What is Bitcoin
Bitcoin is a type of digital money that can be stored, exchanged, and used for payments.
What makes Bitcoin different from national currencies such as the euro, the US dollar, or the Japanese yen lies in its decentralized structure.
With centralized ‘fiat money,’ the currency is issued by central banks, and citizens have to use their country’s currency. Except for cash, transactions are carried out through intermediaries such as banks and payment processors.
Unlike traditional currencies, Bitcoin is neither issued by a central bank nor backed by a government. As a result, inflation rates, monetary policy, and economic growth indicators, which generally influence the value of currencies, do not have as strong and direct an impact on the most prominent cryptocurrency.
Bitcoin is a currency of choice that is controlled by the “consensus” or will of the majority of its users. The asset has a growing network of people who voluntarily agree to Bitcoin’s rules (protocol), a type of monetary policy.
They use the decentralized infrastructure to transact on a peer-to-peer basis (without intermediaries) and store value independently of any government, company, or financial institution.
There is no need to seek permission to use Bitcoin, and the risk of censorship is largely eliminated, with censorship being at odds with the cryptocurrency’s ethos of decentralization.
What makes Bitcoin valuable?
Bitcoin is often compared to gold as it has very similar characteristics.
Both assets have a limited supply. There will only ever be 21 million BTC.
It is easily divisible. You can divide a Bitcoin into 100 million parts. It is durable. A huge globally distributed network of independently managed computers tracks ownership of BTC.
Cryptocurrency is scarce and cannot be counterfeited. The only way someone could create fake Bitcoin is by executing so-called double-spending. This refers to a situation where a user “spends” or transfers the same Bitcoin to two or more separate settings, effectively creating a duplicate record.
How does Bitcoin work?
A blockchain is a connected array of data made up of units called blocks. They contain information about each transaction, including details such as buyer and seller, time and date, total value, and a unique identifier for each transfer.
The records are linked in chronological sequence, forming a numerical chain of blocks. When a block is added to the blockchain, it becomes available for anyone to view, thus acting as a public record of Bitcoin transactions.
The blockchain is decentralized, meaning no person or entity controls it. No one owns the chain, but anyone can contribute to it. When different individuals successfully make changes to it, each copy is updated.
While the idea of anyone being able to edit a blockchain may seem dangerous, it makes Bitcoin reliable and secure. To be included in the Bitcoin chain, most miners in the network must confirm a transaction’s block.
According to the algorithms, new BTCs are generated and made available to users who solve predefined mathematical problems.
Solving these problems (known as mining) consists of knowing a number, a hash, which is a 64-digit hexadecimal number that is less than or equal to the target hash.
This process is significant because it helps verify and secure the transaction history of the Bitcoin network. Anyone who wants to contribute new transactions to the network must first engage in securing it through mining, which requires computing power. As a result, it would be difficult and costly for an attacker even to attempt to cause any harm to the network.
How exactly do transactions work?
While it is possible to handle coins individually, performing a separate transaction for each particle of BTC transferred would be inconvenient. Transactions have many inputs and outputs that allow for the splitting and pooling of value.
Typically, there is either one input from a previous larger transaction, or multiple inputs combining smaller amounts, with at most two outputs: one for the payment and one to potentially return change to the sender.
Now imagine that Michael wishes to send Claire 1 BTC. He achieves this by signing a message containing transaction-specific information with his private key.
But what are inputs?
The inputs contain details of the Bitcoin previously delivered to Michael’s address. Let’s say Mario received 0.6 BTC from Maria and the same amount from George. Now, to send 1 BTC to Claire, there might be two inputs: one for 0.6 BTC from Maria and one for 0.6 BTC from George.
What about outputs?
The first output is 1.2 BTC to Claire’s public address (twice 0.6). The second output is 0.2 BTC in the form of change to Michael.
In this case, Michael will broadcast the intended transaction to the Bitcoin network via his wallet software. The inputs (i.e., the addresses from which Michael previously received the Bitcoin he claims to own) are verified by the participants who perform the mining process on the network, known as “miners.”
Any miner who has executed Proof-of-Work, or PoW, can propose a new block to be added to the chain or “linked” by referencing the previous block. Miners also create a block by combining a list of additional transactions broadcast on the network simultaneously. The network is then informed of the release of the new block.
The other network participants (nodes) will hand it over if they agree that it is a valid block, i.e., the transactions it contains meet all the protocol requirements and adequately link to the previous block.
Another miner would then build on the block by referencing it in the following block. The next miner will have “verified” all the transactions that were added to the last block. The number of acknowledgments for the Mario transaction in the above example increases as more blocks is added to the chain.
Is Bitcoin anonymous?
Bitcoin is often called “anonymous” because it can be sent and received without revealing personal information. However, achieving good anonymity with BTC can be difficult, and complete anonymity may be unattainable.
In the Bitcoin network, each participant has an alias – this is the address where you receive Bitcoin. Every transaction that includes the address is always recorded in the blockchain. Every transaction will be linked to you if your address is associated with your identity. Because of this, Bitcoin is pseudonymous rather than anonymous.
