A comprehensive overview of bitcoin
Classification of bitcoin
Bitcoin was published on October 31, 2008, by an author, or team of authors, under the pseudonym Satoshi Nakamoto. The publication appeared in the style of an academic article on a mailing list for cryptography. It is, however, still unclear today whose identity or identities are hidden by the pseudonym.
Bitcoin is a comprehensive concept that links several technological components together so that the units of value are issued under competition and have both a virtual representation and decentralized transaction processing. In this way, the bitcoin system has created substantially different money from any other money, such as commodity money, cash, or commercial bank deposits.
A physical object represents cash; usually a coin or bill, meaning its value is inseparable from the object. A physical object also represents commodity money such as gold, and again, the current holder of a unit is by default assigned ownership of the value unit. Commercial bank deposits are virtual money. It exists only as a record in an accounting system. Central bank electronic money is also virtual money. Public access to electronic central bank money is restricted to financial intermediaries in most countries.
To achieve the unique combination of controls, bitcoin uses several components.
Bitcoin unit: bitcoin units are the virtual monetary units of the system that does not exist in physical form. Bitcoin units are merely ledger entries that are assigned to a specific individual.
Bitcoin network: the bitcoin network is fully decentralized. It compromises participants and their connections and serves as a primary communication channel for exchanging information and building consensus.
Bitcoin protocol: the bitcoin protocol stipulates the ways and means by which communication for exchanging information and building consensus.
Asymmetric cryptography: asymmetric cryptography (also known as public-key cryptography) is employed for verification purposes. It enables all Bitcoin network users to verify the legitimacy of any transaction message conclusively.
Bitcoin blockchain: the bitcoin blockchain is a public ledger. Every individual can inspect the ledger, download a copy, and change it. However, the network will only consider the version of the ledger that contains only verifiably legitimate transactions and is regarded as the most recent version of the bitcoin blockchain. A consensus protocol guarantees the latter criterion. For this, the bitcoin blockchain utilizes a procedure known as proof-of-work
Bitcoin’s unique selling proposition
The use of a ledger is not a novelty attributed to bitcoin technology. Commercial bank deposits are, for example, nothing other than ledger-based virtualization of claims to physical monetary units (cash). Here the ledger is managed exclusively by a central authority that guarantees transactional capacity, transactional legitimacy, and transactional consensus.
Transactional capacity relates to securing the owner’s ability to initiate a payment. Clients can talk to their client advisor or submit their payment instructions via the bank’s online banking platform in a classical banking system.
Transactional legitimacy is checked when the transaction is initiated. In a classical banking system, the central authority identifies the initiator of the transaction and ensures that this individual is the rightful owner of the referenced balance.
The critical innovation of bitcoin is its refusal to engage a central authority. It is more challenging to guarantee transactional capacity, establish transactional legitimacy, and achieve transactional consensus without a central authority.
The bitcoin network is the foundation of the system. It allows for the exchange of information and is based on peer-to-peer technology. The term peer to peer means that all the network participants are, without exception, and that communication can occur between any two participants. There is no central structure, and no participant has any exclusive privileges.
If a network participant receives a transaction message, he must ensure that the transaction was initiated by the rightful owner of the respective bitcoin units. For this purpose, bitcoin employs proven cryptographic methods. The same cryptographic principles are used for e-commerce, online banking, and many other applications.
Owing to the decentralized nature of the network, there will inevitably be situations in which the various transaction queues of network participants are out of sync or may even contain contradictory transactions.
To understand the consensus mechanism of the bitcoin system, we first have to discuss the role of a bitcoin miner. A bitcoin miner collects pending bitcoin transactions, verifies their legitimacy, and assembles them into what is known as a block. A block is a data structure that includes at least one transaction. The process of building blocks and performing the necessary computations is called bitcoin mining. A miner’s goal is to earn newly created bitcoin units through this activity.
Bitcoin mining is permissionless but requires computation resources. Every work participant is free to decide how much money they wish to spend on computational resources. To become a bitcoin miner, a network user needs the most recent copy of the bitcoin blockchain and a software package that automates the process.
Immutability of the blockchain
The identification number is unique and is dependent on the contents of the block header. Any modification of a block header’s contents will inevitably cause the identifications number to change. This will introduce inconsistencies into the chain structure so that all subsequent blocks will have to be recreated.
The consensus among miners is that every miner who receives a block that includes only valid transactions and has an identification number below the current threshold adds this block to their own copy of the bitcoin blockchain. From a game-theoretical perspective, a hash equilibrium is a strategy profile where all miners add valid blocks to their own copies of the bitcoin blockchain. If a miner believes that all other miners are acting accordingly, then the best response for that miner is to add a valid block candidate to their own copy.
The mining reward is costly, the hardware has to be prowired and maintained, and there are electricity costs. These costs are carried individually by the miners. On the other hand, maintaining the bitcoin blockchain benefits all network participants. Mining provides a public good in this respect: no one can be excluded from using the network, and all network participants profit from the mining activity. No miner, however, would have an incentive to contribute and to bear the cost of maintaining the network if there were no compensation.
The bitcoin system solves this incentive problem by allowing miners to add a so-called coinbase transaction to every block. This transaction generates new bitcoin units that can be claimed by the miner who has successfully added the block to the blockchain. Since everyone follows the longest version of the chain, the coinbase transaction will only be accepted by the network if the block is part of the longest version of the blockchain.
What are a Hard fork, Soft fork, and Forced fork
A soft fork refers to a fork where the new software tightens the rules of acceptance such that the new rules are a subset of the new rules. As a result, valid blocks under the new software will also be accepted as valid under the old software, but most often, not vice versa.
A hard fork refers to a fork where the new software broadens the acceptance criteria such that the old rules represent a subset of the new rules. This has the consequence that blocks created using the latest software can be rejected by the old software. Conversely, the new software will always consider blocks generated with the old software as valid.
A forced fork uses an entirely different rule set where the old software will never accept blocks in accordance with the new rules and vice versa. It, therefore, will always lead to two separate versions of the blockchain.
Here is the development of the ledger versions with soft, hard and forced forks in dependency on allocated computational resources.
Difference between a soft fork and a hard fork
The difference between a soft fork and a hard fork can be easily explained by discussing changes in the block size limit.
A decrease in the block size limit is a soft fork because the old software version considers blocks that are generated by the new version of the software is considered valid by the old software.
An increase in the block size limit is a hard fork because the old software version considers some blocks generated by the new version of the software after the update as invalid. Consequently, the chain of blocks generated by the latest software version is considered invalid by the old software.
Many people are looking for opportunities to invest in Bitcoin. Even large corporations are collaborating with existing crypto clients. More stores, both online and local, are gradually accepting Bitcoin payments. The crypto market is growing with more people buying and selling Bitcoin for profit. The number of people using Bitcoin to store value is increasing by the day.
Bitcoin is the greatest investment opportunity since the internet, we use it almost like a language to communicate value among ourselves in society. On average bitcoin has tripled annually for eleven years with a growth rate of 233%. Paper money has hit an all time low against most hard assets especially bitcoin.
Yes, bitcoin has its pros and cons. Nevertheless, take your time to understand bitcoin, how it works, and how to trade or invest in it.
“BITCOIN CREATES AN ENVIRONMENT THAT IS RIPE FOR INNOVATION, BECAUSE IT’S NOT JUST A CURRENCY; IT’S A TECHNOLOGY, A NETWORK AND A CURRENCY.”
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