Personal Finance and Online Security

What is Bitcoin for Dummies.

You may have heard of Bitcoin or recently read Elon Musk bought bitcoin with Tesla stock, or seen the HODL memes and subsequently decided to read up on Bitcoin. However, it becomes very easy to be overwhelmed with strange terms, such as Blockchain, decentralization, bitcoin miners, Bitcoin wallets. If these words made you break into a cold sweat, you’re not alone.

The cryptocurrency world fantasizes about playing an essential role in the global economy — offering an alternative to Dollars and Pounds. Alas, for many, the idea of cryptocurrencies and Bitcoin can feel impossible to understand due to its technicalities. This article hopes to digest Bitcoin and demystify the world’s largest cryptocurrency.

(A general note: according to the Bitcoin Foundation, the word “Bitcoin” is capitalized when it refers to the cryptocurrency as an entity, and it is given as “bitcoin” when it refers to a quantity of the currency or the units themselves.)¹

What is Bitcoin?

Bitcoin is a digital currency — one that is available in digital or electronic form. There are no physical bitcoins, so don’t be fooled by the stock images of shiny gold coins you may see (like the featured image of this post). Bitcoin has been invented without the need for a central bank. For example, where the Bank of England is responsible for the UK’s monetary system, Bitcoin does not have an organisation in charge. Matthew R. Kratter’s amazing short book titled A Beginner’s Guide To Bitcoin is a fantastic digestible book on Bitcoin and I highly recommend anyone interested in learning more to read it.

So, where did Bitcoin come from?

Birth of Bitcoin

It’s 2008, and a person using the pseudonym Satoshi Nakamoto has just published their whitepaper where they envision the future of their cryptocurrency, Bitcoin. In this world, Nakamoto imagines a world where people can make electronic payments without the need for a bank.

One of the biggest advantages that Nakamoto pushed for Bitcoin would be lower fees when payments are made. There are multiple costs required to keep a bank operating and these costs are often passed onto their customers. Therefore, Nakamoto wanted to cut out this middleman where it was no longer needed.

But… how does Bitcoin work?

Bitcoin is the most successful attempt (so far) to create virtual money through the use of cryptography, the art of writing and solving codes. In its decade-plus history, there have been many imitators inspired by Bitcoin (dogecoin, for example), however, Bitcoin remains the largest cryptocurrency by market capitalisation.

Blockchain

Bitcoin is a network that runs on a protocol known as the blockchain. Blockchain is a relatively new form of record-keeping technology and it can seem complicated, but its core concept is quite simple. First, to understand blockchain, we must define what a database is.

database is a collection of information stored electronically on a computer. This information, or data, is structured in a table format for easier filtering. You may ask why can’t we use an Excel spreadsheet to store data? Well, an Excel spreadsheet is designed for one, or a small group of people, to access a limited amount of information. Whereas, a database holds a significantly larger amount of data that can be accessed by any number of users at once!

How a database does this is by storing all the data on computer servers. A server is built using hundreds, or possibly, thousands of computers to maximise computational power and storage capacity.

Okay, but how does blockchain differ?

One key difference between blockchain and a database is how the data is structured. Whereas a database is tabular, blockchain collects information in groups, known as blocks. These blocks have a certain storage capacity and, when they are filled, they join a previous block, forming the chain of data. This chain is the blockchain. All new data follows this process of forming a block and joining an existing block in the chain.

Photo: https://www.bitpanda.com/academy/en/lessons/how-does-a-blockchain-work/

Therefore, all blockchains are databases but not all databases are blockchains.

This idea of storing data in blocks and forming a chain is one of the biggest advantages of Bitcoin — security. Each block serves as an irreversible timeline of data when implemented in a decentralised nature. Each block is given a timestamp when it is added to the chain — making it impossible to hack.

Transactions

Imagine Susan is sending 0.05 bitcoins to his friend, Ahmad, for £1,880. Once the trade is actioned, a record of this transaction is created. Computers in the network begin verifying this transaction (this is bitcoin mining, more later) — thus, ensuring Susan and Ahmad have the correct amount and everything is legitimate. Once approved, this transaction is added to a block along with other records. This is then connected to the blockchain.

Therefore, a transaction is a transfer of value between Bitcoin wallets which are then added to the blockchain. Bitcoin wallets hold two pieces of information, a secret piece of data called a private key (imagine this as your debit card pin code), and a public key (imagine your debit account number). This private key is used to sign transactions, proving the bitcoins have been sent from the owner of the wallet. All transactions are broadcast to the network and audited to be confirmed in a process called Bitcoin mining.

Bitcoin Mining

The primary purpose of Bitcoin mining is to legitimise and monitor bitcoin transactions and ensuring the validity of each. Nakamoto conceived this idea to prevent the “double-spending problem”. Double-spending is when someone illicitly spends the same bitcoin twice, as there is a risk that someone copies the digital token and sends it to the merchant while retaining the original.

Okay, but why would anyone want to audit bitcoin transactions?

Once a bitcoin miner has verified 1 megabyte worth of bitcoin transactions (what makes up a block), they are eligible to be rewarded with a quantity of bitcoin! (As of today, one bitcoin is worth $50,000, so quite a nice incentive).

Bitcoin mining contains a lot of information that I won’t cover here, it’s more so you understand the basics of Bitcoin and transactions.

Conclusion

If you’ve made it this far — then well done! I hope this article has provided you with a basic understanding of what Bitcoin is and how it works through the use of the blockchain.

So, what have we covered?

We now know that Bitcoin is a cryptocurrency invented in 2008 by an unknown person or group using the name Satoshi Nakamoto. It is a decentralised digital currency, meaning it does not have a central bank or single administrator and it consists solely electronically.

Transactions are verified by network nodes through cryptography (solving puzzles) and are recorded on the irreversible public distributed ledger named the blockchain. Each transaction is confirmed through the process of bitcoin mining where miners are incentivised by the potential reward of bitcoins.

You may now be asking yourself what is the point? What are the benefits of using Bitcoin and does it have a future? Look out for my future posts where I’ll discuss the pros and cons of Bitcoin, as well as, a more detailed article on the process of Bitcoin mining.

Thank you for reading, and as always, I would love to hear your comments.

– PocketPound

Featured image: Dmitry Demidko on Unsplash

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PocketPound

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