Lesson 8

Overview about Bitcoin

VIDEO: Martin Albert - What is Bitcoin

What is a Bitcoin Wallet?

Receiving or spending bitcoins is just as simple as receiving or sending emails. First of all you need a bitcoin address where other people can send bitcoins to. If you want to receive a payment, you just tell the payer your unique and personal address.

To get an email address you need a program or service. With Bitcoin it’s just the same. The program you need is called a “Bitcoin Client”. Open the program and it will provide you with a Bitcoin address and the corresponding password to spend the bitcoins previously sent to this address. The address is a long string of numbers and letters and is also called “public key”. You can share this address with anybody you want to receive payments from. The corresponding password, an even longer alphanumeric string of characters, is called “private key”. It should remain private, so don’t share this key with anybody! Whoever knows the private key of your address can spend all the bitcoins on it – just like somebody who knows your email password can read your emails and send emails from your account.

A big difference to email is that with email a potential hacker of your account needs to know both your password and your email address. In Bitcoin, however, the password or private key is enough. The hacker doesn’t need to know your public key, because the client can easily calculate the public key from the private key. That’s why you have to store your private keys at a safe place.

Some people write it down on paper or encrypt it and store it on their computer. Others, who own a lot of bitcoins, use computers that never touch the internet to store their private keys to be safe from viruses that remember everything on your desktop and send it out over the internet. There is even the possibility of storing your private key in your memory. Since it is a very long and difficult to remember string of characters, this is not very easy to do. But there are programs that help you to create a private key and the corresponding public key with a password of your choice. Make sure to choose a password that is practically impossible to hack by brute force. A safe brain wallet (this is how private keys stored in memory are called) that is still relatively easy to remember would consist of 12 random words for example.


VIDEO: Martin Albert - Why do we need Bitcoin

What are digital signatures?

A Bitcoin digital signature is a way to prove that you know a certain private key without disclosing the key itself to the public.

If you want to send 1 bitcoin from your address to another address, the client creates a message (the digital signature) that is mathematically mixed with your private key and contains the following information: the address or public key you are sending from, the amount and the recipient.

The Bitcoin network uses this digital signature to verify, whether the sender of the payment from a certain public key really knows the corresponding private key. Given the digital signature it is mathematically easy to verify that the sender used the correct private key to sign, but it is practically impossible to calculate the private key from a digital signature.

Digital signatures are different each time you create one. So even if you send 1 bitcoin to an address of your friend and ten minutes later you send another bitcoin to that same address the digital signatures of the transactions will be different. That makes them much safer than a handwritten signature used with credit card payments.


VIDEO: Christian Fernandes - Bitcoin, the better money

Inputs and Outputs – Bitcoin “Change” explained

An input within the ledger of Bitcoin transactions, also called blockchain, is an amount of bitcoins sent to a certain address. The blockchain and all addresses with an input are public.

If you want to buy something with bitcoins, the network has to verify that you have an input in your address that is at least as high as the payment you want to make. Each output you make therefore has to be compiled of one or more previous inputs. Once you use an input as an output the network considers it as spent and you cannot spend this input for another payment.

But what happens, if your account has one input of 1 bitcoin and you want to spend only 0.4 bitcoins? Whenever the output is lower than the input, the rest of the input will also be spent. However it will not be sent to the recipient of the 0.4 bitcoins, but to the same account you sent from. Now you can again spend the remaining 0.6 bitcoins of the original input using your private key. So don’t be afraid, if you see an output higher than what you wanted to pay, because you will get the “change” back immediately.


What are Bitcoin Blocks and Bitcoin Confirmations?

The blockchain consists of “blocks”. But what’s a block? When you broadcast a transaction in which you send some bitcoins to another account the transaction immediately goes into a pool of unconfirmed transactions. When miners find a new block by solving a mathematical riddle, they confirm that the transactions they choose to be contained in that block are valid. Validation of transactions is only possible when the inputs in the corresponding accounts are not lower than the outputs. So miners cannot manipulate the validity of a transaction. They only have the power to choose, which transactions they build into their block. A new block is found on average every ten minutes.

Miners enter the pool of unconfirmed transactions and group them into a block. Now the new block is set at the top of the blockchain and is considered confirmed, because miners immediately start to work on the next block on top of the latest one. If they didn’t, they would lose time in the race for the next mining reward.

Each time a new block is built it means that the older blocks got confirmed again (since they are checked also in the process). The more confirmations you get, the harder it will be for someone to manipulate the system and remove the block containing this transaction from the blockchain, since it’s buried under the other blocks that were confirmed.

It is recommended to wait for at least one hour or 6 confirmations in order to be 99.9% sure that your transaction won’t get canceled. Reversing a transaction takes planning, time and effort and a lot of computing power. Most people probably won’t go through all of that trouble for a small amount of money. So with a smaller transaction you will be relatively safe with only one confirmation.


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