What is Bitcoin?
If you’ve heard about cryptocurrency, you’ve probably heard about Bitcoin. Created by “Satoshi Nakamoto”, it is the first cryptocurrency and has set the standard for every cryptocurrency created since. Since its creation, Bitcoin has consistently had the highest value and is the most publicly-discussed cryptocurrency.
Satoshi Nakamoto believed that there was a need for a decentralized cryptocurrency that was not dependent on or controlled by any centralized organization or group. To address this need, he designed Bitcoin and the blockchain technology upon which the Bitcoin cryptocurrency is based.
Bitcoin’s history has been tumultuous from being derided as a currency for criminals to being hailed as the currency of the future. Despite huge swings in value, Bitcoin has been on an overall upward trend in value and adoption since its creation and remains the most valuable cryptocurrency to date despite its age and the thousands of different coins based upon the technology that it pioneered. However, sentiment about the future of Bitcoin and cryptocurrency in general remains divided with a seemingly equal number of high-profile figures calling it a huge success and the future of currency and those calling it a huge scam doomed to failure. Here, we will provide users with an introduction to the Bitcoin cryptocurrency. This guide is designed to be readable by someone with no background in the field and enable them to walk away with a grasp of the basics of Bitcoin and the resources, ability, and confidence to find more detailed information regarding anything that interests them.
First, we’ll discuss the basics of Bitcoin describing what exactly it is. Then, we’ll move into the reason for Bitcoin’s creation and the underlying philosophy of the blockchain technology created by Satoshi Nakamoto. Finally, we’ll see what Bitcoin has become in the present day and where it is headed in the future.
Satoshi Nakamoto is the pseudonym of the man who created both Bitcoin and blockchain. He designed Bitcoin to be the first cryptocurrency built on the blockchain to create a decentralized financial system. But what does all of that mean? In this section, we’ll break this down into its three main concepts, provide a brief description of the meaning of each of them, and let you know where you can find out more information.
The First Cryptocurrency
Bitcoin is the first cryptocurrency. But what does that mean? What exactly is a cryptocurrency? Cryptocurrencies are currencies that are built on top of mathematical principles derived from cryptography rather than being based on a centralized company or organization. Conventional currencies like cash, credit cards, and Paypal are all founded around some government organization or a corporation. They’re trusted and accepted because the have the backing and stamp of approval of some group rich or powerful enough to back up their promises. If the company or organization fails or makes poor decisions, the value of the currency or financial service that they provide may be diminished or disappear entirely.
Cryptocurrencies, on the other hand, are based on trusting in the underlying principles and mathematics of cryptography. In cryptography, there are several mathematical problems that are easy to solve in one direction but difficult or impossible to solve in reverse. One example is the “factoring problem”, which says that it’s really easy to calculate the product of two large prime numbers given the numbers (you just multiply them together) but it’s very hard to determine the two numbers given the product. In fact, the best way to do so right now is to keep trying to divide the product with different numbers until you find one that works. That can take a long time and is the basis for some of the security on the Internet.
Another commonly used problem is called the discrete logarithm problem. This problem is based on the easiness of exponentiation and the hardness of its opposite, logarithms. Given numbers a and b, it’s easy to calculate a to the power of b (you just multiply a together b times). However, it’s very difficult to calculate b given a and the result of the exponentiation. Like the factoring problem, the best way to solve the problem is to guess values of b until you stumble across the correct one. If b is large enough, this takes a very long time.
The trust that cryptocurrencies puts in cryptography is that no-one has found a better way to solve these problems (and they’ve definitely tried). Cryptocurrency is designed so that someone who wants to attack the system needs to spend a large amount of time and computational resources guessing possible solutions to these and other problems until they stumble across an acceptable answer. Since the difficulty of the problems is easily adjustable (by using bigger numbers), it is easy to design the problems so that finding a solution is impossible in a reasonable amount of time.
Built on the Blockchain
The blockchain is an integral part of the Bitcoin cryptocurrency. But what is it? The blockchain is where all of the information created by Bitcoin is stored. It’s essentially just another way of storing data.
What makes blockchain special is the fact that the way it stores data makes it perfect for cryptocurrency. The blockchain is a series of blocks (just a chunk of data that contains the information to be stored) chained together using mathematical operations from cryptography. Each transaction uses cryptography to protect against forgery (like the signature on a check or a legal document) and blocks are self-contained snapshots of a section of the cryptocurrency’s history (in Bitcoin, theoretically about a ten minute window). This makes updating the blockchain easy and efficient since adding a new block doesn’t require any changes to the blocks that come before.
