Intro to Bitcoin
What is Bitcoin
The term “Bitcoin” is used to describe one of two things; the bitcoin blockchain or the bitcoin cryptocurrency (a digital currency used on a blockchain). The bitcoin blockchain is public, operates on a proof of work system, and its primary use is to maintain a ledger of transactions of bitcoin. Because it is decentralized, distributed, transparent, and the most secure blockchain, it is able to remove the need for banks (centralized intermediaries) and instead allow for a peer to peer exchange of its own currency.
When looking closer at the bitcoin blockchain we see a network that holds copies of a ledger of bitcoin transactions that are bundled into blocks
The History of Money
To understand why bitcoin works as a digital currency, we have to first understand the history of money. Initially, value was placed on goods and services which was why a barter system was created. For example, 12 eggs for 1 gallon of milk. The problem with this was that if two parties did not exclusively want what the other person had or if someone thought the trade was not fair then the exchange would not happen. This proved that there was a need for a medium of exchange. In most parts of the world, the main medium of exchange became gold, because people believed it had value. Gold was a good medium of exchange in the sense that it held its value well since it was scarce. However, carrying around gold to exchange for goods and services was not convenient. Therefore, in parts of the world such as the U.S., paper currency was used and backed by gold, known as the gold standard. This paper currency made exchanging value easier. However, this backing of gold did not last. During economic hardships of countries, mostly due to World War 1, interest rates rose and gold reserves in banks were depleting since people were withdrawing it and using it to pay for cost associated with the war. This led some countries such as the U.S. to break ties with the gold standard and instead shifted their paper currency to be backed backed by the promise the federal reserve made that it was worth something and the trust people had in it and their government. This allowed the federal reserve to pump money into the economy to lower interest rates. These government backed currencies, known as fiat currencies, only have value because we believe in the federal reserve and government that says it has value. This is a problem especially in economies where governments can be corrupt and the printing of too much money can lead to inflation and the decrease of value thus hurting the economy. This was the reason Bitcoin was created after the economic crash in 2008. In contrast to fiat currency, it does not rely on any government saying it has value and people being forced to conform, but instead relies on people from all around the world believing it has value separate from any government or jurisdictions.
Barter system -> Gold -> Gold standard -> Federal Reserve backed money -> Decentralized digital currency
The History of Bitcoin
Following the economic crash of 2008 when trust in federal reserves was at a low, the idea of Bitcoin was shared by an unknown group or individual going by the name Satoshi Nakamoto via a whitepaper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”. In the whitepaper, they explained how the use of blockchain allowed peer to peer transactions of money (bitcoin), solved the double spending problem (explained later), and essentially removed the need for the central authority of a bank or federal currency. After its creation in 2009, Nakamoto continued to work on developing Bitcoin along with other developers up until mid-2010 when Nakamoto “vanished” after leaving the source code, websites, and other material associated with Bitcoin to Gaven Andresen and other members of the Bitcoin community.
Satoshi Nakamoto created Bitcoin using blockchain which gave the world the first decentralized digital currency
Why Bitcoin Rivals Banks
Banks provide certain services to people that make them an ideal place to keep our money. They provide account and identity management, services to transfer and redeem money, record management, and are trustworthy to a certain extent.
Bitcoin provides these same services but instead puts you in control of your own money. Users of bitcoin are given unique addresses that are associated with the amount of currency you have (account and identity management), it allows for transactions anywhere in the world (services to transfer and redeem money), every transaction is verified and recorded on the blockchain (record management), and there are incentives put in place to secure the blockchain from corruption (trust).
In contrast to fiat currencies, bitcoin gives users direct management of their funds and is secured by a worldwide network instead of banks
Bitcoin Solves the Double Spending Problem
Bitcoin was the first digital currency to solve the double spending problem. The double spending problem is defined as the ability to send two different transactions of digital money using the same funds in an account, thus double spending it. Before bitcoin, other decentralized digital currencies were not able to recognize/verify that money in an account had already been spent. Because bitcoin developed its own blockchain to solve this problem, we know that transactions in a block that attempt to be added to the blockchain first need to be verified by a majority of nodes that are upkeeping the network and because its blockchain is transparent, nodes can see if there is actually enough money in an account to make another transaction. If there is not enough money in the account, then the transaction will be rejected and will not execute.
