What is Bitcoin: World’s Largest “Group Project”
Key Questions Answered
“Writing a description for this thing for general audiences is bloody hard. There’s nothing to relate it to.” – Satoshi Nakamoto, July 5, 2010 (Bitcoin Forum)
What is Bitcoin?
Bitcoin is a first-of-its-kind digital currency that can be used without a bank or any other third party. It is also not issued or endorsed by any government but “mined” into existence by a network of computers around the world. Because of this, some see it as the ultimate freedom money; others see it as the biggest scam in history.
At time of writing, Bitcoin is trading at $23,000, with a circulating supply of 19 million coins for a market cap of just under half a trillion dollars.
Who created Bitcoin?
Bitcoin was created by a person/group named Satoshi Nakamoto, whose real identity remains the biggest mystery in the world of cryptocurrency. Two years after he launched Bitcoin in January 2009, he disappeared forever with a very cryptic farewell email to the circle of programmers he had been corresponding with, stating, “I’ve moved on to other things. It’s in good hands with Gavin [Andresen] and everyone.” What is not a mystery is his motivation for creating Bitcoin.
In an online forum, he pointed out the root problem with our existing monetary system–that we have to trust our banks to manage our money, even if they have historically demonstrated a breach of that trust and acted in ways that were not in the best interest of the general public.
In other words, the existing banking system was the financial equivalent of trusting the fox to guard the hen house. Satoshi Nakamoto created a decentralized, peer-to-peer digital cash system so that people could transact with one another without the banks.
The 2008 Global Financial Crisis triggered massive public outrage against banks (Credit: Mario Tama/Getty Images)
Who controls Bitcoin?
If its creator has disappeared, who is controlling and managing Bitcoin? Nobody and everybody. Bitcoin’s decentralized system differs from a centralized one in several key aspects:
- Transaction data lies not in a central server belonging to a bank but replicated on thousands of computers around the world owned by anyone who wishes to participate (you just need to have the right hardware and download the right software). This is the first and most critical aspect of decentralization–control and ownership of data.
- Instead of banking operations personnel, the job of validating, verifying and recording transactions is done by these computers.
- These computers do not report to a CEO or COO, but are governed by cryptography, computer codes and economic incentives.
- These codes cannot be changed by any single person or entity unless there is a consensus. Also, as an open source software, it is being constantly upgraded by developers who work voluntarily to improve the Bitcoin network.
Before we get into the technicalities, read this first if you haven’t: Why Does Bitcoin Have Value?
How do I use Bitcoin?
Bitcoin actually works in a similar way to the e-cash we use nowadays (to pay a vendor on Amazon or subscribe to Spotify), but instead of downloading a mobile banking or payment app, we download a crypto wallet app instead.
And instead of connecting it to a bank account and using PIN codes, we use a different set of numbers–public and private keys. These keys are strings of letters and numbers that perform the same function of ensuring that only the rightful owner can access and spend the money.
Here’s how using Bitcoin looks like:
1) Download a crypto wallet. A crypto wallet is a software that will randomly generate the public and private keys for us to access and spend our bitcoins.
2) Save your seed phrase. When you first start using a crypto wallet, it will give you a seed phrase i.e. a randomly generated list of 12-24 words that nobody else in the world has ever seen. This seed phrase is used to back up, restore and retrieve all your keys and your bitcoins–if you lose it, you lose all your bitcoins, and there is no “customer support” to help you.
3) Send bitcoins: This seed creates a private key i.e. a random large number that acts as the wallet’s password to spend bitcoins. Anytime you want to send bitcoins to someone, you have to prove your ownership of those bitcoins by using this key to create a one-time-only digital signature matching that particular transaction. Obviously, this key should never be disclosed to anyone.
Example of a Bitcoin private key:
4) Receive bitcoins: The public key is cryptographically derived from the private key, and shortened to serve as your address (like an email address) that you can share with others for them to send bitcoins to you.
A screengrab of the Bitcoin Wallet user interface (Source: Bitcoin.org)
While there is no fee charged to receive bitcoins, sending bitcoins incurs a default transaction fee set by your wallet. The transaction typically usually takes minutes to an hour plus for completion (longer if there is a high volume of transactions). There is also the option of not paying a transaction fee, in which case it might take much longer (even weeks) for your transaction to clear.
Who accepts Bitcoin?
Nowadays, a small but increasing number of businesses are accepting bitcoins as payment, from restaurants, cinemas and airlines to online media outlets and even an entire country.
The best way to learn about Bitcoin is really just to get some sats and try it out yourself.
But while cryptographic signatures prevent other people from spending our bitcoins, how do the recipients know that those bitcoins they are receiving from you have not already been used to pay someone else?
This is where Bitcoin mining comes in.
How are Bitcoin transactions processed?
While the user experience of sending and receiving bitcoins may be similar to how you would interact with your mobile banking or payment app, it’s a completely different beast on the backend.