Blocks are tied together using the cryptography “links” that cannot be easily faked. You can’t substitute a fake block for a real block in the chain and have the links work properly. This ties the entire history of the cryptocurrency together and make it more difficult to forge any part of it (for more details see this section). The combination of self-sufficient blocks and unforgeable links make cryptocurrencies efficient and secure. They also allow blockchain to fulfill all of the necessary requirements for a cryptocurrency as defined by Satoshi Nakamoto. We’ll talk more about the foundational tenets of the blockchain (and cryptocurrencies) later in this article.
To Create a Decentralized Financial System
At the time of Bitcoin’s creation, the economy was in bad shape. It was the middle of the Great Recession and many of the world’s economies were hurting. A large part of the Great Recession is attributed to the creation of economic bubbles where centralized organizations (like banks) lent money to people who were unable to cover their loans. When people defaulted on their debts, the bubbles burst and many of the banks were in trouble, leading to government action to rescue the economy.
Satoshi Nakamoto created Bitcoin as a system where the health of the economy was not tied to the decisions made by centralized organizations.
Bitcoin is designed to function as a financial system with no one person or group “in charge”. The network is governed solely by consensus and majority vote. The goal was to create a system where the health of the system is based upon transparency, public agreement, and trust in the system rather than trust in an organization.
The Purpose of Bitcoin
Bitcoin is designed as a completely decentralized financial system, meaning that it allows people to send and receive money from one another without relying on some organization to keep track of balances and verify the validity of transactions. In order to achieve this goal, Satoshi Nakamoto invented the blockchain and defined the central tenets that such a system would operate under. In this section, we’ll talk about these underlying principles of Bitcoin (and cryptocurrencies in general) and why they are vital to the Bitcoin ecosystem.
Central Tenets of Blockchain
To really understand Bitcoin, you need to understand where Satoshi Nakamoto was coming from when he designed Bitcoin and blockchain. Bitcoin was created in the middle of the Great Recession, when governments were making the decision to bail out banks to rescue them from collapse and bankruptcy. It wasn’t one of the better times for the financial industry and it took awhile for the world economy to recover afterwards.
Nakamoto believed that these centralized organizations should not have complete control over people’s money and designed Bitcoin, and more generally blockchain, to be a system that no individual or group has control or even a high level of influence over. Here, we’ll talk about some of the founding tenets of blockchain that influences the design and functionality of the blockchain.
Bitcoin, and more generally blockchain, is designed to be a decentralized system. Before Bitcoin, all financial systems were under the control of a government organization or corporation. Governments print currency and its value is based upon the actions of and trust in the government. Banks and credit card companies like Mastercard and Visa are the authority on storing and transferring money, answering only to government institutions (another centralized system).
With Bitcoin and blockchain, a method of performing financial transactions without requiring the centralization of power (in some way or another) in the system under some organization. The blockchain is stored and maintained throughout the entire network, using a peer-to-peer system and principles of cryptography to maintain consensus without the need for an ultimate arbitrator.
Related to the principle of decentralization, Bitcoin and blockchain are designed to be a trustless system. In traditional financial systems, trust in the value of the currency is derived from trust in the government or organization that oversees it. On US currency is printed the phrase “This note is legal tender for all debts, public and private.” Who says so? The Federal Reserve Bank of the United States and behind that, the US government. Why do people accept these pieces of paper as valid currency? Because the US government tells them to and they trust the government that they’re able to trade in the paper for something that else of actual value. The trust required in traditional financial systems goes another step further. When you go to a bank, you give them this piece of paper that has value (because someone told you it does) and in return you get a bigger number in you account on their system. You’re trusting that when you want to buy something, the bank will let you trade some of the number in your account for whatever you want to buy.
Before Bitcoin, the only way to have a trustless system is to hoard a bunch of something that people this is valuable (like gold) and trade it for what you want when you want. However, this system only works for in-person transactions. You can’t put a gold bar into your computer to buy something off of Amazon.
Bitcoin provides a trustless system by keeping an account ledger ledger in a bank but stores it in a decentralized manner, using principles of cryptography to protect the ledger. Anyone can request the ledger from anyone else and verify its authenticity without needing to trust the source of the download. This was a breakthrough because it enables a system where no-one needs to trust anyone else. The required trust is transferred to the security of the underlying cryptography, which, if it’s broken, means we have much bigger problems than Bitcoin collapsing.
