What is Bitcoin
Bitcoin is money. However, in order to be money, several extremely stringent criteria need to be met. Besides all the technical aspects of it, which make it seem extremely complicated, there are some very basic attributes that have to be in place in order for Bitcoin to be money. These are:
- is limited in supply
- It is expensive to create
- It is very near impossible to counterfeit
- It keeps its purchasing power better than competing currencies over the long term
Bitcoin’s creator, Satoshi Nakamoto, explained Bitcoin’s purpose in the whitepaper:
“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
Bitcoin is a digital currency. Unlike fiat currencies such as the U.S. dollar, Bitcoin is not controlled by any central authority. Instead, Bitcoin is regulated by the entire network. This makes Bitcoin decentralized. Nobody independently owns or controls Bitcoin, but everyone can participate in the network.
Bitcoin transactions are strictly peer-to-peer, and do not require any third parties to facilitate payments. Transactions are made with pseudonymous Bitcoin addresses. If the owner of the address is unknown, transactions with that address will be effectively anonymous.
Bitcoin was created in tandem with the rules that govern its use and supply. As such, the supply of bitcoin is predetermined and will not be changed. The supply of bitcoin will never exceed 21 million, making it provably scarce.
How Is Bitcoin Used
Bitcoin can be used in similar ways to other currencies. It can pay for goods and services based on the value of the currency. To send Bitcoin to another party, the sender only needs to know the recipient’s Bitcoin address.
All transactions can be seen by everyone in the network, and the balance of an address can be easily checked. However, addresses do not directly identify the person that controls them. This makes the network pseudonymous as transactions are public, but the human owner may not be known. This introduces a degree of anonymity, because an address does not identify the owner. A single person can control as many addresses as they like, making it difficult to tie an address to its owner.
Every address has a private key that is used to initiate a transaction to a new address. This is the single criteria used to initiate a transaction from one address to another. For this reason it is very important to keep private keys a secret.
Many people who own bitcoin do not control their private keys directly. Instead, they allow a trusted custodian, such an exchange, to maintain the custody of their bitcoin. This custodian will need to maintain private keys for any address in which they store bitcoin.
Useful Qualities of Bitcoin
Many people choose to use Bitcoin instead of other currencies because it satisfies the characteristics of money very well. Among other factors, the divisibility, portability, durability, and scarcity of Bitcoin make it a very effective form of money.
Bitcoin’s Rapid Settlement
On average, Bitcoin transactions are confirmed every ten minutes, although this period varies. A transaction is usually reliable after a single confirmation, but most people prefer to wait for 2-6 additional confirmations before accepting the payment as an additional security measure.
Even if you wait for several confirmations, Bitcoin payments clear much more quickly than traditional fiat currencies, which may take days to move through legacy financial institutions and do not clear on weekends or holidays. You might think that your bank offers instant transfers, but that is nothing more than an I.O.U. issued by the bank. The actual cash balance may take weeks to settle between banks, a process that most individuals are unaware of. Ultimately what this means is that Bitcoin settles with finality in approximately ten minutes, compared to all other monies, this is blisteringly fast.
There will never be more than 21 million bitcoin. This means that, no matter how high demand for bitcoin rises, the supply is fixed, and thus, the value of Bitcoin can ascend indefinitely. Scarcity is a valuable trait for money because it enables money to be a truly fair, unchanging measure of value.
Although there are only 21 million bitcoin, each bitcoin is divisible into 100 million pieces, called satoshis. This allows bitcoin to be spent in small amounts even as the price of a single bitcoin continues to skyrocket. Because bitcoin is purely digital, satoshis can be further divided infinitely on other layers.
Bitcoin is completely decentralized, and uncontrollable by any one party. This means that, unlike with other currencies, particularly fiat currencies, no centralized party can arbitrarily change the rules, produce more bitcoin, or redistribute bitcoin.
Furthermore, no one can be banned from the Bitcoin network. Anyone can mine, run a node, or send and receive transactions. No qualifications or permission is required.
How Bitcoin Works
Bitcoin uses a blockchain to store all of the transactions that occur on the network. Bitcoin’s blockchain is a shared public ledger that all participants in the network can observe. Data is added to the blockchain in blocks. Every block is appended chronologically to the previous block. The chronological ordering of blocks ensures that no bitcoin is double spent.
Every block contains Bitcoin transactions. There is a limit to the number of transactions that can be included in a single block, so a transaction might not be confirmed in the first block after it was initiated. A transactor can include a higher network fee to incentivize miners to include their transaction as quickly as possible. This fee generally represents a very small percentage of the overall transaction.
The procedure for adding new blocks to the blockchain ensures that past transactions cannot be changed. This immutability ensures that payments will never be reversed. Once a transaction has received multiple confirmations, the recipient can feel confident that the money has settled. Every additional confirmation makes this transaction less likely to be reversed.
What is Bitcoin Mining?
Mining is the process of adding transactions to the blockchain and if successful, being rewarded with freshly minted Bitcoins.
What is a Decentralized Network?
A decentralized network is a “trustless environment,” where there is no single point of failure. The nodes connected in the network are not dependent on a single server point and each node holds the entire copy of the network configurations. As the information never passes through a single server, a decentralized network is highly secure.
- Setup ensures anonymity and privacy
- Highly scalable
- Bandwidth is never an issue, as there is no single server that can create an operational bottleneck
- Efficient and high-speed operations
- More machines needed to support the system, driving up infrastructure costs
What is a Centralized Network?
The word “centralized” gives away how these networks are structured. A centralized network has a middleman to facilitate its operations, like a bank of all your transactions and information. This means it holds all your data, and therefore, trust is paramount.
- Consistent and efficient
- Requires less infrastructure support, making it an affordable network
- Users need to give up control of their data
- Has a single point of failure that can compromise the availability of the entire network
- Scalability limitation, as it is dependent on a single server
- Bandwidth limitations, as the server become a bottleneck in cases of multiple transactions
Bitcoin is a distributed network whereas Visa and Mastercard are great examples of centralized networks. Because Bitcoin is distributed, it is extremely robust and can handle sustained attacks or natural disasters without the risk of losing track of which addresses own what Bitcoin. Centralized networks are prone to censorship and enforced control. This can be seen when your bank accidentally freezes your account due to an admin error, or even worse when they freezes the account of somebody for political reasons, at the behest of the state or public pressure. This cannot happen in the Bitcoin network.