What is Bitcoin? A Guide
Without question, Bitcoin (BTC) and the Bitcoin network are the best-known names in blockchain and cryptocurrency.
The individual, or group, behind the invention of Bitcoin, remains pseudonymous, and this has arguably had a massive impact on the community. Additionally, there is no individual with total power or control over the system.
A simplistic way to think of Bitcoin is a combination of computing, cryptography, and a system of economic competition designed to ensure following the rules is in everyone’s best interest, without a central authority. The network manages itself, with no single party controlling the system. Honest work that supports the network, such as validating transactions, is rewarded, creating a mechanism for new bitcoin to be programmatically introduced into the system in a predictable way, achieving the key quality of scarcity. While Bitcoin participants may at times have conflicting interests, they share the goal of seeing Bitcoin succeed. But who controls the Bitcoin ledger, and how does it achieve sound money?
Bitcoin can be explained as a peer-to-peer network of computers all following a set of rules and instructions (the Bitcoin protocol) for validating transactions and issuing new coins. Any computer running any software that respects these rules - Bitcoin Nodes - can participate in the Bitcoin network.
The protocol is like the banking laws of a country, but the Bitcoin protocol is enforced by code, and not by law.
Bitcoin has a ledger of all the transactions - the blockchain - where transactions are recorded in blocks created at set intervals and connected to the previous block to create a chain. Then there is the mechanism for adding blocks to the chain and reaching an agreement, or consensus, that transactions are valid and the chain accurate – this is mining.
The ledger and the way transactions are validated are revolutionary.
We trust banks to maintain the integrity of their ledgers, but cannot verify this for ourselves. On the Bitcoin network, anyone can have a copy of the ledger containing every transaction ever made. This allows everyone to mathematically verify that every transaction in it is legitimate, and transactions that don’t respect the rules are automatically rejected by the software.
This does lead to questions, however. For example, how do we all agree that the current version is the most up to date one and how can thousands of computers reach consensus without someone in charge?
Mining is about solving a complex mathematical problem, and it is competitive, with the winner being able to add to the chain of transactions and receive a reward.
Everyone can verify that the solution is right, so if a miner cheats, other participants will simply discard the block.
In theory, anyone can mine, but the maths problems are so difficult, and the competition so fierce, you’d need a lot of specialised computer equipment. Despite the costs this can involve, it can be very profitable, and the competition ensures no one person has complete control.
As mentioned, mining is also the way new bitcoin (BTC) enters the system. When a miner gets to add a new block of transactions to the blockchain, they receive a reward of new bitcoins.
The transaction fee is the sum of fees paid for all transactions included in that block, which vary according to demand. This is BTC already in circulation.
The block rewards, however, are entirely new coins and currently set at 6.25 BTC per block until 2024. This process will continue until all 21 million BTC are released, at which point miners will only receive transaction fees.
It is this which gives BTC the scarcity its value needs.
So, bitcoin achieves reliable digital scarcity with no one in charge. What about the other properties of sound money?
Durability – As every node has a copy of the ledger, destroying the Bitcoin network would require that all 50,000 nodes be destroyed at the same time, along with all backups. Unlikely.
Divisibility – The smallest unit of Bitcoin is the satoshi, which is 1/100,000,000 of one coin. That’s far more precise than even the smallest microtransactions would require, although network fees make that level of precision impractical at the moment.
Fungibility - All Bitcoin have equal value, just like one gram of gold is equal to any other gram of gold.
Portability – It is entirely digital and incredibly portable, and can be stored on a computer, mobile phone, and on paper.
No system is entirely perfect. For the Bitcoin network, the chief limitation focuses on the relationship between security, scalability, and decentralisation.
Scalability is the capacity of the system to execute a higher volume of transactions
Security is the capacity to protect the ledger from cheating and attacks
Decentralisation is what stops any one party from controlling the network
When you design a network, you have to make trade-offs in this area as you can’t have all three completely. Fiat currency is scalable and quite secure, but is centralised and controlled by a small group. Meanwhile, Bitcoin is focused on decentralisation and is secure, but at the price of scalability.
At the moment, Bitcoin's maximum transaction speed makes it impractical to scale (compare five transactions per second to the reported 50,000+ leading debit/card handlers deal with). This, to an extent, is why bitcoin is stored for value rather than used as a medium of exchange.
Author: Brendan Beeken
Moni Talks Founder and Chairman Brendan Beeken is an entrepreneur, commercial strategist, investor, and philanthropist. He writes on a wide range of subjects, including cryptocurrency, decentralised finance, blockchain, business advice, and professional wellbeing, for news and business websites, as well as Latest Moni and his personal site, brendanbeeken.com. Brendan draws from his own research and more than two decades of personal experience in business to offer a unique insight, perspective, and commentary on diverse subjects. He is passionate about making the cryptocurrency space more accessible and encouraging safer and more responsible trading and investing. Brendan's LinkTree is https://linktr.ee/brendanbeeken.