I first came across Blockchain Technology when China declared it wouldn’t accept Bitcoin as legal tender.

“Does the Chinese central bank really think Bitcoin will replace the Yuan? No way.”

China made that announcement in December of 2013. A few weeks prior, on November 30th, one Bitcoin was valued at $1,165.89 USD – its highest ever.

“This is nuts! Why would I pay almost $1,200 for a virtual currency that’s not even issued by a central bank?”

Shortly after China’s stern warning, the price of Bitcoin tumbled to less than $500.

Now, as I write this, a little over 3 years later, the price of Bitcoin has blown past that all-time high, approaching $1,300, and becoming more valuable than gold

Bitcoin fever has gripped, not just the Chinese, but the world at large – including North America.

With all of this happening, I can’t help but wonder, will the dollar become obsolete?

Satoshi Nakamoto

 

Satoshi Nakamoto is the anonymous creator of Bitcoin

Not his actual photo

Revolutionizing currency was Satoshi Nakamoto’s main goal when he created Bitcoin.

On Friday, October 31st, 2008, he published a paper entitled, “Bitcoin: A Peer-to-Peer Electronic Cash System.” 

On Saturday, January 3rd, 2009, Satoshi minted the very first Bitcoin and left an interesting text message on the Blockchain:

“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”

An obvious reference to a piece in the Financial Times published on the same day. 

The revolutionary message Satoshi Nakamoto left on the Bitcoin genesis block

Six days later, on Friday, January 9th, 2009, he released the first implementation of the Bitcoin Core software, effectively launching the Bitcoin Blockchain.

Currently, no one knows who Satoshi Nakamoto is. Maybe he’s one person. Maybe it’s a group of people.

He claimed to be a man, born in 1975, living in Japan. However, most people don’t believe this.

In fact, several individuals have been considered candidates for the true identity behind Satoshi Nakamoto, most notably Craig Wright, who attracted much fanfare when he publicly claimed to be Satoshi in May of 2016. His claim is now widely regarded as a hoax.

 

What is Bitcoin?

Put simply, Bitcoin is the world’s first peer-to-peer digital currency.

You can send Bitcoin directly to someone else without going through a financial institution or other third party.

“This isn’t [just] money, it’s a decentralized trust network”

Andreas Antonopoulos

I cannot emphasize enough how revolutionary the italicized portion of that phrase is.

“This isn’t [just] money, it’s a decentralized trust network,” said Andreas Antonopolous, one of Bitcoin’s most vocal proponents.

What Andreas is referring to is the true magic of Bitcoin. Under the hood is a well-oiled engine that keeps the Bitcoin network running – the Bitcoin Blockchain.

Read my other post: What’s A Blockchain?

We’ll discuss how the Bitcoin Blockchain works in the ensuing paragraphs. For now, let’s look at a decades-old problem that Bitcoin elegantly solved.

The Double-Spend Problem

Why do you value the twenty-dollar-bill in your pocket? Probably because it’s worth twenty dollars and you can exchange it for something else that’s also worth twenty dollars.

Since it’s a physical note, whenever you decide to exchange it for a product or service, the seller of that product or service is confident the same twenty-dollar-bill doesn’t exist elsewhere – it’s unique.

Practically speaking (apart from counterfeiting), the double-spend problem isn’t an issue for physical money.

What about digital money? How can a seller be confident you won’t just copy and paste that same $20 to hundreds of other merchants?

This is called the double-spend problem, and prior to Bitcoin, the only way to solve it was to use a trusted intermediary like a bank or credit card company.

 

The “double-spend problem” refers to how digital currency can be spent more than once

Bitcoin was the first attempt at creating a digital currency that didn’t need a trusted third party, and instead relied on complex algorithms, digital signatures, and a decentralized peer-to-peer network.

It not only succeeded, it changed the world.

 

Why Does Bitcoin Matter?

So why are people paying almost $1,300 for one Bitcoin? Why were over 100,000 merchants – worldwide – accepting Bitcoin as early as February 2015? In other words, why does Bitcoin matter?

I’ll boil down the significance of Bitcoin to three interrelated innovations:

1) Bitcoin was the first digital currency to solve the double-spend problem

2) In doing so, Bitcoin created the Blockchain – a technology many are hailing as the “second internet”

3) The Bitcoin Blockchain is public, free, and not controlled by any single authority. This means, Bitcoin the currency, is also not controlled by any single authority

Within each of these 3 breakthroughs are several important inventions as well. For example, algorithmic Proof-of-Work mining: how the network processes transactions and issues new Bitcoin. In fact, let’s take a look at how the whole thing works.

How Bitcoin Works

Let’s assume you already own some Bitcoin (if you don’t, scroll below to learn how to buy it).

If you purchase a product from a merchant who accepts Bitcoin, you would simply scan a QR code with your smart phone.

The price of the product is converted from dollars to Bitcoin (currency symbol: BTC) based on the prevailing exchange rate.

