How exactly to categorize Bitcoin is a matter of controversy. Is it a type of currency, a store of value, a payment network, or an asset class?

Fortunately, it’s easier to define what Bitcoin actually is. It’s software and a purely digital phenomenon—a set of protocols and processes.

 

It is also the most successful of hundreds of attempts to create virtual money through the use of cryptography. Bitcoin has inspired hundreds of imitators, but it remains the largest cryptocurrency by market capitalization, a distinction it has held throughout its decade-plus history.

Like standard currency, Bitcoin is produced and has processes and safeguards in place to prevent fraud and ensure appreciation in its value. The main building blocks of Bitcoin are blockchain, mining, hashes, halving, keys, and wallets. They are discussed in detail below.

(A general note: According to the Bitcoin Foundation, the word “Bitcoin” is capitalized when it refers to the cryptocurrency as an entity, and it is given as “bitcoin” when it refers to a quantity of the currency or the units themselves. Bitcoin is also abbreviated as BTC.1 Throughout this article, we will alternate between these usages.)

 

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KEY TAKEAWAYS

  • Bitcoin is a digital currency, a decentralized system that records transactions in a distributed ledger called a blockchain.
  • Bitcoin miners run complex computer rigs to solve complicated puzzles in an effort to confirm groups of transactions called blocks. Upon success, these blocks are added to the blockchain record, and the miners are rewarded with a small number of bitcoins.
  • Other participants in the Bitcoin market can buy or sell tokens through cryptocurrency exchanges or peer-to-peer.
  • The Bitcoin ledger is protected against fraud via a trustless system; Bitcoin exchanges also work to defend themselves against potential theft, although high-profile thefts have occurred.

 

The Blockchain

Bitcoin is a network that runs on a protocol known as the blockchain. While it does not mention the word blockchain, a 2008 paper by a person or people calling themselves Satoshi Nakamoto first described the use of a chain of blocks to verify transactions and engender trust in a network.2

The blockchain​ has since evolved into a separate concept, and thousands of blockchains have been created using similar cryptographic techniques. This history can make the nomenclature confusing. Blockchain sometimes refers to the original Bitcoin blockchain. At other times, it refers to blockchain technology in general, or to any other specific blockchain, such as the one that powers Ethereum​.

Any given blockchain consists of a single chain of discrete blocks of information, arranged chronologically. In principle, this information could include emails, contracts, land titles, marriage certificates, or bond trades. In theory, any type of contract between two parties can be established on a blockchain as long as both parties agree on the contract. This takes away any need for a third party to be involved in any contract and opens up a world of possibilities including peer-to-peer financial products, such as loans or decentralized savings and checking accounts, wherein banks or any intermediary are irrelevant.

Blockchain’s versatility has caught the eye of governments and private corporations; indeed, some analysts believe that blockchain technology will ultimately be the most impactful aspect of the cryptocurrency craze.

In Bitcoin’s case, the information on the blockchain is mostly transactions. Bitcoin is really just a list. Person A sent X bitcoin to person B, who sent Y bitcoin to person C, etc. By tallying these transactions up, everyone knows where individual users stand. It’s important to note that these transactions do not necessarily need to take place between humans.

Bitcoin’s blockchain network creates vast possibilities for the Internet of things. In the future, we could see systems in which self-driving taxis or Uber vehicles have their own blockchain wallets. The passenger would send cryptocurrency directly to the car, which would not move until the funds were received. The vehicle would be able to assess when it needs fuel and use its wallet to facilitate a refill.

Another name for a blockchain is a “distributed ledger,” which emphasizes the key difference between this technology and a well-kept Word document. Bitcoin’s blockchain is distributed, meaning that it is public. Anyone can download it in its entirety or go to any number of sites that parse it. This means that the record is publicly available, but it also means that there are complicated measures in place for updating the blockchain ledger. There is no central authority to keep tabs on all Bitcoin transactions, so the participants themselves do so by creating and verifying “blocks” of transaction data. See the section on mining below for more information.

You can see the status of blocks, and their associated transactions, on sites. Such sites list the address identifier for the transacting parties, dates, the date on which the transaction took place, and the time of the transaction.3

The long strings of numbers and letters are addresses, and if you were in law enforcement or just very well informed, you could probably figure out who controlled them. It is a misconception that Bitcoin’s network is totally anonymous, although taking certain precautions can make it very hard to link individuals to transactions.

 

Mining

The process that maintains this trustless public ledger is known as mining. Undergirding the network of Bitcoin users who trade the cryptocurrency among themselves is a network of miners who record these transactions on the blockchain.

Recording a string of transactions is trivial for a modern computer, but mining is difficult because Bitcoin’s software makes the process artificially time-consuming. Without the added difficulty, people could spoof transactions to enrich themselves or bankrupt other people. They could log a fraudulent transaction in the blockchain and pile so many trivial transactions on top of it that untangling the fraud would become impossible.

By the same token, it would be easy to insert fraudulent transactions into past blocks. The network would become a sprawling, spammy mess of competing ledgers, and Bitcoin would be worthless.

Combining “proof of work” with other cryptographic techniques was Nakamoto’s breakthrough. Bitcoin’s software adjusts the difficulty miners face in order to limit the network to a new 1-megabyte block of transactions every 10 minutes. That way, the volume of transactions is digestible. The network has time to vet the new block and the ledger that precedes it, and everyone can reach a consensus about the status quo. Miners do not work to verify transactions by adding blocks to the distributed ledger purely out of a desire to see the Bitcoin network run smoothly; they are compensated for their work as well. We’ll take a closer look at mining compensation below.

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