The purpose of this article is to give anyone beginning to learn about Bitcoin the basics, and to clear up some of the vagueness around this popular but still quite misunderstood cryptocurrency. Let’s get started.
Bitcoin has been around since 2008, but there are still a lot of people out there who don’t understand exactly what it is.
That’s not too surprising, as it was supposedly invented by someone going by the fake name of Satoshi Nakamoto.
This person apparently created Bitcoin, explained it to the world, and vanished forever.
In fact, to this day, no one really knows this person’s true identity. Lots of people have been pegged as the creator, but no one has been 100% confirmed. In any case, that doesn’t matter now – Bitcoin is up and running!
One thing that most people who care about monetary systems of value do know for sure is that it has incredible potential for shaking up the world of finance as we know it, as it clearly already has.
Here is how much a bitcoin is worth right at this moment (Dec / 2017) – impressive for a virtual coin, right?
What Is Bitcoin?
A bitcoin is a unit of virtual currency and also the first cryptographic proof to overcome the so-called “double-spending problem”, which is a problem specific to digital currency involving duplication and fraud.
Satoshi Nakamoto explained this concept in his paper that he released back in ’08.
Bitcoin is also a more general term for that virtual or digital currency that refers to a group of computers that maintain a public ledger, AKA the blockchain.
Bitcoin’s ledger is different from a bank ledger because it is maintained by the collective rather than a single entity, ie. decentralized instead of centralized banking.
Hence, the blockchain, as it is called, is made up of blocks that are broken up and stored onto separate nodes throughout the global network.
This is what makes bitcoin so different and so scary to a lot of people, as it’s very much a concept that was meant to be controlled by the masses rather than some huge corporation.
While the concept makes some people uneasy, while others find it to be more reasonable as they see big banks as being corrupt and regular currencies as being outdated.
Overall, Bitcoin is becoming increasingly popular and changing how monetary systems work.
We cannot over-emphasize this “public ledger” or blockchain idea. Again, the difference between the Bitcoin system and the current banking system is that everyone knows about everyone else’s transactions.
This is quite a novel idea and is seemingly more honest, while still retaining privacy for its users.
Since everyone is anonymous in this system (real names of people are not used, just digital signatures), you aren’t supposed to trust them individually as one would not trust a complete stranger with your valuables, but collectively everyone is held accountable because Bitcoin’s records are open to all who use it.
Also, trust between two strangers isn’t exactly needed in Bitcoin’s system, because, at the end of the day, everything is protected by special mathematical functions.
In essence, everyone is managing everyone else’s financial transactions and it is held in place by inscrutable math behind the scenes.
When someone sends someone else an amount in Bitcoin, all the nodes will update their ledgers accordingly. What authenticates requests?
Basically, for a single user to unlock funds, a special password or key is needed, also known as a digital signature.
This digital signature is equivalent to a real hand written signature, but it is authenticated though a mathematical algorithm that prevents copying or forgery.
The unique thing about these passwords is that they are unique for every transaction. No one single password is used more than once.
This is due to the fact that with Bitcoin, everyone is monitoring and actually verifying everyone else’s transactions, so this requires a high level of behind the scenes security that we will touch upon shortly.
Public and Private Keys
Unique signatures or “keys” are what make transactions happen in Bitcoin, and there are two types of digital signatures – private and public.
The private signature, or key, creates the signature, and the public key is so others can verify it. Public keys are also the address to which bitcoins are sent.
So, when you send funds to someone, they are receiving it via their public key. Because all keys are unique, no one is allowed or able to modify them as they pass through the network.
The math behind this is complex, but one way that it is referred to is the “elliptic curve digital signature algorithm”.
Also, it’s worth stating that you don’t need to know this complex math to either mine or trade in Bitcoins, but it obviously would help somewhat if you did understand it.
Another notable thing about the Bitcoin system is that conventional account balances are not used.
This would seem strange, perhaps, since everyone is able to see everyone else’s balance on the ledger, and so one might assume this would involve an account history whereby one might know if someone has enough bitcoins to pay for a purchase.
This is just like looking at your bank account to see how much is in there before you buy something. With normal banking, you can go back and look at what debits or credits lead to your current balance.
With Bitcoin, instead of an account history or a balance sheet, the system uses what are called “inputs” or transaction references.
These transaction references can be used to verify the math behind whether or not someone has a certain amount of Bitcoins in order to cover their purchases, or to trade.
Before you can do anything with Bitcoin, you need a virtual wallet. When you download a bitcoin wallet, it will check all previous reference transactions to check for validity before it’s ready to be used.
There is no such thing as doubling up on any transaction for any purpose, because of the unique nature of each transaction.
This is the cryptographic proof we mentioned that Bitcoin has accomplished in the beginning of this article.
