What is Bitcoin? Part 2
In my first post, “What is bitcoin? Part 1”, I approached the question in terms of bitcoin’s use as a digital currency to transfer value between peers. However, Bitcoin can also be defined as a network.
Question #2: What is Bitcoin?
Bitcoin (capital “B” connoting network) is a network of connected devices that observe a common set of rules and procedures, which govern how to transmit and verify data about bitcoin (lowercase “b” connoting the digital currency) transactions.
The largest network of connected devices is the internet. We interface with the internet predominately through the web and mobile applications. For example, you pull out your computer, open a browser and type a link. Voila! You’re looking at this medium post. However, there are a series of communication standards and processes observed across the network that allow you to view this post. These procedures govern everything from how your browser requests information from a web server (Hypertext Transfer Protocol) to how to assign unique IDs to individual devices on the network (Dynamic Host Configuration Protocol). These standards and processes, called protocols, build off one another to offer a full protocol suite or stack.
Protocols, implemented through the use of specific software and hardware, are necessary for large computer networks to work cohesively. In this case, the Bitcoin Protocol provides guidelines for how devices in the Bitcoin network can operate together to verify and record bitcoin transactions.
Bitcoin Network Stakeholders
Let’s recall the stakeholders in the Bitcoin network:
- Developers: create software (to reflect the specifications of the Bitcoin Protocol) that validators can download to participate in the network.
- Validators (also referred to as “Miners”): download software and operate custom hardware in order to verify that user transactions are valid (in other words, that the user is not conducting fraudulent activity).
- Users: broadcast information about a bitcoin transaction across the network of miners so they can approve and process it.
Bitcoin Network in Practice
At a very high-level, the Bitcoin network is designed to function as follows:
1. A user utilizes a Bitcoin payments app to make a bitcoin transaction. This transaction is broadcast to the network.
2. Miners receive data for that transaction as well as data from a number of other transactions to form the next transaction set called a “block.”
3. Miners run each transaction in the block against a locally-stored, time-stamped record of every transaction made on the network, called a blockchain, to ensure that no fraudulent activity has occurred.
4. While each miner independently verifies the transactions in the set, they compete against each other to be the first one to propose to all the others that the block be added to the blockchain.
5. The lucky winner proposes the block be added and if the majority of validators agree, each miner adds it to the blockchain. The “winner” is rewarded in bitcoins.
6. Rinse, repeat.
Importance of Understanding Bitcoin as a Network
You may think that understanding bitcoin as a digital currency is more important than understanding Bitcoin, the network. Ultimately, you do not need to know how the internet functions in order to interface with the web. However, there are few primary reasons understanding Bitcoin as a network (observing a common set of data transmission and verification guidelines) is important.
First, if you are going to exchange dollars for bitcoins, you should have a basic understanding of how this works. It is your money after all! You should know of potential vulnerabilities in the network’s design and be cognizant of how developers plan to improve upon it. The network’s design is fiercely debated across stakeholders and this will have implications on the network’s development.
Second, there are now over 1,000 digital currencies. Many of these currencies are derivatives of bitcoin. This means that they copy and adjust the Bitcoin Protocol to create rules about how data regarding their transmission and verification should be done.
Third, the concept of a blockchain is being leveraged, copied and repurposed for a variety of other use cases. Blockchain’s are:
- fraud proof. The system was designed to make it very difficult for someone to conduct fraudulent activity by creating a trail of every transaction on the network. Furthermore, the majority of miners have to agree that the transaction is valid before appending it to the blockchain.
- immutable. Every transaction is time-stamped and each block is linked to the previous one, making it extremely difficult to go back and change this historical record.
- transparent. Anyone can view the blockchain and see all the transaction activity that has ever occurred on the network. This also means that attempts to overtake the network for selfish purposes can be identified.
These characteristics make blockchains an appealing means of verifying and recording data that has absolutely nothing to do with digital currencies. Returning to the example of the internet, it’s precursor was created solely to share academic research between a handful of universities and was largely supported by agencies like the Department of Defense. Now, the internet’s open source protocols are the foundation that connects billions of devices and enables endless applications across nearly all industries.
The Bitcoin Protocol could also impact a number of industries as it informs how devices can operate together in an unprecedented way. Blockchains can be used to bring transparency to post-trade settlement, take market share away from e-commerce giants like e-bay, and even register human identity. Moreover, while headway is being made in these areas, the primary use case for a blockchain remains to record information about digital currency transactions.
More specifically, since Bitcoin was created, there have been over 240M bitcoin transactions recorded and processed for millions of users across the globe. There are now over 16M bitcoins in circulation with a market value of 72B USD. These numbers also don’t reflect the market activity of other digital currencies that were created after bitcoin.
Who designed the Bitcoin network and why it was created will be next.
