How it works

What Is Bitcoin

By July 5, 2017 2 Comments

At the beginning of my adventure with cryptocurrencies, I was desperately trying to explain to people what is it and why they should at least try to understand the money of the future.

As soon as I put the wordcryptocurrency on the table, all I got was a blank face.

So I’ve started mentioning to people ‘Do you know what is Bitcoin’, and this when I saw a fading light in a tunnel — people had heard about Bitcoin. But then it followed by ‘I don’t understand’.

The chances are that you’ve heard it mentioned now and then but have no clue what hides behind the term.

This guide will not only explain the basics of Bitcoin and its blockchain technology, but I will also tell you why should you care more about Bitcoin and cryptocurrency in general.

Bitcoin Definition

Bitcoin is the first and most well-known cryptocurrency that was ever invented. Nowadays, there are over 900+ cryptocurrencies available worldwide, but Bitcoin is without a doubt the most famous one.

It’s a form of digital currency, created and held electronically. What does it mean? Bitcoins don’t have their physical representation, unlike Dollars or Euro, we won’t see Bitcoin in cash or coins as we know it.

Bitcoin was invented in 2008 by a person (or a group of people) under a pseudonym Satoshi Nakamoto. Small wonder, Bitcoin was created after the 2008 Wall Street crash, during which people have lost their trust in banks and accused them of misusing borrowers’ money.

Nakamoto created then a currency that would be entirely decentralised and independent from a third party or government involvement. Bitcoin pioneers wanted to cut the middleman, avoid transaction fees as well as make transactions transparent.

The conventional currency has been based on gold or silver, but Bitcoin is based on something less tangible… Mathematics.

Don’t worry — you don’t have to know maths to be able to understand what Bitcoin is.

Maths for Bitcoin is like a money printing machine — it’s used to confirm all transactions, and through that, it generates new bitcoins. The circulation of bitcoins is provided by a network of users (miners) and to make it even more transparent — all users have access to the record of transactions, and anyone can become a miner.

Above all, with Bitcoin, it’s you who’s in charge and control of your own money. Not a single institution controls Bitcoin network, and it’s a collective effort to keep the currency running smooth. Bitcoin cryptocurrency wallet, unlike traditional bank accounts, cannot be frozen.

The fees associated with Bitcoin are also minuscule comparing to bank transfers, PayPal or credit cards.
What’s more — Bitcoin respects your privacy and doesn’t require providing your real name or address. Everything is based on a long number combination; hence the transactions will never be tracked to you personally but to your digital identity.

The privacy is one of the most significant aspects of Bitcoin. It doesn’t care who you are or where are you based. You can be sending Bitcoins to a person standing next to you or someone on the other side of the world, and both the speed and fees of a transaction will be the same.

The drawback of Bitcoin is its limited availability. The current estimation is that by 2140 we will simply run out of Bitcoins and there won’t be any more to produce. Unless the protocol changes, only 21 mln Bitcoins can be created.

How Does Bitcoin Work

How Does Bitcoin Work

Bitcoin’s backbone is blockchain technology, otherwise known as a public ledger. All confirmed transactions are stored on this vast network in so-called ‘blocks’.

The public ledger works on the basis of a peer-to-peer network, to which everyone has an access, and it’s decentralised. So nobody can have an exclusive ownership of the system.

As soon as somebody requests a new transaction, a new block enters the system and the peer-to-peer network is notified.

After the transaction is broadcasted to all users, the computers are solving a complicated mathematical formula to validate the transaction as legitimate. This way all users are aware of the transaction, which prevents stealing and double-spending.

Here’s a funny thing about Bitcoins: they don’t exist anywhere. We always talk about someone having an X amount of Bitcoins or purchasing a certain amount, but there are no digital Bitcoins.

Instead, there are only records of transactions between different addresses, with balances increasing and decreasing.

What’s even more interesting — if you want to work out the balance of any Bitcoin address, the information won’t be there. You would have to reconstruct it by looking at the blockchain and the transactions’ history.

What Is Bitcoin Mining

bitcoin miningMining, or processing, takes its name from historical gold mining. And it does the same function — extracts new Bitcoins.

The process adds new transactions (blocks) to the chain and it keeps them in a queue. Blocks are chopped off as soon as the transaction is finalised, codes are decoded, and bitcoins are passed.

Bitcoins are ‘mined’ by bitcoin miners — participants of the network who perform additional tasks of validating the transactions. This process is crucial in preventing a user from spending the same bitcoin twice. Hence, it solves the double-spending problem.

As you can imagine, finding a block is not easy, and it closely resembled winning a lottery ticket. Every attempt at finding a new block, which is a random guess, costs a miner a certain amount of energy. Most of these efforts fail and only every 10 minutes or so a lucky miner finds a block and adds it to the blockchain.

This also means that the miner who found a valid block burnt much more energy due to all the failed attempts. It’s what we call a ‘proof-of-work’ and it’s at the heart of Bitcoin’s success.

