Bitcoin, the first decentralized cryptocurrency and payment system in the world, was launched by an unknown creator named Satoshi Nakamoto in 2009. Cryptocurrency refers to digital assets that are protected and verified by cryptography, a scientific method of encoding or decoding data. These transactions are stored on computers all around the globe using a distributed ledger technology called Blockchain.
It was first published in Satoshi Nakamoto’s Bitcoin whitepaper – Bitcoin: A Peer-to-Peer Electronic Cash System in 2008, describing the cryptocurrency’s technical specifications and motivations.
Bitcoin can be broken down into smaller units called “satoshis” (up to 8 decimal places). These are used for payments and also serve as a store value, like gold. The reason for this is that the price of one bitcoin has risen significantly since its inception, from less than a penny to tens or thousands of dollars. Bitcoin is known by the ticker symbol BTC when it is discussed as a market asset.
When discussing cryptocurrency, the term “decentralized” is often used. It simply refers to something distributed without a single central location or controlling authority. Bitcoin, as well as many other cryptocurrencies, is decentralized. The technology and infrastructure that regulate its creation, supply, and security do not depend on central entities like banks or governments to manage them.
Bitcoin, instead, is designed so that users can directly exchange value with each other through a peer-to-peer network. This type of network allows users to have equal power and connect directly to one another without any intermediary or central server. This allows data to easily be shared and stored.
The Bitcoin network (capital B, when referring both to the technology and the network, and lower-case “b”, when referring to the actual currency, bitcoin) is open to everyone. This means that anyone with an internet connection can join the network without restrictions. Open-source means that anyone can access and share the source code on Bitcoin that was created.
The easiest way to comprehend bitcoin is to see it as the internet for money. It is completely digital. No one owns it or controls it. It runs 24/7 and anyone can share data with it. Imagine if everyone could use the internet to create an ‘internet currency’ that they could all use to issue and pay each other. This is why bitcoin is essential.
Alternative to fiat currency
Nakamoto created bitcoin originally as an alternative to traditional money. His goal was to make it a global legal tender so that people could use it for purchasing goods and services.
Bitcoin’s price volatility has hampered its utility as a payment method. Volatility refers to how an asset’s value changes over time. Bitcoin’s price can fluctuate dramatically from day to day and even minute-to-minute. This makes it less of a good payment option. You wouldn’t pay $3.50 for a cup of coffee, and then 5 minutes later it’s worth $4.30. It doesn’t work for merchants if the price of bitcoin drops dramatically after the coffee’s been handed over.
Bitcoin works differently than traditional money. It’s not issued or controlled by a central banking institution, has a fixed supply (which prevents the creation of new bitcoins at will), and its price is unpredictable. Understanding bitcoin’s differences are key.
What is Bitcoin?
It is important to know that Bitcoin has three components. Together, they create a decentralized system of payment.
- The Bitcoin network
- Bitcoin (BTC), the native cryptocurrency of Bitcoin, is also known as bitcoin.
- The Bitcoin blockchain
Bitcoin works on a peer-to-peer network. Users, typically individuals or entities looking to exchange bitcoins with other users on the network, don’t need intermediaries to execute or validate transactions. You can connect your computer to the network directly and download its public ledger, which contains all historical bitcoin transactions.
This public ledger is based on a technology called “blockchain,” also known as “distributed ledger technology.” Blockchain technology allows cryptocurrency transactions to be authenticated, stored, and ordered in an immutable and transparent manner. For a payment system that is based on zero trust, transparency and immutability are crucial attributes.
Every transaction that is confirmed and added to the ledger is updated by the network to reflect any new changes. It is like an open Google document, which updates automatically whenever anyone has access to its content.
The Bitcoin blockchain, as its name suggests, is a digital string consisting of chronologically arranged “blocks” — bits of code that include bitcoin transaction data. It is important to note that bitcoin mining and validating transactions are two separate processes. Mining can still take place regardless of whether transactions are added or deleted from the blockchain. The rate at which miners discover new blocks are not affected by an increase in Bitcoin transactions.
No matter how many transactions are still waiting to be confirmed by Bitcoin, new blocks will be added to the Blockchain approximately every 10 minutes.
All network participants can track and evaluate bitcoin transactions in real-time due to the open nature of the blockchain. This infrastructure decreases double-spending, which is an online payment issue. Double spending is when two users attempt to spend the same cryptocurrency.
Bob might send 1 bitcoin to Rishi and Eliza simultaneously.
Because reconciliation is done by a central authority, double spending in traditional banks is not possible. This is also not a problem for physical cash, as you cannot give two people the same dollar bill.
Bitcoin has many copies of the same ledger, so all users must agree on the validity and legitimacy of every transaction that occurs. This is known as “consensus” and it involves all parties.
