#howtotrade

There are numerous ways you can use Bitcoin, but all basically involve the same process. There are three steps to using Bitcoin: acquiring Bitcoin, managing your wallet, and trading Bitcoin for goods and services. Let’s look at the steps one by one:

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1. Acquiring Bitcoin

Besides mining Bitcoin (which we discuss in Section 2), you can simply purchase it. This can be done through an online exchange or by making an Over The Counter (OTC) transaction.

OTC transactions are trades made with another individual – generally via a broker who manages negotiations. This is the favored method for those seeking to buy substantial sums of Bitcoin (i.e., in the hundreds of thousands or millions of dollars worth). This is because exchanges don’t have the liquidity to facilitate such large transactions.

Although OTC trades aren’t regulated like exchanges, a reputable broker will ensure that no fraud occurs. Some high profile brokers include China-based Richfund, New York’s Genesis Global Trading, and London-based Bitstocks.credit.

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For the ordinary Bitcoin user, exchanges, such as Coinbase, Coinmama, or itBit are the safest and easiest way to procure Bitcoin. To avoid foreign exchange fees, it’s best to buy from an exchange in your country, which are typically directly integrated with local banks.

Exchanges are straightforward to navigate. You just go to the website and follow the sign-up instructions, and you can get started buying Bitcoin right away.

What’s important to note is that most exchanges require personal information such as your name, email, and phone number. And obviously, if you’re using your credit card to buy Bitcoin, or are doing so via a bank transfer, it will have that information too.

If you choose to use an exchange, this point in the process – when you buy or sell Bitcoin – is when you can lose your anonymity.

Managing Your Wallet

On the Bitcoin network, owning Bitcoin simply means having an address and private key. As we discussed above, this private key allows you to encrypt digital signatures.

Without a private key, you have no access to your Bitcoin and no way of proving that it belongs to you, so you should keep it in as secure a place as possible.

You receive a private key when you are issued a Bitcoin address. The key is a 256-bit length of data, which can also be represented alphanumerically. For example, people sometimes use it in hexadecimal form – meaning 64 characters in the range of 0-9 or A-F. The most common option is to use the Wallet Import Format (WIF), which is 51 alphanumeric characters, the first of which is always the number 5.

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Losing your private key is like losing your Bitcoin. If you lose your private key, you cannot recover your Bitcoin. Similarly, if someone else gets hold of your private key, then he or she can withdraw all your Bitcoin.

So, how do you protect your private keys and your coins?

One option is to store your coins offline. Storing your coins and private key on a USB drive ensures that attackers and hackers cannot steal your information. However, if you lose that drive – or if someone manages to steal it physically – you’re out of luck.

Another option is to store your Bitcoin with a third-party provider – or client – that offers a Bitcoin wallet. This is a type of software that stores the addresses and key pairs for all your Bitcoin transactions.

However, the growing number of attacks these days targeting crypto exchanges have made it slightly unsafe to store your keys with them. Experts recommended you store your keys offline.

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Suppose Alice has an online shop that accepts Bitcoin payments. Bob comes to her website and places an order for an iPhone. If Bob chooses Bitcoin as the payment option, Alice would, of course, wait for the payment confirmation before sending the iPhone.

But because of the way blockchain works, Bob could try to defraud Alice by initiating two transaction messages with the same signature – one in which he sends the money to Alice, and another in which he sends it to himself at a different address.

Once Alice sees the transaction message sending her the money, she would ship the product. However, if the transaction in which Bob sends himself the money makes it onto the blockchain before the legitimate transaction, then that’s the one that’s going to go through – so Bob ends up getting his iPhone for free.

This makes it seem like if Alice were wise, she wouldn’t send the iPhone right after the transaction was broadcast; instead, she would wait until it’s on the blockchain.

But actually, not even that is good enough.

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This is because occasionally, more than one block is added at a time, creating a fork in the chain. In these instances, the next miner who finishes a block can choose which branch he wants to add to. Pretty quickly, one branch will become longer than the other. When this happens, the shorter branch is dumped, and all the transactions on it are shunted back to the mempool.

Because of this, a transaction should only be considered complete after at least six blocks are added to the chain. The transactions that have been recently added to the blockchain are sometimes referred to as hot transactions.

From this, we again see how proof-of-work – i.e., doing more computational work – secures transactions.

But let’s take a look at another hypothetical: What if Bob managed to create two branches, with one block containing the legitimate transaction, and the other the fraudulent one? And he added to the fraudulent one at the same rate other miners added to the legitimate one. Alice, seeing the branch with the legitimate transaction grow, would get a false sense of security, leading her to send the iPhone. Eventually, Bob could make his chain longer, sending the legitimate transaction back to the mempool. Because it has the same signature as the fraudulent transaction, if it gets picked up again, it will be considered invalid.

It’s an interesting hypothetical, and in theory, it could work.

But in reality, it’s impossible.

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This is because it takes computational power and time to solve and add a block. Even with an incredibly powerful processor, Bob would need to control more than half the CPU on the Bitcoin network to pull off this stunt. That’s why this concept is sometimes referred to as a 51% attack.

In reality, the branch with the legitimate transaction would end up longer, and the fraudulent transaction would get dumped back in the mempool. By the time it gets picked up by another miner, it would be considered invalid because the signature was already used in the legitimate transaction.