and desktop wallets.

Multibit

Like Electrum, Multibit is a lightweight client, although it is perhaps one step below Electrum in the regard. Unlike Electrum, Multibit does not need to rely on servers; instead, it connects directly to the network, using a new feature known as bloom filters implemented in BitcoinQt 0.8 to only download a small subset of the Bitcoin blockchain, and thus avoid the 6 GB download that the Satoshi client and Armory require, while still keeping track of all transactions that are relevant to the user. MultiBit is also known for having translations into dozens of languages worldwide, as well as having the ability to manage multiple wallets.

Mobile Bitcoin Wallet Reviews

Mobile Bitcoin wallets are specifically targeted for mobile phones and offer a different array of features to consider in the bitcoin wallet reviews. Advanced private key importing and message signing functionality is out, but features such as the ability to create payment requests in the form of QR codes, and scan such requests made by others, are included in all the options, making sending and receiving bitcoins on a smartphone much easier. Note that this page describes wallets for Android only, as Apple does not allow Bitcoin applications on its platform to offer sending and receiving features.

Blockchain.info

Blockchain’s mobile wallet is similar to its desktop wallet in operation, but it only offers the simplified interface of receiving and sending bitcoins, as well as the standard mobile QR code functionality including importing of private keys. The mobile wallet and the desktop wallet can be made to point to the same account. This empowers you you to spend your bitcoins anywhere.

Just like in the browser wallet, transaction signing is done client-side, so Blockchain themselves never gain access to your wallet. Like the other major mobile wallets, it does offer the ability to set a PIN for security, but the feature is hard to find – it requires adding a second password from within Blockchain’s desktop browser interface, which will then be required on both your smartphone and your desktop.

Bitcoin Spinner

Bitcoin Spinner differs from many of its alternatives in that it does everything client-side; transactions are signed and received locally on your phone, and your private keys are never sent over the internet, even in an encrypted form. Spinner does rely on a server to function, but its role is limited to simply relaying transaction data and it has no way to gain access to your wallet.

However, with greater power comes responsibility. If you forget to back up your private key and your phone breaks or is lost, your funds are gone forever. Fortunately, Spinner does make the backup process fairly easy; all you need to do is go to Settings-> Backup Wallet in the menu and you will be able to QR scan the key or copy it to your clipboard.

Andreas Schildbach’s Bitcoin Wallet

The original Bitcoin wallet for smartphones and written using Mike Hearn’s BitcoinJ Java library. It is by far the most independent of all mobile wallets, requiring no third parties whatsoever to continiue functioning; the client connects to the Bitcoin network directly and stores a small portion of the blockchain locally to verify incoming transactions.

Like Bitcoin Spinner, however, it does require the user to take care to manage their own backups. Until very recently, the wallet was very slow and data-hungry due to its need to process the entire blockchain, but its latest version and the advent of BitcoinQt 0.8 means that it can now download transactions much more quickly which is positive for the bitcoin wallet review.

On March 1, web hosting provide Linode’s servers were hacked, resulting in a theft of 3000 BTC from Slush and, most severely, 43000 BTC from Bitcoinica. There have been two major Bitcoin heists before, one 25000 BTC theft in June and a 17000 BTC theft from the Bitcoin exchange bitomat.pl in August, resulting in the exchange being bailed out and acquired by MtGox. Security is a major issue in the Bitcoin community, and many are worried that if they want to carry out a significant portion of their economic activity in bitcoins their money will not be safe. Many traditional banking proponents see the theft in June and now this heist as clear indications of the inferiority of Bitcoin’s lack of reversibility and an effective audit trail, and it cannot be denied that incidents such as these do shake even Bitcoin proponents’ confidence in the system, but it is critically important that we do not fall into hysteria and exaggerate the consequences and instead approach the issue with a cool head. There are several reasons why this theft is in fact less consequential to the Bitcoin community than it might seem at first glance.

