What is Bitcoin? A look at the world’s most popular cryptocurrency — AAX News & Insights
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Bitcoin is a peer-to-peer electronic cash system which allows people to transact value. Unlike mainstream payment systems currently in place around the world, Bitcoin was not created by a business or government-backed financial institution. Bitcoin does not require a bank, government or cooperation in order to operate. Instead, the coin relies on those using the network to maintain it, and in exchange for their efforts, they get rewarded new Bitcoin.
As a society, some would argue, we have become too reliant on financial institutions to govern, direct and protect our collective and individual wealth — something which proved to be quite dangerous during the previous financial crisis in 2008.
Bitcoin provides an alternative which places more responsibility with the owner, granting a measure of digital freedom that is particularly appealing in these times of increased surveillance. Some proponents of the digital currency believe Bitcoin will one day replace ordinary money, such as the US dollar.
Reasons for this belief:
- Global debt is unsustainable
- Negative interest rates
- Countries continue to see fiat currencies fail
- Keynesian economics does not encourage long term sustainability
- The move away from the gold standard / QE (Quantitative Easing)
Bitcoin was created in 2008 by Satoshi Nakamoto. We do not know who this is, or where this person or group went after going dark in 2011. What we do know is that the creation of Bitcoin sparked the emergence of an entirely new asset class and industry. Its development is important from a technology point of view, but also because it forces us to think and re-think the way society has organised its economy.
Bitcoin was relies heavily on cryptography. Currently using over 100,000 lines of code, the Bitcoin blockchain is among the most secure payments network in the world. The Bitcoin blockchain is where all transactions of Bitcoin, the currency, are recorded, and as it is based on cryptography, this coin is referred to as a cryptocurrency, or crypto asset.
Previous digital currencies
When Bitcoin was created it solved a number of problems seen with previous digital currencies.
In the 1990s we saw a digital currency boom, with many private companies creating their own digital currency in an attempt to revolutionise worldwide payments. These digital currencies all failed and there was one main reason for this: centralisation.
Before the creation of Bitcoin’s blockchain technology in 2008, digital currencies relied on centralised systems. The servers were often managed by a single entity. This meant that people still needed to place their trust in a third party to record transactions, keep tabs, and basically ensure that people’s funds were safe. Previous digital currencies were also vulnerable to hacking, as seen with Flooz which had an estimated $300,000 USD stolen.
But the main issue was really that digital currencies were vulnerable to the double spending problem. With paper money this is not an issue; once you give away a hundred dollar bill, you can’t also give it to someone else. With digital assets, this is not so easy — for example, you can make a copy of an mp3 or a picture and send it to two people (or a thousand) at once, and no one would know the difference. With pictures that may be fine, but when it comes to digital money, it’s a problem.
It’s just with a credit card — once you’ve paid something with your credit card and you’ve reached your maximum limit, the bank will prevent you from being able to promise anyone else money with it. It prevents you from double spending your credit. But with a decentralised system this is not so easy to achieve.
The solution to this problem was achieved with blockchain technology. Just like Google Docs, which allows multiple people to work on a single document, the blockchain — which records every single transaction of Bitcoin — is basically one giant document that people from around the world work on.
With the Bitcoin blockchain you can generate an address (similar to an email address) and when you send an amount of Bitcoin to that address, your transaction is made known to thousands of computers that are keeping an eye on the ‘Bitcoin Google Doc’ (so to speak), and once a ‘miner’ confirms that the transaction indeed happened, and that the same ‘email’ was not also sent elsewhere, then it will be confirmed and added to the blockchain document as a ‘block’. Basically, a ‘page’ is added to the big Bitcoin book. That page also works as a stamp of approval for all previous pages.
The Bitcoin mechanics
Bitcoin uses PoW (Proof of Work) as its consensus algorithm. This consensus algorithm allows all of the machines on the network to agree on what is true and false, preventing double spending. Bitcoin’s consensus algorithm — PoW is decentralised. This allows the machines running the Bitcoin network to communicate from all around the world, with no single entity needed to govern the network.
Miners are people who use their computing power to support the Bitcoin network. In simple terms, they keep their computers running and working to make sure the ‘Bitcoin Google Doc’, or let’s say, the Bitcoin ledger, is kept up to date.
In exchange for the work miners do to keep the Bitcoin ledger up to date, and each other in check, miners are paid in Bitcoin. In fact, with every new ‘block’ of data added to the blockchain, the responsible miner will be given new Bitcoin. The amount of Bitcoin given to the miner changes over time, decreasing — the assumption here is that Bitcoin will become more and more valuable over time. Right now, for each block (created every ten minutes) a reward of 6.25 Bitcoin is generated on the chain. Every four years, rewards are cut in half.
The most recent halving for Bitcoin happened in May 2020, with the next set to occur March 2024. Due to the huge computing power needed to mine a Bitcoin block, miners team up in the form of mining pools. In a mining pool, each miner is awarded a portion of any block reward they helped to earn. For example, if a mining pool mined a block and a mining farm within that pool contributed 10% the pool’s computing power, they would receive 0.625 Bitcoin (10% of the block reward).
Hashing is where mathematical formulas are generated by machines until a solution is found for the data. Basically, all transactions on the blockchain are noticed and broadcast, but in order to add these transactions to the blockchain in the form of a block of data, miners need to let their computers do complicated math to solve complicated problems. It is very expensive to do this and if miners are found to be trying to meddle with information, the network will eventually reject them, meaning they cannot get rewards — which will lead to bankruptcy very quickly.
