What Is Bitcoin?

17 August 2021

Chapter 1 – Introduction to Bitcoin

Contents

  • What is Bitcoin?
  • What is Bitcoin used for?
  • What makes Bitcoin valuable?
  • How does Bitcoin work?
  • What is the blockchain?
  • Is Bitcoin legal?
  • A History of Bitcoin
    • Who created Bitcoin?
    • Did Satoshi invent blockchain technology?
    • Digital cash before Bitcoin

 

What is Bitcoin?

Bitcoin is a digital form of cash. But unlike the fiat currencies, you’re used to, there is no central bank controlling it. Instead, the financial system in Bitcoin is run by thousands of computers distributed around the world. Anyone can participate in the ecosystem by downloading open-source software.
Bitcoin was the first cryptocurrency, announced in 2008 (and launched in 2009). It provides users with the ability to send and receive digital money (bitcoins, with a lower-case b, or BTC). What makes it so attractive is that it can’t be censored, funds can’t be spent more than once, and transactions can be made at any time, from anywhere.

What is Bitcoin used for?

People use Bitcoin for several reasons. Many appreciate it for its permissionless nature – anyone with an Internet connection can send and receive it. It’s a bit like cash in that no one can stop you from using it, but its digital presence means that it can be transferred globally.

What makes Bitcoin valuable?

Bitcoin is decentralized, censorship-resistant, secure, and borderless.

This quality has made it appealing for use cases such as international remittance and payments where individuals don’t want to reveal their identities (as they would with a debit or credit card).

Many don’t spend their bitcoins, instead choosing to hold them for the long-term (also known as holding). Bitcoin has been nicknamed digital gold, due to a finite supply of coins available. Some investors view Bitcoin as a store of value. Because it’s scarce and difficult to produce, it has been likened to precious metals like gold or silver.
Holders believe that these traits – combined with global availability and high liquidity – make it an ideal medium for storing wealth for long periods. They believe that Bitcoin’s value will continue to appreciate over time.

How does Bitcoin work?

When Alice makes a transaction to Bob, she’s not sending funds in the way you’d expect. It’s not like the digital equivalent of handing him a dollar bill. It’s more like her writing on a sheet of paper (that everyone can see) that she’s giving one dollar to Bob. When Bob goes to send those same funds to Carol, she can see that Bob has them by looking at the sheet.

 

 

The sheet is a particular kind of database called a blockchain. Network participants all have an identical copy of this stored on their devices. The participants connect to synchronize new information.

When a user makes a payment, they broadcast it directly to the peer-to-peer network – there isn’t a centralized bank or institution to process transfers. To add new information, the Bitcoin blockchain uses a special mechanism called mining. It is through this process that new blocks of transactions are recorded in the blockchain.

What is the blockchain?

The blockchain is a ledger that is append-only: that is to say, data can only be added to it. Once information is added, it is extremely difficult to modify or delete it. The blockchain enforces this by including a pointer to the previous block in every subsequent block.
The pointer is actually a hash of the previous block. Hashing involves passing data through a one-way function to produce a unique “fingerprint” of the input. If the input is modified even slightly, the fingerprint will look completely different. Since we chain the blocks along, there is no way for someone to edit an old entry without invalidating the blocks that follow. Such a structure is one of the components making the blockchain secure.
For more information on blockchains, see What is Blockchain Technology? The Ultimate Guide.

Is Bitcoin legal?

Bitcoin is perfectly legal in most countries. There are a handful of exceptions, though – be sure to read up on the laws of your jurisdiction before investing in cryptocurrency.

In countries where it’s legal, government entities take varying approaches to it where taxation and compliance are concerned. The regulatory landscape is still highly underdeveloped overall and will likely change considerably in the coming years.

 

A History of Bitcoin

Who created Bitcoin?

Nobody knows! Bitcoin’s creator used the pseudonym Satoshi Nakamoto, but we don’t know anything about their identity. Satoshi could be one person or a group of developers anywhere in the world. The name is of Japanese origin, but Satoshi’s mastery of English has led many to believe that he/she/they originate from an English-speaking country.
Satoshi published the Bitcoin white paper as well as the software. However, the mysterious creator disappeared in 2010.

Did Satoshi invent blockchain technology?

Bitcoin actually combines several existing technologies that had been around for some time. This concept of a chain of blocks wasn’t born with Bitcoin. The use of unalterable data structures like this can be traced back to the early 90s when Stuart Haber and W. Scott Stornetta proposed a system for timestamping documents. Much like the blockchains of today, it relied on cryptographic techniques to secure data and to prevent it from being tampered with.

Interestingly, at no point does Satoshi’s white paper make use of the term “blockchain.”

Digital cash before Bitcoin

Bitcoin wasn’t the first attempt at digital cash, but it is certainly the most successful. Previous schemes paved the way for Satoshi’s invention:

DigiCash

DigiCash was a company founded by cryptographer and computer scientist David Chaum in the late 1980s. It was introduced as a privacy-oriented solution for online transactions, based on a paper authored by Chaum

The DigiCash model was a centralized system, but it was nonetheless an interesting experiment. The company later went bankrupt, which Chaum believes was due to its introduction before e-commerce had truly taken off.

B-money

B-money was initially described in a proposal by computer engineer Wei Dai, published in the 1990s. It was cited in the Bitcoin white paper, and it’s not hard to see why.
B-money proposed a Proof of Work system (used in Bitcoin mining) and the use of a distributed database where users sign transactions. The second version of b-money also described an idea similar to staking, which is used in other cryptocurrencies today.

Ultimately, b-money never took off, as it didn’t make it past the draft stage. That said, Bitcoin clearly takes inspiration from the concepts presented by Dai.

Bit Gold

Such is the resemblance between Bit Gold and Bitcoin that some believe that its creator, computer scientist Nick Szabo, is Satoshi Nakamoto. At its core, Bit Gold consists of a ledger that records strings of data originating from a Proof of Work operation.

Like b-money, it was never further developed. Bit Gold’s similarities to Bitcoin have, however, cemented its place as the “precursor to Bitcoin.”

 

 

Chapter 2 – Where Do Bitcoins Come From?

Contents

  • How are new bitcoins created?
  • How many bitcoins are there?
  • How does Bitcoin mining work?
  • How long does it take to mine a block?

 

How are new bitcoins created?

Bitcoin has a finite supply, but not all units are in circulation yet. The only way to create new coins is through a process called mining – the special mechanism for adding data to the blockchain.

How many bitcoins are there?

The protocol fixes Bitcoin’s max supply at twenty-one million coins. As of 2020, just under 90% of these have been generated, but it will take over one hundred years to produce the remaining ones. This is due to periodic events known as halvings, which gradually reduce the mining reward.

How does Bitcoin mining work?

By mining, participants add blocks to the blockchain. To do so, they must dedicate computing power to solving a cryptographic puzzle. As an incentive, there is a reward available to whoever proposes a valid block.

It’s expensive to generate a block, but cheap to check if it’s valid. If someone tries to cheat with an invalid block, the network immediately rejects it, and the miner will be unable to recoup the mining costs.

The reward – often labeled the block reward – is made up of two components: fees attached to the transactions and the block subsidy. The block subsidy is the only source of “fresh” bitcoins. With every block mined, it adds a set amount of coins to the total supply.

 

How long does it take to mine a block?

The protocol adjusts the difficulty of mining so that it takes approximately ten minutes to find a new block. Blocks aren’t always found exactly ten minutes after the previous one – the time is taken merely fluctuates around this target.

 

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