What is Bitcoin?
Say there’s a coin that’s currently worth Thousands of U.S.
dollars, but it does not have any physical shape. In
fact, it’s not the kind of coin that you can hold in your hand or stick in a piggy
bank. It’s a digital currency, which means it only exists electronically. I’m
talking about bitcoin.
Bitcoin doesn’t work like most money. It isn’t attached
to a state or government, so it doesn’t have a central issuing authority or
regulatory body. Basically, that means there’s no organization deciding when to
make more bitcoins, figuring out how many to produce, keeping track of where they are, or investigating fraud. So how does bitcoin work as a currency, or have any value at all? Well, bitcoin wouldn’t exist without a whole network of
people and a little thing called cryptography. In fact, it’s sometimes
described as the world's first cryptocurrency. And here’s how it works.
Bitcoin
is a fully digital currency and you can exchange bitcoins between computers in
a worldwide peer-to-peer network. The whole point of most peer-to-peer networks is sharing stuff, like letting people make copies of super legal music
or movies to download. If bitcoin is a digital currency, what's stopping you
from making a bunch of counterfeit copies and becoming fabulously wealthy?
Well, unlike an mp3 or a video file, a bitcoin isn't a string of data that can be
duplicated. The blockchain records every
bitcoin transaction that has ever happened. And, as of late 2016, the complete ledger is about 107 gigabytes of data. So when you send someone bitcoins,
it’snot like you’re sending them a bunch of files. Instead, you’re basically
writing the exchange down on that big ledger – something like, “Michael sends
Hank 5 bitcoins.” Now, maybe you’re thinking, “But, wait. You said bitcoin
doesn’t have a central authority to keep track of everything!” Even though the
blockchain is a central record, there’s no official group of people who update
the ledger and keep track of everybody money like a bank does – it’s
decentralized.
Bitcoin Transactions
In fact, anybody can volunteer to keep the blockchain up to date
with all the new transactions. And a ton of people do. It all works because
there are lots of people keeping track of the same thing, to make sure all
transactions are accurate. Like, imagine you’re playing a game of poker with some pals, but none of you has poker chips, and you left your cash at home.
There’s no money on the table, so a few of you get out some notebooks, and start
writing down who bets how much, who wins, and who loses. You don’t need to trust anyone else, so everyone keeps their ledgers separately. And at the end of
every hand, you all compare what you’ve written down. That way, if someone makes
a mistake, or tries to cheat and snag some extra money for themselves, that
discrepancy is caught. After a couple hands, you might fill up a page of your
notebook with notes about the money movement. You can think of each page as a
“block of transactions.”
Eventually, your notebook will have pages and pages of
information – a chain of those blocks. Hence: blockchain. If thousands of
people are separately maintaining the bitcoin blockchain, how all the
ledgers kept in sync? To stick with our poker analogy: think of the entire
bitcoin peer-to-peer network as a really huge poker table with millions of people. Some are just exchanging money, but lots of volunteers are keeping
ledgers. So when you want to send or receive money, you have to announce it to everyone
at the table, so the people keeping track can update their ledgers. So for every
transaction, you’re announcing a couple of things to the bitcoin network: your
account number, the account number of the person you’re sending bitcoins to, and
how many bitcoins you want to send. And all of the users who are keeping copies of the blockchain will add your transaction to the current block. But if all it takes to send bitcoins is a couple of account numbers,
that seems like it might be a security problem. It’s a huge problem with
regular money – just think about all the ways criminals try to steal other
people’s credit card information. And with bitcoin, there’s no central bank to notice anything weird going on to shut down fraud, like if it looked like suddenly you spent your entire life savings on beef jerky.
So what’s stopping
Hank from pretending he's me and just sending himself all of my bitcoins?
Bitcoins are kept very safe thanks to cryptography, which is why it’s
considered a cryptocurrency. ” When you create
an account on the bitcoin network, which you might have heard called a “wallet,”
that account is linked to two unique keys: a private key, and a public key. So let’s say I want to send a message to the network that says, “Michael
sends 3 bitcoins to Olivia.” I sign that message using my private key, which
only I have access to, and nobody else can replicate. Then, I send that signed
message out to the bitcoin networks, and everyone can use my public key to make
sure my signature checks out. That way, everyone keeping track of all the bitcoin trading knows to add my transaction to their copy of the blockchain.
