What Is Bitcoin?
Introduction To Bitcoin
What is Bitcoin?
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).
Although there are remarkable differences, BTC, as a digital form of money, shares some similarities with the fiat money we are all used to. So, let’s discuss first the value of fiat money before we dive into the cryptocurrency ecosystem.
Why does money have value?
In short, what gives money value is trust. Essentially, money is a tool used to exchange value. Any object could be used as money, as long as the local community accepts it as payment for goods and services. In the early days of human civilization, we had all kinds of objects being used as money – from rocks to seashells.
What is fiat money?
In the past, people could go to the bank to exchange their paper money for gold or other precious metals. Back then, this mechanism ensured that currencies like the U.S. dollar had their value tied to an equivalent amount in gold. However, the gold standard was abandoned by the majority of nations and is no longer the basis of our monetary systems.
- It’s issued by a central authority or government.
- It has no inherent value. It’s not backed by gold nor any other commodity.
- It has an unlimited potential supply.
Why does fiat have value?
Why does crypto have value?
When it comes to Bitcoin, we can narrow it down to six features that we’ll discuss in more detail later: utility, decentralization, distribution, systems of trust, scarcity, and security.
What is intrinsic value?
A lot of the discussion regarding Bitcoin’s worth is whether it has any intrinsic value. But what does this mean? If we look at a commodity like oil, it has intrinsic value in producing energy, plastics, and other materials.
The traditional financial system has many investment options that carry intrinsic value, from commodities to stocks. Forex markets are an exception as they deal with fiat currencies, and traders often profit from short or mid-term exchange rate swings. But what about Bitcoin?
Bitcoin’s value in utility
Bitcoin’s value in decentralization
Bitcoin’s value in distribution
By allowing as many people as possible to participate, the Bitcoin network improves its overall security. The more nodes connected to Bitcoin’s distributed network, the more value it gets. In distributing the ledger of transactions across different users, there’s no need to rely on a single source of truth.
Without distribution, we can have multiple versions of the truth that are difficult to verify. Think about a document sent via email that a team is working on. As the team sends the document among themselves, they create different versions with different states that can be difficult to track.
Also, a centralized database is more susceptible to cyber-attacks and outages than a distributed one. It’s not uncommon to have issues using a credit card because of a server issue. A cloud-based system like the one of Bitcoin is maintained by thousands of users around the world, making it much more efficient and secure.
Bitcoin’s value in systems of trust
Trust is an essential part of any valuable item or commodity. Losing trust in a central bank is disastrous for a nation’s currency. Likewise, to use international money transfers, we have to trust the financial institutions involved. There is more inbuilt trust in Bitcoin’s operations than other systems and assets we use daily.
However, Bitcoin users don’t need to trust each other. They only need to trust Bitcoin’s technology, which has proven to be very reliable and secure and the source code is open for anyone to see. Proof of Work is a transparent mechanism that anyone can verify and check themselves. It’s easy to see the value here in generating consensus that is almost always error-free.
Bitcoin’s value in scarcity
Bitcoin’s value in security
In terms of keeping your invested funds safe, there aren’t many other options that provide as much security as Bitcoin. If you follow the best practices, then your funds are incredibly secure. In developed countries, you can easily take for granted the security offered by banks. But for many people, financial institutions cannot provide them the protection they need, and holding large amounts of cash can be very risky.
The only real threats to the storage of your BTC are:
- Fraud and phishing attacks
- Losing your private key
- Storing your BTC in a compromised custodial wallet where you don’t own the private key
Bitcoin as a store of value
- Durability: So long as there are still computers maintaining the network, Bitcoin is 100% durable. BTC cannot be destroyed like physical cash and is, in fact, more durable than fiat currencies and precious metals.
- Portability: As a digital currency, Bitcoin is incredibly portable. All you need is an Internet connection and your private keys to access your BTC holdings from anywhere.
- Divisibility: Each BTC is divisible into 100,000,000 satoshis, allowing users to make transactions of all sizes.
- Fungibility: Each BTC or satoshi is interchangeable with another. This aspect allows the cryptocurrency to be used as an exchange of value with others globally.