After reviewing everything, you would authorize the payment, and voila – a Bitcoin purchase!

As you can probably tell, it’s very much like your typical credit card payment, and just as fast – a few seconds.

Now let’s take a look at the mechanics under the hood.

The Bitcoin Blockchain

The elaborate system that runs Bitcoin is fairly complex. This will be a very general overview of how the hypothetical transaction described above flows through the Bitcoin Blockchain.

I’ll start by listing a few basic definitions that I’ll be using throughout this article:

• Protocol – rules defining how everything should communicate on the Bitcoin network

• Client software – end-user software the actually implements the protocol

• Node – a computer running Bitcoin client software

• Wallet – software or a device that facilitates Bitcoin transactions

• Digital signature – a system of private and public keys used to authenticate electronic transactions

• Public key – an address (like an email address) you’ll need in order to receive Bitcoin. Here’s a random example:

1BvBMSEYstWetqTFn5Au4m4GFg7xJaNVN2

• Private key – a secret code (like a PIN) used to authorize spending. It looks something like this:

5Kb8kLf9zgWQnogidDA76MzPL6TsZZY36hWXMssSzNydYXYB9KF

• Mining – solving complex mathematical problems (proof-of-work) and processing transactions in order to earn newly minted Bitcoin. Nowadays, this requires dedicated, specialized computer hardware

• Block – A collection of validated, timestamped transactions on the Bitcoin Blockchain

• Hash – the output of a complex cryptographic “hash algorithm”

• Nonce – an arbitrary number used to generate hash outputs

After scanning your QR code, reviewing the cost, and deciding to buy, you authorize the transaction and send the required amount of Bitcoin to the merchant’s address (public key) using your private key. Most of this would be handled by your wallet software, oblivious to you.

The transaction is now broadcast to the Bitcoin network. Several mining nodes pick up the transaction, validate it, then include it in a newly created block. They receive a small fee for this.

Every 10 minutes or so, a new block is created and confirmed. After about an hour, five more blocks are added “on top” of your block. This means your transaction has now been confirmed six times.

As a rule of thumb, once a transaction has been confirmed six or more times, it’s considered permanent. This is because it would be extremely difficult for anyone to go back six blocks and recalculate each block.

This difficulty increases exponentially as additional blocks are added on top of your block, increasing the permanence of your transaction.

This “difficulty” is actually the key innovation of Bitcoin, and is what makes a decentralized network possible. It’s called, Proof-of-Work (PoW).

Mining and Proof-of-Work

Proof-of-Work (PoW) refers to the processing of data such that an output is difficult to produce. However, it’s fairly easy for others to review that output and verify that a person actually spent the computational resources required to produce it.

Bitcoin uses Adam Back’s “HashCash” algorithm for proof-of-work.

Mining involves the processing of Bitcoin transactions and the creation of new Bitcoin – similar to how central banks print money – except, Bitcoin does this predictably and algorithmically.

As miners are validating transactions, and adding them to new blocks, they are also competing for newly minted Bitcoin using proof-of-work.

Bitcoin mining and other activities allegedly consume 600 megawatts – enough to power a city of 300,000

Each miner is required to produce a hash of the candidate block header. This hash must be less than a specified target value – in other words, it must contain a certain number of preceding zeros and be less than the target.

For example, in the scenario below, the hash has the required number of preceding zeros, and “24fd” is less than the target’s “24fm.”

Hash:   0000000000000024fd9371ddff055eed7f02348e4eda36c741a2fc62c85bc5lm

Target: 0000000000000024fm00000000000000000000000000000000000000000000000

This is a completely random process. Each block contains a small “nonce” field. A nonce is an arbitrary number used to generate hash outputs.

In order to produce a hash less than the target, a mining node will continuously alter the nonce, generating a different hash each time.

If, lo and behold, the miner is lucky enough to produce a hash value less than the target, he wins 12 ½ Bitcoin!

Note: the number of Bitcoin generated per block is halved every four years (approximately). 50 BTC: 2009 – 2012, 25 BTC: 2012 – 2016, 12½ BTC: 2016 – 2021, and so on.

The miner himself is not directly involved in this intense computational effort. This is left to the fancy mining computer he owns.

Here’s the kicker – finding a value less than the difficulty target may require several trillion attempts. This is why miners:

  • Use specialized computers specifically designed for Bitcoin mining
  • Join mining pools – teams of miners who pool their computing resources to increase the odds of winning Bitcoin (and split their earnings accordingly)

Bitcoin mining therefore consumes an enormous amount of electricity. One source puts the total electricity consumption of the Bitcoin network at 600 megawatts – enough to power a North American city with a population of 300,000.

While this is arguably Bitcoin’s most significant drawback, it’s also the network’s “superpower” (pun intended).

The electricity, and more specifically, the computational effort – or hash rate – required to keep the network running, prevents malicious attackers from attempting to tamper with the Bitcoin Blockchain.