With or without banks, transactions need to be validated. And when people talk about bitcoin mining, they are really referring to the process of validating and confirming transactions in exchange for bitcoin rewards. The following sequence does not capture every technical intricacy of this process. Instead, it aims to provide a high-level, conceptual understanding of how Bitcoin transactions are processed.
Let’s break it down.
- At a basic level, the banks’ most critical job is to ensure that nobody is spending money that is not theirs.
- They know if somebody is trying to make a fraudulent transaction because they keep a running record of all their customers’ transactions and how much they have in their accounts.
- Before computers, these records were kept in a physical ledger i.e. a book of value transactions, and the banks just keep updating these ledgers page by page so that they always have the latest records to validate customers’ transactions. Nowadays, banks maintain this ledger digitally under the highest security measures (when your money is only represented as digital data, the money is only as good as the data is accurate.)
- In order to do the bank’s job of validating transactions, Bitcoin needs to have a ledger just like this, but instead of pages, it has blocks of transaction records all chained together–known as a blockchain.
- This ledger is stored in many computers across the world known as “nodes,” who are each independently responsible for updating it. This distributed manner of storage ensures that there is no single point of failure so that it cannot be easily censored by authorities or attacked by hackers.
- When users send bitcoins using a wallet app like what we have seen above, new transactions are created. Special nodes called “miners” batch this incoming list of transactions into a block in order to confirm it to the blockchain.
- How will these miners get paid for the work of processing the transactions? Here’s where it gets interesting–it’s a race of sorts. The first one who successfully uploads the block to the blockchain wins some bitcoins.
- But before any miner can successfully add a block to the blockchain, they need to find a special number–the ID of that block, also called a hash.
- This hash is a cryptographic string of 64 characters that looks like this: eru4y3974j3ihfonfkshurir462hdkfig8wdkghryyh4001ikj63geeyurnutqaz.
- It is unique for each block, and every node that runs the same input of transaction details i.e. date, timestamp, amount, address of sender and recipient through the cryptographic algorithm will arrive at the same hash.
- There are two special qualities about this hash. Firstly, it cannot be calculated, only guessed, or “mined”. This guesswork is called “Proof-of-Work (PoW)” as it “proves” that the miner has made a significant investment into getting this hash–it takes billions of tries, consuming immense computing power and electricity costs.
- This PoW is the system that secures the Bitcoin network. It is intentionally resource-intensive for one reason–to deter fraud, or to use the more specific term in our context, double-spending. If the miner tries to sneak in a fraudulent transaction, he knows that all that effort and costs will go down the drain.
- This is because the hash is hypersensitive. If the miner changes even a single number in the block, he will arrive at a hash change that is different from that of all the other nodes. In other words, the hash makes it obvious if the block has been tampered with, and the other nodes will invalidate his block and he will lose out on his winnings.
- If all the transactions are valid, all the other nodes will come to a consensus (51%) and accept the block (this requirement is coded into the Bitcoin software), which then goes on the blockchain, confirming the transactions. The winning miner earns some bitcoins as the block rewards and transaction fees for creating the winning block.
- Everybody then works on creating the next block in the chain in the hopes of mining the winning block, using the hash of the accepted block. This way, all the nodes have a running, identical record of truth joined chronologically with one another–even if they are all working independently on their own copy of the ledger.
- A final point about the consensus–it is the last line of defense. A rogue miner can still try to game the system but he will need to take over a majority of the nodes (51%) so that he can “re-manufacture” the consensus for the fake hash. Given the staggering collective computing power of the network, it will be almost impossible to achieve. Plus, as he is busy trying to take over the other nodes, they are already working on the next block, so he is forever playing catch-up. In short, the network remains secure even if not all the participants can be trusted.
If you’re still with us up till this point, congratulations, you have just learned how blockchain works. In essence, it is really about securing the transactional data on the Bitcoin network so that people can rely on it to trade with one another. The bitcoin cryptocurrency is just the reward for doing this all-important job.
The Bitcoin transaction verification process (Source: Euromoney)
At the heart of it is how Satoshi overcame the seemingly unsolvable dilemma that has stumped cypherpunks for years–maintaining a single record of truth among complete strangers without any single authority in charge. Using cryptography, computer code and a reward system, Satoshi enabled the creation of a common record of truth that everybody can trust, because it requires no trust at all.
(The Cypherpunk movement began in the 1970s in the San Francisco Bay Area when a group of computer programmers started exploring ways of using cryptography to safeguard what they considered to be a core tenet for an open society in a digital age–privacy.)
If you go to Blockchain.com, you will see, in real time, all the bitcoin transactions in queue, waiting to be confirmed before being added to the blockchain. In a world where people once had to cart heavy gold coins around at risk of robbery, to the present day burden of expensive bank charges, conversion fees and time delay, to see this flurry of value exchange happening without a single third party, is, to put it mildly, remarkable.
Here’s a screenshot of the action:
Bitcoin transactions awaiting confirmation before being added to the blockchain (Source: Blockchain.com)
How do I buy Bitcoin?