- Scarcity: There will only ever be 21,000,000 BTC in existence, and millions are already lost forever. Bitcoin’s supply is much more limited than inflationary fiat currencies, where the supply increases over time.
- Acceptability: There’s been widespread adoption of BTC as a payment method for individuals and companies, and the blockchain industry just continues to grow every day.
There is, unfortunately, no single and neat answer as to why Bitcoin has value. The cryptocurrency has the key aspects of many assets with worth, like precious metals and fiat, but doesn’t fit into an easily identifiable box. It acts like money without government backing and has scarcity like a commodity even though it’s digital.
But, ultimately, Bitcoin runs on a very secure network and the cryptocurrency has a considerable amount of value placed on it by its community, investors, and traders.
If you’d like to view Bitcoins performance compared to various other assets over the past few years including precious metals such as Gold and Silver, public companies such as Apple and Tesla, ETFs (Exchange Traded Funds) such as Select Sector SPDR ETFs and iShares Treasury and Corporate Bond ETFs you can do so at PricedInBitcoin21.
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.But, ultimately, Bitcoin runs on a very secure network and the cryptocurrency has a considerable amount of value placed on it by its community, investors, and traders.
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 with each other to synchronize new information.
What is the blockchain?
For more information on blockchains, see What is Blockchain?
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.
What if I lose my bitcoins?
Can I revert Bitcoin transactions?
How can I store my bitcoin?
There are many options to store coins, each with their own strengths and weaknesses.
Storing your bitcoin on an exchange
Storing your coins on Binance allows you to easily access them for the purposes of trading or lending.
Storing your coins in a bitcoin wallet
Non-custodial solutions are the opposite – they put the user in control of their funds. To store funds with such a solution, you use something called a wallet. A wallet doesn’t hold your coins directly – rather, it holds cryptographic keys that unlock them on the blockchain. You have two main options on this front:
Cryptocurrency wallets that are not exposed to the Internet are known as cold wallets. They’re less prone to attack because there is no online attack vector, but they consequently tend to provide a clunkier user experience. Examples include hardware wallets or paper wallets. Most widespead examples of this being the Ledger Nano and the Trezor.
A History Of Bitcoin
Who created Bitcoin?
Did Satoshi invent blockchain technology?
Bitcoin actually combines a number of 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:
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.
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.
Like b-money, it was never further developed. Bit Gold’s similarities to Bitcoin have, however, cemented its place as the “precursor to Bitcoin.”
How are new bitcoins created?
How many bitcoins are there?
How does Bitcoin mining work?
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.
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 taken merely fluctuates around this target.
The Bitcoin Halving
What is the Bitcoin halving?
A Bitcoin halving (also called a Bitcoin halvening) is simply an event that reduces the block reward. Once a halving occurs, the reward given to miners for validating new blocks is divided by two (they only receive half of what they used to). However, there is no impact on transaction fees.
How does the Bitcoin halving work?
When Bitcoin launched, miners would be awarded 50 BTC for each valid block they found.
The first halving took place on November 28th, 2012. At that point, the protocol reduced the block subsidy from 50 BTC to 25 BTC. The second halving occurred on July 9th, 2016 (25 BTC to 12.5 BTC). The last one took take place on May 11th, 2020, bringing the block subsidy down to 6.25 BTC.
In the above chart, we can see the decrease in the block subsidy over time and its relationship with the total supply. At first, it may seem that the rewards have dropped to zero and that the max supply is already in circulation. But this is not the case. The curves trend incredibly close, but we expect the subsidy to reach zero around the year 2140.
Why does the Bitcoin halving happen?
It’s one of Bitcoin’s main selling points, but Satoshi Nakamoto never fully explained his reasoning for capping the supply at twenty-one million units. Some speculate that it’s merely a product of starting with a block subsidy of 50 BTC, which is halved every 210,000 blocks.
It makes sense that there are limits on how fast participants can mine coins. After all, 50% were generated by block 210,000 (i.e., by 2012). If the subsidy remained the same, all units would have been mined by 2016.
With the halving mechanism, there is an incentive to mine for 100+ years. This gives the system more than enough time to attract users so that a fee market can develop.
What impact does the Bitcoin halving have?