 

Depiction of a Bitcoin mining setup

Furthermore, since the network has almost 6,000 nodes, randomly coming on and off the network, and processing transactions almost simultaneously, there must be some way for the network to consistently select the authoritative chain of transaction blocks, as several may be created at any given moment.

In other words, the network must achieve consensus.

Blockchain consensus is an interesting topic, but to make a long story short, the Bitcoin network always selects the chain with the most computational effort as the “official” record.

 

Looking Forward: Pros and Cons

CONS

As I noted above, electricity consumption (and its related issues) is perhaps the most important problem facing Bitcoin today. In my opinion, other notable challenges include:


Scalability:

Bitcoin has become more popular than most anticipated. How will it adapt as it transitions from being a techie’s cryptocurrency to being the dollar’s kryptonite? The infamous block size debate is case in point


Volatility:

For Bitcoin to be widely used as a currency, it must achieve better stability. Bitcoin prices can swing wildly, even intraday


Complexity:

To use Bitcoin and store it securely, a certain level of technical ability is required. My mother wouldn’t touch those scary Bitcoin addresses with a 10-foot pole


Irrevocable transactions:

Once a Bitcoin payment has been sent, it can’t be revoked. It’s gone forever


Permanent loss:

If you lose your private key, the funds accessed by that key are also lost – forever


 

PROS

Despite these challenges, I’m still a Bitcoin advocate. Here’s why:

 


 

Peer-to-peer payments:

In my opinion, if Bitcoin became widely adopted and more user-friendly, it’s impact would be even more significant than what we’re seeing today. I still view disintermediation as Bitcoin’s crowning achievement


Nominal fees:

A miner will receive a small fee for including your transaction in a block. This is usually no more than a few cents. Compare that to the 2-3% charged by your bank or credit card company


Zero merchant fees:

In addition to the ridiculously low fees, merchants who accept Bitcoin get charged absolutely nothing by the network


Privacy:

Although technically not anonymous, Bitcoin transactions don’t require the use of any personal details like your name or address (i.e. they are “pseudonymous”)


A public immutable record:

All Bitcoin transactions are public. Anyone can view them. Once a transaction is confirmed, it has a permanent place on the Bitcoin Blockchain. Obviously, this feature has its drawbacks, but in my opinion, it’s an auditor’s dream


No one “owns” the Bitcoin network:

Bitcoin is not a central bank, or company. It’s owned by everyone, and no one. Your account can’t be controlled by anyone else (unless they have your private key).

The currency is designed to be deflationary, which has pros and cons. But think about it, no quantitative easing, no bailouts, no limits…actually there is a limit – the last of 21 million Bitcoin will be minted in 2140…


 

Buying Bitcoin

  1. Choose a wallet

By now, you’re probably itching to go out and buy yourself some Bitcoin. Before you do that, get yourself a wallet.

Most digital wallets out there are online applications or “hot wallets.” These are great for speed, convenience, and ease of use.

However, once you amass a significant amount of Bitcoin, the safest way to store it would be offline “cold storage.” This involves paper wallets and hardware wallets.

Weusecoins.com has an epic post on wallets if you want to explore more on the topic, or if you need helping choosing one.

  1. Buy some Bitcoin

Once you have a wallet, you’re ready to purchase some Bitcoin:

The easiest way to purchase Bitcoin quickly and easily is through a reputable exchange like Coinbase or Kraken. Personally, I prefer the Coinbase interface.

These exchanges also feature built-in wallets. While that’s convenient, it’s always better to store your Bitcoin in your own wallet, where you control the private key.

Remember, whoever has access to your private keys has access to your money. Several exchanges have lost millions in Bitcoin (notably Mt. Gox and Bitfinex). Don’t say I didn’t warn you.

Here are a few other ways to buy Bitcoin:

• Find a seller on localbitcoins.com

• Check coinatmradar to see if you have a Bitcoin ATM nearby

• Buy from a friend or family

• Sell something and request Bitcoin as payment

Thousands of Bitcoin ATMs are being set up all over the world

Conclusion

Although I had Bitcoin on my radar for several years, I only decided to read Satoshi Nakamoto’s landmark whitepaper last year.

I devoured each sentence, and by the end of it, was almost moved to tears by the elegance of his invention.

“This is big…”

I implore you to do the same. You can read the Bitcoin white paper here.

My question to you: Do you understand Bitcoin a little bit better now? Let me know by leaving a comment below.

Enjoyed this post?

Subscribe & be the first to know when we post Frederick's next article.

You'll also get our 3 most important Blockchain videos.

2 Comments

  1. Johnc202

    Hey there, You have done a great job. I’ll definitely digg it and personally recommend

    Reply
  2. Smithe188

    I simply couldn’t depart your web site prior to suggesting that I actually loved the usual info a person supply for your guests? Is gonna be again continuously in order to check up on new posts.

    Reply

Submit a Comment

Your email address will not be published.

Pin It on Pinterest

Share This