How to Explain Bitcoin to your Parents
Q: What is bitcoin?
A: Bitcoin is a type of cryptocurrency, a digital currency powered by the combination of various technologies such as cryptography, hashing, and P2P networks. There are no physical coins; only account balances that are stored on a distributed, public ledger. It can be used as a store of value or as a currency for online transactions. It’s money that you can’t see or touch (kind of like a credit line), but you own it!
Q: How can I get a bitcoin?
A: There are various ways to acquire rights-to-use of bitcoins: mining them yourself (which requires a significant amount of computing power), buying them on the Internet through an exchange (such as Coinbase), buying them with physical cash from a bitcoin ATM or in-person through mobile wallets, or using a service such as Earn.com to earn bitcoin through internet activities. Owning a bitcoin (or portion of a bitcoin: you don’t have to own whole coins) does not mean you get a physical coin; it just means you have the right to send that bitcoin to someone else. You can get your rights-to-use (your private key) printed on a little card and store it somewhere safe. The private key represents the ability to initiate transactions, so keep it safe!
Q: Where does bitcoin come from?
A: Thin air. Numbers. Math. Code. Bitcoins are created through mining, a process by which transactions are reviewed, validated, and added to the public ledger.
Q: How is the value of my bitcoin determined?
A: Economics. If something is scarce (limited supply) and useful (utility), it will have a value and demand a specific price, if all other things are equal. Price is determined based on the market’s supply and demand. There will and only ever be 21 million bitcoin available to be mined. Assume 4–5 million of that has been lost/burned/destroyed over the infant years of bitcoin, and now you’re left with ~16 million bitcoin, a very limited supply compared to the demand. Bitcoin also has utility as a payment system and as an asset class.
Q: Where is my bitcoin located?
A: The record of your rights-to-use are located on the blockchain, an immutable, distributed, public ledger. You can unlock access to and use your bitcoin via your private key.
Q: How can I cash out my bitcoin?
A: You can either sell your bitcoin online or in person.
Online sales take place through an online exchange (either direct to an individual or to an exchange) or through peer-to-peer trading marketplaces (individuals who want to use Bitcoin to buy goods from sites that don’t support Bitcoin and individuals who want to use a debit/credit card to purchase Bitcoin).
In-person sales are simpler: scan a QR code on another person’s phone and accept payment in cash. This is done by sending bitcoin from person to person with mobile bitcoin wallet software. You should agree on a price, and of course, be careful if carrying a large amount of cash.
Q: How should I store my bitcoin?
A: There are a variety of wallets in which to store your private keys: desktop, mobile, web, paper, and hardware. The first three are considered hot wallets, whereas the last two are considered cold wallets. Hot wallets enable user to access their bitcoin from pretty much anywhere; these wallet addresses are always connected to the Internet and maintains an active connection to the Bitcoin network. Cold wallets (“cold storage”) allow you to store your bitcoins completely offline. This means you can’t spend them easily, but they’re also much safer from the hackers with sticky fingers on the Internet.
Q: What is blockchain technology?
A: A blockchain is a a public record of transactions, and is governed by a set of rules. The Bitcoin blockchain posits that bitcoins cannot be double spent and the origin of every coin must be traced back to the mining of a valid block. It is a growing, immutable, chronological, public list of records. Even though all of the information is public, it is pseudonymous: just by looking at the ledger, people cannot easily trace transactions to you specifically without additional investigative work and information.
Q: How does a blockchain work?
A: A blockchain can be considered a database that is distributed across a network of computers that communicate with each other and maintain a public ledger that they all agree on.
The underlying structure of a blockchain is a Merkle tree for the primary purpose of saving space. A Merkle (hash) tree is a type of tree in which every leaf node (nodes that do not have descendants) holds some kind of data and every non-leaf node (nodes that do have descendants) holds a cryptographic hash of the data of its child nodes. If any part of the underlying data is changed, the cryptographic hash of the data will change, and therefore, change all of the parent hashes above.
The top hash of a Merkle tree becomes the transaction root in a Bitcoin blockchain. The combination of the transaction root hash, timestamp, nonce, and previous block’s hash then create the hash of the block, which is linked to the next block in the chain. Any change to the underlying data will cause the series of hashes to change and be different from what is recorded in the entire network.
Q: What is a bitcoin transaction?
A: It is a signed piece of data that is broadcast to the Bitcoin network. If the transaction is valid, then it will end up in a block on the blockchain. A bitcoin transaction can only transfer rights-to-use of any amount of bitcoin from one bitcoin address to another. The transaction contains basic information of how much bitcoin you’re spending and what address you’re sending the bitcoin to.
A standard transaction has four components: a Transaction ID, descriptors and meta-data (such as number of inputs, number of outputs, lock time, and size of transaction in bytes), Inputs, and Outputs. All transactions follow four truths:
- Any bitcoin amount that is sent is always sent to an address.
- Any bitcoin amount received is locked to the receiving address (usually associated with your wallet).
- Any time bitcoin is spent, the amount you spend always comes from funds previously received and currently present in your wallet.
- Addresses receive bitcoin, but only wallets send bitcoin. Wallets always keep inputs/outputs separate and distinct — this enables historical traceability of every bitcoin.
Q: How does a bitcoin transaction work?
A: Let’s say my wallet has a balance of 1.3 BTC from 3 transaction inputs (UTXO — unspent transaction outputs): 1 BTC, 0.1 BTC, and 0.2 BTC. If I spend 0.15 BTC, the transaction will “spend” the UTXO of 0.2 BTC by sending 0.15 BTC to the recipient and 0.05 BTC to an address that my wallet owns as “change”. Now my wallet contains UTXOs of 1 BTC, 0.1 BTC, and 0.05 BTC for a balance of 1.15 BTC.
Spending transactions consumes UTXOs and creates new UTXOs. All transaction inputs are prior transaction outputs. Each unit of BTC in my wallet is traceable to past transactions.
And my favorite from the grandparents (when they realize you work for a company in the crypto industry):
Q: You work for Bitcoin?
A: Bitcoin is not produced, owned, or operated by a single company. It is a creation born out of the combination of various technologies and the efforts of random individuals all around the world.
Dedicated to my parents and special thanks to Star (author of this Chinese Bitcoin blog) for all of our conversations.