If a person A has 10btc and sends 7btc to person B and then attempts to send 5btc to person C the transaction will be rejected
Advantages of Bitcoin
The benefit of Bitcoin as a currency compared to traditional fiat currencies is that it is not governed by a single person or organization but instead is governed by a network of people around the world who use computing power to upkeep it. This is especially beneficial if a country’s government is corrupt or people do not trust their federal currency because they believe its value may deteriorate. Since fiat can be created by governments at will, there is no limit to the amount of money they can print, and an excess amount of printed currency can lead to inflation which lowers the value of that currency. Bitcoin does not have this problem of unlimited printing because it is fixed at 21 million coins that can ever exist. These 21 million coins are released on a fixed schedule set to have all bitcoin released by the year 2040. In addition, as mentioned previously, Bitcoin is universal and serves as a worldwide currency since it is not specific to any country or government and allows peer to peer transactions removing the need for a bank to facilitate them. Because the currency is digital, as long as someone has access to the internet, they can send it anywhere in the world with small transaction fees compared to sending fiat across borders. In summary, unlike fiat, bitcoin is a global currency that is scarce (like gold), has minimal transaction fees, and is more secure than a central database.
In contrast to fiat currencies, bitcoin is universal, scarce, rewards altruism, and has lower transaction fees across borders
Disadvantages of Bitcoin
The current disadvantages of bitcoin, which are also problems for current blockchains in general, is the speed of transactions that the bitcoin blockchain can process, the difficulty of using it, and its cryptocurrency price volatility. Currently, the bitcoin blockchain can only handle 8 transactions per second (txs/sec) which is significantly slow compared to the 1000s of tx/sec that visa can handle. If the bitcoin blockchain attempted to handle as many transactions as visa does daily, it would be backed up significantly. This creates a boundary to the scalability of bitcoin as an everyday currency.
Another disadvantage of bitcoin is that there is currently a certain amount of technical knowledge that is required to use it. The technical knowledge can be learned by people new to the space, however it isn’t the simplest to use. Currently, if some information such as an address is input incorrectly, you may not be able to retrieve your bitcoin. In addition, the price of bitcoin fluctuates much more than any fiat currency making it an unreliable medium of exchange to transact confidently with. Despite these downsides, in the future cryptocurrencies aim to be faster, more user friendly, and if not stable then a better alternative to hold the value of money in countries where economic systems are collapsing.
1) Slow but secure 2) Difficult but learnable 3) Volatile but should stabilize later
How Bitcoin Works (The Basics)
Front End (The user interface): When you sign up for an exchange you are given a digital wallet that can store your Bitcoin (more about storage will be explained in the next section). These wallets have a public address that is composed of a random string of numbers and letters that allows you to receive bitcoin similar to a mailbox address allowing you to receive mail. If you wanted to send Bitcoin to someone else, you would select “withdraw” from your wallet and input the public key of the person you want to send bitcoin to. When sending Bitcoin to a public address it is very important that you ensure that the public address is correct because there is no way to recover your funds if you input the wrong address. It is best to copy and paste the address and double check the first and last four characters of the address which helps ensure the entire address was pasted correctly. Once you have checked the address is correct, you confirm the withdraw of your bitcoin, and wait anywhere from 10 minutes to several days (depending on the priority of your transaction and the congestion of the network) for the other person to receive the funds. You may check the status of your transaction at (https://www.blockchain.com/explorer) by inputting your transaction number.
Backend (What is happening in the backround):
The Path of a Transaction
Once you have gone through the frontend steps listed above and have sent your bitcoin, that transaction will be bundled with other transactions in a block that is created by a miner. To review, a miner is a person who is using computational power to host the blockchain (like a node) and also participates in adding blocks to the blockchain in return for bitcoin. When a miner creates a block, they verify it and solve a computational puzzle to request to add it to the blockchain. If a majority of the miners agree that the transactions within the block are valid and the solution to the puzzle is correct then the block the transaction is bundled in will be added to the blockchain. Typically, only a certain number of confirmations are needed to successfully transfer funds. Once confirmed, the funds should become available to the receiving party and you should see that the transaction was sent successfully from your wallet, the receiving wallet, or by viewing the transaction status on the blockchain using you transaction number.
Example of withdrawing Bitcoin from the Coinbase exchange. They also allow you to send Bitcoin to another user's email to simplify the process.
Overview of Bitcoin
Bitcoin is a digital currency that was the first to solve the double spending problem by using the decentralization of blockchain technology. It is not tied to any government or organization so is used across borders, resists inflation due to having a fixed amount, and makes participants work in the best interest of the network by rewarding them for it. Despite it being slow, having an initial tech barrier for use, and having a fluctuating price it has the potential to replace weak fiat currencies in crumbling economies around the world and has served as a catalyst to other blockchains that serve as much more than just a medium of exchange such as Ethereum. If you’re interested in buying Bitcoin and other cryptocurrencies check out the purchasing crypto section.
“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. Their massive overhead costs make micropayments impossible.”
Satoshi Nakamoto
Creator of Bitcoin
