Exploring Bitcoins

In case you haven’t read the first post, here is the link — Why and What of Cryptocurrencies?

In this post, I’ll explain Bitcoins and how they were introduced and gained traction. As always, feel free to point out mistakes to ensure collaborative learning. Hope this post helps.

What is Bitcoin?

Bitcoin is a type of cryptocurrency invented by a pseudonym — Satoshi Nakamoto (pseudonym because nobody knows if Satoshi is a guy or group of guys under this name). Bitcoin was introduced when the world was moving towards the era of Digital payments. Introduced in 2009 as an open-source software, Bitcoin’s purpose was to serve as a decentralized currency facilitating seamless peer-to-peer transactions thereby eliminating the need of an intermediary or a middle man (in our case central banks).

When Bitcoin was invented/introduced as the world’s first digital decentralized cryptocurrency, it was wrapped up together with the Blockchain technology. Bitcoin was the first practical application for the online distributed ledger — Blockchain. While Bitcoins are currencies, Blockchain is a technology that was used to record the transactions made with Bitcoins (analogous to the accounting or book keeping done by banks).

The book keeping in the Blockchain technology is done in the form of blocks and each transaction between peers or to a merchant gets added to the block forming a chain hence giving rise to the name — Blockchain.

How were Bitcoins introduced into the system?

It’s important to understand how fiat currencies like USD, Euro, INR are introduced into the markets. Increasing or decreasing the money in circulation is a complex decision and the deciding power resides with the central banks of the respective countries. Let us take the example of USD to understand how to increase the circulation of USD.

The Federal Reserve, Central Bank for United States of America, observes the market performance in terms of the current inflation to take a call on the circulation of money. If the Fed decides that there should be more currency in circulation, the following are the steps that would be adopted,

1) Reduce the overnight interest (Federal Funds Rate) rate — the rate that Fed charges other banks while lending money. This ensures that the other banks can avail cheaper credit and would start lending more themselves thereby increasing the money in circulation

2) Change the reserve requirements — The Fed can reduce the limit that the banks are supposed to hold as reserves which leads to banks having increased credit opportunities thereby increased their lending (making it cheaper too sometimes)

3) Open market operations — The Fed can step in to buy Govt. securities links bonds thereby increasing the money in circulation

It’s important to understand that this decision is solely based on the market’s performance.

Since Bitcoin was to be replacement for the Fiat currency that we use every day, the following were needed for it to gain traction,

1) People with Bitcoins to spend them

2) Markets where Bitcoins were accepted as mode of transaction

3) A seamless way of book keeping with better security standards to prevent fraud

Bitcoins were invented and introduced by a pseudonym Satoshi Nakamoto. Satoshi was the first person/entity to mine the first block (called genesis block) in the Blockchain which had a reward of 50 Bitcoins. In lay man’s language — Satoshi released bunch of Bitcoins (50) to himself and record this transaction in the Blockchain as the first block.

Satoshi then selected bunch of people and sent them Bitcoins for them to adopt and promote. Programmer Hal Finney was the first person with whom Satoshi transacted by giving him 10 Bitcoins. Eventually bunch of people ended up getting Bitcoins from Satoshi.

As Bitcoin was gaining popularity in the Silicon Valley, the merchants wanted to jump in the bandwagon too as they anticipated this could be the future and they wanted to experience the kick themselves. The value in terms of Bitcoins was ascertained initially as a result of negotiations between multiple people in bitcointalk forum. The first transaction using bitcoins to purchase a commodity was 2 pizzas from Papa Johns at 10,000 BTC which made it the most expensive pizza in the history. Currently there are more than 100k merchants who accept Bitcoins and other cryptocurrencies as a mode of payment leading the digital currency industry to boom.

All this was made easier with Blockchain — the digital ledger that helped keep books of the Bitcoin transactions. Blockchain is a decentralized ledger that eliminated the need of a central party or a middleman for peer-to-peer transactions thereby lowering the transaction fee and ensuring high security and transparency.

Like fiat currency, the supply of Bitcoins is limited too. While the monetary policy for Bitcoins was framed, Satoshi based it on artificial scarcity that there would only be 21 million Bitcoins.

More about Blockchain in the upcoming article.

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