In normal currency, a central bank would generate notes that are backed by an equivalent valuable good (ex. Gold, Jewels, etc). I am aware that's not true in modern systems because a central bank can emit more inorganic notes, but that has a direct impact in the inner value of the currency.
In this system, I can't see who is in charge of emitting the digital "note". So, how is exchange rate calculated then? Bitcoin mining is another blur concept.
Does anybody know how this actually works?
Edit: Fixing some typos
When someone sends you Bitcoins, your bitcoin software will decide whether they are fake or not. Since the entire transaction history is public, it can find all transactions to and from the person who is sending you coins, and see if they indeed have enough to pay you.
The problem is that, at first, nobody had coins. To get them into circulation a system was built: For finding a "proof of work" (just assume for now that it's something that takes a computer a certain amount of work to find), the program agrees that you earned an X amount of coins. It used to be 50 coins per proof of work, right now it's 25. It will get down to zero eventually and there will be 21 million coins in circulation. Never more.
A proof of work is easy to validate. It's like a big number is given, and you have to find its prime factors. It takes forever to search all possibilities, but once they're found, you can easily multiply them to check the validity.
So when you are sent coins, your Bitcoin program (called the bitcoin client) will check the transaction history for who found proof of works, how much they gained from it, and who sent coins to who. After this you know how much money someone has, and whether he can pay you.
It's up to your bitcoin client to use the same rules as everyone. You can decide that proof of works are worth much more or much less than everyone else agrees upon, but it will only prevent you from using the network. Most, ifnot all, other clients will reject your version of the truth.
I hope this cleared things up. It probably rose other questions, but most are asked before. Just google for it ;)
I also wrote a blogpost about Bitcoin, if you are interested: http://lucb1e.com/?p=post&id=99
As for mining... yes. Early adopters got 'free money' for buying into the system. Those with lots of computing power can more easily mine but, at present, in order to be cost effective, serious miners have had to move to custom designed hardware. It takes a serious investment and a large ongoing electrical bill to compete.
Never for free. For a much smaller cost, yes. It always required the computation or at least the effort to turn the the mining software on.
The thing in the start was that nobody believed in the currency, therefore bitcoins were practically free. After some time people started using & believing in bitcoin concept, and from there on the currency started gaining value. Same as with traditional stocks.
Yes and no. Yes, you can get money doing this, but many people are. Because of this, the difficulty has increased to a point where it's fairly hard to make money (you've got to consider the electricity costs, for example). GPUs are the minimum you need, many people use FPGAs. Recently released are the first custom ASIC chips designed solely to mine bitcoins, which will drive up the difficulty extremely sharply and push GPUs and FPGAs out of the market.
You can't generate a 'enough proof of work in a cheap manner' because the rate at which currency is handed out is fixed. You can only fight other people for the currency being generated by having more computers than them.
IMHO this puts BTC in the 'massive waste of electricity' camp.
You don't see any value in a currency that can't be counterfeited, manipulated by a central bank and also enables great privacy & low-fee transactions?
And really I rather like the idea of a central bank that is able to help stabilise currency by taking various actions, but then I'm not someone that gets upset at inflation 'stealing' value from my savings. Governments and central banks can help keep money and food prices relatively stable.
The privacy, yeah, good I guess. Low-fee... don't really care. The lack of any sort of chargeback facility makes the entire system very unattractive for someone who is not an online seller.
Although there are some ideas about how to reduce the amount of computing the network needs to prevent an attacker from forking the block chain: http://gavintech.blogspot.com.ar/2012/05/neutralizing-51-att...
Another social advantage of bitcoin is that you can make transactions without being at the mercy of a payment processor. Wikileaks vs. visa and mastercard, for example.
However I don't think it covers all the cases for a payment method, and as I say, I quite like some of the features of centrally controlled currency.