Thanks to the proof-of-work, miners cannot create bitcoins out of thin air — they must burn real energy to earn them. It also increases Bitcoin’s security to a great extent. If a hacker was to try and change a transaction that happened in the past, would have to redo all the work that has been done by miners and catch up with a long chain.

Each block that gets to be solved, results in awarding a miner with 12.5 new bitcoins. Additionally, miners get to keep any extra fees associated with the transaction.

Anyone can become a miner, but it has grown increasingly difficult over the years. Nowadays, mining is mostly done by professionals with specialised hardware, cheap electricity, and some go to the extent of having big data centres that can process transactions quicker.

What Are The Advantages Of Bitcoin

Bitcoin’s pros reflect all the advantages of cryptocurrency and broader blockchain network:

Decentralisation

No central authority controls Bitcoin network. There isn’t one central authority that can print more money to cover the debt and devaluate the currency, or take money away from the citizens.

If you look at the Central European Bank and its action with Cyprus in 2013, you would much appreciate that Bitcoin cannot just take people’s bitcoins away from them. There is no gatekeeper in Bitcoin network.

It’s easy and cheap to set up

I don’t know how about you but I had to go through so much bureaucracy while trying to create a bank account. Endless questions, credit checks, paperwork and the list just kept on growing.

With Bitcoin, you don’t have to do any of them. Setting up and account takes few minutes, and there are no fees attached.

You also don’t have to pay high transaction fees, unlike with a traditional bank, where an international bank transfer can cost up to 50 Euro. This is, however, changing now due to a slow transaction time.

It’s fast

As I mentioned before, if you want to send money to a different country or a continent, it’s going to take the same amount of time as if it was between you and your local bank.

Miners aim to solve the block within less than ten minutes and that’s the maximum you will have to wait for bitcoins to arrive at your digital address.

Transparency

Because everyone has access to the network, your history of transactions and record is also publicly available. That means there are no hidden transactions, fees or extra charges.

The blockchain reveals it all.

On another note, with Bitcoin, you’re also anonymous. So even though everyone can see your bitcoin balance, nobody will know it’s you. You’re protected by a unique digital address, and it isn’t connected to your real details.

Security

Last but not least, Bitcoin is one of the most secure networks out there. The funds are locked in a public key cryptography system.

Only the owner of the private key can access the account and send bitcoins.

Cryptography and complex maths only help with securing your funds even more, and it’s almost impossible to break the scheme.

What Are The Disadvantages Of Bitcoin

Bitcoin, in general, has started off the wrong foot with its founder Satoshi Nakamoto. We know it wasn’t a real name, we don’t know who this person (or group of people) was, and Nakamoto has never been found.

Hence, that didn’t help in building a good name for a network that was born out of anger at the traditional banking system and Fiat money.

Even though Bitcoin is still way more secure than most banks there are certain disadvantages:

It’s irreversible

Once you send your bitcoins and process with a transaction, that’s it. There’s no way back. Unless the recipient sends them back you, they are gone forever.

You cannot make a mistake and send an incorrect amount or choose a wrong recipient.

It’s not widely accepted

Bitcoins are still not universally accepted, so you cannot use as a comfortably as fiat currency. For the time being it’s more of an investment. If you’re hoping to pay for groceries with bitcoins, then you will have to prepare for a wait.

Wallets can be lost or corrupted

If for some reason your hard drive crashes or your software gets attacked by a virus, and the wallet file is damaged, your bitcoins are lost. There’s nothing you can do to recover them.

Fluctuation and no guarantee of valuation

The value of bitcoin is continuously changing, growing accordingly to customer’s’ demands. Due to the constant variation, the prices keep on changing. This would become an issue if we were going to start using bitcoins on an everyday basis.

Imagine you buy a t-shirt for two bitcoins and after a week you want to return it. But in a meantime, the value of bitcoin has changed. So should you be refunded the amount you paid or the current value of bitcoin? This is still an important question that leaves users without a consensus.

Because there isn’t one authority controlling the value of bitcoin, if a large amount users decided to drop it or sell it, the price will automatically go down. In this case, the decentralised nature of Bitcoin is both a blessing and a curse.

No buyer protection

Since bitcoin transaction cannot be reversed there are a lot scam related risks. For instance, if you pay for goods but the seller decides to pocket your money and never send it to you, there’s nothing you can do.

So far there were a few platforms that offered this kind of services, liaising between a buyer and a seller. However, they became the middleman, which Bitcoin has been trying to avoid. In this sense, Bitcoin transactions would come closer to functioning like a traditional bank.

How To Buy Bitcoins

How to buy Bitcoins

OK, so you’ve learned the basics about bitcoin. The next step is to buy them. But how?

You can purchase bitcoins either from cryptocurrency exchanges or directly from the owner via a marketplace.

There are various ways you can pay for bitcoins with. From cash to credit cards and bank transfers. You can even buy them with cryptocurrencies. It all depends on who are you buying them from and where you live.

It also depends on the jurisdiction of the country you live in. For instance, you won’t be able to buy bitcoins from Russia or Bangladesh.

For a starter, you have to get yourself a wallet, which will function in a similar way to your traditional bank account.

