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Jason Ogaard: A bit of knowledge on bitcoins

Currency is basically the foundation of a society. We trade our services for it, and then use it in exchange for goods and services from others. Historically, a currency is issued by some kind of central authority, such as a government.

A few years ago, Satoshi Nakamoto decided he was going to create his own currency.

One of the ways to secure traffic on the Internet is through a digital signature. That signature doesn’t let anyone but the keyholder read the message. No one could fake your signature unless they were to get your key. Nakamoto took this idea and applied it to a digital currency.  Here’s how it works: say I have one bitcoin and I want to give my bitcoin to Jim. I could write a message with my key stating ‘I give Jim my bitcoin.’ If Jim wanted to pay someone else, say Bob, he could write a message stating that Jim gives his bitcoin to Bob along with the message from me. This way it is verifiable that the bitcoin went from me to Jim to Bob. Bob could then pay someone with this bitcoin in a similar manner.  

But what happens if I am a dastardly person and after I give Jim my bitcoin, I decide to go give my bitcoin to Charlie, as well? I could do this because I can sign as many bitcoins with my key as I want to. This is a big problem. Well, Nakamoto came up with a clever solution to this problem.

When I give Jim my one bitcoin, we would broadcast that transaction to everyone we know, they would pass it along to everyone they know and so on. This way, if I gave Jim my bitcoin and later tried to give Charlie my bitcoin, everyone would know that I already gave it to Jim. But what if I were to try to give Jim and Charlie my bitcoin at the same time. How would we know who the rightful owner is? There is a network of people running machines all the time to verify these transactions that would sort this out.

What would happen is this: I give you and Charlie my one bitcoin. When the transaction occurs, it is broadcast to the bitcoin network. The network votes on who would the winner should be. After several rounds of voting for the same winner, the winner is announced. This usually only takes a few minutes. So why would people spend time and money on computers that essentially vote on transactions?

Every bitcoin transaction carries with it a fee. That fee is divided up between the machines that voted on it based on how much processing power they spend on it. Voting is also how new bitcoins are awarded. When you hear that someone is mining bitcoins, they are running the program that votes on transactions. Every time they vote, there is a small chance that they could be awarded a block of newly minted bitcoins. Considering the price of bitcoins today that can add up to a lot of money.

The value of bitcoins is determined by many factors. They are traded just like any other currency on exchanges for bitcoins. Many vendors today accept bitcoin as a payment method with more vendors accepting them every day. As more vendors accept bitcoins, they will become more desirable.

Don’t mistake bitcoins as an anonymous currency. Since we have to broadcast our transaction, everyone will know that I gave you my bitcoin. But we aren’t broadcasting our names or anything very personal, just our addresses. Bitcoins right now are a volatile investment and fun to watch; but they have the possibility to be disruptive in the financial system. Other variants of crypto currencies have popped up and are becoming popular in their own right. You could create your own, too, if you want.

JASON OGAARD was born in Bemidji and is a software engineer for FICO, a Minneapolis based public company providing analytics and decisionmaking services, including credit scoring credit bureaus.