You don’t have to be a geek or a finance expert to understand the basics of Bitcoin. Anyone can use it after learning 13 key concepts.
- Bitcoin is a communication and data recording system which allows the transfer of value or digital money from one person to another without the need of banks, government permission, and knowledge of the identity of the recipient.
- The transfer can be international and is almost instantaneous; it takes only 10 minutes to be fully confirmed.
- Internet is the network of choice, but other communication systems are also possible, including satellites.
- The transaction has a low cost and cannot be reversed, but it is publicly acknowledged by recording it in a distributed account ledger (blockchain) that anyone can read using the proper software. The digital tokens never move, they are simply assigned new ownership inside the ledger that keeps track of all exchanges since the very first one. The full confirmation of the group of transactions contained inside a block takes about 10 minutes.
- The system is so secure that after more than ten years of operation, it has been violated only once, with no consequences, at the very beginning. No hacker has been able to crack it since. The only true weakness is in wallets that can be hacked, stealing the keys that give ownership to the Bitcoin tokens. Wallets are particularly vulnerable when stored online or when they are on a computer connected to the Internet. The vast majority of thefts have happened inside exchanges: computer systems that use their own internal wallets to facilitate the conversion of Bitcoin in other currencies or cryptocurrencies. Exchanges get hacked and criminals steal any cryptocurrency which is stored inside.
- Bitcoin is legal in many countries, included the USA, and can be used to also transfer nationally or internationally other currencies, like dollars or euros, after first converting them into Bitcoins and then back into dollars or euros. The conversion happens through one of many exchanges that were born in the last few years and that operate 24/7.
- People can buy merchandise directly from the numerous vendors that already accept Bitcoin payments.
- The value of a Bitcoin has grown constantly since its origin, although with wild and rapid fluctuations. Many use Bitcoin just as an investment tool, some trade on it daily to speculate on its rapid value changes. The gains that are made this way are considered “capital gains” in the USA and taxed accordingly by the IRS and other tax authorities around the world.
- There is a limited amount of Bitcoins available in the world, which makes them scarce and therefore, increasingly valuable. They are minted following a rigid mathematical formula that cannot be manipulated by any single entity. The Bitcoin monetary policy is set in stone inside the software that runs the system itself and can only be modified by a consensus of a majority of its users and developers.
- Changes and evolutions constantly happen in the direction of making it easier to use, capable of managing more transactions per minute, with less cost. Yet its fundamentals remain unchanged since its inception.
- There are several “flavors” of Bitcoin, but the dominant one, by far, is Bitcoin Core (BTC), which has changed the least since the original genesis of the protocol.
- Bitcoin will maintain and increase its value to the degree that more people believe in it and use it. Government restrictions, tax laws, social and technological phenomena will influence on it, but its survival will only be assured by mass adoption. It is intrinsically unstoppable provided enough individuals will continue to support it.
- Bitcoin allows some form of privacy. It is possible, in most cases, to trace back the sender and the recipient of a transaction, but it requires special knowledge and a certain effort. There are techniques capable of greatly enhancing privacy and developers are currently working to improve this aspect of Bitcoin. Other cryptocurrencies exist, such as Monero and Zcoin, that provide tight privacy and which can be used in combination with Bitcoin.
Who invented Bitcoin?
Bitcoin was originally proposed in November 2008 by an anonymous developer known with the pseudonym of Satoshi Nakamoto. He figured out the combination of elements needed to create a Bitcoin network. Most of the discoveries were not new and came from scientists and researchers who had tried to develop a digital currency for three decades. Satoshi was able to brilliantly integrate all the components in a system that could work.
It is the most important change that happened in the financial and economic world since the invention of digital payment systems. Bitcoin provides a practical way to transfer money and pay goods without having to depend on intermediaries or opening a bank account. It is censorship-resistant; therefore, you don’t need the permission of anyone to use it. After the huge financial crisis of 2008, Satoshi wanted to provide the world with an alternative to a corrupt banking monopoly.
He developed the majority of the initial official bitcoin software. The network came alive on January 3, 2009, with him creating (through the process of mining) the initial (genesis) block of the Bitcoin ledger. The first transaction happened a few days later, on January 12, 2009, and was performed again by Satoshi himself transferring 10 Bitcoins to Hal Finney, the first key co-developer who had downloaded the Bitcoin software the very day of its release, on January 9.
Satoshi Nakamoto stopped working on the project in the middle of 2010 and left the project altogether in April 2011, announcing he was “moving on to other things.”
Despite several investigations and multiple pretenders, his or her identity remained anonymous. He was replaced by several developers that kept building the code needed to perform all the required functions on a big scale. Some of the original developers are still working on the project, new have joined, and others have left to work on different cryptocurrency projects, some in direct competition with the original Bitcoin (BTC). None of the competitors has succeeded in replacing the original.
What is the double-spending problem?
Using a form of digital money like Bitcoin, one faces the issue of preventing forgeries and the duplication of “coins.” It is very easy to make a copy of a digital file, and therefore it is just as simple to spend the same electronic coin many times, defrauding the recipients.