Those that are most impacted by halvings are miners. It makes sense, as the block subsidy makes up a significant part of their revenue. When it is halved, they only receive half of what they once did. The reward also consists of transaction fees, but to date, these have only made up a fraction of the block reward.
Halvings could, therefore, make it unprofitable for some participants to continue mining. What this means for the wider industry is unknown. A reduction in block rewards might lead to further centralization in mining pools, or it could simply promote more efficient mining practices.
Historically, a sharp rise in Bitcoin price has followed a halving. Of course, there isn’t much data available as we’ve only seen two so far. Many attribute the price movement to an appreciation of Bitcoin’s scarcity by the market, a realization triggered by the halving. Proponents of this theory believe that value will once again skyrocket following the event in May 2020.
Common Bitcoin Misconceptions
Is Bitcoin anonymous?
Is Bitcoin a scam?
No. Just like fiat money, Bitcoin may also be used for illegal activities. But, this doesn’t make Bitcoin a scam in and of itself.
Is Bitcoin a bubble?
Due to Bitcoin’s unique nature as a decentralized digital commodity, its price is entirely dictated by speculation in the free market. So, while there are many factors driving the Bitcoin price, they ultimately affect market supply and demand. And since Bitcoin is scarce and follows a strict issuance schedule, it’s thought that long-term demand will exceed supply.
The cryptocurrency markets are also relatively small when compared to traditional markets. This means that Bitcoin and other crypto assets tend to be more volatile, and it’s quite common to see short-term market imbalances between supply and demand.
Does Bitcoin use encryption?
It’s worth noting, though, that many applications and crypto wallets make use of encryption to protect users’ wallets with passwords. Still, these encryption methods have nothing to do with the blockchain – they’re just incorporated into other technologies that tap into it.
What is scalability?
Scalability is a measure of a system’s ability to grow to accommodate increasing demand. If you host a website that’s overrun with requests, you might scale it by adding more servers. If you want to run more intensive applications on your computer, you could upgrade its components.
In the context of cryptocurrencies, we use the term to describe the ease of upgrading a blockchain so it can process a higher number of transactions.
Why does Bitcoin need to scale?
To function in day-to-day payments, Bitcoin must be fast. As it stands, it has a relatively low throughput, meaning that a limited amount of transactions can be processed per block.
As you know from the previous chapter, miners receive transaction fees as part of the block reward. Users attach these to their transactions to incentivize miners to add their transactions to the blockchain.
How many transactions can Bitcoin process?
Because it’s not managed by a data center that a single entity can upgrade at will, Bitcoin must limit the size of its blocks. A new block size that allows 10,000 transactions per second could be integrated, but it would harm the network’s decentralization. Remember that full nodes need to download new information roughly every ten minutes. If it becomes too burdensome for them to do so, they’ll likely go offline.
If the protocol is to be used to payments, Bitcoin enthusiasts believe that effective scaling needs to be achieved in different ways.
What is the Lightning Network?
The Lightning Network allows users to send funds near-instantly and for free. There are no constraints on throughput (provided users have the capacity to send and receive). To use the Bitcoin Lightning Network, two participants lock up some of their coins in a special address. The address has a unique property – it only releases the bitcoins if both parties agree.
From there, the parties keep a private ledger that can reallocate balances without announcing it to the main chain. They only publish a transaction to the blockchain when they’re done. The protocol then updates their balances accordingly. Note that they don’t need to trust each other, either. If one tries to cheat, the protocol will detect it and punish them.
In total, a payment channel like this one only requires two on-chain transactions from the user – one to fund their address and one to later dispense the coins. This means that thousands of transfers can be made in the meantime. With further development and optimization, the technology could become a critical component for large blockchain systems.
What are forks?
Since Bitcoin is open-source, anyone can modify the software. You could add new rules or remove old ones to suit different needs. But not all changes are created equal: some updates will make your node incompatible with the network, while others will be backward-compatible.
Older nodes can still receive these blocks or propagate their own. That means that all nodes remain part of the same network, no matter which version they run.
Bitcoin’s Segregated Witness (or SegWit) is an example of a soft fork. Using a clever technique, it introduced a new format for blocks and transactions. Old nodes continue to receive blocks, but they don’t validate the new transaction type.
