What exactly is Bitcoin?
Bitcoin is a peer-to-peer payment network with its own native currency, bitcoin.
Bitcoin (upper case “B”) refers to the network, whilst bitcoin (lower case “b”) refers to the currency. Also known as BTC, like how the U.S. dollar is also known as USD.
There are three participants in the Bitcoin network:
- Users
- Nodes
- Miners
The users are the people transacting in bitcoin.
Their transactions are added to a memory pool (called the mempool), where they wait to be added to the blockchain.
The blockchain is a series of data packets (blocks) containing transaction data linked together in order of when they were added to the chain.
Nodes each keep a complete record of the blockchain, as well as the consensus rules for adding blocks.
Blocks are added to the blockchain in a process called mining, which is where miners use computational power to solve cryptographic puzzles faster than other miners in a process called Proof-of-Work (PoW).
The winner is awarded the right to propose the next block, which is made up of transactions the miner has selected.
Miners select transactions that contain the largest miner fees, which are voluntary “tips” that users offer so that their transactions are processed quickly.
The miner will propose a block, and the nodes will check that the block doesn’t break the consensus rules (for example, that it doesn’t contain transactions involving bitcoin that have already been spent).
If the proposed block doesn’t break any rules, the nodes agree to add it to the chain.
The Bitcoin network has the following characteristics:
- Decentralised – There is no singular entity that owns or controls the network
- Trustless – Because it is peer-to-peer, there is no need to trust a third party
- Permissionless – Anyone with an internet connection can use the network
- Pseudonymous – There is no KYC (Know-Your-Customer), so your identity is safe
- Immutable – The blockchain is a permanent record that cannot be altered
- Public – The blockchain is a public ledger, so anyone can read it
How did Bitcoin begin?
Bitcoin was invented by the pseudonymous Satoshi Nakamoto, whose real identity remains unknown.
Nakamoto released the Bitcoin whitepaper in October 2008. In January 2009, he mined the “Genesis Block”, the first block in the Bitcoin blockchain.
Nakamoto combined pre-existing technologies to create Bitcoin, mainly: the timestamp server (blockchain) and the PoW consensus mechanism.
By combining these technologies, Nakamoto solved the “double-spend problem”. This had prevented anyone from creating a digital currency up until that point.
The blockchain ensures that no one can spend the same bitcoin twice, because there is a permanent record of the first transaction.
The PoW consensus mechanism ensures that “attacking” the network, trying to split the blockchain in two, thus allowing the attacker to double-spend, is prohibitively expensive because real-world computational resources have to be expended.
Since this requires electricity, the more mining power is assigned to the network, the more expensive it is to attack, so the more secure it is.
What is Bitcoin used for?
Because Bitcoin is a permissionless network, it is useful for people who don’t have access to the traditional banking system.
These people are referred to as “unbanked”, and Bitcoin is the perfect technology to provide them with financial services.
People can save in bitcoin, and because it’s a great store of value in the long term, it is actually better to save in bitcoin than it is to save in traditional currencies. (known as fiat currencies)
Bitcoin is a better form of money than fiat currencies because it has a maximum supply. There will never be more than 21,000,000 bitcoin, whereas fiat currencies can be endlessly inflated.
In countries such as Venezuela and Argentina, citizens are using bitcoin to hedge against hyperinflation since the value of bitcoin remains roughly the same (or goes up) whilst the value of their own currencies drastically falls.
Since Bitcoin is censorship-resistant (governments cannot prevent transactions), citizens of these countries (and others) also use bitcoin to circumvent authoritarian monetary controls.
Summary
Bitcoin is a financial network that doesn’t require a centralised authority or a third party to facilitate or approve transactions.
The network is made up of users, nodes, and miners.
Nodes keep a record of the blockchain, and miners add blocks to the blockchain through a process called Proof-of-Work.
This keeps the network safe and ensures bitcoin isn’t double-spent.
Bitcoin is a store of value, making it a great hedge against inflation, and its other characteristics (permissionless, censorship-resistant, trustless, peer-to-peer) make it a great alternative to the traditional financial system.
