Proof of work
What is Bitcoin?
Bitcoin is a decentralized digital currency that allows for peer-to-peer transactions without the need for a central authority or intermediary. It was created in 2009 by an individual or group of individuals using the pseudonym Satoshi Nakamoto. The underlying technology behind Bitcoin is called blockchain, which is a public ledger that records all transactions made with the currency. Bitcoin fulfils the three roles of money as a store of value, medium of exchange, and unit of account. Bitcoin is often seen as a revolutionary technology with the potential to disrupt traditional financial systems.
How does it work?
“Bitcoin” refers to both the currency tokens (“bitcoin”) and the protocol or network (“Bitcoin”). Here is how it works:
- Bitcoin token: A bitcoin is a digital token of value. One bitcoin can be divided into 100 million satoshis, so it possible to own or transact in fractions of a bitcoin.
- Bitcoin network: The Bitcoin network is a decentralized global network of a) computers called nodes, that maintain a complete copy of the blockchain, validate transactions and blocks, and enforce the protocol's rules, and b) miners, which are powerful computers that secure the network and verify transactions
- Bitcoin protocol: The Bitcoin protocol is a set of rules and algorithms that define how the Bitcoin network operates. It governs how transactions are created, processed, and recorded on the blockchain, ensuring that the decentralized system functions smoothly and securely. The protocol is implemented by the open source Bitcoin software program.
- Blockchain: The blockchain is a public ledger that records all Bitcoin transactions, ensuring that the entire network has a consistent view of the Bitcoin supply.
- Mining: New Bitcoins are created through a process called "mining," where powerful computers solve complex mathematical problems to validate transactions and add them to the blockchain using a consensus mechanism called Proof-of-Work. Miners get rewarded for this in Bitcoin.
- Halving: That rate at which miners are rewarded for securing the network in bitcoin is halved very 4 years.
- Transactions: When a user wants to send bitcoins to another user, they create a transaction and broadcast it to the network.
- Verification: The transaction is verified by nodes on the network, and if it's valid, it's added to the blockchain.
- Wallets: A Bitcoin wallet is a software program or hardware device that stores your private keys, which allow you to access and manage your Bitcoins. Think of it like a bank account for Bitcoin, but you control the keys (and therefore the security) yourself.
- Cryptographic protocol: Bitcoin uses cryptographic techniques such as public key cryptography to ensure that funds can only be spent by their rightful owners. Each user's Bitcoin wallet is associated with a public key and a private key that control access to their bitcoins.
- Bitcoin Lightning: Bitcoin Lightning is a faster, cheaper way to send small amounts of Bitcoin using a network built on top of the main Bitcoin blockchain.
Why was it created?
Satoshi Nakamoto developed Bitcoin at least in part, in response to the Great Financial Crisis and bank bailouts of 2008. Bitcoin was created to address several key problems associated with traditional financial systems and fiat currencies. Here are some of the core ways in which it achieves this:
- Decentralization: Traditional financial systems are centralized, with control resting in the hands of banks and governments. This can lead to issues like censorship, where certain transactions or accounts may be blocked or frozen. Bitcoin's decentralized nature allows for peer-to-peer transactions without the need for intermediaries, reducing the risk of censorship and manipulation.
- Financial inclusion: Many individuals around the world lack access to banking services. Bitcoin provides an alternative financial system accessible to anyone with an internet connection, allowing unbanked populations to participate in the global economy.
- Trust and transparency: Traditional banking requires trust in third-party institutions. Bitcoin's blockchain technology provides a transparent and immutable ledger of transactions, reducing the need for trust and increasing accountability.
- Inflation control: Fiat currencies can be subject to inflation, as central banks have the ability to print money at will. This can lead to the devaluation of currency over time. Bitcoin's fixed supply limit of 21 million coins creates a deflationary environment, potentially preserving value better than traditional currencies.
- Security and lower fees: Bitcoin transactions can offer improved security and, in some cases, lower transaction fees compared to traditional banking, especially for cross-border payments. This is particularly beneficial for remittances, where traditional services can be costly and slow.