Different wallets provide different levels of security, and some of them function as a spending wallet, while others have a military-grade protection system.

The main wallet options are:

  • Software Wallet — stored on the hard drive of your computer; the wallet has to be regularly backed up in case of file corruption
  • Online Wallet — web-based service, available as long as you have an internet access
  • Hardware Wallet — works offline and uses a number of keys to protect an account

How To Make a Bitcoin Transaction

Once you create your wallet, follow these steps:

Step 1 — To send Bitcoins you need two things:

  • Public Key — it’s your address, and it’s publicly available to everyone; it’s generated randomly, and it’s a sequence of numbers and letters
  • Private Key — it’s also a random sequence of numbers and letter, but it must be kept secret at all times

Step 2 — After you input a number of Bitcoins you want to send, a message will be generated with all the details of the transaction, and it requires your signature to authorise it.

Step 3 — The signature is not your physical, handwritten signature. It’s a long combination of numbers and letters, generated as a Private Key.

Step 4 — Click ‘Send’ and the transaction will be broadcasted to a broad public network.

Step 5 — From there, Bitcoin miners work on verifying the transaction, putting it into a transaction block and eventually solving it. The verification process should take up to 10 minutes.

Let’s say you have four different transactions on your record that all together come up to 10 Bitcoins. But you only want to send 3.50, and none of the transactions match this amount.

What you would have to do is send an entire transaction, e.g. 4 or 9 Bitcoins, and you will receive a change in return. So in the end, you credited another account with the amount you wanted — 3.50.

You can also send just a part of a Bitcoin. The smallest available amount is a Satoshi (named after the founder of Bitcoin) — one hundred millionth of a Bitcoin. And it’s possible to send as little as 5430 Satoshis on the Bitcoin network.

At the moment, most transactions are growing. And with time, when the reward for mining decreases, the charge is likely to grow, and it will go to the lucky miner who solved the transaction.

Bitcoin Value

Bitcoin is unique in its own way not just because it doesn’t have its physical representation, but it’s also incredibly fragile to market fluctuations.

As it stands today, 1 bitcoin is worth over $7,000.

Bitcoin has been on a historic tear at the beginning of 2017, and it stood at $1,000 on the 1st of January. Six months later, the price reached an all-time high of $3,000 in June 2017.

Additionally, some of the most popular Bitcoin wallets have seen a massive growth in users over the last few months.

Coinbase saw an increase of 1 mln users in May 2017 alone. In comparison, Blockchain.info registered a total of 15 mln users as of July 2, which is a 10 mln increase since last year!

But what causes this rapid growth?

One of the main reason is Bitcoin’s growth in popularity, and more and more people are becoming aware of the technology behind cryptocurrency.

Donald’s Trump’s election and Brexit were another significant factors that shook the financial market in general, and Bitcoin wasn’t any different. Many people have decided to turn their investment into Bitcoin to avoid the economic instability.

Recent predictions show that Bitcoin will only keep on growing — soon Bitcoin will reach a value of $10,000. Some, on the other hand, speculates that the bubble is soon to burst and cause a crash on bitcoin market.

Why Should You Care About Bitcoin

So if you cannot casually use bitcoin to pay for everyday needs, why should you even be bothered? Especially, if you’re not an investor or don’t understand finances and technology at all?

Bitcoin was perhaps one of the most significant leaps in technology since Internet, disrupting the financial industry and introducing a new era of digital money. It proposed a new paradigm with transparency and trust at its core.

Schopenhauer’s philosophy perfectly reflects what bitcoin revolution is: first it was mocked and laughed at, then violently opposed, until it reached the acceptance stage.

While we are still quite far from reaching the ultimate acceptance stage, banks and leading financial institutions have started investing in research. More and more studies are done on how to implement blockchain technology into everyday life, and without a doubt, it’s the future.

Above all, Bitcoin puts mathematics on its pedestal, indicating the extent to which money can disrupt the changing times we live in. From finances to politics and trivial activities like shopping.

Undoubtedly, Bitcoin has challenged the traditional financial system and had an impact on world’s government. If anything, it introduced a huge need for more transparency and showed contempt for corruptive practices.

It is only logical to start reducing humans’ involvement in money distribution and with technology evolving so fast, the time has come for money. It’s the next step to solving economic issues around the world as well a step forward for our society.

Don’t take me wrong — Bitcoin, and other cryptocurrencies, still have a lot to work on to fully introduce them into our lives. They will eventually replace the traditional banking system and money as we know, but only time will tell which generation will be there to witness this remarkable transition.

The day when we stop asking the question ‘What is Bitcoin’ is the day we reach the acceptance stage. A stage, at which Bitcoin will have the same echo as Dollar or Euro nowadays.

And now, it’s time to create your first cryptocurrency wallet and start investing in Bitcoin!

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Megan Frydel

Author Megan Frydel

Megan is a self-thought blockchain enthusiast. She enjoys combining finance with technology, from a less-techy perspective. BiteMyCoin is her most recent project underneath the umbrella of an international digital marketing agency ANCHOVY.

More posts by Megan Frydel

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