What is Bitcoin? ...and is it safe?

After two years I’ve decided to post an update on my blog to answer two questions that friends and colleagues have been asking in the past months. The questions are ‘Do you know about Bitcoin?’ and ‘How safe is Bitcoin?’

The answer to the first question is Yes, I do know about Bitcoin, how much I know? is another question, but let’s start with the basics! Bitcoin is a virtual currency, which means that no physical money is used in the transactions, and it has three main characteristics:

1. It uses concepts of cryptography to make transactions and to control the amount of bitcoins created.  For this reason that Bitcoin can be defined as a crypto-currency
2. It’s based on a peer-to-peer payment without intermediaries like financial institutions to establish rates, and
3. It’s decentralised, which means that nobody controls it or has authority over it.  This is the main difference compared to other currencies, where banks and governments control the production of the currency as well as the transactions

The process to create bitcoins and make transactions is a little technical and there are already great articles, videos and websites that explain this process in detail. Hence, if you are really interested in understanding how the Bitcoin protocol works I recommend the following sources:

• Bitcoin.org
• Paper by Satoshi Nakamoto (creator of Bitcoin)
• And my favourite, an Infographic created by Joshua J. Romero, Brandon Palacio and Karls S. Inc., explaining how a Bitcoin transaction works (see image below)

Bitcoin is not the only crypto-currency on the market, but it is probably the most common one used these days, even being adopted by well known retail businesses (e.g Victoria's secret, Target, and eBay) as well as casinos (e.g. Golden Gate and D casino in Las Vegas).

The special characteristics of Bitcoin make it attractive to many people and businesses, including terrorists, fraudsters and money launderers.  The fact that terrorists have quickly adopted Bitcoin, and that Bitcoin has enabled alternative ways to launder money raise significant concerns about an increase of illicit activities.  Hence, Banks, Government Regulators and Law Enforcement don’t see any benefits, but troubles in crypto-currencies like Bitcoin.

Eventually, Law Enforcement and Governments will find ways to apply regulations to digital currencies, which is not a bad thing and will help to change the view of Bitcoin as a currency of the black market.  I consider that regulations are key to the success of any virtual currency as far as it doesn’t limit the innovation.

In relation to security, I think Bitcoin as a protocol is well designed, but it’s not 100% safe (most systems and protocols aren’t). Bitcoin security could be in danger if cyber-criminals take advantage of the 10 minutes delay that exist between each transactions to commit fraudulent activity or make use of quantum computers to deduce private keys. However, for this last threat the protocol could be modified and it will take some time until actual quantum computers are used to exploit the vulnerabilities of Bitcoin.

Most of the times, the security problems with Bitcoin transactions don’t lie in the protocol itself, but in the techniques to store the private key required to send and receive bitcoins. The application used to store the private keys is called wallet, and there are different types of wallets available, where offline wallets are perhaps more secure than online wallets.

I like to think about the security of Bitcoin wallets as normal cash wallets, where you, as individual, are responsible for the security of your wallet. With wallet applications you take similar risks to wehn you go out with cash in your wallet.  For example;

• When you have cash with you, it’s your responsibility to take care of it. No bank will reimburse for cash that was stolen; different story if it is a credit or debit card.  In the case of Bitcoin, if someone get’s to know your private key and steals your bitcoins, nobody will cover your loss.
• If thieves don't have access to your wallet they can't steal it. Similarly, if your wallet can't be accessed or it's accessed but it's protected they won't be able to steal your money.
• Losing your wallet with cash means losing your money.  With Bitcoin if you have lost your wallet and it’s secured nobody will be able to spend the bitcoins in it unless they get the private key from you.

Many reported Bitcoin security incidents are associated with wallet’s security breaches.  Therefore, everybody should spend some time deciding which type of wallet to use, which are the advantages, disadvantages and risks of each option before using Bitcoin.

Personally, I consider Bitcoin a great innovation that enables many possibilities for all countries and most of them haven’t been discovered yet. However, likewise with the Internet back in mid-90s, not all people believed in the success of that global computer network that enabled a new form of interaction between individuals and businesses. It is possible that Bitcoin doesn't succeed in a long term, but the concept of cryto-currencies will do.

Bitcoin is in early stages and the price of each bitcoin will continue fluctuating drastically in the next months. Thus, my final advice for anybody who thinks of using Bitcoin is to spend time understanding the high risk that it involves and stop thinking about saving bitcoins as an opportunity to become rich in a short time.