• Bitcoin’s security has gotten better between this theft and the one that happened six months ago, and will only continue to get better in the future. When bitomat.pl was hacked, the 17,000 of their Bitcoins that they lost represented all of their clients’ money, and MyBitcoin’s losses were equal to 51% of their total funds. Bitcoinica’s losses, though staggering to the average individual, were mild enough that they were able to reimburse all of their customers and continue running. They are upgrading their security following this incident and are working on a more secure, specialized server. Soon, innovations like multi-signature transactions will enter mainstream usage and increase security even more.
• Storing $220,000 worth of data is not something unique to Bitcoin. Businesses like Sony and Stratfor had to suffer much worse as their proprietary data was leaked by Anonymous, and there are many low-profile cases that do not make the news. A report by the Ponemon institute shows that the average cost of a stolen laptop is $49,246, including $39,297 due to lost or leaked data. We only pay so much attention to Bitcoin-related losses because the value is so clearly quantified and because Bitcoin business remains extremely open and community-oriented — normally, banks do not announce their robberies to the public because they do not want to be perceived as vulnerable and take a hit to their reputation.
• Bitcoinica is a financial services business and they have to deal with these kinds of risks in ways other businesses do not. It’s worth keeping in mind that such risks are not unique to Bitcoin — MF Global saw $1.2 billion, or roughly 100% of what was then its net worth (the derivatives broker has since collapsed), simply disappear without a trace. Bitcoinica, on the other hand, managed to remain solvent. For the average Bitcoin-handling business, such risks are much milder as all of their Bitcoins can be stored in cold storage as they simply need to accept money coming in all the time, not take it out.
• The little guy is secure. Bitcoinica has taken the entire 43000 BTC hit and the balances of individual Bitcoin users remain untouched. The ironic thing is, this is exactly how things work for the consumer in the real world. When your credit card gets stolen and the thief buys $10000 worth of goods with it, the bank refunds your losses and your balance remains untouched, just as happened here (although the consequences to the merchant who sold the goods are somewhat less pleasant). This is one of the key points of Bitcoin: Bitcoin does not force you to be your own bank. You can keep your bitcoins stored with a Bitcoin bank if that makes you feel safer, and as more and more average users begin to accept Bitcoin such services will begin to appear. There are already various options with as many levels of convenience and paranoia as there are types of smartphones. Freedom is superior to non-freedom not because people always prefer it no matter what the consequences, but because it allows the expression of a preference in the first place.

 

  
 

The Network and the Blockchain

• The Bitcoin network is the network of computers through which Bitcoin transactions are broadcasted and which maintains the public blockchain. Sometimes, the term is used to refer to just miners (see below).
• The blockchain is a public list of all transactions that have ever been sent, ensuring that everyone knows which bitcoins belong to whom. All fully fledged nodes on the network keep a copy of the blockchain.
• A block is an individual unit of a blockchain. Each block contains the hash of the previous block (so someone passing along the blockchain can’t take out or change any block without making some hash along the way not match), as many unconfirmed transactions as can be found in the network, and a number called a nonce. Someone creating a block must find a nonce such that the hash of the block is below a certain threshold (the target), which can only be done by trying out all the nonces one after the other until one that produces a desirable hash is found, and is harder the lower the target is. The reason why block creation is made deliberately difficult is to prevent someone from spending bitcoins and then creating and pushing his own blockchain that doesn’t contain the transaction that shows that the bitcoins are spent, effectively erasing that record and allowing him to spend them twice. When a valid block is created, it is distributed through the network and work on the next block starts.
• The genesis block is the first block of the blockchain released on Jan 4, 2009.
• An unconfirmed transaction is a transaction which is not yet part of a block. A confirmation is when a transaction is put into a block to permanently become part of the blockchain. “6 confirmations” means that the transaction is in a block and there are 5 blocks after it in the chain, which provides added assurance that the transaction is legitimate.
• A miner is someone who tries to create blocks to add to the blockchain (the term also refers to a piece of software that does this). Miners are rewarded for their work by the Bitcoin protocol, which automatically assigns 50 new bitcoins to the miner who creates a valid block. This is how all bitcoins come into existence.
• The difficulty is how difficult it it to create a new block (ie. the inverse of the target), and it is automatically adjusted to ensure that the network takes an average of 10 minutes to find a valid block.
• A mining pool is a service that allows miners to work together on creating blocks and split the profits evenly, providing miners with a reliable income rather than a small chance of 50 BTC profits.
• A 51% attack is an attempt to gain the power to block and reverse Bitcoin transactions by obtaining and using a sufficiently strong pool of computing power to overpower the rest of the Bitcoin network combined (ie. controlling at least 51% of the network).
• A double spend is an attempt to send the same bitcoins twice. Miners generally prevent this, but such an attack is possible against users who accept unconfirmed transactions and in conjunction with a 51% attack.

