Bitcoin is the first example of a cryptocurrency with references to Hashcash from A.Back, b-money from W. Dai and Public key cryptosystems from R.C. Merkle among others. It is an asset class that has combined traditional currency with verification based on cryptography, first introduced as an electronic payment system based on mathematical proof.
Bitcoin is a peer-to-peer version of electronic cash used for payments sent directly from one party to another without going through a financial institution. The most widespread definition describes bitcoin as the world´s first decentralised digital currency limited to a supply of 21M and with no trusted third party. Meaning that no single person, organisation or authority has control over it. Anyone can buy it, anyone can receive it.
Bitcoin was invented by a person or a group of people under the pseudonym Satoshi Nakamoto and it was announced publicly on bitcoin.org in November 2008. On January 3rd, 2009, the first block was mined, labelled as the Genesis Block with the embedded text, “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”.
We know bitcoin as the coin, which is a code representing ownership over coins, an IOU if you like, and Bitcoin as the protocol, a distributed network maintaining a ledger of balances of the previously mentioned bitcoin coins.
What is BTC
The bitcoin symbol is ₿ and its ticker price is BTC (XBT). The bitcoin unit of account is bitcoin and the denomination is one hundred of a millionth (0.00000001) with the smallest unit called a satoshi (sat). Other alternative units for smaller amounts are millibitcoin (mBTC) for 0.001 bitcoin or 100,000 satoshis. The maximum bitcoin supply is 21M, controlled by the Bitcoin algorithm.
The bitcoin currency runs on the Bitcoin network, operating on the Bitcoin protocol, called the blockchain. The blockchain is a shared public ledger with records of bitcoin transactions that the Bitcoin network relies on. The blockchain is built as a chain of blocks that contain transactions and is maintained by a network of communicating nodes running Bitcoin software. Nodes are carrying out a set of rules to verify transactions on the network. Verification occurs through the process called mining, those nodes are called executing or mining nodes. The nodes are involved to make sure that all participants on the Bitcoin network have a consistent view of the data. There are four types of nodes on Bitcoin blockchain: full nodes, super nodes, light nodes and before mentioned mining nodes.
Anyone can be a Bitcoin user by downloading its open-source software. Users on the network are identified by Bitcoin addresses, which appear as random strings of numbers and letters. These addresses are pseudo-anonymous, so Bitcoin can be used anonymously to some extent.
Bitcoin is stored on a Bitcoin address (Public Key) generated from a Private Key (Seed). The Private Key is strings of numbers and letters associated with the address. The owner of the Private Key is the owner of the coins stored on the Bitcoin addresses.
Storing Bitcoin means storing private keys.
Private Keys can be stored in different ways. They can be stored on a USB drive, on a computer (full node) or more common devices such as hardware wallets (Ledger, Trezor). These are physical devices that encrypt keys needed to spend bitcoin. A common practice is that these devices stay offline and are harder to hack. More convenient, but less secure, is storing bitcoin in a software wallet, a piece of software that you download and run on your computer or mobile device. And a remnant from the first days of bitcoin is a paper wallet, that is printed on a piece of paper that has a private key, Bitcoin address and a QR code representing both. They are the most difficult to set up properly and in a safe manner.
Bitcoin can be also stored on an exchange, but this is not recommended either. Bitcoins stored on an exchange are stored on an exchange’s wallet to which the user has no private key. Exchanges are normally under high risk of hacks and therefore it is not advisable to leave any large amount of bitcoins on an exchange.
A bitcoin transaction is a transfer of value between Bitcoin wallets and is included in the blockchain. For example: if Alice sends Bob a bitcoin, she sends bitcoin from her Bitcoin wallet that generates a Bitcoin address, also known as the public key, from her private key (seed). The nodes on the network that see her intention and validate first that she really has this bitcoin and, second, that she has not yet sent it to someone else. Alice proves that the bitcoin is hers by signing it with her private key. After the transaction is validated, it gets included in a “block” with other transactions.
The first to get a bitcoin was cypherpunk Hal Finney, who had created the reusable proof-of-work system (RPoW) in 2004. The first transaction amount was 50 bitcoins and those were sent by Satoshi. This transaction occurred on Jan. 12, 2009 and was included in block 170.
The first known commercial transaction was confirmed in 2010 and contained 10,000 bitcoins for two pizzas. This transaction occurred in block 57043, on May 22, 2010 by Laszlo Hanyecz.
How Bitcoin Works: Protocols and Architecture
Bitcoin can be used anywhere where the internet is. The Bitcoin network is decentralised and maintained by a network of users by consensus of the network’s members with no central authority enforcing rules. A group of volunteer coders take care of development and an open network of nodes runs it. A node is a computer running Bitcoin software that keeps Bitcoin users apprised of information. Anyone can run a node that will transmit bitcoin transactions around the network. Some nodes are mining nodes. Miners provide a service for the network by confirming transactions that users send each other. Miners combine transactions on the network into blocks. Every new block refers to the previous block. More blocks form a blockchain.
Mining is a system of confirming pending transactions in a block, employing a distributed consensus method to maintain an honest network. The method consists of a set of cryptographic rules to secure the blockchain and prevent double-spend transactions to sustain from an alteration of previous blocks. Miners are agents who protect the neutrality of the network and present agreement among different nodes on the state of the system by chronologically ordering transactions in the Bitcoin blockchain.