Now there are two different protocols, each with a different currency. All the balances on the old one are cloned, meaning that if you had 20 BTC on the original chain, you have 20 NewBTC on the new one.
In 2017, Bitcoin went through a controversial hard fork in a scenario similar to the above. A minority of participants wanted to increase the block size to ensure more throughput and cheaper transaction fees. Others believed this to be a poor scaling strategy. Eventually, the hard fork gave birth to Bitcoin Cash (BCH), which split from the Bitcoin network and now has an independent community and roadmap.
Participating In The Bitcoin Network
What is a Bitcoin node?
“Bitcoin node” is a term used to describe a program that interacts with the Bitcoin network in some way. It can be anything from a mobile phone operating a Bitcoin wallet to a dedicated computer that stores a full copy of the blockchain.
There are several types of nodes, each performing specific functions. All of them act as a communication point to the network. Within the system, they transmit information about transactions and blocks.
How does a Bitcoin node work?
Full nodes are integral to Bitcoin’s decentralization. They download and validate blocks and transactions, and propagate them to the rest of the network. Because they independently verify the authenticity of the information they’re being provided with, the user doesn’t rely on a third party for anything.
Light nodes are not as capable as full nodes, but they’re also less resource-intensive. They allow users to interface with the network without performing all of the operations that a full node does.
Light nodes are ideal for devices with constraints in bandwidth or space. It’s common to see this type of node being used in desktop and mobile wallets. Because they can’t perform validation, however, light nodes are dependent on full nodes.
Mining nodes are full nodes that perform an additional task – they produce blocks. As we touched on earlier, they require specialized equipment and software to add data to the blockchain.
Mining nodes take pending transactions and hash them along with other information to generate a number. If the number falls below a target set by the protocol, the block is valid and can be broadcast to other full nodes.
But in order to mine without relying on anyone else, miners need to run a full node. Otherwise, they can’t know what transactions to include in the block.
If a participant wants to mine but doesn’t want to use a full node, they can connect to a server that gives them the information they need. If you mine in a pool (that is, by working with others), only one person needs to run a full node.
How to run a full Bitcoin node
A full node can be advantageous for developers, merchants, and end-users. Running the Bitcoin Core client on your own hardware gives you privacy and security benefits, and strengthens the Bitcoin network overall. With a full node, you no longer rely on anyone else to interact with the ecosystem.
A handful of Bitcoin-oriented companies offer plug-and-play nodes. Pre-built hardware is shipped to the user, who just needs to power it on to begin downloading the blockchain. This can be more convenient for less technical users, but it’s often considerably more expensive than setting up your own.
In most cases, an old PC or laptop will suffice. It’s not advisable to run a node on your day-to-day computer as it could slow it down considerably. The blockchain grows continuously, so you’ll need to ensure that you have enough memory to download it in its entirety.
A 1TB hard drive will suffice for the next several years, provided there isn’t any major change to the block size. Other requirements include 2GB of RAM (most computers have more than this by default) and a lot of bandwidth.
How to mine Bitcoin
In the early days of Bitcoin, it was possible to create new blocks with conventional laptops. The system was unknown at that point, so there was little competition in mining. Because activity was so limited, the protocol naturally set a low mining difficulty.
Mining Bitcoin today requires significant investment – not only in hardware but also in energy. At the time of writing, a good mining device performs upwards of ten trillion operations per second. Although very efficient, ASIC miners consume tremendous amounts of electricity. Unless you have access to several mining rigs and cheap electricity, you’re unlikely to ever turn a profit with Bitcoin mining.
With the materials, however, setting up your mining operation is straightforward – many ASICs come with their own software. The most popular option is to point your miners towards a mining pool, where you work with others to find blocks. If you’re successful, you’ll receive part of the block reward proportional to the hash rate you’ve provided.
How long does it take to mine a bitcoin?
Who can contribute to the Bitcoin code?
The Bitcoin Core software is open-source, meaning that anyone can contribute to it. You can propose or review new features to be added to the 70,000+ lines of code. You can also report bugs, or translate and improve the documentation.
Changes to the software go through a rigorous reviewing process. After all, software that handles hundreds of billions of dollars in value must be free of any vulnerabilities.