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Bitcoin for beginners, Part 1: The economics and use of Bitcoins

Using the Bitcoin network for e-commerce and online transactions

By Dirk Merkel, JavaWorld.com, 11/22/11

Whether you are interested in Bitcoin as an open source software project, peer-to-peer network, or decentralized virtual currency, insight into its many facets will help you make sounder decisions about implementing it. In this article (one of three parts) Dirk Merkel gives an overview of Bitcoin, discussing its characteristics as a peer-to-peer network and decentralized currency. He also explores motivations for contributing to the project or implementing it in online transaction systems, as well as some of the pitfalls of doing so.

Since its inception in 2007, Bitcoin has captured the imagination of many people, including software developers, consumers, and economists. Numerous factors have contributed to the project's popularity and mystique, not least the fact that its creator used a pseudonym to remain anonymous and has publicly withdrawn from the project (see Resources). As an open source software project, peer-to-peer network, and decentralized virtual currency, Bitcoin is applicable to a range of private and commercial interests. Its social implications have also made it a matter of public interest, and widely discussed in mainstream media. And Bitcoin's maintainers have effectively used peer-to-peer networks and public-key cryptography to spread Bitcoin's message and proliferate the technology.

This three-part article attempts a well-rounded introduction to Bitcoin. In this first part we'll explore some of the motivations for creating and using Bitcoin, as well as discussing characteristics of a Bitcoin implementation. In Part 2 we'll dive into some of the theory and design of Bitcoin, including its elegant solutions to certain problems inherent in currencies and payment systems. Part 3 will be your chance to put some of what you've learned to practical use with BitCoinJ, a Java implementation of Bitcoin.

Motivations for developing and using Bitcoin

Several factors seem to have motivated Bitcoin's creator and the many enthusiasts who use and contribute to the project. So let's start by considering those motivations and how well they are reflected in Bitcoin as a whole system.

Voluntary transaction costs

First, Bitcoin aims to eliminate the need for a third-party (such as a credit card company or PayPal) to mediate online transactions. This is a cost motivation, since electronic transactions often involve fees. For credit cards, transaction fees are typically in the 1.5% to 2% range.

By enabling direct transfer of funds from one user to another, Bitcoin eliminates the need for an intermediary. Users like the fact that transaction costs are thus extremely low; in fact the transaction fee is at the discretion of the person making the payment! Any fee paid is viewed as an incentive for the Bitcoin network to confirm the transaction. The higher the fee included in a transaction, the faster and more likely it is that the transaction will be confirmed. As of the current version of the Bitcoin client application, the minimum transaction fee is 0.0005 BTC (BTC is the currency symbol for Bitcoins).