Mining is a process where miners use energy to maintain the network and for doing so, receive payment. Their incentive to include transactions into blocks by converting electricity is newly minted bitcoins and miners fee – component of every bitcoin transaction. Their payment, the new bitcoins reward is perceived as one additional transaction contained in every confirmed block. The reward is distributed on average every 10 minutes along every confirmed block and is best understood as a lottery.
A randomly chosen miner who burned energy will receive the reward for the mathematical computation task, also known as a hashing function. This hash function prevents prediction of output and is done by random guessing. In this task, the goal is to find a nonce that will produce a “hash”. The “hash” is a combination of the nonce linked with the block data and passed through a hash function. A product is a hash string with an integer including a pre-determined number of zeroes at the beginning. The difficulty of such mathematical calculations is adjusted for every computational challenge, that is a 10-minute block confirmation. The difficulty is expressed in hash rate and works as a measuring unit for the processing power of the Bitcoin.
The bitcoin reward for work is also a mechanism for new bitcoins coming into circulation. This reward for miners performance is deliberately decreasing with a process called halving and will exist until all 21M bitcoins are circulating. The block reward already underwent four halvings and went from 50 coins to 25, to 12.5 and currently 6.25 bitcoins per block.
How to mine bitcoin
Due to the random nature of mining, individual miners can combine hash power and mine as one big miner in Pool mining. This guarantees that they will find blocks more regularly and make earnings from mining rewards more constant.
Anyone can become a miner, but mining requires computational resources and electricity. Money is a representation of the work required to have goods and services produced and can be viewed as stored energy. Bitcoin is a commodity minted from energy by using Proof-of-Work (POW). PoW transmutes electricity into digital assets and, thus, bitcoin is mined.
Proof-of-Work (PoW) mining is a consensus system where dedicated machines for block reward convert electricity into bitcoin. The machines are application-specific integrated circuits (ASICs) constantly performing hash operations until a cryptographic puzzle is solved to prove with the solution that energy was spent. For such work, miners in return receive block reward (bitcoins). PoW becomes especially important when it comes to the Bitcoin Ledger. The blockchain can be immutable only if it is costly to do so. That is why PoW features high cost and the Bitcoin Ledger is secured by its collective hashing power, the sum of all energy expended. PoW was designed to change political votes to apolitical votes (hashes) via the conversion of energy.
The Bitcoin block size limit is a parameter in the Bitcoin protocol that limits the size of Bitcoin blocks. This is a limit of how many transactions can be included in one block that happens about every 10 minutes. Block size used to be 1 megabyte, or dependent on the size of a transaction, on average, three to seven transactions per second. In 2017, the block size limit was replaced by a block weight limit of four million weight units, changing the way data in blocks was being counted. Now, Bitcoin blocks have a theoretical maximum size of four megabytes but, more realistically, two megabytes.
Bitcoin has gone through improvements since its first launch. The Bitcoin Improvement Protocol (BIP) was introduced by Amir Taaki in 2011 to make Bitcoin development more structured and accountable. BIP is a standard for proposing changes to the Bitcoin protocol, either as soft or hard fork protocol upgrades or other changes.
There are different Bitcoin Forks, a codebase fork, that is a copy of the code and normally results in a whole new cryptocurrency, a blockchain fork, which brings two versions of the transaction history. Or a hard fork, a protocol upgrade that loosens or removes rules and a soft fork, a protocol upgrade that tightens or adds rules. Sometimes forks are not easily distinguishable and even experts cannot agree.
Bitcoin’s most known protocol upgrade from August 2017 is SegWit, Segregated Witness, which eliminates transaction malleability. SegWit was intended to support the Lightning network to improve scalability.
Bech32 is a SegWit address format determined by BIP 0173, known as “bc1 addresses”. Bech32 addresses are a friendly environment for small transactions alongside having improved functions in the domain of error detection. They have a human-readable part and use “bc” for accessing mainnet, while “tb” is used for testnet.
Legacy Bitcoin addresses (also the original BTC addresses)
The Lightning network is layer two of the bitcoin protocol proposed in 2015 by Joseph Poon and Thaddeus Drya. It was designed as an overlay of a payment channel for fast and cheap transactions that don’t slow down the mainnet. Lightning payments are not recorded on the Bitcoin blockchain directly but through channel-funding and channel-closing transactions. In practice, this means Lightning transactions are settled with fewer on-chain Bitcoin transactions.
The most famous bitcoin hack is the Mt.Gox hack, which happened in 2014, when the bitcoin exchange from Tokyo, Japan was handling about 70 per cent of all bitcoin transactions worldwide. The settlements with bitcoin traders are still ongoing.
Bitcoin is a digital asset that can be traded or exchanged for traditional currencies like EUR, USD, GBP etc.
First Bitcoin block was mined on 03. January 2009. Otherwise, the idea of digital money is from 1982.
Start with buying satoshis and eventually you will own a bitcoin. All you need is a bitcoin wallet that you download #url (do wallets) and choose a payment method. Buy bitcoin with a credit card, a wire transfer or exchange other cryptocurrencies.
You can buy bitcoin in various ways. The most convenient is use of a credit card or a wire transfer directly to an exchange.
Bitcoin halving is a predetermined process that occurs every 4th year and halves the number of newly mined bitcoins that come into circulation with every new bitcoin block.
Bitcoin can be used for many different purposes, yet its killer app is money.
Bitcoin can be exchanged for cash OTC or at a local crypto ATM.