AN INTRODUCTION TO BITCOIN

The wounds created by the global financial crisis of 2008 made people want to turn their backs on the banking industry. Trust in centralization was lost and people started to look for alternative solutions. When one institution disappoints and damages this many people, these people will start to look for alternatives.

To satiate this need for change in the financial world, a mysterious man named Satoshi Nakamoto published a whitepaper for a project named Bitcoin in 2008. Chances are you’ve probably heard of it already. Currently, it is the most popular cryptocurrency, it holds number one position in terms of Market Cap, and it’s the pioneering cryptocurrency for every other digital coin that has come after it.

Take a minute now and watch the quick introduction video to what Bitcoin is below.

A SIMPLIFIED DEFINITION OF BITCOIN

Bitcoin is known to be the first decentralized digital currency. This means that it works without a central administrator, and there are no third parties or middle-men involved in any transaction. This system is called peer-to-peer because transactions are directly made from the giver to the receiver.

Transactions between users are broadcast to the blockchain. These transactions are then verified and confirmed by multiple nodes that make up and secure the network. Apart from decentralizing the handling of money and securing it, Bitcoin also provides privacy by using pseudonyms in the form of alphanumeric addresses.

SATOSHI NAKAMOTO AND THE CREATION OF BITCOIN

Satoshi Nakamoto is the creator of Bitcoin. He published a whitepaper on October 2008 to a mailing list revolving around cryptography. In this essay, titled Bitcoin: A Peer-to-Peer Electronic Cash System, Nakamoto references b-money, an early proposal for digital currency published in 1998 by Wei Dai, that aimed to be the first electronic cash system. Bitcoin’s way of working is very similar to what the concept of b-money was, and it seems to provide the model that Nakamoto would inevitably follow.

Satoshi’s identity is somewhat of a mystery, and it’s been the focus of quite a lot of speculation. He did not disclose any information regarding his identity when he discussed the technicalities of the project. Many theories have appeared based on investigations of his spelling and terminology when he talked about Bitcoin, the big conclusion being that he is British. Some others believe he is not actually one person, but a group of people that developed Bitcoin together.

In January 2009 the open source code of Bitcoin was born, with their first client and payment. These coins were mined by Satoshi himself, known as the “genesis block”, getting a 50 bitcoin reward. The world’s first Bitcoin transaction was between Satoshi Nakamoto and Hal Finney (a PGP Corporation developer), where the latter received 10 bitcoins. The value of these first bitcoins was discussed by members of the community on the bitcoin talk forums.

In 2011 Satoshi walked away from Bitcoin, disappearing from any involvement in the network. By that time, he was estimated to have mined approximately 1 million bitcoins. He gave his position as lead developer to Gavin Andersen, a developer involved with Bitcoin since 2010.

HOW BITCOIN WORKS

The Bitcoin system is based on a blockchain. This method consists of a public ledger that is updated and published by the global network of nodes. The nodes receive the transactions that are being broadcasted to the entire network, and then they validate and add them to their own copy of the ledger, which is then broadcasted to the rest of the nodes. A group of transactions that are validated is called a “block”, and about six times per hour a new block is added and published to the ledger. The next block needs to be consistent to the previous one, that’s why it’s called a blockchain.

The nodes are also known as “miners”, and the process of validating the transactions is called “mining”. The blocks contain a cryptographic hash function of the previous block, using the SHA-256 algorithm. This system runs on proof-of-work, which ensures each block will be accepted by the rest of the nodes. The miners need to complete a complex mathematical problem to get rewarded for the block they are mining, and that is the only way the rest of the network will accept that block and incorporate it into their copy of the ledger.

The miner that validates the new block is rewarded with newly created bitcoins and well as a transaction fees. The creation of new coins each time the miners solve the mathematical problem is what inspired the term “mining”, as it resembles the mining of gold. The transaction fees vary from one to the other, and the miners tend to prioritize the transactions with the highest fees.

The necessary information for a person to transact bitcoins is stored in a digital wallet. The analogy to the wallet is somewhat flawed, as it is not a place to store bitcoins, but holds instead the credentials that allow people to access and spend their bitcoins.

HOW BITCOIN IS USED

Bitcoin was intended to work as currency, and as time goes by, more institutions are starting to see it as one. Currently, more than 100,000 merchants accept bitcoin. But there’s still a dispute as to whether or not Bitcoin should be considered as currency.

As of the legality of Bitcoin, it varies from one country to the other. There are a number of countries that allow the trade of bitcoin, while others have restricted it. As bitcoin can be converted into other currencies, these regulations need to be taken into account.

Most merchants who accept bitcoins use payment services which accept the coins, convert them into the local fiat currency, and then send those converted funds to the receiver, charging a fee for the transaction. Coinbase and BitPay are two examples of companies who offer this service.

While Bitcoin has certainly come a long way, it faces more and more challenges every day. Ever since its release, hundreds of other cryptocurrencies have been created, each one aiming to solve some of the problems existing within the Bitcoin code. However, as the pioneer of a new financial era, Bitcoin still holds the title of the number one cryptocurrency, and, if they play their cards right, they could continue to hold their position for a long time.