 

The Market

• An exchange is a service which allows people to buy and sell bitcoins to each other. The most popular at the time of this writing are MtGox,  CryptoXChange, Cavirtex (Bitcoin to Canadian dollars) and Intersango (Bitcoin to UK pounds).
• The “ask” price is the lowest price people on a certain exchange are willing to sell bitcoins for, and the “bid” price is the highest price people are willing to buy for. The ask-bid spread is the difference between the two.
• The volume of an exchange is the number of bitcoins traded during a given time period.
• The market depth is the number of bitcoins that people have put up for sale on an exchange and haven’t been sold yet (since no one is yet willing to accept their price) at a given time.
• A speculator is someone who tries to make money by buying bitcoins at a low price and selling them at a high price. Arbitrage is the activity of trying to make money by taking advantage of price differences across multiple exchanges, and high-frequency trading is the activity of trying to make money by predicting very short term price movements and buying low and selling high on those.
• A bubble is when people are optimistic about the Bitcoin price going up in the future, and buy bitcoins to speculate on this, causing the Bitcoin price to go up, and continuing the cycle until the bubble “pops” and the price crashes back down (a correction). The largest bubble to date has been the April-June 2011 bubble, pushing the price up from $0.75 to over $30 before it crashed back down to $2 (from which level it is, as of the time of this writing, picking up again).
• Margin trading is a risky form of speculation where you trade bitcoins using borrowed money in addition to your own (the ratio of total money to your own money being the leverage), allowing much higher profits but risking liquidation (losing all your money) if the price falls by, for example, 20% at a 5-to-1 leverage. It’s also possible to use margin trading to bet against bitcoins (shorting), in which case you’re buying dollars with borrowed bitcoins, so you earn a profit if the bitcoin price goes down and you get liquidated if the bitcoin price goes up too much. The first margin trading service available was Bitcoinica, which is now no longer operational, and Kronos.io will likely be the first competitor to replace it.

 

Miscellaneous

• A satoshi, named after Bitcoin creator Satoshi Nakamoto, is one hundred-millionth of a bitcoin, or the smallest unit of the currency that can possibly be sent.
• A tumbler, or Bitcoin laundry, is a service that allows people to put their bitcoins in and then randomly hands them back and equal (perhaps minus a small fee) amount of bitcoins from someone else. These new bitcoins cannot be traced back to the old ones through the blockchain except by the tumbler operator themselves.
• An escrow service is one that holds payments made for a service and releases them to the intended recipient only after it has been verified that the recipient has kept his end of the deal.
• A script is an advanced Bitcoin feature that allows for unconventional transactions like transactions that can be spent by anyone and, in the future, transactions that require two or more (or even two out of three) people to sign. Technically, all Bitcoin transactions use scripts but the term is typically used only in discussions surrounding unconventional transactions.
• A fiat currency is a traditional currency like the US dollar and the euro, which ultimately derives its value from its use being mandated by a government for payment of taxes and as legal tender.

 

  
 

Cryptography

• A hash is a function which transforms any number or string into a fixed size output which is impossible to do in reverse without trying all possible inputs. As an example of a simple hash function, consider the square root: the square root of 17202 is easy to calculate – it’s about 131.15639519291463, so a simple hash function might be the later digits of this, 9291463. However, given just 9291463 it’s much harder to figure out what number it came from, and you basically have to go through all the possibilities. Modern cryptographic hashes like SHA-256 are a much more complex and secure version of this. The word is also used to refer to the output of such a function.
• A traditional encryption algorithm is a function that transforms a message into an unreadable, random-seeming string using an encryption key, which cannot be reversed (ie. getting the original message back) except by someone who also knows the key. Encryption is the way that private data is sent over the public internet without serious risk of outsiders finding out what is being said.
• Public key cryptography is a method of encryption where every private key has a corresponding public key, from which it is impossible to determine the private key, and data encrypted with one key can be decrypted with the other. This lets you publish a key that lets anyone send encrypted messages to you without having to exchange a secret key first.
• A digital signature is something which can be attached to a message to show that the sender of the message is the owner of a private key corresponding to some public key while keeping the private key secret. It works by taking the hash of the message and then encrypting the hash with the private key. Someone checking the signature will decrypt the encrypted hash with the public key and check that the result matches the hash of the message. If the message is at all changed, or the private key is wrong, the hashes will not match. Outside of the Bitcoin network, signatures are generally used to authenticate the identity of the sender of a message – people publish their public keys, and send messages signed with the corresponding private key which can then be verified against the public key.