The reason why the mathematical puzzles are so difficult is to counter manipulation. The more computing power miners use, the more difficult the problems will be — the Bitcoin code is that brilliant. (Perhaps we could say it’s a kind of Quantum Economics, where the Object being observed changes its reality in response to the Observer?)
Bitcoin’s blockchain is transparent: every single transaction which has taken place on the Bitcoin network is stored on the Bitcoin blockchain. That means if you want to, you could find out every transaction which took place in March 2012 for example. Through Bitcoin being transparent it allows us to see the entire history of Bitcoin. This transparency creates a level of traceability, with anyone on the network able to see what address Bitcoin has been sent to and which address was the sender.
When using Bitcoin, you determine the level of privacy which you wish to have. With traditional payment processes your identity is not separate from your payment. Instead, your identity is linked to the payment, although your transaction is being handled by a trusted third party.
This comes with a number of problems. First of all, you are also trusting the bank with your personal details which can be dangerous. For example, in 2019, Capital One was hacked, with the hacker obtaining the personal information of 100 million plus users. This incident demonstrated that the multibillion dollar companies who hold our information are far from invincible and that our privacy is always at risk. Bitcoin offers us a way to mitigate this risk as we do not need to rely on third parties to secure our information, instead we need to do this ourselves.
Addresses, allowing for different levels of privacy
When transactions take place on the Bitcoin blockchain all transactions are public and transparent. When we send and receive Bitcoin on the network we use addresses.
In this example we will look at how this works: Imagine that Sirius wants to send 0.1 BTC to Vega. Sirius’ address is public and is stored on the Bitcoin blockchain, although no one knows who he is. This is due to his personal information not being associated with the payment or address. Bill wants to send 0.1 BTC regularly to Vega. Using the same public address each time works. Of coursel, if Sirius sends 0.1 BTC to Vega regularly it allows others looking at the network to build up a profile of the receiver, and if purchases are made where the recipient of these payments does use their actual name, it is eventually possible to figure out their identity.
This is fine if Sirius feels as though his transactions do not require low traceability. Whereas if Sirius wants to send 0.1 BTC privately each time to Vega, they can use a different private address each time, this means although anyone can see that 0.1 BTC is being sent, no one could know that it is Sirius and Vega who are transacting value.
Scalability is the ability for something to increase and decrease in size. Bitcoin’s scalability is very poor. The cryptocurrency can only pump through around 4 transactions per second (TPS). With millions of people using the Bitcoin network on a daily basis, this is problematic. Users have reported that it sometimes takes them hours to complete transactions, with some even reporting having to wait multiple days for transactions to be confirmed.
This is one of the reasons why Bitcoin has become a store of value, rather than a medium of exchange — similar to gold. Although, not everyone is convinced about Bitcoin’s power to serve as a proper store of value.
In response to Bitcoin’s shortcoming, a number of other currencies that use the same code with some alterations, have been issued. Example are Bitcoin Cash (BCH), Bitcoin SV (BSV), but also Litecoin (LTC) and Dash (DASH).
We can see in the table above that BTC is not the only major cryptocurrency struggling with scalability. Ethereum also has very poor scalability. However, the release of Ethereum2.0 with sharding functionalities is expected to improve scalability. Other initiatives that seek to improve scalability include Bitcoin’s Lightning Network.
Why is it so slow?
Satoshi Nakamoto purposefully implemented a block size limit, effectively increasing the Bitcoin network security in order to prevent Bitcoin from being subject to a DoS attack. A DoS attack is when the network is flooded with traffic of huge volumes in order to crash the network. This block size limit effectively prevents large quantities of data from flooding the network.
This brings us to the blockchain trilemma.
The blockchain trilemma
Bitcoin cannot, with its current setup, increase scalability without decreasing its level of decentralisation or security. IOTA believes to have solved the blockchain trilemma, although the cryptocurrency uses a completely different type of blockchain. IOTA uses something called The Tangle alongside Coordicide, solving the trilemma. It is not possible for Bitcoin to move towards this.
Significant Bitcoin figures
Craig Stephen Wright
Craig Wright is known for his audacious claim claim to be Satoshi Nakamoto. This is not widely accepted and remains a point of debate in the community. Undoubtedly an early user of Bitcoin, Craig Wright has been a prominent figure in the cryptocurrency market, and is the creator of Bitcoin SV — a coin purportedly better aligned with Satoshi Nakamoto’s vision.
A strong advocate of Bitcoin for years, McAfee is one of the most prominent figures in crypto. Claiming to know who Satoshi is, while clearly stating that it is not Wright, McAfee is the founder of McAfee antivirus software. He amassed a fortune of over $100 million USD before the 2008 financial crisis. This subsequently shrank to $4 million USD with his investments in ruins.
Since 2009 McAfee has created a currency called GHOST, his own cryptocurrency exchange, and he ran for the US presidency. He currently supports XMR, claiming that BTC uses “ancient technology”. McAfee is one of the world’s leading privacy experts and is like Marmite in the crypto community, you either love or hate him.
Roger Ver is an early investor in Bitcoin and the founder of Bitcoin Cash (BCH). He is one of the ‘Bitcoin foundation’ founders, an organisation created in order to restore Bitcoin’s reputation after these events in 2011:
- MT Gox hack
- WikiLeaks adoption
- Silk Road adoption
- MyBitcoin failure
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This introduction to Bitcoin was written by Oliver Page, and commissioned by AAX, for marketing and educational purposes only. The views, analyses and projections are based on the author’s independent research. The report should not be taken as a form of investment advice.
Originally published at https://blog.aax.com on June 22, 2020.