Bitcoin for Dummies

Photo (cc) by PerfectHue

I read a lot of science fiction. It’s not all I read, but there’s something in thinking about the future and what might be possible that really clicks with me. So in 2011, when I heard there was a real thing called a “cryptocurrency” and I could own some, I sent $50 to a now infamous company, Mt. Gox, and purchased 18.1358063 bitcoins.

As of my writing this, I can sell those bitcoins for about $9,000. It’s the best investment I’ve ever made. Or rather, the luckiest investment I’ve ever made, because I can honestly say I had no idea the thing I was buying would be worth anything three years later.

And I have no idea what those bitcoins will be worth three years from now. No one really does. For every believer predicting $1 million per bitcoin, there’s someone on the other side of the fence labeling the whole thing a bubble or mirage.

The only certain thing is that there is a tremendous amount of uncertainty around bitcoins, with very large potential profit or loss for anyone thinking about owning some.

But while I can’t tell you if investing in bitcoins is good for your long-term retirement plans, I can tell you a little bit about them, and how to purchase and store them safely should you wish to take the plunge.

First, watch Money Talks News founder Stacy Johnson‘s video report, then read on for more details.

What are bitcoins?

It might be simplest to think of bitcoins as a digital commodity, like electronic gold. They can be bought and sold, traded and taxed, divided or combined, or squirreled away for a later date. If one day someone discovered a previously unknown precious metal that could somehow be sent over the Internet, that’s bitcoin.

But Bitcoin is also the network of its users, who together build and distribute a collaborative record of who owns which bitcoins. No single person is in control, complex mathematics ensure that no one needs to be, and more than $5 billion is currently accounted for within the system.

Are they risky?

Oh, yes. At this point, bitcoins are so new that no one knows if they’ll be the predominant currency of the future or end up as just another item in the long list of promising technologies that never took off. That uncertainty means the value of a bitcoin can change dramatically.

In one recent price swing — prompted by reports of a Chinese bank crackdown on bitcoin exchanges — the value of a bitcoin went from $444 on April 10 to $356 on April 11 to $437 on April 12. Now that’s volatility!

So if you are going to purchase bitcoins, do not invest more than you can afford to lose. It’s entirely possible every penny you’ve put in could evaporate tomorrow.

But despite the seemingly insane risk, money is flooding into Bitcoin because the potential upside, being among the first to invest in a brand-new currency, is so great. Predictions on the future value of a bitcoin extend all the way up to $1 million.

What are bitcoins good for?

Right now, you can use bitcoins to purchase almost anything, though not necessarily from anywhere. The number of merchants accepting them as payment is small. Depending on where you live, there might not be any local businesses taking them (you can find out on this map), and even if you find one that does, the cashier might not be trained to use them, making the whole process a giant hassle.

Since bitcoins can’t be refunded by a third party like your credit card company, you’ll have less recourse in the event a business you’ve paid cheats you or doesn’t deliver what it promised.

And the potential for your bitcoins to appreciate in value means you might not want to spend them, anyway.

So why go through all the hassle of using bitcoins? Why not just use a credit card?

Discounts. When you purchase something with a credit card, 2 or 3 percent of the purchase price gets sent off to the credit card company as a swipe fee. Retailers know that they have to pay these fees, and so typically increase the price of whatever they’re selling by 2 or 3 percent to compensate.

With bitcoins, transaction fees are optional, though recommended. The currently suggested fee works out to about half a cent, whether you’re purchasing socks or a house.

This means that retailers that do accept bitcoins often provide discounts to those who pay with them. Gyft, which allows you to purchase gift cards for hundreds of major retailers and store them on a smartphone app, offers 3 percent off through its rewards program when you buy with bitcoins.

Likewise, you can send bitcoins to a friend anywhere in the world almost instantly and with the same half-cent fee. I priced sending $100 from Seattle to France, the country my girlfriend is from, and Western Union charges between $10 to $12 to transfer the money. It’s not even close to competitive with $0.005.

Privacy. Sure, most of the things we buy online don’t require a great deal of privacy from the companies we’re purchasing from. After all, if Amazon didn’t know your name and home address, it wouldn’t be able to ship you whatever it is you bought. But that doesn’t mean you want every company you transact with online to know that kind of information about you.

Maybe you’re signing up for an online magazine and you don’t want them sending junk mail to your home. Maybe you’re privacy-conscious, and unless the company you’re purchasing from needs your address, you don’t want them to have it. Or maybe what you’re buying might be embarrassing, and you would just rather not have your name and address in their members database.

Unlike credit card transactions, bitcoin transactions do not require the company you’re purchasing from to know anything about you in order for them to accept your bitcoins. It’s like you’re handing someone a $1 bill.

Where do I buy bitcoins?

Right now, the safest place to buy bitcoins is Coinbase. It’s a Silicon Valley company with a team of tech veterans and $31 million in venture capital backing.

You’ll need to link a U.S. bank account and go through a set of questions to confirm your identity (“Which of these streets did you live on?,” “Which of these cars have you owned?,” etc.), but once you’re up and running, it’s incredibly easy to buy or sell bitcoins. Just put the amount you’d like to transact in a form and click “OK.”

Coinbase isn’t the only option, just the only one I’d recommend to my mother. The website howtobuybitcoins.info has an extensive list of places to buy bitcoins. But be extremely careful. Bitcoin exchanges have been known to disappear overnight with any bitcoins held in their possession.

Where do I store bitcoins?

Bitcoins are stored in public addresses that look like this: “1FDoodNaSmZ4vnePePDEnJtAiQNrpcGwjC.” If you want someone to send you bitcoins, you can give them one of your public addresses.

Each public address has a private key; it’s like a password. Only someone who knows the private key can spend the bitcoins stored there.

To make dealing with all of this easier, you can use a bitcoin wallet. A wallet can be either a program you download on your computer or a website where you simply log in. But it’ll help you manage all of the address and key stuff easily.

Coinbase is a bitcoin wallet. Not only can you purchase and sell bitcoins for dollars, but you can send and receive bitcoins to and from any address. So if you’ve signed up with them, then you’ve already done everything you need to do to start using bitcoins.

But you should also look at GreenAddress.it and BitGo, two additional online wallets that provide advanced security and backup features you may find beneficial.

Without getting into too much additional detail, if you’re worried about your wallet being hacked and emptied, you can also store bitcoins on paper, which you could keep in a secure location like a safe deposit box.

Creating a paper bitcoin wallet is really nothing more than printing out a public address and the matching private key. But for more information on how to do that safely, this page is an excellent resource.

If this article has piqued your interest and you’d like to learn more about bitcoins, Bitcoin.org is a great place to start.

Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.

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