Basic Terminology

• A Bitcoin client is a piece of software that handles receiving and sending bitcoins. The most popular is the standard Bitcoin client downloadable from bitcoin.org, although there are many other options with different features.
• The term wallet can have two meanings: it can either be a synonym for a Bitcoin client (although the terms are in practice used slightly differently, “client” referring more to fully fledged desktop clients and “wallet” more to lightweight browser-based and online managed services) or it can refer to a file which stores bitcoin addresses and the private keys needed to use them.
• A Bitcoin address is a string like “13ignD31FysQbaBBVJUzffcQoFxxEuEcbE” that you need to know from someone to send bitcoins to them. The process of creating a bitcoin address and the private key going along with it can be done by bitcoin clients.
• A private key in the context of Bitcoin is a key connected to an address (technically, the address is the hash of the public key corresponding to the private key) that is stored behind the scenes and allows you to send bitcoins that have been previously sent to that address. Note that because of the way the encryption algorithm that Bitcoin uses (ECDSA) works it is possible to generate the public key and the address from just the private key.
• A transaction is a message that informs the Bitcoin network that a transfer of ownership of bitcoins has taken place, allowing the recipient to spend them and preventing the sender from spending them again once the transaction becmes public.

 

  
 

In this part we will talk about “pooled mining” and compare the different approaches.
With increasing block generation difficulty, mining essentially becomes a lottery, as it may take years before an individual node manages to create . To provide a more smooth incentive to lower-performance miners, several pooled miners have been created. With a mining pool, a lot of different people contribute to generating a block, and the reward is then split among them according to their processing contribution. This way, instead of waiting for years to generate 50btc in a block, a smaller miner may get a fraction of a bitcoin on a more regular basis.A share is awarded by the mining pool to the clients who present a valid proof of work of the same type as the proof of work that is used for creating blocks, but of lesser complexity, so that it requires less time on average to generate.

Pooled Mining Approaches

Currently there are several pooled mining different approaches used:

• The Slush Approach – Sometimes referred to as “slush’s pool”, follows a score-based method. Older shares (from beginning of the round) has lower weight than newer shares, which demotivate cheater from switching between pools inside one round.
• The Pay-Per-Share Approach – This approach consists, in to offering an instant flat payout for each share that is solved. The payout is offered from the pool’s existing balance and can therefore be withdrawn immediately, without waiting for a block to be solved or confirmed. The possibility of cheating the miners by the pool operator and by timing attacks is thus completely eliminated.This method results in the least possible variance for miners while transferring all risk to the pool operator. The resulting possibility of loss for the server is offset by setting the payout lower than the full expected value.
• Luke-Jr’s approach – Luke came up with an approach borrowing strengths from the other approaches. Like slush’s approach, miners submit proofs-of-work to earn shares. Like puddinpop’s approach, the pool pays out immediately via block generation. When distributing block rewards, it is divided equally among all shares since the last valid block. Unlike any preexisting pool approach, this means that the shares contributed toward orphaned blocks are recycled into the next block’s shares. In order to spare participating miners from transaction fees, rewards are only paid out if a miner has earned at least 1 BTC. If the amount owed is less, it will be added to the earnings of a later block (which may then total over 1 BTC). If a miner does not submit a share for over a week, the pool sends any balance remaining, regardless of its size.
• The Triplemining approach – The Triplemining approach is to bring together a medium-sized pool with no fees and clever redistribution of 1% of every found block to allow your share to grow more rapidly than on any other bitcoin mining pool.For every found block, Triplemining redistributes 1% of the profits to all minipool owners (people with 1 or more friends mining with them). The redistribution is connected to the shares found by the members of the minipool. So if the hash rate of the minipool members equals or is bigger than yours, the part in the redistribution will be equally bigger.
• P2Pool approach – P2Pool mining nodes work on a chain of shares similar to Bitcoin’s blockchain. There is no central point of failure and thus P2Pool becomes DoS resistant.P2Pool works different from existing mining pool technologies — each node works on a block that includes payouts to the previous shares’ owners and the node itself. 99% of the block reward (the 50BTC reward plus any included transaction fees) is distributed evenly to miners based on work done recently. An additional 0.5% is awarded to the node which solves the block.
• The puddinpop approach – Another approach is the ‘metahash’ technique, used by puddinpop’s remote miner. Clients generate hashes, and also submit ‘metahashes’, which are hashes of a large chunk of generated hashes. The server checks that the metahashes are correct (in a round-robin fashion, picking up a metahash from a client that hasn’t been checked on the longest), thus preventing clients from simply claiming that they have done work without actually doing the work. The withholding of good blocks by the clients is prevented via the server being in possession of the private key, just as in the previous approach. Rewards are distributed based on the number of metahashes submitted by the clients.The generated blocks contain multiple keys in the generation transaction, giving fractional bitcoin amounts to each key, in proportion to their hashing contribution for that block. As of February, 2011, there are no puddinpop pools running.

