Cryptocurrency Explained: Bitcoin
What is Bitcoin?
In the simplest terms, Bitcoin is a cryptocurrency - a tradeable and fungible asset that is entirely digital.
Unlike the dollars you have in your pocket, which are backed by the might of the United States treasury, Bitcoin's backing comes from the comingling of cryptography and the blockchain, and is maintained by thousands of unrelated computers, spread out across the planet.
Bitcoin's Genesis
In October of 2008, Satoshi Nakamoto, a user on the cryptography mailing list Metzdowd, published an abstract to a whitepaper about a cashless peer-to-peer payment system called Bitcoin.
The image below comes from the Metzdowd archive and presents Satoshi's post exactly as it would have appeared in somebody's email. It references the Bitcoin Whitepaper, which you can read here.
Then, on January 3, 2009, Nakamoto created the first Bitcoin block, which is a bundle of transactions on a public database known as the bitcoin ledger. A few days later he processed a second block, which was cryptographically linked to the first, creating what we call the Bitcoin Blockchain.
By the way, The first block is called the Genesis Block, and you can view it on any Bitcoin blockchain explorer. If you look in the block's timestamp data you will see some extra letters and numbers - hexidecimal code - the translation of which says,
The Times 03/Jan/2009 Chencellor on brink of second bailout for banks
This inscription serves at least two purposes:
It works as a backup timestamp, as it shows the headline of the British daily newspaper, The Times, for January 3rd, 2009.
The inscription is a derisive commentary on monetary policy, specifically fractional-reserve banking, which is the global standard where banks hold a small amount of their deposits and loan the rest out - many people blame this for the financial crisis of 2008/9.
Core Concepts of Bitcoin
Bitcoin is Decentralized
All major currencies around the world are managed and controlled by that country's central bank. In the USA that’s the Federal Reserve. But Bitcoin? There is no central bank. Instead, it starts as a public ledger that tracks and records all transactions. This ledger is distributed, meaning a copy of it exists on thousands of computers across all seven continents. Anyone can access this ledger anywhere in the world as long as they have Internet access.
So, instead of having one central ledger in one location (Federal Reserve), the ledger is decentralized with no central authority governing it. This distributed, decentralized ledger contains a record of all Bitcoin transactions arranged in sequential "blocks."
As with any payment ledger, there needs to be a level of trust where everyone can agree that all the information is fair and accurate. But how can everyone be sure that the ledger is correct? This is where complex mathematics, known as cryptography, comes into play.
Bitcoin is Cryptographic
The 'crypto' in cryptocurrency comes from the mathematical field of cryptography, which is the study and practice of securing communication in a way that only the sender and intended recipient can understand.
Bitcoin and other cryptocurrencies use a hashing algorithm to turn data into a string of numbers and letters, thereby encrypting it. Bitcoin does this with the Secure Hashing Algorithm, or SHA-256, which was developed by the National Security Administration in the 1990s.
Why use cryptography? This mathematical process allows a one-way calculation using two keys - one called Public and the other Private. The public key is a stand-in for your identity on the blockchain, but the private key is how you access information.
Here's an example of a very simple encryption:
Let's start with the word CoinFlip
First, reverse it :pliFnioC
Second, turn the lower-case letters into their numerical place on the alphabet. For letters that have two numerical digits, add a "&" before and a "@" after (eg: a=1, f=6, n=&19@): &16@&12@9F&19@9&20@C
Randomly place the "$" symbol throughout: &16$@&12@$9F&19@$9&20@C$
Now we have our encrypted message as a hash: &16$@&12@$9F&19@$9&20@C$
In cryptography, this random-looking string is called the public key. In cryptocurrency it's called a public address, or wallet address. Anybody can see this hash and if it were connected to a blockchain you could share it with peers to start receiving cryptocurrency.
Without instructions for translating a coded message into something legible, the public address is meaningless. The private key or decryption key contains the decipher instructions. The intended recipient should be the only person with access to the private key.
So how does this help us with a Bitcoin transaction? On the Bitcoin ledger is a record with your unique Bitcoin wallet address that states you have the five bitcoins. If you want to send 1 of your bitcoins to another wallet, you need that wallet's public key - this allows anyone to deposit bitcoin to that wallet. But spending? Only the person with the private key can withdraw or spend the bitcoin in a particular wallet.
