Hi,
I'm completely new to this so apologies for the basicness of these questions. This is my understanding so far...
- So as far as I can tell the "wallet" sits on my PC with my bitcoins in and is secure.
For a newbie, this is a good way to think of it.
In reality, what your wallet stores is "private keys" that act as passwords that allow you permission to transfer control of bitcoins to someone else. As long as you have access to those private keys (through your wallet or otherwise) you have the necessary resources to control your bitcoins. If anyone else gets access to those private keys, then they will have the ability to take/spend your bitcoins. If those private keys are permanently lost, then the bitcoins will never again be spendable.
- I can accept money into and pay money out of my wallet directly to/from someone else.
Correct.
- If I want to 'buy' bitcoins with my local currency then I need to do this via an exchange.
This is one of the more common ways to exchange local currency for bitcoins. Another method is to find someone locally who has bitcoins and wants local currency. You can then meet up with them and give them some of your local currency in exchange for some of their bitcoins. A good place to find local people that wish to engage in such an exchange is localbitcoins.com
Assuming that my understanding is correct how am I affected if an exchange goes bust or shuts down?
You would no longer be able to use the exchange to convert your local currency to bitcoins, or your bitcoins to local currency. If you had sent any of your local currency or bitcoins to the exchange and had not yet received some of the local currency or bitcoins back, then it might be difficulty to recover your funds.
For example, I read about the MtGox thing where apparently a lot of bitcoins went missing or were stolen or whatever - but basically people got screwed out of their bitcoins. So if an exchange is just a place to exchange bitcoins with other currencies how did people lose their money? I would assume that once the transaction had gone through the bitcoins would be in the peoples wallets so they would be safe...? Or were people somehow 'storing' bitcoins at the exchange? Or did the people that lost money just happened to be in the middle of the transaction when MtGox shutdown (so they took the cash, but didn't send the bitcoins)?
I just want to try and understand how they lost the bitcoins when that happened as, from my basic understanding, it doesn't seem to make any sense?
Lets use the 'purchase' of bitcoins as an example.
First you send some of your local currency to the exchange.
Once the exchange confirms that they have received the currency from you, and that the transaction sending the local currency is not reversible, they display on their website when you log in a balance of your local currency available for you to exchange.
You then add an order to the order book requesting an amount of bitcoins in exchange for an amount of your local currency.
The exchange compares your order to other orders on the order book from other users that request an amount of your local currency in exchange for an amount of their bitcoins. If the exchange finds a match, they update your "account" with them to indicate the now reduced amount of your local currency that you have available for you to exchange and to indicate a now increased amount of bitcoins that you have available for you to exchange.
At this time, the bitcoins are still under the control of the exchange. They still "own" the bitcoins. You just have an indication on their website that they are allowing you control of that amount of bitcoins. You can:
- Exchange those bitcoins for some form of local currency through another order, updating your account with them to the new amount
- Request that the exchange now send those bitcoins directly to your wallet to put them under your complete control
- Request that the exchange send those bitcoins to someone else on your behalf
Because it was possible to request that the bitcoins be sent directly to someone else, many people found that they could just use their account at MtGox as a sort of "wallet". They simply trusted that MtGox would always be there and would always honor their request. This meant that (as long as they trusted MtGox completely) they didn't need to install any wallet software, or concern themselves with securing their wallet against loss.
Additionally, since it is only possible to place an order onto the order book for bitcoins or currency that the exchange has complete control of, anyone who wanted to try and profit by quickly "buying" bitcoins anytime the exchange rate got a bit low and then quickly "selling" those bitcoins anytime the exchange rate increased a bit would have to leave the bitcoins and local currency under the control of the exchange. They would not be able to withdraw the funds back to their own bank account (for local currency) or bitcoin wallet (for bitcoins), because it would take to long for the exchange to confirm that they irreversibly had control of the funds to be able to send them back and take advantage of small changes throughout the day.