Comparison

The cooperative mining approach (slush and Luke-Jr) uses a lot less resources on the pool server, since rather than continuously checking metahashes, all that has to be checked is the validity of submitted shares. The number of shares sent can be adjusted by adjusting the artificial difficulty level. Furthermore, cooperative mining allows the clients to use existing miners without any modification, while the puddinpop approach requires the custom pool miner, which are as of now not as efficient on GPU mining as the existing GPU miners.

Puddinpop and Luke-Jr miners receive coins directly, which eliminates the delay in receiving earnings that is required on slush-based mining servers. Additionally, the puddinpop and Luke-Jr approaches of distributing the earnings by way of including precise sub-cent amounts in the generation transaction for the participants, results in the presence of sub-cent bitcoin amounts in your wallet, which are liable to disappear (as unnecessary fees) later due to a bug in old (before 0.3.21) bitcoin nodes. (E.g., if you have a transaction with 0.052 in your wallet, and you later send .05 to someone, your .002 will disappear.).

P2Pool’s main advantage is not technical, but rather political – if all the miners mine through a few traditional pools, then the owners of those pools end up having a great amount of power over the network, while P2Pool operates without anyone having control of it.

 

  
 

Введение в Биткойн

Биткойн – это одноранговая децентрализованная электронная валюта. По своей сути, она сходна с банковским счетом в том, что ваши деньги хранятся в виде чисел в базе данных и в ходе операции система перемещает эти числа с одного счета на другой. Однако поскольку система децентрализована, база данных хранится одновременно на каждом компьютере-участнике.

Bitcoin – первая рассредоточенная таким образом валютная система, и вследствие этой структуры система не имеет посредников, взимающих комиссию с каждой вашей сделки, и не контролируется никакой организацией или правительством.

Электронная почта позволяет отправлять сообщения бесплатно в любую точку мира. Тем же отличаются телефонные разговоры по Скайпу. А теперь есть Bitcoin, дающий возможность пересылать деньги из любой точки мира в другую, забыв о каких-либо ограничениях или государственных границах, за менее чем один процент платы за сделку.

Система была впервые описана в 2008 году Сатоши Накамото в его документе, разъясняющем технологию Биткойна, который был разослан через криптографический список адресов электронной почты; а сам оригинальный проект с открытым исходным кодом был пущен в ход 3 января 2009 года. В течение первых двух лет он постепенно расширял свою пользовательскую базу, пока в конце 2010 года упоминание о нём в статье на Slashdot не стимулировало внезапный приток в проект новых пользователей и внимание к нему СМИ, а также стремительный рост цен, поскольку Bitcoin впервые по-настоящему предстал перед реальным миром. С момента своего создания, система выросла до размера более миллиона пользователей и 8500000 существующих сейчас узлов обладают общей стоимостью в десятки миллионов долларов.

Децентрализованная база данных Биткойна обеспечивает переводы между счетами (или, в терминологии Биткойна, адресами) с использованием математического алгоритма, известного как цифровая подпись. Проблема так называемых двойных расходов – отправки тех же биткойнов двум разным людям – предотвращается путём трансляции всех транзакций в сеть, которая отслеживает, какие биткойны были потрачены и в какое время, и синхронизирует эту информацию для всех участвующих машин.

Поскольку операции транслируются по всей сети, они в самой своей основе публичны. Обычная банковская система обеспечивает финансовую безопасность клиента тем, что держит в тайне записи о его операциях. В отличие от этого, Биткойн сохраняет нераскрытыми данные обладателей адресов, и тем достигается анонимность самих операций.

Когда активно участвующий в сети компьютер, который называется “майнером”, получает информацию о новой сделке, если он удовлетворен проверкой её допустимости, он добавляет эту сделку со штампом времени в конец коллективно поддерживаемого списка всех известных операций, тем самым её «подтверждая». Этот общий список называется «блокчейн» («цепь блоков»). Любая попытка послать те же биткойны снова будет отклонена, так как блокчейн обеспечивает четкое доказательство того, что монеты уже были потрачены.