When the various nodes are verifying a transaction, they simultaneously check all other transactions to check if they have been used or not.
This helps to keep the ledger AKA blockchain updated and indeed is crucial to making sure the system works properly and effectively.
So, in order to arrive at your own balance, the Bitcoin system requires that you go through every transaction ever made in the ledger and tally up all your unspent inputs to arrive at your current balance.
Imagine a large public account where everyone can see all the transactions, but only the people with the proper keys or passwords can access certain funds in that public account.
This is how bitcoin functions. At the same time, these transactions can become more complicated depending on the nature of the transaction, and the key can become more like a complex math problem to be solved.
In fact, even simple passwords are in essence math problems that need to be solved rather than your typical password. This enhances the security of Bitcoin and makes the system more unique.
It is also important to understand that because Bitcoin is operating in a decentralized fashion, when a user makes an error of some kind, which is entirely possible, there is no one to appeal to to correct this error, as there is no central system owner who is responsible.
If an error is made, it is your fault alone and you must deal with the consequences, which may involve lost bitcoins from the whole of the bitcoin economy.
This may occur if, for example, you lose your private key. It can also happen if you happen to throw out a hard drive that contains bitcoins, and your wallet was on that hard drive. It has happened, so look out!
If you’ve heard of Bitcoin, you probably have heard of Bitcoin mining, which involves “miners” using their computers to verify the transactions we’ve been talking about.
Mining, since the beginning of Bitcoin, has been incentivized because miners get a payout in Bitcoins (or fractions thereof) for doing “work” to solve these computational problems or puzzles involving the public ledger aka blockchain.
This is a diminishing reward system for miners as the “block reward” that they get for mining is halved every 4 years, and will eventually be gone, removing the incentive to mine.
Basically, the more computer power a miner uses to mine, the harder the puzzles will become to solve, and the monetary rewards increase.
These days, people who own PC’s cannot compete with the “big guys” who use entire rooms full of computers to mine for Bitcoins. Watch the following video to see what we mean.
What Is Proof of Work (PoW)?
Proof of Work is when a miner provides the solution to a particular challenge or puzzle. The puzzles in question are what we were referring to previously – verifying transactions.
In a way, mining is similar to providing the correct combination to a complicated lock. If the lock opens, it proves that you did the required work to figure out the combination.
Some of the downsides to the “Proof of Work” concept include the fact that it requires large amounts of computing energy just to make random guesses miners need to make for the mathematical challenge.
Also, Bitcoin will eventually run out one day (there is a limited supply), and that presents a problem too, as it will lead to people only just trading bitcoins, not mining them, which is a different idea altogether.
As such, the “Proof of Stake” concept is slowly being adopted to counteract some of Bitcoins inherent flaws.
Bitcoin’s PoW Algorithm – SHA265
If you aren’t utterly confused at this point, get ready, because it’s going to get more confusing in a second. Bitcoin uses the SHA256 algorithm to do the “work” we’ve talked about.
So SHA256 came from research into cryptographic hash functions over a long period of time. It was not originally created for the purposes of hashing for Bitcoin, specifically.
There were many algorithms like this before it came along, and some were known to be weak, so people in the crypto community constantly were making new ones.
By the way, “hashing” just means doing the work, or the puzzle-solving. The SHA256 algorithm was chosen because it is a strong and practical cryptographic hash algorithm.
It didn’t require any new math – it just goes off on existing probability and that SHA256 was a well recognized hash function.
Also, once the work is done, it is very easy to check if someone is right.
The miner, for example, would have to work very hard to get the random number needed, but checking to see if it was right is relatively easy.
That’s what separates the SHA256 algorithm from many possible proof of work functions where checking to see if the answer was right is much more power consuming.
So, someone faking many answers could slow down other people (who were checking to see if answer is right) in cases where verification is difficult.
SHA1, which came before SHA256, was susceptible to a kind of attack in a specific situation. See https://shattered.io/
Benefits of the SHA256 Hashing Function
Being a solid hashing function, SHA256 has several benefits which we will outline here:
What Is A Block in the Bitcoin Blockchain?
Up until now we’ve been going on about the “blockchain”, but what is it?
The blockchain is the various “pages” on the virtual ledger that contains all of Bitcoin’s coded transactions, which is constantly being updated by all of the miners as it is being used.
A block is just a single page from this chain. Another way to put it is the number of transactions that take place in 10 minutes.
So, all the transactions are not contained in a single block, but throughout the entire chain, which is, of course, linked to the other blocks.
The blocks of the block chain are spread throughout the nodes of the entire global network, and each block is many gigabytes in size.
There’s definitely a lot more to say about Bitcoin and cryptocurrency in general, but we’ll leave it at that for now.
Hopefully this helped explain a few things about Bitcoin.
Stay tuned for more articles that will provide more information on similar content – knowledge is power!