The easiest way to buy some bitcoins today is through cryptocurrency exchanges like Phemex. While Phemex offers both spot and contract trading for investors to choose from, spot trading is the recommended avenue for beginner crypto buyers. To buy Bitcoin on Phemex, simply follow the instructions below.
Go to the Phemex homepage, register for an account, and select Markets.
On the Markets tab enter BTC into the search bar on the top right, immediately after, the BTC/USDT trading pair will appear below – select Trade to move on to the next step.
You will then be redirected to the Phemex trading platform for the BTC/USDT pair. To do a simple spot trade we recommend doing a market order where you can buy BTC at the market price. To do so, select Market, enter the amount of USDT you want to buy of BTC, and click Buy BTC.
Can I buy $1 of Bitcoin?
Yes, you absolutely can. You do not have to buy a whole bitcoin at once.
At the current price of $23,000 per bitcoin, you can buy just $1 worth of bitcoin, which will get you about 4,348 sats. A “sat” is short for “satoshi,” which is the smallest unit in a bitcoin, just like one cent is the smallest unit in a dollar. There are 100 million sats in one bitcoin.
Hot tip: Websites like earncarrot.com will give you free sats for reading articles about Bitcoin.
Limitations of Bitcoin
Scalability: As Bitcoin slowly gained popularity and adoption over the years, its greatest strength became its greatest weakness. The security measures put in place have safeguarded the network from hacks but it also kept it from scaling i.e. it simply cannot be used by too many people at the same time. While credit card networks like Visa process anything from 1,700 transactions per second (TPS), Bitcoin can only do three to five TPS.
Smart contract processing: Presently, the Bitcoin software can only be used to store and transfer value, instead of more complex functions such as borrowing, lending and trading.
Energy consumption: There has been much controversy about the high energy consumption of Bitcoin’s Proof-of-Work process. However, the latest Q2 2022 report from the Bitcoin Mining Council (BMC) has stated that almost 60% of the electricity used to power Bitcoin (BTC) mining machines comes from sustainable sources.
Even though it’s the first and oldest cryptocurrency around, the Bitcoin software is still in beta phase, and every now and then security flaws are found and fixed. In November 2021, Bitcoin got its first upgrade in four years called “Taproot,” aimed at increasing transaction processing efficiency and privacy. Notably, it will also enable the Bitcoin blockchain to perform more complicated transactions instead of merely value transfer, potentially bringing it a step closer to Ethereum (the second largest cryptocurrency) in terms of smart contract processing.
Outside of Bitcoin, other innovations are extending Bitcoin’s capabilities. The Lightning Network, for example, enables multiple transactions to be relayed between parties on a secondary channel, thus freeing up processing capacity on the main Bitcoin network.
Is Bitcoin a good investment [Updated 2022]?
As Bitcoin is still a young asset, its price is heavily influenced by supply and demand as well as market sentiment and speculation, thus the volatility. The quick answer to the question of whether Bitcoin is a good investment, therefore, is equally varied:
- Yes, if you had bought in pre-COVID, when Bitcoin was trading for under $10,000
- No, if you had FOMO-ed and bought in when it was trading at its peak of over $60,000 in November 2021–and panic-sold when the entire crypto market started trending down since then
- Maybe, if you are still HODLing your bitcoins and the price appreciates in future.
Notably, however, Bitcoin has been the best-performing asset over the last decade, surpassing gold and S&P 500. At the end of the day, individual risk appetite and investment horizon are critical factors that determine the returns one stands to gain from investing in Bitcoin.
(Source: Messari.io, Bitcoincharts.com)
What should I know before investing in Bitcoin?
The most important thing to know before investing in Bitcoin is that as with all investment, there is a risk and Bitcoin, being an extremely volatile asset, is especially risky. In fact, Bitcoin has lost about 70% of its peak value, trading at around $23,000 at time of writing. However, drastic price crashes like this are common especially in the crypto markets and experienced investors and traders see these as money-making opportunities–”buy low, sell high.”
Ultimately, Bitcoin is a high-risk, high-reward asset and should be treated the same as any other risky investment. In fact, the golden rule in investing applies to Bitcoin: do not invest what you cannot afford to lose. If you do, you will be much more prone to panic-selling when Bitcoin’s price plunges, which will result in you losing out on potential gains when the price appreciates again.
For example, if you bought Bitcoin in December 2017 when it was trading at $18,000, you would be pressured to sell as you see the value of your investment drop by about 80% when Bitcoin’s price fell to $3,500 in December 2018. However, if you held on to it for two more years, you would have seen your investment grow by more than 600% as Bitcoin surged to $22,000 by December 2020.
Before Bitcoin, the idea of money being beyond the remit of banks was completely inconceivable, at least for the man on the street. Today, there are more than 19,000 cryptocurrencies in the market, many of which are trying to beat Bitcoin at its own game.
At the same time, while it is too early to say that it has “arrived” as a global P2P currency, Bitcoin has the advantage of a head start, an active, passionate development ecosystem and most importantly, an unblemished security track record till date. If it succeeds in gaining mass adoption one day, it will transform modern trade in ways we cannot imagine today.