Процесс добавления блока к цепи (блокчейну) был сознательно разработан как сложный, требующий времени и вычислительной мощности для выполнения. Поэтому практически невозможно создать поддельный блокчейн без наличия большей вычислительной мощности, чем в целом во всей остальной сети Биткойн. Каждый блок имеет значение, называемое хэш. Это число, математически генерируемое из данных блока с использованием функции, которая специально разработана, чтобы быть настолько запутанной, что её результат по своей природе случаен, и невозможно заранее предсказать, каким будет вывод из данного ввода. Сложность создания блока выходит из факта, что хэш действительного блока должен быть ниже некоего очень низкого “целевого показателя”. Майнеры, таким образом, вынуждены продолжать видоизменять блок, подставляя различные значения фиктивной переменной, называемой “Нонс” до тех пор, когда одному из них повезет и он заметит, что хэш одной из его версий блока падает ниже целевого показателя. В этот момент блок добавляется и процесс начинается заново. Целевой показатель автоматически регулируется так, что новый блок появляется примерно каждые 10 минут.

Каков же стимул, побуждающий майнера тратить усилия на попытки создания блоков, если на это уходит так много вычислительного времени и энергии? Ответ заключается в том, что человек, которому удаётся создать блок, получает вознаграждение. Это вознаграждение состоит из двух частей. Во-первых, производитель блока получает премию, состоящую из некоторого числа биткойнов. Размер данной премии согласован участниками сети. В настоящее время он составляет 50 биткойнов, но это значение снизится вдвое в декабре 2012 года и впредь будет ополовиниваться примерно раз в четыре года, так чтобы общее число премиальных приближалось к, но никогда не превышало 21 млн. биткойнов. Во-вторых, производитель блока вправе претендовать на любые биткойны, поступившие в оплату операций, включенных в блок. Правила сети таковы, что постоянство примерного времени производства одного блока (10 минут) поддерживается добавляемой сложностью. Таким образом, чем больше майнеров вовлечено в вычисления, тем труднее для каждого отдельного майнера создать блок.

Помимо его важности для поддержания базы данных транзакций, Добыча биткойнов также, и в первую очередь, является единственным механизмом, посредством которого Биткойны создаются и распространяются среди людей в Биткойн-экономике.

Добыча биткойнов используя центральный и графический процессор

На заре существования Биткойна каждый мог с лёгкостью находить новые блоки с использованием стандартных центральных процессоров. По мере того, как в майнинг включалось все больше и больше людей, трудность нахождения новых блоков значительно возросла, до того, что теперь среднее время, необходимое ЦП для нахождения единственного блока, мерится годами. Единственным экономически эффективным способом добычи стало использование высококачественных графических карт со специальным программным обеспечением и / или вход в майнинговый бассейн.

Некоторые пользователи Биткойна могут задаться вопросом, почему существует огромный разрыв между майнинговой эффективностью ЦП по сравнению с ГП. Ответ на этот вопрос кроется в принципиальных различиях в функционировании этих двух типов процессного оборудования и в цели их создания. ЦП спроектирован в первую очередь как гибкий исполнитель, принимающий решения в соответствии с указаниями программы. ЦП очень эффективен в следовании инструкциям типа “если – то, в противном случае – что-то иное”. С другой стороны, ГП были разработаны таким образом, что они очень хороши для видеообработки и менее ценны в отношении гибкости. Обработка видео являет собой большое количество монотонной работы, так как постоянно выполняются те же команды в отношении больших групп пикселей на экране. Для обеспечения эффективности этой функции, видеопроцессоры разработаны с упором на способность совершать повторяющуюся работу, а не на способность быстро переключаться между задачами. ГП снабжены большим количеством АЛУ (арифметико-логических устройств), в отличие от ЦП. В результате, они могут производить в большом количестве громоздкие математические вычисления, в гораздо большем количестве, чем ЦП.

Для наглядности можно представить себе ЦП в виде маленькой группы очень умных людей, которые могут быстро выполнить любое данное им задание. ГП же представляет собой большую группу относительно недалёких людей, каждый из которых сам по себе не слишком хорошо и быстро соображает, но которые могут быть обучены выполнять повторяющиеся задания, и в совокупности могут быть более продуктивны только за счёт своего количества. Повторяющаяся проверка версий хэша – процесс, лежащий в основе добычи биткойнов, – очень монотонное задание, подходящее для ГП, поскольку с каждой попыткой оно варьируется лишь изменением одного номера (так называемого «Нонса») в данных хэша.