- Self-sovereignty: Bitcoin allows users to have full control over their own funds without relying on banks or third-party services. This empowers individuals to manage their wealth and transactions independently.
- Fast and borderless transactions: Bitcoin enables fast and borderless transactions, which can be processed relatively quickly compared to traditional banking methods, particularly for international payments.
Bitcoin myths
- It is mainly used for terrorism, child porn and money laundering: Like any money or open protocol (such as the internet), Bitcoin can be used by anyone for both good and bad purposes. While some illicit activities are conducted using Bitcoin, studies have shown that the percentage of Bitcoin transactions linked to illegal activities has been consistently declining and make up a very small fraction of all Bitcoin transactions. The transparency of blockchain transactions can dissuade large-scale use for such purposes, as transactions can be tracked and potentially traced back to individuals. The US Dollar is by far the most used currency in international crime.
- It is a Ponzi scheme: A Ponzi scheme is a fraudulent investment pyramid scheme where early investors are paid off with the money from later investors, creating an illusion of high returns. Bitcoin's decentralized nature, its value based on market forces, and its transparency through the blockchain make it fundamentally different from a Ponzi scheme.
- It is not backed by anything: Well firstly, no modern currency is backed by anything, hence the use of the term “fiat” to refer to modern currencies that are money by the decree of government. The US Dollar ceased to be backed in value by gold in 1971, and now all other currencies are valued relative to the Dollar, so the whole global financial system is a house of cards. Secondly, Bitcoin is backed by an immense, decentralized computing network that leverages a massive virtual wall of cryptographic computation power and electrical energy. This complex infrastructure enables the secure and transparent processing of transactions, making it a cornerstone of the digital currency's resilience and integrity.
- It is bad for the environment: Bitcoin's security relies on a consensus mechanism called Proof-of-Work, which requires powerful computers to solve complex mathematical problems. These computers, called miners, use massive amounts of electricity to perform the calculations. However, over 50% of the energy used by miners is renewable energy, which is the highest of any industry. Bitcoin mining enables the productive use of stranded renewable energy such as hydro-electric or landfill methane sources situated far from other potential users such as cities, and that would otherwise go to unused. Bitcoin mining is even supporting conservation in Africa (see Engage).
- Bitcoin is the same as any other cryptocurrency: Bitcoin was the very first cryptocurrency to be developed. Thousands have since been created to either mimic Bitcoin or to serve other purposes, but Bitcoin is unique for several reasons.
- It is the oldest and largest cryptocurrency both in terms of the size of the network and the market capitalization of the currency. It has the first-mover advantage with the widest adoption. Its wide user base and network create a self-reinforcing cycle called the “network effect”. The Bitcoin network effect refers to the phenomenon where the value and utility of Bitcoin increases as more users, nodes, and services join the network. This creates a self-reinforcing cycle where the network becomes more valuable and useful as more people use it. The network effect is a key driver of Bitcoin's growth and adoption.
- Unlike every other cryptocurrency, Bitcoin is not run by a company, foundation, or a small user community. It has an unknown founder who has no control over it. It is just about the only truly decentralized cryptocurrency on earth. This makes it resistant to censorship, manipulation, and government intervention. The protocol code can also not be changed at the whim of a group of individuals. To change Bitcoin would require more than 50% of the thousands of nodes and miners in the network to agree to the change.
- The maximum number of bitcoin that can ever be created – 21 million – is hard-wired in the protocol code and can’t be changed. In doing so Satoshi Nakamoto invented digital scarcity that is counter to the inflationary outcome of limitless money “printing” by governments and banks, who create money out of thin air. Very few cryptocurrencies have a capped supply, and those that do, could have the supply cap changed relatively easily.
- The Proof-of-Work consensus mechanism used by Bitcoin is a more secure and decentralized consensus algorithm than others such a Proof-of-Stake, as it provides a robust security framework, incentivizes security measures, and fosters a competitive market among miners. Although it uses more energy than the Proof-of-Stake mechanism used by many cryptocurrencies, it is a superior mechanism for securing the largest peer-to-peer payment system on earth.