Bitcoin Overview

Bitcoin Overview

Bitcoin is the most popular cryptocurrency, a digital monetary system that allows for fast and cheap payments anywhere around the globe. It differs significantly from government-issued cash, however, due to a number of factors.

Firstly, and perhaps most importantly, the Bitcoin ecosystem is decentralised – no single party has the ability to modify its code or to bring the network to a halt. This is achieved by having participants run software that allows them to stay up to date with a database viewable to anyone. This database (better known as the blockchain or ledger) is updated roughly every ten minutes and provides information on the movement of bitcoins between addresses.

This property of the Bitcoin network makes it both censorship-resistant and permission-less. Anyone in the world can send or receive payments, all without needing to present any identifying information – as far as the protocol is concerned, users living under oppressive regimes are indistinguishable from those in freer nations. Bitcoin is not anonymous, but rather pseudonymous: provided the right precautions are taken, this guarantees the user a high degree of privacy.

As aforementioned, Bitcoin doesn’t rely on centralised parties to function, so it instead implements a process called ‘mining’ to ensure that anyone can6append a block – containing a selection of transactions from the mempool – to the blockchain.

Worth noting is that Bitcoin has a fixed supply – there will only ever be 21 million units in circulation, which are extracted by mining. This puts it more on par with gold or other precious metals than fiat money (and is likely where the term ‘mining’ stems from).

Bitcoin History

Bitcoin is born out of cypherpunk philosophy, a movement championing freedom and privacy in the digital age. Spanning back to the early nineties during the times of the ‘Crypto Wars’, its proponents have been responsible for the creation of privacy-enhancing technologies such as PGP encryption, TOR and iterations of anonymous remailers.

The cypherpunks were particularly interested in developing solutions that would circumvent surveillance by nation states, and as such, recognised the importance of concepts like encryption, self-sovereign identities, pseudonyms, digital free markets and digital cash.

The Bitcoin white paper first surfaced in late 2008, published by the elusive Satoshi Nakamoto (whose real name, to date, remains unknown). A few months later, the first Bitcoin block (called the genesis block) was mined, and the network has enjoyed more than 99.98% uptime in the 10+ years since.

To say Bitcoin materialised out of nowhere, however, would be false. Existing technologies and digital cash systems (both proposed and implemented) clearly served as a source of inspiration.

Proof of Work

The mechanism underpinning the mining process of Bitcoin was, in fact, developed originally as a solution to email or DDoS spam (its origins dating back to a paper by Dwork and Naor entitled Pricing via Processing or Combatting Junk Mail). Cryptographer (and now CEO of Blockstream) Adam Back’s HashCash protocol operates on a similar premise, requiring that users contribute computing cycles before using resources – in this way, a regular user won’t be overly inconvenienced (due to low usage), but a spammer abusing a system with, say, thousands of emails will quickly rack up computational costs.

Back’s work on HashCash is cited in the Bitcoin white paper as the basis for the proof of work algorithm used in Bitcoin to generate blocks.

B-money

Computer engineer Wei Dai’s B-money is a set of proposals for a digital cash scheme that surfaced in 1998, and bore many of the hallmarks of cryptocurrencies today – proof of work for the creation of money, public-key cryptography en lieu of participants’ identities and a ledger keeping track of the movement of funds.

Though it was never launched, B-money caught the attention of Satoshi, who reached out to Dai while working on Bitcoin. Like Back, his work is credited in the white paper..

Bit Gold

Bearing even more similarities to Bitcoin was Nick Szabo’s Bit Gold. The father of smart contracts proposed his own digital cash system where, much like B-Money and Bitcoin, individuals would burn computing cycles to hash a particular piece of data in an attempt to generate one below a certain target. Should an individual succeed, a distributed registry would tie their public key to the hash after it had been timestamped by different servers.

Bit Gold is not mentioned in the white paper, though Satoshi later acknowledged that Bitcoin was an implementation of both B-money and Bit Gold.

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Blockchain

As the name suggests, the blockchain is a chain of blocks. Anytime a Bitcoin block is produced, it is added to a growing chain downloaded by nodes on the network, and cements the transfer of funds as set out in the transactions included within in it.

The term immutability is often used in the context of blockchains, and it’s due in part to the structure of the blockchain ledger: for a block to be valid, one of the pieces of information it must include is the hash of that coming directly before it. This ensures that the blocks are cryptographically linked, and that, with each one appended, it becomes harder and harder to modify or undo transactions on older blocks – building off an older block means that all the subsequent blocks would need to be rebuilt (and overtake the current chain). In practice, this is not technically feasible unless a malicious actor is in possession of the majority of the combined network mining power.