Every bitcoin holder is responsible for verifying and updating all balances, just as banks update their users’ balances regularly. The question is, how does the Bitcoin network make sure consensus is reached, even though there are many copies of the public ledger scattered around the globe? This is called “proof-of-work.”
What is proof of work?
To validate transactions and protect the Bitcoin network, computers use the proof-of-work process (PoW). The Bitcoin blockchain’s consensus mechanism is proof-of-work.
Although Proof-of Work was the first and most popular type of consensus mechanism for cryptocurrency that runs on blockchains, there are many others. Most notably proof-of-stake PoS), tends to use less computing power (and thus less energy).
After proving their commitment to the network, proof-of-work elevates some network contributors to the position of “validators”, more commonly known as “miners,” they must demonstrate their commitment by dedicating a large amount of computing power to finding new blocks. This process typically takes around 10 minutes.
The successful miner who discovered a new block through the mining process is rewarded with 1 megabyte of valid transactions. The new block is added to the chain, and everyone’s copy is updated with the new data. The miner gets a bitcoin amount and any fees they incur by adding transactions to the chain. A “block reward” is the new bitcoin that’s created and given to successful miners.
Bitcoin users must pay a network fee every time they send a transaction. This fee is usually based on its size before the payment can go to validation. It’s like purchasing a stamp to send a letter.
To ensure that your transaction is processed quickly, the fee must match or exceed other participants’ average fees. To make as much money as possible by filling new blocks, miners must pay for their electricity and maintenance.
The average fees for the Bitcoin mempool can be viewed. This can be compared to a waiting area where unconfirmed transactions remain until they are added to the blockchain by miners.
How was bitcoin created?
When miners add new blocks to the Blockchain, the Bitcoin network releases newly-minted bitcoin automatically to them. The total bitcoin supply has a limit of 21 million coins. This means that once 21 million coins are in circulation, the protocol will cease minting new coins. Bitcoin mining acts as both transaction validation and issuance. Once all coins have been mined, it will function only as the transaction validation process.
It is important to note that increasing the computing power used for bitcoin mining does not necessarily mean that more bitcoins will be mined. The chances of getting rewarded with the next bitcoin block are increased by miners who have more computing power. Therefore, the amount of bitcoin mined is relatively stable.
The Bitcoin network uses a coin distribution method called ” Bitcoin halving”. This ensures that miners receive less bitcoin over time. The idea behind it is to reduce the amount of bitcoin in circulation slowly, which will support the asset’s value (based on fundamental principles of supply-demand).
The bitcoin halving, sometimes called “halvenings”, occurs approximately every 4 years or 210,000 blocks. Each successful miner was awarded 50 bitcoin (BTC), as a block reward when the bitcoin protocol was first launched in 2009. Fast forward to 2021: Block reward amounts are now 6.25 BTC. This reduction from 12.5 BTC before the bitcoin halving of May 2020.
The next halving will take place in 2024. Block rewards will drop to 3.125 BTC, which is the same time as the previous halving. This will continue until there are no more coins to mine.
There are currently 18.7 million bitcoins in circulation, which means that there are only 2.25 million bitcoins left to be mined. It is estimated that the last bitcoin mined will occur around 2140, taking into account the halving principle, and other network factors such as mining difficulty.
What is a Bitcoin wallet?
A bitcoin wallet is software that runs on a computer, or a dedicated device and provides all the functionality needed to send, receive, and secure bitcoin. Contrary to popular belief, bitcoin is not kept in a wallet. The wallet stores the cryptographic keys, which are essentially highly specialized password that proves ownership of a certain amount of bitcoin on the Bitcoin network.
When a bitcoin transaction takes place, ownership of the bitcoin is transferred from the sender and the recipient. The network then designates the keys of the recipient as the new password for accessing the bitcoin.
To protect its blockchain’s integrity, Bitcoin uses public-key cryptography (PKC). PKC was originally used to encrypt or decrypt messages. It is now used to protect transactions on blockchains. Only those with the correct keys can access certain coins using this system.
Two types of keys are required to execute and own bitcoin transactions: a private key and a public key. These keys are strings of random alphanumeric characters that can be used to decrypt or encrypt transactions. PKC uses one-way mathematical functions on the bitcoin network that are simple to use and nearly impossible to reverse.
To create a public secret key from the private key, the blockchain uses a one-way mathematical algorithm. This makes it virtually impossible to generate a public key from a private key. You will also receive a public address, which is the hashed version of your public keys.
The address works in the same way as a house address and can be shared to receive bitcoin. The private key, however, must be hidden from prying eyes just like your debit card’s pin is for your eyes only.
You will need your private key and your public key to sign and encrypt your Bitcoin transactions. You must also include the public address of the recipient. Only the recipient who has the correct private key can unlock the bitcoin or claim it.