If you walked into a bank and asked to see their account ledgers, they would probably either laugh at you or call for security. Despite the fact that banks manage other people’s money, their internal processes and records are considered confidential and not accessible to the general public. While this is a good thing in many cases (you probably don’t want someone to have access to your account information), it also means that you have to trust the bank to do the right thing with your money.
The blockchain, on the other hand, is completely public. Literally anyone can request a copy of the entire distributed ledger and read through it at their leisure. This brings an unprecedented level of transparency to the financial industry since people have complete control over their own money.
This level of transparency has its advantages and disadvantages. On the plus side, you can see the complete financial history of an organization that you wish to do business with (assuming that they only have one account on Bitcoin). You can get an idea of how successful they are by their trade volume and the amount of Bitcoin in their account. You can even use this information to make ethical decisions about trading with them or not. For example, if they have past transactions with an account published recently in an FBI report as belonging to a drug dealer, maybe you don’t want to do business with them.
On the flip side, anyone can see your complete transaction history on Bitcoin, including who you’ve had dealing with (as long as they know the owner of the particular account), how much you’ve sent to each person, and how much is in your account. Since this is essentially the contents of your credit/debit card and account statements combined, you may be uncomfortable with this. Others who share that discomfort have created different cryptocurrencies with more privacy.
Finally, the blockchain is designed to be unchangeable after the fact. If you think about it, this makes perfect sense. You don’t want to sell something to someone, give them the product, and then have them claim that the transaction never happened and get their money back. Without a centralized authority, if there is a transaction dispute in Bitcoin there is no-one for you to call. For this reason, the blockchain is designed to be impossible to modify after the fact and the record of history stored on the blockchain is the final answer. Theoretically at least. In practice, you can read about when the Bitcoin network rewrote history by changing the blockchain.
The immutability of the blockchain is secured using cryptographic principles and the clever use of scarce resources. Several systems exist for determining who gets to create the next block of the blockchain (see our cryptocurrency mining section for details about the most popular two). In all systems, the creator is either calculated using some public algorithm or is the winner of some contest.
In the first type, rewriting a block in the blockchain (unless you are the chosen one) is impossible since you can’t pretend to be that person. In the second, it takes a lot of work to find a solution to the contest and you have to do so extremely quickly because you need to do more work more quickly than the real blockchain (which is supported by everyone else in the network) to be accepted. It’s just not going to happen.
This protection of the history of the blockchain is what makes cryptocurrency possible. It is also a useful feature for a variety of other applications (see some examples).
A Distributed Financial System
The central tenets of blockchain that we just discussed tie directly into Bitcoin’s mission to become a decentralized, trustless financial system. In Bitcoin, copies of the history of all transactions performed in the Bitcoin network are stored on the nodes that make up the Bitcoin network. This means that the Bitcoin network is robust enough to weather the failure of any of the nodes that make it up.
The Bitcoin network can operate with a single functional node or a million. This means that the currency could still continue to operate even after losing over 99% of its infrastructure. If 99% of banks suddenly went out of business, would business be able to continue as normal? Probably not. The decentralization of Bitcoin means that its stability and value are directly tied to its users: as long as people believe that Bitcoin has value, then it will have value.
Bitcoin began essentially as one man’s pet project. Satoshi Nakamoto believed that the current financial system was flawed and created Bitcoin to be an alternative. Since then, Bitcoin has grown into a network with hundreds of thousands of users and a daily trading volume in the hundreds of millions to billions of US dollars. Beyond its own success, Bitcoin has also inspired thousands of other cryptocurrencies that have achieved daily trade volumes in the tens of billions of dollars and a market cap in the hundreds of billions.
The original design of Bitcoin made it incapable of scaling to meet the needs of a direct competitor to the credit/debit card industry. However, the success of Bitcoin has inspired developers to create second-level systems that are built on top of Bitcoin (and other cryptocurrencies) to deliver the capabilities that Bitcoin needs to meet the needs of its growing user base. One of these, the Lightning Network, provides instantaneous transactions which can theoretically scale infinitely to meet the needs of the network. Other proposals are designed to increase the privacy and efficiency of the network to better meet its users’ needs. For more information on some of these proposals, check out the section on Bitcoin’s history and future roadmap.
Since its humble beginnings, Bitcoin has grown to be an widely accepted worldwide currency. The blockchain technology that Satoshi Nakamoto created as part of Bitcoin has gone further, to revolutionize computing. The size and activity of Bitcoin’s user and developer base seems to promise that Bitcoin will continue to evolve and grow in the future to better suit the needs of the global economy.