Bitcoin is Immutable or Unchangeable
Bitcoin's ledger is built so that it can never be changed or updated once a transaction has occurred. Instead, a new transaction must be added to the chain of transactions. All transactions are recorded in the ledger - who deposits where, and who withdraws, and from which account. These records are cryptographically linked to the previous transaction block so that you cannot tamper with any transaction without altering the block before it, and the one before that, and the one before that... going all the way back to the genesis block. This means that new information can only be added to the chain over time and cannot be deleted. Once the information has been confirmed in the blockchain, it is permanent and cannot be erased.
How Does Bitcoin Work?
Bitcoin works using a technology called blockchain. Through blockchain technology, data is spread across many different computers called nodes that manage and record transactions. Transactions are grouped into blocks and added to a chain. Each block on the Bitcoin blockchain is composed of a list of around 500 recent transactions.
Bitcoin transactions occur across the world, dozens of times per second. To make sure all the nodes agree on the validity and order of these transactions, there needs to be a consensus mechanism. A consensus mechanism is any method used to achieve agreement, trust, and security across a decentralized computer network. Consensus allows all of the network nodes to follow the same rules to validate transactions and add new blocks to the chain, therefore making sure all nodes continue on the same blockchain as it grows.
Bitcoin Mining
Bitcoin uses a process known as Proof-of-Work (PoW) to achieve consensus. In PoW, a type of node called a miner competes with other miners to solve complex mathematical puzzles using computational power. Miners "solve for the nonce" which really means guessing a number between 1 and 2^32, then adding it to the block's hash and checking to see if it happens to match the secret requirements to be considered the winner. Miners run these calculations as fast as they can, as each one wants to have the right guess, and the more guesses you make the more likely you are to win.
The network has a set time for releasing new blocks. For Bitcoin, it's roughly every ten minutes. The network can tell when there are a lot of miners racing for the nonce, so it will add digits to the solution to make it harder to guess. When the network is slow, it takes away digits, so the solution is easier to guess.
The first miner to find the correct solution broadcasts it to the rest of the network and is rewarded with cryptocurrency. The other computers add the new block to their copy of the blockchain and begin working to solve the next block.
Mining Rewards
The Bitcoin protocol works in a way that it should take ten minutes to find a new block. Every 210,000 blocks, or about 4 years, the reward for mining gets cut in half. Currently, the reward for adding blocks to the chain is 3.125 bitcoin. Because this reward decreases over time, there will never be more than 21 million bitcoin in existence. It is estimated that the last coin will be mined in 2140.
However, this doesn't mean miners will stop earning money. In addition to the block reward, miners also pick up transaction fees. Bitcoin transaction fees are associated with the time it takes to add transactions to the chain.
Bitcoin Fun Facts
Your public key on Bitcoin is pseudonymous, meaning your transactions may be traced back to your identity. Learn more on our page "Is Bitcoin Traceable?".
A fundamental aspect of Bitcoin is that every entity on the network is equal, and all transactions are considered peer-to-peer, same as cash. Other functionality has been added to network using layers on top of the main codebase
Anybody can suggest changes to the Bitcoin code by issuing a Bitcoin Improvement Proposal (BIP) to bitcoin.org. You can see updates in real-time on Bitcoin's Github.
The bitcoin code is open source and has been copied and modified by dozens of other projects in a process called "hard-forking."
The smallest unit of bitcoin is called a “satoshi,” which is equal to 0.00000001 BTC
How to Get Involved
Bitcoin has revolutionized the way we view money. Since Bitcoin's creation, miners have been investing their time and computational power into cryptocurrency. This initial investment by miners, paired with the transparency of blockchain technology, helped create a snowball effect of trust over time.
As confidence and trust in Bitcoin grow, demand grows alongside it as more people decide to invest. The price of bitcoin is determined by the economic principles of supply and demand. This means that as demand increases, then the price per BTC also increases.
Are you looking to buy bitcoin? You can do so at a CoinFlip ATM or through CoinFlip Preferred!