Transactions

A Bitcoin transaction is created when a party wants to transfer funds to another. They will craft a message to the effect of ‘Alice pays Bob x BTC, with a mining fee of y BTC’ (this is an oversimplification – names do not exist in the Bitcoin protocol).

The transaction must be signed with the sender’s private key before it is propagated and pushed into the mempool, a sort of limbo where transactions have not yet been written to the chain (and thus cannot be relied on as they can be altered). A higher miner fee incentivises the inclusion of the transaction in the next block, as it maximises the revenue the miners can make.

Mining

To deter dishonesty and promote greater decentralisation, parties wishing to mine must repeatedly perform math functions in order to generate an output – if the resulting output falls below a target outlined in the Bitcoin software, the block is accepted as valid and is therefore added to the chain.

Presently, mining is incredibly competitive. Whilst blocks could once be generated relatively easily on home PCs, the current difficulty of producing one means that specialised equipment is required. The upfront cost of such hardware is high, as are the running costs. It’s very easy for someone to check that a block is valid, but much harder for them to ‘guess’ it in the first place.

A good analogy is that of a sudoku puzzle spanning multiple columns and rows – it will be complicated to solve, but if it has been filled out, it’s easy to tell if the solution is correct. Every ~10 minutes, the grid is reset and the race to fill it out starts again.

For their troubles, a miner that appends a block will currently receive 6.25 BTC as a reward, as well as any fees paid to incentivise the inclusion of transactions into the block. Given the capital expended in a mining operation, it’s in the miner’s best interest to behave honestly to recoup their investment.

The Lightning Network

The Lightning Network is an extension of the Bitcoin protocol that sits on top of the blockchain itself. It allows users to create a special kind of Bitcoin address which allows them to create a payment channel with another user. These allow participants to keep off-chain records of transactions between themselves, meaning that there are no fees and near-instantaneous payments.

Should parties decide to close the channel, they would publish the most recent record of transactions of the channel to the blockchain, which would then redistribute on-chain funds to the participants as outlined by the record of transactions.

These channels can further connect to others, in such a way that if Alice had a payment channel open with Bob and Bob had another open with Carol, Alice could pay Carol by routing her payment through Bob. This allows the network to scale above the Bitcoin blockchain.

FastBitcoins is the first cash-to-Lightning exchange – a voucher can be redeemed both on-chain and off-chain.

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Markets & Value

Fundamentally, units are not backed by anything (much like government-issued currency).

As with most things, the value of Bitcoin depends entirely on the market’s demand. While a single bitcoin could once be bought for mere cents, they reached an all-time high in 2017, going for $20,000 apiece (before undergoing a significant correction).

Bitcoin has uses outside of speculation, of course: it allows for international remittance with negligible fees, no trust in third-party establishments to uphold its value and, to many, it’s a hedge against other assets. Many further see value in its censorship-resistant properties and irreversible transactions – no one but the owner of the private key tied to the funds can stop the owner from transacting with whoever they please.

The current Bitcoin market price can be found on any number of cryptocurrency exchanges – most search engines will automatically return the current value in your local currency when ‘Bitcoin price’ is searched.

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Warnings

Bitcoin is incredibly volatile. The price could increase, but it could also decrease. It should not be viewed as a get-rich-quick scheme. Never invest more than you can afford to lose.

The cryptocurrency space is wrought with scams. Scammers are creative when it comes to separating Bitcoin owners from their funds. Common ones to look out for:

Altcoins

Altcoins: Since Bitcoin’s creation, there have been hundreds of alternative cryptocurrencies released and often marketed as superior to Bitcoin. Some have niche use cases, but none are as secure or as liquid as Bitcoin. Given their smaller market caps and oftentimes asymmetrical distributions, other tokens and cryptocurrencies are also more easily manipulated.

Giveaways

If it sounds too good to be true, it probably is. Your private key should never be given to anyone, much less entered in a website promising to double your wealth. Another popular scam (often seen on Twitter) involves soliciting holders to send their coins to an account impersonating a celebrity, in return for a certain amount back.

Trading Bots/Groups

The cryptocurrency markets are unpredictable, and few are able to consistently turn a profit (particularly during a bear market), much less code a program to do so. Anything or anyone claiming guaranteed profits or insider knowledge should be treated with caution.

Malware

Bitcoin holders are also lucrative targets for cybercriminals, so any cryptocurrency-related activity on a networked computer or device should be done with caution: hardware wallets are recommended for the storage of large amounts of coins, and users should be careful when copy/pasting addresses into wallet applications to make payments – ’clipboard malware’ (that is, software that waits until a Bitcoin address is copied before swapping it out for an attacker-owned address) has seen a surge in popularity in recent times.

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