The creation of Bitcoin
On October 31, 2008, an individual (or group of people) going by the pseudonym “Satoshi Nakamoto” published a document titled “Bitcoin: A Peer-to-Peer Electronic Cash System,” which is the “whitepaper” on cryptocurrency.
A whitepaper is a report that gives readers information about an issue and presents a potential solution or philosophy to the writer.
Bitcoin’s white paper details a “peer-to-peer electronic money system” concept – a global financial infrastructure based on cryptographic evidence instead of trust.
The paper’s purpose is to provide a comprehensive understanding of the flagship cryptocurrency, providing context for its creation, key events in its history, how it functions, descriptions of its unique properties, and guidelines for participating in this new financial paradigm.
When Satoshi unveiled his proposal for Bitcoin, it attracted the interest of a very niche online community of cryptographers and computer professionals, many of whom have been involved in similar projects and initiatives.
The goal of the pseudonymous creator of Bitcoin was to build a financial infrastructure with a minimum level of trust that could be maintained for years to come.
Instead of building a new solution, he leveraged previous research in distributed systems, financial cryptography, network security, and more.
After Satoshi sent in his proposal for a new digital money system, the project became the subject of discussion among an online group of cryptographers and computer scientists. Satoshi wrote much of the Bitcoin codebase before publishing the whitepaper but opened it up for public scrutiny.
From the beginning, Bitcoin was an open-source software project built and maintained by a community of developers and enthusiasts. On November 8, 2008, BTC was registered on the open-source software development platform SourceForge.
On January 3, 2009, the first block, called the genesis block, of Bitcoin was mined by Satoshi within seven days. In this initial transaction, also called a “coinbase,” Satoshi included a headline from the Times Magazine.
“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”
This announcement was a clear signal of Bitcoin’s intentions. As the world was going through the biggest financial crisis since the Great Depression, a new vision of a monetary system separate from the state was emerging.
On January 12, 2009, the first post-Bitcoin transaction occurred between Satoshi and renowned software developer Hal Finney in block 170. There are also claims Finney was the first to mine BTC alongside Satoshi after the network launch.
On April 26, 2011. Satoshi quit the project, which was until then run mainly by “them.” Gavin Andreessen and the community supporting open-source projects took over the development leadership.
The inventor’s anonymity has been central to the success and sustainability of the project.
In the following years, law enforcement authorities became involved in investigating the misuse of cryptocurrencies. Had Satoshi been identified, the creator of the alternative monetary system could have received a sentence not dissimilar to that of Ross Ulbricht, the founder of the online marketplace Silk Road.
Satoshi’s withdrawal from the project was essential for Bitcoin to remain true to its foundation as a decentralized, sustainable financial system that minimizes the trust it needs to function.
Bitcoin and inflation
Bitcoin was created to mimic the steady inflation rate of gold. Although the common definition of deflation may suggest that Bitcoin is deflationary as its purchasing power increases over time.
Deflation refers to a decrease in the money supply. It is not simply a price reduction, though it is often defined that way. Deflation is a monetary phenomenon that causes such a fall in prices. By this logic, Bitcoin cannot be deflationary because its supply will not decrease. On the contrary, its supply will continuously increase until it reaches 21 million coins. On current forecasts, this is likely to happen sometime in 2140.
When this upper limit is reached, Bitcoin will be neither inflationary nor deflationary. Instead, it will become disinflationary, as it is programmed to be. The goal is to achieve a stable monetary base and an unchanging supply.
Like gold, Bitcoin is inflationary as more of it is mined. However, given that the mining of new coins is automatically reduced by 50% every four years, the inflation rate will also decrease.
As long as the asset’s value continues to rise relative to fiat currencies, Bitcoin’s typical annual inflation rates are usually not an issue. It is important to stress that this is not true for all cryptocurrencies.
Bitcoin’s fixed supply makes it a good hedge against inflation. When the supply of an asset is fixed and limited, no new coins can enter circulation – thus eliminating the risk of inflation.
Like gold, Bitcoin does not belong to any person, economy, or currency. It is an international asset class that reflects global demand. BTC is a better option than stocks because it does not have to deal with the many economic and political risks associated with stock markets.
Like gold, Bitcoin is scarce and secure but has an advantage over the metal because it is more portable, decentralized, and transferable.
Because of its decentralized nature, anyone can store Bitcoin. Conversely, gold cannot boast this quality, as sovereign states control its supply.
Bitcoin was born after the financial crisis of 2007-2008. In response to widespread bank failures, Satoshi Nakamoto created the cryptocurrency to provide the public with an asset that did not need third parties or central authorities. The result was a cryptocurrency independent of any entity or sovereign state.
Because Bitcoin is also diversified in nature, it can serve as a recession-proof asset. While the US dollar is dependent on the strengths and constraints of the US economy – such as GDP, export prices, monetary policy, and currency demand – Bitcoin is not constrained by the losses or gains of any one country.
BTC’s primary purpose is to store value, which is exactly why it is expected to outperform other cryptocurrencies, such as Ethereum, when a recession occurs.