Important Stuff for New Bitcoiners

caution with bitcoin

The list below contains some essential information for those wanting to get started with Bitcoin. Hopefully it will help you avoid some common pitfalls and headaches.

  • Bitcoin is not inherently anonymous

    Bitcoin is pseudonymous. Bitcoin transactions do not contain any personally identifying information, but every transaction contains the Bitcoin addresses of the sender and the recipient(s) of the transaction. All transactions are permanent public data available for anyone to inspect.

    If your real identity can in anyway be tied to one of your Bitcoin addresses, all transactions involving that address can be traced back to you. This commonly occurs when you disclose ownership of an address, for example, by publishing a Bitcoin address on a public website (e.g. personal blog, forum, or social site), or supplying an online exchange with your real identity for verification purposes. Additionally, using a Bitcoin tumbler or mixing service can help if you’ve entered into this scenario.

    Also, an entity that can analyze significant portions of internet traffic (i.e. the NSA) could potentially determine the IP address of the sender of a Bitcoin transaction. However, using network tools such as a 3rd party VPN or the Tor network to broadcast transactions may assist in circumventing this type of network analysis.

    Physical cash is more anonymous than Bitcoin.

    For more details, see Using Bitcoin Anonymously.

  • You need to keep your Bitcoin wallet secure

    Security is an essential part of bitcoin ownership. Hundreds of thousands of bitcoins have been irrevocably loss due to theft, hard disk failure, and forgetfulness. Protecting and backing up your wallet is a must.

    Offline and encrypted wallets are the most secure option, but can be susceptible to physical theft, loss, or forgetting one’s passphrase. See my guide to selecting a wallet for best security practices and backup procedures. Additionally, take a look at The Piachu’s Basic Security Guide on reddit. It covers the basics of being a security conscious Bitcoin user.

    If you are storing your bitcoins with a 3rd party, make sure they are reputable, trustworthy, and have stringent security practices for storing bitcoins, like using a cold storage method for the majority of their funds.

  • Don’t store large amounts of bitcoins in an online wallet

    There have been many cases of 3rd parties losing or stealing bitcoins. Reasons are typically hacking, theft by the service operator, or loss due to technical reasons.

    If you must use an online wallet, try to keep the amount of bitcoins stored there to a small amount. There’s always a chance you’ll never get them back.

  • Don’t use a brain wallet unless you know what you’re doing.

    Brain wallets are Bitcoin private keys programmatically generated using only a passphrase. This eliminates the need to store a wallet file on a computer. Anyone with knowledge of the passphrase can generate the private key and spend any bitcoins belonging to it.

    Automated bots around the world have already generated millions of brain wallets with common passphrases. They monitor the block chain for transactions sent to these wallets. If your brain wallet password is a common set of words, a phrase found in a book, or a line from the movie, any bitcoins sent to it will be stolen within a matter of seconds. Humans are poor sources of randomness and hence come up with non-random passphrases. So only use a brain wallet if you are extremely confident your passphrase could never be discovered.

  • Transactions are irreversible

    Once you’ve sent bitcoins and the transaction has been sufficiently confirmed, the transaction cannot be reversed. There is no way to get your bitcoins back. So be extremely careful when you enter the amount and recipient address of a Bitcoin transaction.

    If a transaction has not been sufficiently confirmed (6 confirmations is generally agreed to be sufficiently confirmed), it can be possible for a subsequent conflicting transaction to be accepted rather than the original, unconfirmed transaction. Known as a double spend attempt, this can occur if the conflicting transaction is quickly broadcast to the network after the original. Typically, a miner will only accept the first transaction seen on the network, and ignore the subsequent conflicting transaction. But some miners have been known to choose the conflicting transaction if it pays a higher fee. Additionally, the conflicting transaction can be broadcast quickly enough to appear as the first transaction to other nodes on the network. If two miners solve blocks at roughly the same time, a block chain fork can occur: two different versions of the transaction ledger existing at the same time.

    Eventually, one of the transactions will become valid and the other ignored. If one of the transactions was included in a block first, the other will be discarded. If a block chain fork has occurred, eventually one version of the block chain will become longer than the other, and the transaction in the longer chain will be considered valid.

    Thus, if you are accepting bitcoins as payment for a physical item, you should wait until the transaction is sufficiently confirmed before handing off the merchandise.

  • Don’t invest more in Bitcoin than you can afford to lose

    This should go without saying, but if you’re spending your money on bitcoins, be prepared that it could lose most or all of its value. The price is currently very volatile due to a number of reasons:

    • Bitcoin is very young and is still gaining the trust of the general public.

    • Public trust and interest is heavily swayed based on Bitcoin related events and media coverage.

    • A majority of bitcoins may be owned by a tiny percentage of the public, which potentially allows these folks to manipulate prices. An example tactic is selling huge amounts of bitcoin during panic sell events, and buying huge amounts once the price bottoms out.

    Although unlikely, if a fundamental flaw is found to exist in the Bitcoin protocol, it is very possible that the price of a bitcoin could be reduced to nearly nothing.

  • Mining is only profitable with expensive ASIC computers

    In the early days of Bitcoin, blocks were mined using the CPU’s of the first adopters’ personal computers. Today, most mining is done using ASIC computers with hardware specifically designed to do one thing only: mine bitcoins. Since the release of ASIC Bitcoin hardware, the mining difficulty has skyrocketed. Thousands of people have purchased and run these computers 24 hours a day, 7 days a week, pushing the difficulty higher and higher.

    Unless you can afford to spend tens of thousands of dollars on mining equipment, the startup and electricity costs will be far greater than could be earned by mining bitcoins.