Bitcoin is the grandfather of cryptocurrencies as we know them today.
Bitcoin in fact is 2 things: a cryptocurrency and a payment system.
It was invented by a programmer or a group of programmers under the name Satoshi Nakamoto. On October 31, 2008 it was introduced to people on a cryptocurrency mailing list. The open source code (software) was released in 2009.
Cryptocurrencies had been around for some time already, but this was the first time the issue of double spending was solved. A major break through. With bitcoin being released there now was a protocol that ensured that each coin could be spent only once.
It is a peer-to-peer system where transactions take place between users directly, without interference of anyone. All transactions are verified and confirmed by nodes (miners) in a distributed ledger. This distributed ledger is called the blockchain. BitCoin is its units of account. There is no central administrator nor a central ledger. Everything is decentralized.
Bitcoin is the first decentralized digital currency.
Bitcoins are created as a reward in a competition in which users spread all over the world, offer their computing power to verify and record bitcoin transactions into the blockchain. This activity is referred to as mining and successful miners (nodes) are rewarded with transaction fees and newly created bitcoins.
Units of account
Bitcoin is the unit of account of the bitcoin system. Since 2014 it is symbolized with BTC, XBT or ฿, where XBT is the official ISO denominator. To honor Bitcoin’s creator the smallest part of a bitcoin, 0.0000001 is called a Satoshi. That is one hundred millionth of a bitcoin. A microbitcoin is 0.000001 or one millionth and a millibitcoin represents 0.001 or one thousandth of a bitcoin.
Now if we’d compare bitcoin to gold, it is pretty tough to divide a gold bar in one hundred millionths of that very bar isn’t it? With bitcoin that is as easy as blinking your eyes.
Validity of transactions
As in any payment system the validity of a transaction is important. For a transaction to be valid it must be an unspent output of a previous transaction. Each and every transaction must be digitally signed. This is done by using the private key that belongs to a bitcoin wallet. It goes without saying that keeping that private key absolutely private and absolutely safe is very important. Without that private key there is no proof of ownership and any bitcoins in that wallet are simply lost.
Mining is a process of keeping records. Miners (nodes) keep the blockchain complete, consistent, safe and impossible to alter. It is done by repeatedly verifying and collecting new broadcast transactions into a new group of transactions. These groups are called the blocks. As explained in Part 2 of this blog series, each block contains a cryptographic hash of the previous block, thus creating a chain of blocks: the blockchain.
The goal is to get a block accepted by the rest of the network. In order to be accepted a new block must contain what is called a proof-of-work. You can see a proof-of-work with the CAPTCHA code; you often are required to fill in when completing a form online. CAPTCHA is intended for humans, so is easy to complete. For the proof of work in the blocks computing power requires it to be a much more complex process: the difficulty of the blockchain.
The proof-of-work requires miners to find a number, a nonce. It is done in such a way that when a nonce is hashed along with block content, the result is numerically smaller than the network’s difficulty target. Verification of the proof is easy, but it is very time consuming because of the almost endless possibilities, to finally meet the difficulty target.
Every 2016 blocks (approx. 14 days), the difficulty target is increased based on the network’s recent performance. The aim is to keep the average time between new blocks at ten minutes. In this way the system automatically adjusts to the total amount of mining power on the network.
The proof-of-work system combined with the chaining of blocks makes modifications of the blockchain extremely hard. A potential attacker must modify all subsequent blocks in order for the modifications of one block to be accepted. New blocks are mined 24/7/365, the difficulty of modifying a block increases as time passes and the number of subsequent blocks (also called confirmations of the given block) increases. It is estimated that it would require half a billion dollar to hack the blockchain for just 10 minutes! I’d call this highly secure.
More on mining in a next part of this series.
Supply of bitcoins
As explained above the miner who finds the block is rewarded with new coins and transaction fees. As per July 2016 the reward is 12.5 coins per block that are added to the blockchain. To claim this reward, a coinbase, a special transaction, is included with the processed payments. All bitcoins that are in existence have been created in coinbase transactions. The bitcoin protocol specifies that the reward for adding a block will be halved every 210,000 blocks (about every four years). Eventually, the reward will decrease to zero, and the limit of 21 million bitcoins will be reached in the year 2140. From that moment on the record keeping will be rewarded by transaction fees only.
Basically it means that bitcoin’s inventor Nakamoto did set a monetary policy based on artificial scarcity. This policy was set at bitcoin’s inception and included the fact that there would never be more than 21 million bitcoins in total.
There is a large payment processing industry, charging you to send your own money to another party. The percentages being charged can reach really serious heights. Bitcoin allows people to charge for sending a transaction. Miners can chose to process the higher transaction fees transactions first. Opposite from the almost criminal charges in the ‘normal’ world, bitcoin transaction fees amount from entirely free to 2%. Fees are based on the storage size of the transaction that is generated. The storage size is determined by the number of inputs used to create the transaction. Also, priority is given to the oldest unspent inputs.
Once this series of blog articles have been completed there also will be a small course available, which will also cover the various types of Bitcoin wallets. That is a topic on its own already. Get yourself on the email list so you will be notified when that course is released.
Every bitcoin wallet has an email address and is showing in the blockchain with a unique code. Since the blockchain is a public ledger anyone can see the transaction with that code. However, no one knows who that code belongs to. Most bitcoin wallets will require the well known “Know Your Customer” documents in order for you to process larger transactions (buy/sell of bitcoins). That is where the anonymity then stops. Just recently the IRS has summoned Coinbase to hand over all data (transactions as well as identities of wallet owners) over the period since 2013.
Bitcoin is a payment system that takes away the heavy influence of authorities, regulators and banks on your payment behavior. If power is taken away, you will see strong objections coming from exactly these parties to influence the masses in trying to stop them from getting involved with these new payment methods. Less power means less control after all.
It is said that cryptocurrency is the ultimate way for people to get out of poverty. Since there is no interest in Bitcoin it is safe to say there are no religious objections from specific groups of people either. Where many can’t get access to a bank account, they can easily access the bitcoin system and create their wallet. Alternative banking to those who have been without up until now.
Value of bitcoin
The value of bitcoin is measured in USD (or any other Fiat currency) is determined by supply and demand. We already saw that supply will never be more than 21 million bitcoins. Demand however is rapidly increasing. With more and more countries embracing demonetization (India, Pakistan, Venezuela), its people will turn towards a currency their government cannot make worthless overnight. Investors will use bitcoin to hedge against their regular investments. This is why bitcoin also is called the Digital Gold.
All in all a lot of information on the best known cryptocurrency Bitcoin.
In Part 4 we will look into Altcoins, all cryptocurrencies that surfaced since Bitcoin.