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How Bitcoin really works

You may have heard the hype that Bitcoin is a currency without any middle man and that you can easily transfer funds from your wallet to any other person in minutes. That is simply a lie!

There is always a middleman in the mix and if you don't pay a hefty fee, you will not be allowed to transfer your funds and you may even have trouble getting those funds you sent out back. This is how the process really works...

You start your transaction by deciding how much of a transaction fee you are willing to pay. Today (12/15/17) the default fee to get your transaction accepted within about 30 minutes is 0.8276 mBTC (or about $14.70 US dollars). And it doesn't matter how much you are trying to transfer but if you are senging funds to more than one person, the price will go up. You see, the fee is based on the amount of information that is in your transaction not the value of your transaction. So small value transactions are rediculously overloaded with a transaction fee. The next thing you do is enter the amount you want to send to the receiving person. Finally you send the transaction off.

Seems simple and you may have been told that the person on the other end receives the funds almost instantly. That too is a lie. It is unlikely that your device will ever directly communicate with the device of the person you are sending your funds too.

Bitcoin does indeed run on a  peer-to-peer network. This means that there is no central server or company that processes your transfer request. This means that the network won't go down as a whole, but it also means that you really have no idea what other computers you may be connected to at any given moment.

So your transaction goes to some random computer that you connected to. That computer will inspect your transaction to make sure it is valid and if you didn't offer a high enough fee, they will simply throw your transaction away. But lets assume you did offer enough of a fee. This computer you sent the transaction too will now pass it on to all the other computers that it is connected to. And each of them will do the same process of checking and sending your transaction on.

The person you sent the funds to will not see those funds until one of the peer computers they are connected to gets the transaction. This could take a few seconds or several minutes or even hours. It really depends on how their device is connected to the network. Many people store their wallets online so the process is fairly quick but online wallets are very insecure. The company running the wallet can be hacked or go out of business and you really have no way to get your money at that point.

But even after your transaction has been delivered, the person receiving the funds cannot spend them. As a matter of fact, that transaction is still pending as long as it is unconfirmed. So how do these transactions get confirmed?

Well confirming transactions is where miners come into the game and this is where that transaction fee comes into play. Originally, the concept was that thousands and thousands of individuals would be the miners and each would bundle up a group of transactions along with information about the previous group and do some super complex math called hashing. Then someone out of these thousands of miners would come up with a hash that works for the group and they would submit the group back to the chain. At this point, your transaction has been accepted by one miner. It is fairly safe to assume you are good but most wallets won't let you spend those funds until several additional blocks (groups) have been added to the chain. Normally 6 blocks is considered fully completed.

So the theory that Bitcoin has no middle man is utterly rediculous. Not only does it have a middle man, it has many that all have to handle your transaction, examine it, process it and someone is taking that fee you paid. The fee goes to the one miner that solved the hash the others are out of luck. And in this day of Bitcoin, there are a hand full of big miners and all the little guys are simply working as teams known as pools. The pool is run by a miner that passes out packets of work to all the little guys. They all work together and if a pool solves the hash, the reward is devided up between all the pool miners based on how much processing power each provided with the pool operator taking a slice as well.

Now this process is robust in the fact that there is no central point of failure. There is no single company in control forcing its rules on you. But it fails in many other places. It is a very slow and bulky process. It is easy for funds to be lost or stuck. If you get tricked or scammed, there is no way for you to get your money back. If things aren't working, there is no one to complain to. Because there is no one in charge, you are on your own when things go bad.

Centeralized banking and credit cards on the other hand are very fast. Thousands of times faster actually. You are guaranteed that the transaction is valid before you finish communicating sending your funds. There are far fewer steps in the mix. And the transaction fees are very low when compared to the cost of Bitcoin transactions when you are talking about every day size transactions. As of this December 2017, standard banking fees are far less than Bitcoin fees as long as your transaction is under $500 US Dollars. Above that then Bitcoin starts to win because the fee charged in standard transactions is based on the amount of money being moved but with Bitcoin it is the amount of information being moved. And transfering large or small amounts of Bitcoin use about the same amount of data. So if you are trading thousands or millions of dollars worth of Bitcoin around, the fees are trivial. But if you are doing normal daily business with every day items, your fees are outragious.

All in all, Bitcoin is a very poor form of currency. You may want to read my article that explains this issue more: Bitcoin will never be "real money"

As an investment, you are taking a hefty risk but you could get a big reward. The only catch is the amount you need to invest right now to make it worth the effort. Keep in mind that you need to pay fees to get your cash into the system and then more fees to get it back out. You also need to buy low and sell high before the bottom falls out.

 

Here are a few YouTube videos that you may enjoy on this subject:

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