In other words, if the public key works, that proof that the message was
signed by my private key and is something I wanted to send. Unlike a
handwritten signature or a credit card number, this proof of identity isn’t
something that can be faked by a scam artist. The “who” part of each
transaction is obviously important, to make sure the right people are swapping
bitcoins. But the “when” matters, as well. If you had a thousand dollars in
your bank account, for example, and tried to buy two things for a thousand
dollars each, the bank would honour the first purchase and deny the second one.
If the bank didn’t do that, you’d be able to spend the same money multiple
times.
How Bitcoin work
Which … might sound awesome, but it's also terrible. So if I only have enough
money to pay Oliviaor Hank, but I try to pay them both, there’s a check built
into the bitcoin system. Both the bitcoin network and your wallet automatically check your previous transactions to make sure you have enough
bitcoins to send in the first place. But there’s another problem that might happen with timing: Because lots of people are keeping copies of the blockchain
all over the world, network delays mean that you won’t always receive the transaction requests in the same order. So now you’ve got a bunch of people with a bunch of slightly different blocks to pick from, but none of them is
necessarily wrong. Okay, bitcoin. How do you solve that problem? Turns out, it’s
by actually solving problems. Math problems. To add a block of transactions to
the chain, each person maintaining a ledger has to solve a special kind of math
problem created by a cryptographic hash function.
A hash function is an
algorithm that takes an input of any size and turns it into an output with a
fixed size. For example, let’s say you had this string of numbers as your input
And our example hash function says to add all of the numbers together. And the output would be 10. What makes hash functions really good for cryptography is that when you’re given an input, it’s really easy to find
the output. But it’s really hard to take an output and figure out the original
input. Even in this super simple example, there are lots of strings of numbers
that add up to 10. The only way to figure out that the input was ‘1-2-3-4’ is to
just guess until you get it right. Now, the hash function that bitcoin uses is called SHA256, which stands for Secure Hash Algorithm 256-bit. And it was
originally developed by the UnitedStates National Security Agency. Computers
that were specifically designed to solve SHA256 hash problems take, on average,
about ten minutes to guess the solution to each one. That means they’re churning
through billions and billions of guesses before they get it right. Whoever
solves the hash first gets to add the next block of transactions to the
blockchain, which then generates a new math problem that needs to be solved. If
multiple people make blocks at roughly the same time, then the network picks one
to keep building upon, which becomes the longest, and most trusted chain. And
any transactions in those alternate branches of the chain get put back into a
pool to be added onto later blocks.
These volunteers spend thousands of dollars on special computers built to solve SHA256 problems and run their
electricity bills up sky high to keep those machines running. But why? What do
they get out of maintaining the blockchain? Is it just community service? Well,
bitcoin actually has a built-in system to reward them. Today, every time you win
the race to add a block to the blockchain, 12 and a half new bitcoins are
created out of thin air and awarded to your account. In fact, you might know
the bitcoin ledger-keepers by another name: miners.
Value Of Bitcoin
When bitcoins were first created in 2008, they didn’t
really have any perceived value. Tens of bitcoins would have been worth the same as a bunch of pennies. As of November 10th, 2016, though, one bitcoin is worth
708 US dollars. So 12 and a half bitcoins are worth 8,850dollars. That’s a nice
chunk of change! Every single bitcoin that exists was created to reward a
bitcoin miner. Besides the big payout when they add a new block of transactions,
miners are also essentially tipped a very small amount for each transaction they add to the ledger. It’s also worth noting that every 210,000blocks, the number
of coins generated when a new block is added goes down by half.
So what started
as a reward of 50 bitcoins decreases to 25, then 12 and a half. It’ll only be
around 6 bitcoins in a couple more years, and keep decreasing. Eventually, there
will be so many transactions in a block, that it’ll still be worthwhile for
miners to mostly be paid in tips. According to current projections, the last bitcoin – probably around the 21 millionth coin – will be mined in the year
2140. This decreasing number of bitcoins is actually modelled off the rate at
which things like gold are dug out of the earth. And the idea is that keeping
the supply of bitcoins limited will raise their value over time. So, is
investing in bitcoin a good idea?
Bitcoin is still volatile, and experimental. A lot of people love it,
and a lot of people think it’s doomed to fail.
0 Comments