Вот почему, в двух словах, графические процессоры способны добывать биткойны намного быстрее, чем центральные. Добыча биткойнов не требует принятия решений – для компьютера это повторяющиеся математические вычисления. Единственное решение, которое должно быть принято в процессе добычи биткойнов, это “является ли мой блок действующим” или “он таким не является”. Это отличное задание для загрузки им графического процессора.

 
перевод на русский язык Богданы Некрасовой
 
  
 

Bitcoin is a new kind of digital currency originally created by Satoshi Nakamoto in 2009. Of course, the idea of digital money is not new; for many years now we have had Paypal, credit cards, WebMoney dollars and even the virtual gold in video games like World of Warcraft. What makes Bitcoin different from anything that came before it, however, is that Bitcoin exists only on the internet, and is not dependent on any government or corporation. Instead, the Bitcoin system is collectively maintained by thousands of computers owned by various individuals around the world. Because of this, Bitcoin is able to offer a number of advantages over other methods of digital payment:

1. Bitcoin has very low fees. Technically, you do not need to pay any fees at all, although if you do not include a small fee of about 0.0001 BTC (~$0.01) transactions below 0.01 BTC (~$1) will be processed more slowly.
2. Your Bitcoin wallet cannot be frozen or seized. Some kinds of organizations – particularly political organizations, must frequently deal with Paypal or credit card companies refusing to process payments for them and even freezing their account, leaving their owners to maintain them out of pocket. With Bitcoin, there is no way for anyone to block or reverse transactions.
3. You have increased privacy with Bitcoin. Although all transactions between Bitcoin addresses are public, you do not have to tell anyone which Bitcoin addresses belong to you (to further increase privacy, most Bitcoin wallets give you a new address every time you receive money), making it very difficult for anyone to link you with your transactions.
4. Bitcoin transfers are nearly instant. When someone sends you bitcoins, you will see the transaction within five seconds, and it will usually be “confirmed” by the network within ten minutes. Accepting transactions without confirmations is sufficiently low-risk for nearly all applications, so many merchants will accept your payment immediately.
5. Bitcoin is international. Paypal is unusable in 60 countries around the world, and international payments often charge hefty fees, but with Bitcoin sending money from Kyrgyzstan to Guatemala is exactly as easy, quick and cheap as sending money to your own neighbor.

Essentially, Bitcoin does to finance what email did to our communications.

Bitcoin Wallets

In order to use Bitcoin, you need to have a Bitcoin wallet. The purpose of a Bitcoin wallet is, as the name implies, to let you receive, store and send bitcoins. To receive bitcoins, you need to have a Bitcoin address; this is a series of numbers and letters like “1McqmmnxRwZRCpD2VoGEMzCYcdeXYvCBsB” that is essentially the equivalent of a bank account number – you give your Bitcoin address out to people so that they can send you money. Your wallet will generate Bitcoin addresses for you. When you want to send money, your Bitcoin wallet will have a form where you can paste in the Bitcoin address you want to send to, enter the amount, and hit “Send”. It’s just like email or a bank account; if you just want to use Bitcoin to send and receive money that’s all there is to it.

Bitcoin wallets can be desktop programs, smartphone apps (Android only so far unfortunately; blame Apple’s policies) or websites. Here is a page listing the more popular ones.

Transactions: the Technical Description

There are three numbers connected to each Bitcoin address:

1. The private key. This is needed to sign transactions (more on this below).
2. The public key. This can be derived from the private key, and can be used to verify that a signature made with the associated private key is legitimate, without actually knowing the private key.
3. The Bitcoin addreess itself. This is the hash (a mathematical one-way compressing function) of the public key.

Here is one example of such a triple:

• Private key: c4bbcb1fbec99d65bf59d85c8cb62ee2db963f0fe106f483d9afa73bd4e39a8a
• Public key: 0478d430274f8c5ec1321338151e9f27f4c676a008bdf8638d07c0b6be9ab35c7
1a1518063243acd4dfe96b66e3f2ec8013c8e072cd09b3834a19f81f659cc3455
• Address: 1JwSSubhmg6iPtRjtyqhUYYH7bZg3Lfy1T

In order to send money to someone, you (or rather, your Bitcoin wallet) must create a file called a Bitcoin transaction and publish it to the network. A Bitcoin transaction contains five basic parts: (1) the previous transaction that originally gave you the money that you are trying to spend, (2) the public key associated with the Bitcoin address that the previous transaction was sending money to (ie. your address), (3) the destination Bitcoin address that you are sending to, (4) the amount to send and (5) a digital signature of the rest of the transaction signed by the private key associated with the same address whose public key you included. To verify that a transaction is legitimate, the Bitcoin network does the following:

1. Check the signature to make sure that (i) the transaction was signed by the private key connected with the public key included in the transaction and (ii) the transaction was not tampered with.
2. Check that the public key included in the transaction matches the receiving address of the previous transaction.

