Bitcoin introduction
Bitcoin has become a more and more popular payment method in recent years. Many vendors accept Bitcoin directly by now and you can purchase a variety of products on the internet. Many hosters offer dedicated servers and VPS for Bitcoins and many other services accept Bitcoin including most VPN providers. Of course you can pay your Perfect Privacy VPN account with Bitcoin as well.
Another typical use of Bitcoins is for getting gift cards. There are several websites where you can exchange Bitcoins for gift cards from Amazon, eBay, Steam and many more. Finally you can also exchange Bitcoins into Fiat currencies like US-Dollar or Euros. Several Bitcoin exchangers offer such service, you can think of them as a Bitcoin bank where you can cash out your Bitcoins to your bank account or debit card.
In this article you will find the necessary information you should know before using Bitcoin as payment method. In two more articles we describe the setup of your personal Bitcoin wallet and how to use Bitcoin exchangers. Who wants to start to play with Bitcoin software right away can read the client article with step-by-step instructions. But we recommend reading this article as well to understand the basics about Bitcoin.
How does Bitcoin work?
This article will not go into technical details but only cover the essential knowledge necessary to use Bitcoins. If you want to know more about the technical details can find a more detailed but still beginner friendly article here: How the Bitcoin Protocol works.
The Bitcoin Wallet
Anyone who wants to send or receive Bitcoins needs a Bitcoin wallet. This wallet contains the necessary information to generate Bitcoin addresses. Simply put, a Bitcoin address corresponds to a bank account number.
Bitcoin addresses are encoded with Base58. This is a special format that allows all letters and numbers except “0”, “O”, “I” und “l” to provide better readability. Typically Bitcoin addresses start with 1 or 3 and are 33 or 34 characters long. A valid Bitcoin address looks like this example: 1JWkoVVGcoBbCsvo6QwizMte7NAkubXRU2.
You can find some more details about Bitcoin addresses here: Bitcoin addresses
With a Bitcoin wallet you can generate an unlimited amount of Bitcoin addresses. This is necessary because in most cases you want to use a Bitcoin address once only. This not only makes it more difficult to correlate the address for outside people but also makes it easier for you to keep an overview: Since each Bitcoin address can have a description of your choice you can use this for information about the payment for each transaction.
It is important to understand that Bitcoins are not stored in your wallet. Instead they are stored in the blockchain. This basically is a public ledger that contains all Bitcoin transactions ever made.
Each of these transactions is verified with a cryptographic method. We will not go into the technical details as this is rather complicated and not necessary for the daily usage of Bitcoins.
An important thing to keep in mind is that Bitcoin transactions are similar to cash transactions: Once a transaction is finished, it can not be reversed. All transactions are final. For this reason you should always double check the amount and address before sending out any Bitcoins.
Also you should take extra care of your Bitcoin wallet. If it gets lost, all Bitcoins are lost as well: While your Bitcoins are still stored in the blockchain you still need your wallet to spend them.
Therefore you should secure your wallet with a strong passphrase and make backups which are stored on different external storage devices like flash drives. The strong passphrase is important so that other persons can not access your funds even should they get hold of your wallet.
The Bitcoin Client
To create a wallet you need a Bitcoin client. You have the general choice between the original Bitcoin client “Bitcoin Core” or a third party client.
Some of the alternate clients offer a number of advantages over Bitcoin Core: With so called “HD Clients” you can restore your Wallet (and your Bitcoins) even if you lose the wallet file and/or the passphrase for your wallet. To do this you need to enter a number of code words which are generated when creating the wallet. These words can be noted down and stored in a safe place. For more information on this please read the Bitcoin Client article which contains a more detailed description of HD wallets.
The second advantage of some alternative clients is that they are so called “light clients” while Bitcoin Core is a a “full node client”. The difference is that a full node client needs to synchronize the complete blockchain on the first start. This step is very heavy on CPU ressources and by now takes several days, even with good bandwidth and an i7 CPU.
Lite wallets rely on an external proxy server instead. This proxy server runs the bitcoin service and synchronizes with the blockchain. This means you don’t need to synchronize the blockchain on your own computer and the Bitcoin client is ready for use immediately. For the practical use we recommend using a HD wallet like Electrum or MultiBit HD. In the client article we will specifically describe the Electrum Bitcoin client.
The Bitcoin Exchanger
With a Bitcoin wallet you can only receive and send Bitcoins. To exchange Bitcoins into other currency you need to use a Bitcoin exchanger. The most popular ones are Bitstamp, Kraken, BTC-E and Bitfinex.
If you are registered with a Bitcoin exchanger you can buy or sell bitcoins from other users. Additionally, Bitcoin exchangers offer different methods to deposit US Dollar or Euros on your account. With these funds you then can buy Bitcoins. In the same way you can exchange your Bitcoins into Dollar or Euro again. Then you can cash out with different methods depending on the exchanger; most commonly bank wire transfer or a cashout to a debit card.
In the Bitcoin Trade article we go into more detail on how to use Bitcoin exchangers. But we recommend reading the Bitcoin Client article first because it is not recommended to store Bitcoins on an external site – Bitcoin exchangers should only be used for transactions. Longer term storage of your Bitcoins should be done with your own Bitcoin wallet.