What is Bitcoin? A Beginner’s Guide
Just a simple question containing three little words, four little syllables, but to the bitcoin enthusiast it is a question that evokes panic. What is bitcoin? Wait, you think, should I really get into it? Am I meant to give a proper answer, or will I come off as the crypto-equivalent of an annoyingly enthusiastic vegan? Should I wave off the question? But if I wave off the question have I inadvertently passed on a meaningful conversation with someone who has interest? But if I do enter that conversation – in the immortal words of Kevin Spacey in The Usual Suspects – “What if I miss?” I might cement a negative attitude towards bitcoin and towards my own seriousness!
We dedicate this article to you, you beautiful, awkward steward of bitcoin, in your quest to explain what bitcoin is. We hope this helps.
Bitcoin is a Store of Value
Bitcoin is the culmination of years of advances in cryptography and computer science; however, it was launched in 2009. To the anonymous founder of Bitcoin Satoshi Nakamoto, the backdrop of the Great Recession – that disastrous, self-inflicted wound – perfectly summed up everything wrong with the modern financial system, and demonstrated exactly why bitcoin was needed.
“The root problem with conventional currency is all the trust that’s required to make it work,” Nakamoto wrote. “The central bank must be trusted not to debase the currency, but the history of fiat [paper] 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.”
Governments inevitably devalue national currencies to the detriment of savers, the only question is how quickly and by how much. Banks facilitate the process with spendthrifty lending, risking the need for bailouts with printed cash. The same banks must be trusted to store savings – but are also granted the power to freeze accounts if governing authority demands it or, in extreme circumstances, socialize losses to offset their own negligent behavior.
Nakamoto hardcoded Bitcoin to act differently.
- Bitcoin has a predetermined and decreasing rate of inflation. New bitcoin is released based on a timetable, approximately once every 10 minutes, with the amount released halving every four years. (50, 25, 12.5, 6.25 and so on)
- Bitcoin has a hard cap. Production of bitcoin will cease after 21 million are released. So far, a bit more than 17 of the 21 million are in circulation. It is predicted that bitcoin will stop production in 2140.
- Bitcoin is controlled by no central agency. It is developed with a single-minded focus on keeping the network decentralized.
Assuming a steadily increasing demand, a relatively stagnant rate of supply, and governments periodically instituting monetary policies harmful to savers, bitcoin would be expected to continue appreciating in value.
You hold your savings.
The savvy bitcoin user maintains complete and singular control over his savings. Suffice it to say here that control is maintained using a digital signature system in which a user holds the only digital key able to unlock the bitcoin wallet. Control over one’s bitcoin mitigates the issue of trust in custodial accounts that Mr. Nakamoto alludes to in the opening quotation. Wherever you go, your wealth goes with you.
The system so far described establishes a non-inflationary and limited digital asset, with singular control of the asset held by the owner. But how do two strangers who hold their own wealth transact with one another without the intermediary that Nakamoto removed from the equation?
Bitcoin is a means of Transferring Value
Transferring value is deceptively simple. There are tons of different payment mechanisms that allow for easy value transfer between individuals – paypal, credit cards, and banks to name three. However, these three payment mechanisms have something in common that is missing from bitcoin, namely a trusted intermediary that mitigates counterparty risk. Your bank knows how much money you have because they hold your money as custodian, and they know how much John Doe has because they can simply ask his bank or paypal.
A large part of bitcoin’s uniqueness and value is that monetary transactions can be confirmed as valid without the need to trust banks, money transmitters, or any other central agency. It is the absence in bitcoin of a central agency that makes the protocol impervious to political, criminal, or any external pressures, ensures that ALL transactions are (relatively) quickly processed, and guarantees the immutability of your savings. Read the introduction to bitcoin transactions to find out how these transactions work!
So how does the bitcoin protocol verify transactions between two users without an intermediary?
Decentralization, or how bitcoin removes the central agency
First the master ledger of transactions, or bitcoin blockchain, is itself distributed and updated by thousands of network participants. I am currently writing this article on a mid-range Toshiba computer I bought in 2015. The computer is also performing its duties as a bitcoin node, one of about 12,000 that operate at any given time worldwide. The responsibility of a node is to store bitcoin’s digital ledger of transactions, receive the newest updates of the ledger, transmit it between nodes, and in the process transmit the information to the world.
For those that use torrent sites, nodes are equivalent to seeders, or those that share data with one another to allow the downloading of movies or other stuff. It is basically impossible to stop torrent sharing by going after the thousands of seeders. Same deal with bitcoin.
A distributed method of holding the ledger isn’t so groundbreaking – the peer to peer method just described has been around for years. However, the question of how to add additional transactions to the ledger in an entirely decentralized fashion is something else entirely. How does a decentralized network agree that the ledger, including all new transactions, are valid in such a way that everyone can trust the process?
When bitcoin first launched, each and every node also served as ‘miners’. It was the role of the miner not only to store and distribute the ledger, but also to gather new transactions organize them into a new page/block, and add them to the end of the ledger/blockchain. In order to ensure that no miner was able to gain an advantage over the others, which would enable the manipulation of the new transactions included in the block to his advantage, mining was engineered to be entirely random.
For more information on how this works, you can check out our introduction to bitcoin mining. However, for the purposes of this introduction, it is enough to say that miners must solve an entirely random problem, the answer to which may only be found through trial and error. Once a miner has stumbled upon the answer, it is broadcast throughout the network. Nodes are easily able to check that the answer is correct after which they signal their acceptance. The block is then added to the end of the chain and the process begins anew.
The successful miner is rewarded with a number of bitcoin – which is how new bitcoin is released into the market – and the fees for the transactions. To ensure that the bitcoin is released according to schedule – every 10 minutes you’ll remember – the difficulty of the random mining problem is adjusted once every two weeks.
This process was hardwired into the bitcoin code by Mr. Nakamoto, and has run essentially flawlessly while demonstrating imperviousness to attack for the last nine years now, in that jungle known as the internet.
Interested in getting started? Check out our article on how to buy bitcoin.