If you know (1) and (2), you know that the transaction was signed by the owner of the private key connected to the receiving address, and so they are entitled to spend the money. Every “full node” in the Bitcoin network makes this calculation, and if everything checks out the transaction is accepted.

Mining

Mining is the other important part of Bitcoin’s underlying cryptographic mechanism. The transaction system solves one major problem of security: it ensures that no one can spend other people’s money, either by making transactions themselves or by modifying other transactions in transit. However, there is still another attack that the transaction system by itself does not solve: the double spending attack. The attack works like this:

1. Alice sends 10 BTC to Bob, and publishes the transaction.
2. Alice waits for Bob to give her some product (in order to be effective, it must be some instant-transfer digital good, like a one-time code or another cryptocurrency)
3. Alice makes a transaction sending the exact same 10 bitcoins to herself, and publishes that transaction. She then floods the network with this second transaction with thousands of computers, hoping that the majority of computers will accept her transaction (thus nullifying the conflicting transaction to Bob) even if Bob’s came first.

The naive way to resolve this is by saying that the first transaction always wins. However, the problem is that this can easily fragment the network; for example, evil Eve might send a 10 BTC transaction to Alice to one half of the network and a 10 BTC transaction to Bob to the other half, and then watch in glee as Alice and Bob make further transactions and the Bitcoin network splits in half over the disagreement. To ensure consensus, Bitcoin uses the mechanism that is known as mining.

Roughly every ten minutes, Bitcoin transactions are gathered together and published in what is called a “block”. A block has certain mathematical properties that make it very hard to create – so hard, in fact, that it takes the entire Bitcoin network an average of ten minutes to create one (the difficulty of the mathematical property in question is deliberately adjusted to ensure this). The only algorithm for making blocks is basically to change around insignificant details in the block until the mathematical property checks out. This is what Bitcoin miners do – they keep on trying different values until eventually one gets lucky, creates a valid block, and the process continues from there. Note that each block also contains a pointer (technically, a hash) to the previous block, so if someone tries to change one block in the middle then the next block will need to also be re-created (there are no shortcuts here; this is just as hard as creating that block was originally), and from there the block after that will also need to be re-created, and so on. Now, what happens if Alice wants to carry out her attack?

1. Alice sends 10 BTC to Bob, and publishes the transaction.
2. Bob, being a particularly security-conscious merchant, waits for three confirmations, and sends off the good. This means that he waits until his transaction was put into a block and then two further blocks were published after it.
3. Alice sends 10 BTC to herself. This transaction will not be accepted by the network, because a conflicting transaction was already made three blocks ago. She cannot simply modify a block in the middle, because of how the blocks are linked to each other. Thus, her only choice is to replace every single block after the one that she wishes to change.
4. Even though Alice spent $100,000 on Bitcoin mining hardware, she still has a hundred times less computing power than the rest of the Bitcoin network put together. Thus, in the time that she creates the three blocks needed to catch up, the rest of the network will already be three hundred blocks ahead. Once Alice catches up to there, the rest of the network will be thirty thousand blocks ahead, and so on.

Thus, Alice’s situation is hopeless. The only way she could possibly catch up to the rest of the network is if she had more computing power than the rest of the network combined – perhaps the weakest security assumption in the entire Bitcoin system, but nevertheless a very daunting task. To date, no one has managed to do such a thing and it is getting harder for an outside attacker to pull this off every month. Since the more legitimate miners there are, the harder this gets, the Bitcoin network incentivizes mining by giving every miner that creates a block 25 BTC plus all transaction fees (about 0.25 BTC per block right now).

Should I Mine?

Probably not. Mining these days is done by computers with specialized chips known as ASICs (application-specific integrated circuits), which are hundreds of times more efficient than the average CPU. If you have a computer with a powerful graphics card, you may or may not be able to profitably mine with your GPU; you may want to check your local electricity costs, get a Kill-A-Watt to measure your electricity usage and try it out for yourself. You may also wish to consider mining Litecoin instead; there are currently no Litecoin ASICs (and when they do come out they will have less of a speed advantage), so the situation is stacked somewhat more in your favor. If you wish to own bitcoins, it is probably a better idea to buy or earn them instead.