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I thought I understood the gist of what "bitcoins" are: electronic currency tokens representing $X USD that could be used to trade, buy or sell online items.

But recently I heard the term "mining for bitcoins" and it piqued my interests...

I read this article and still feel like I'm missing the bigger picture here.

If I understand "mining" bitcoins correctly, then:

  • Bitcoin mining is the act of setting up a commodity hardware cluster to try and "crack" some cryptographic puzzle
  • When you finally crack such a puzzle, you are rewarded in bitcoins
  • You can then, theoretically, sell bitcoins for real money

So to start, if anything I have said so far is off base or needs correction, please begin by clarifying what bitcoins and/or bitcoin mining is!

Assuming I am more or less correct, then I have several questions that (surprisingly) have been nearly impossible to find answers for:

  1. Who issues these puzzles and validates a correct answer?
  2. Who brokers the generation and awarding of "mined" bitcoins (after you've cracked the puzzle)?
  3. Isn't this (really) just a crytpographic game? You play the game, and you win, except you get money. But there's no reason why someone would need you to be cracking these randomly-generated crypto puzzles.
  4. When new "puzzles" are generated, and new bitcoins are generated and awarded to the people who correctly solve these puzzles, doesn't that dilute the value of each existing bitcoin? Not an economist here, but if you have more of something, it's value usually goes down since it's not as scarce.
  5. Is it even worth a programmer's time to delve into this stuff or is the bubble already bursting?

To me it seems like bitcoins are just a game that has been disguised to as a pyramid scheme that has been disguised as a legitimate radicalization of e-commerce. Thanks in advance for any help/insight here!

marked as duplicate by Stephen Gornick, eMansipater, cdecker, o0'., Stéphane Gimenez Apr 29 '13 at 12:20

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migrated from programmers.stackexchange.com Apr 28 '13 at 14:03

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  1. The puzzle is to find ordering and choice of pending transactions with certain restriction of hash and put the into a block. Therefore the puzzle is part of system. The verification is done by everyone - every time you connect to bitcoin you verify that block chain you have received is valid. If it is not you just reject it.
  2. No one awards them. Simply the person who puts a block is allowed to add note that he put it at the end. (S)he is awarded the benefits of putting it (transactions costs and the mining award)
  3. Bitcoin mining as activity can be viewed in this way but it is not the only way of viewing it. In gold standard when you gold mine you are playing 'a game' however it is not the main purpose of money in such system.
  4. Yes. However there is limit of how many bitcoins will ever be produced and you know exactly the schedule. The increase of money supply can be offset by money demand. In the end the only award for minings will be voluntary transactions costs (on the other hand as miner picks the transactions it is presumed that the highier the donation the faster the transaction will be processed).
  5. I won't answer it but technically you can image say a country adopting bitcoin as official currency. This is for you to decide.

I believe there are several in-depth answers you can find on the web. I belive there is episode of Security Now, Linux Outlaws as well as bitcoin wiki which can answer further questions. My guess is that bitcoins per se were not design as scheme and mining in principle can be seen similar to gold one (assuming gold had no other purposes then currency) with possibility of gold fevers. If it will survive I don't know.

In any case please do NOT consider this answer as investment advice (or any other advice).

EDIT Simple explanation of terms as I understand them

  • Transaction: Any sending from one bitcoin address to others is transaction - it is not revertable. The transaction is verified by the sender private key but all transactions are public (bitcoin is not anonymous - even the amount of money on the account is visible). Once it is done the transaction is pending. You may set a transaction cost to ensure quicker processing of it.
  • Block: Block is a set of transactions that have been confirmed. They are verified by hash which, in addition, needs to fulfil certain requirements like number of 0-s at the beginning (the proof-of-work). Person who created a block is awarded all of the transactions costs and up to the point a bonus (currently 25 bitcoins). Currently the latter is main benefit of mining. However in future the award will be 0.
  • Block chain: Block chain is chain of blocks. As this is distributed systems the histories might diverge - as general rule the longest wins (first in case of ties).
  • Thanks @Maciej Piechotka (+1) - Although I appreciate your input enormously, there's one bottleneck in your answer that is preventing me from understanding anything else. In #1 above, you use the terms "transaction", "block" and "block chain". Looking these terms up on Bitcoin's wiki, they are all vaguely defined without any concrete examples of what these terms actually mean. Can you please give me a simple, concrete explanation of what these terms mean, and perhaps even use them in a real example? Thanks again, and of course, I know this is not investment advice! – TicketMonster Apr 28 '13 at 11:50
  • @TicketMonster: I haven't look at bitcoin for a long time. I'd recommend to look on Security Now episode for technical explanation in detail. I've tried to add the explanation from my memory. Blocks are public so you can see them online: blockexplorer.com/b/233561 – Maciej Piechotka Apr 28 '13 at 12:11
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    @TicketMonster: A transaction is a record of some amount of bitcoins being transferred between two accounts. Recent transactions are collected in blocks, and take part in the mining process in such a way that it validates the legitimacy of the transaction (and prevents things such as double spending). All validated blocks form a chain, and the further back in the chain a transaction is, the more certain is its legitimacy. – Michael Borgwardt Apr 28 '13 at 13:48
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    @TicketMonster If someone were to try and manipulate the system, it would create a forked block chain, and the longest part is considered "correct". For the manipulation to be successful, the manipulator would have to control more than half the computation power involved in the mining process. – Michael Borgwardt Apr 28 '13 at 13:50
  • Thanks @MichaelBorgwardt (+2 both) - I'm beginning to understand this, but have a few followups (for anyone): (1) Why have blocks at all? If a block is a collection of transactions, and a block "chain" is a chain of blocks, why have blocks at all? Why not just chain transactions together? (2) I'm still not understanding what is being computed/solved by these bitcoin generating machines: they create a block by solving a crypto problem, but how is that possible if a block is a collection of existing transactions (that already took place)? Or is a block an empty container for transactions? – TicketMonster Apr 28 '13 at 14:16

The important thing about the economics of bitcoin mining is that the cost, in electricity, of generating a new coin is very significant.

The overall bitcoin system is designed to be mathematically self-limiting, so there is no way even in principle for anyone to fabricate bitcoins by any other means. Unlike ordinary currencies, "the fed" can't print money, and unlike gold, no miner will ever discover a seam of bitcoin gold that will flood the market.

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