Bitcoin 101: a simplified guide for beginners
The first decentralized digital currency
As with most cryptocurrencies, bitcoin or BTC represents a digital asset and is designed to work as a medium of exchange that uses strict cryptography instead of relying on banks or payment gateway to secure financial transactions.
The concept behind bitcoin was to produce a medium of exchange that is transferable electronically between users in a secure, verifiable and permanent way. It solves the double spending problem that plagues most digital transactions, where digital assets or electronic money can easily be copied and re-used.
According to the whitepaper of bitcoin:
A purely peer-to-peer version of electronic cash would allow electronic payments to be sent directly from one party to another without going through a financial institution.
The idea of a virtual currency autonomous from the government or any kind of regulatory bodies’ control attracts all types of people all over the world that the value of bitcoin surged in an unprecedented turn of event in late December 2017.
Its immense implications and possibilities that could potentially disrupt the existing economic model of the world as we know it, along with the limited supply of bitcoin—there will only ever be 21 millions of bitcoins that can be produced—has everyone in a mad dash to take a piece of this game changer.
Long before altcoins (alternative coins other than bitcoin) such as ripple, litecoin, ethereum, etc., started popping up, bitcoin has dominated the crypto market. It started out under 10 cents when it came into circulation in 2009, and its value has almost reached a staggering value of $20,000 at its peak late last year. Since then, the value of bitcoin has dropped to $6100, but the fad surrounding it has yet to subside. As of the moment, there are over 4,000 altcoins circulating in the market aside from bitcoin.
Who created bitcoin
Bitcoin was pseudonymously developed by an individual or arguably by a group of people known as Satoshi Nakamoto. It was released in 2009 as an open-source software, a free software available for everyone to use, edit and distribute as they see fit.
To this day, the identity of the elusive Satoshi Nakamoto remained unconfirmed, and the mystery enshrouding him served to fuel outrageous speculations and controversial theories by bitcoin enthusiasts across the globe. One notable theory as of late was the creator of bitcoin could be Tesla CEO Elon Musk, to which the latter denied on a tweet on November 28.
How bitcoins are created
While bitcoin shares the same characteristics as traditional money in the sense that it represents a standard of value and can be exchanged for goods or services; however, unlike fiat money, bitcoin is not printed on paper.
Bitcoins are produced by users all over the world using a free software through a process known as mining. This is a complex record-keeping process that makes use of computer processing power of the miners to solve complicated algorithm problems and confirm past bitcoin transactions by recording them in the blockchain or Bitcoin public ledger for a chance to win bitcoins.
Transaction speed
Typically, if one needs to send transactions across the world, a bank would need to verify that transaction, and this verification process would normally take days. Since bitcoin can be transferred from user to user on the peer-to-peer Bitcoin network directly, the recipient would then be able to receive the currency faster than what would normally take days.
Put simply, instead of a bank or financial institution verifying the transaction, all participants in the network have equal privilege and power to verify the transactions by solving algorithmic problems and recording all bitcoins transactions in a public ledger that is visible to everyone in the network.
Breaking down bitcoin technology
Public distributed ledger or shared ledger
The use of ledger to record economic transactions and summarized financial information has been around since ancient times. This was revolutionized with the application of digital technology, cryptography, and mathematical algorithm, and ultimately coalesced into blockchain technology.
Blockchain, in layman’s term, is a continuously expanding list of records of transaction data, known as blocks, which is secured using a cryptography, a practice used to try to keep information secret and safe by preventing the public from reading private messages and reinforce information security.
Each of these blocks contains a timestamp, cryptographic hash of the previous block, and transaction data that reference previous transaction outputs as new transaction inputs and assigns all input bitcoin values to new outputs.
Mining
The main purpose of mining is to record past bitcoin transactions in such a way that it would be impractical to modify these transactions without resorting to vast resource expenditures. Computers connected to the Bitcoin network are able to reach consensus about the ordering of events in bitcoin by downloading and verifying the blockchain. Procuring bitcoin through mining is difficult, costly and time-consuming, and this is designed as such so that the number of blocks to be earned remains constant.
This record-keeping process was named mining because it bears resemblance to the mining of other commodities, given how it requires tremendous effort and how it slowly introduces new units to anybody who wants to join mining. The main difference between the two is that supply does not affect the output, which means that increasing the hashpower of miner does not affect the long-term creation of bitcoins.
Miners are also paid with transaction fees paid by users when sending bitcoin transactions to other users and are also rewarded with newly minted bitcoins. This serves an important function of distributing new coins in a trustless manner and incentivizing people to reinforce security for the system.
Once the bitcoin transaction is validated, it will then be recorded on the blockchain permanently and this processed transaction then becomes irreversible. The transparency of these recorded transactions is what makes it really hard for anyone to change any information that has already been stored in the network, thus fraud and double-spending can be avoided.
Proof of Work
Proof of Work (PoW) is a piece of data required for block generation, which covers all of the data in the block and is completed by miners each time they receive a block. For the blocks to be considered valid, it must contain a PoW.
Generating a valid PoW can be difficult as it is a random process so a lot of trial and error effort goes into making a valid proof of Work. And due to the very low probability of successful generation, it is unknown which network node will be able to generate the next block.
Each computer or node represents one vote and consensus decision is represented by the longest chain, which contains greatest proof-of-work effort. This is to say that if a majority of CPU power is controlled by honest nodes, the honest chain will grow the fastest and outpace any competing chains.
Network nodes
We were told again and again that for the transaction to be verified, it must be added to a block that meets stringent cryptographic rules that will be verified by the network nodes. A node is any computer that connects to the Bitcoin network. The network node on a Blockchain network is where the entire foundation of the blockchain technology relies on. These devices on blockchain network are distributed across a widespread network and perform various tasks.
All of these nodes are constantly communicating with each other and feeding each other with information of what they believe to be the most updated version of the data, which in this case is the longest chain of blocks because it has the longest history.
Transaction Fees
We now have an idea that one can transact using bitcoin without paying a single cent, however, it’s good to keep in mind that those who paid transaction fees will be prioritized by miners because they are incentivised to prioritize to include these transactions to their block, thus making these “paid” transactions to be confirmed faster as opposed to those “free” transactions.
How to use Bitcoin
Using Bitcoin might sound daunting due to the intimidating technology behind it; however, it is very far from the truth. In fact, using Bitcoin is as easy as step 1,2,3!
- Download Bitcoin wallet on your mobile phone or install it in your desktop.
- Generate Bitcoin address. (You can generate more the next time you need to transact using Bitcoin)
- Give generated addresses to other parties so that you can receive or send money
In a nutshell
Bitcoin is just another type of digital currency which can be sent anywhere in the world with little to no fees. It employs a curious amalgam of the most ancient way of accounting and modern digitized technology that makes used of sophisticated arithmetic rules to manage the recording of financial information.