Satoshi was the first one to solve this issue setting in motion a popular movement that today involves over 7 million active users with some 32 million wallets, with an overall market value of $ 183 billion, at the date of this writing.
It is virtually impossible to spend the same Bitcoin twice, provided you give enough time to the network to validate a transaction. The suggested waiting time is 10 minutes, with some also advising to wait 20 minutes.
The long wait time is needed to guarantee the safety of the system and preventing hackers from manipulating it. At the same time, it is one of the major hurdles which is preventing a wide-scale use of Bitcoin as a common payment tool. The Bitcoin development community is working on systems that will overcome this weakness by providing a faster and somewhat less secure process for smaller payments.
How many Bitcoin versions are there?
There are FIVE different versions of Bitcoin, at this time, with the main one being, by far, Bitcoin Core (BTC). It uses free and open software which derives directly from the original development by Satoshi Nakamoto. When installed on a computer, the Bitcoin Core creates a node of the Bitcoin network, with its wallet and the capability to send and receive money. The word core is therefore used, in this case, to distinguish this portion of software the wider Bitcoin network and its protocols.
When Satoshi Nakamoto abandoned the Bitcoin project in 2011, he left behind a community of developers tasked with the duty of evolving the platform. Any changes would be possible only if accepted by the majority of the network players and developers. In such a way, no single individual or group would have been able to twist the system to their benefit.
Like Satoshi Nakamoto, all initial developers contributed to the project for free, but over time economic factors entered the picture and it opened the door to the in-infighting and the splitting of different factions.
Hal Finney was the initial key opinion leader and contributor to the development project. He was ill and was soon replaced by Gavin Andresen, from Massachusetts, who also participated in starting the Bitcoin Foundation in 2012. It was an organization created precisely with the purpose of collecting funding for the development effort. The organization did manage to collect money but was disbanded in 2015 for insolvency. In the meantime, Wladimir J. van der Laan, from Holland, replaced Andresen as lead developer In April 2014. Today the development effort is carried forward by volunteers as well as corporations that contribute to the open-source code.
Andresen initially tried to facilitate the expansion of Bitcoin Core as a whole but flip-flopped supporting antagonist projects already in 2016 and was eventually banned from changing the BTC software that same year. In 2020 he announced his support for a completely different and competitive environment: Ethereum.
Gavin’s main complaint was that BTC didn’t evolve and change fast enough to meet its scalability challenges (the ability to process many more transactions per minute). Yet this is considered to be the actual strength of Bitcoin Core: a very conservative development approach that follows the original formula as closely as possible. Stability fosters trust and it translates into the huge market valuation of BTC today.
Litecoin versus Bitcoin Core
The limit of processing only about 3,500 transactions every 10 minutes generated infighting in the Bitcoin development group fairly rapidly. Some of them parted their way, evolving their version of Bitcoin. Such a mechanism is called “hard fork,” and it is similar to the forking of a railway. One train arrives at the hard fork and it splits into two separate convoys, each following a separate and diverging path.
The first departure from the original Bitcoin is called Litecoin, or LTC. It was created as a friendly hard fork of the original project on October 13th, 2011. Litecoin is a complement to BTC for small payments. It uses the same software, but it validates a block in 2.5 minutes instead of 10 minutes, like BTC. Furthermore, it allows the production of 84 million coins over its lifetime, versus the 21 million allowed for BTC. It is today the 6th cryptocurrency in value. His creator, Charlee Lee, is still active in developing it.
Bitcoin Cash versus BTC
Bitcoin Cash is an alternative version developed in August 2017. It aims at reducing transaction costs by increasing the amount of information processed in a single block. By block we mean the digital container hosting all the information related to multiple transactions approved in one cycle. Bitcoin Cash, or BCH, uses blocks with a size of 8 MB versus the 1 MB allowed by Bitcoin Core. And it allows for a maximum block size of 32 MB. It can record more transactions per minute, but it reduces security and introduces more centralization of control. Furthermore, it creates a huge database of previous transactions limiting the ability to maintain a truly decentralized network. Decentralization works when many people can participate independently in operating the network with their computer or smartphone.
BCH tried immediately to gain popularity as a complete alternative to BTC but never succeeded. Today it occupies the 4th position in the list of top cryptocurrencies. One of its key developers, Amaury Séchet, claimed he was the original Satoshi Nakamoto, but he was never able to prove it. Another key developer, the Californian Roger Ver, strongly supported the original Bitcoin. He was one of the original five founders of the Bitcoin Foundation. Later he turned to Bitcoin Cash and developing a whole series of Bitcoin and crypto-related startups.
Bitcoin Gold versus BTC
On October 24, 2017, another hard fork took place on the main Bitcoin Core blockchain. The name of the new controversial project was Bitcoin Gold which aimed at facilitating the mining (minting) of new Bitcoins. The hard fork involved the issuance of tokens (money) to the exclusive benefit of the group supposed to develop. The event lowered the trust factor in the Bitcoin community. Today Bitcoin Gold (BTG) is 40th in the list of the overall market value of major cryptocurrencies. It is the worst-performing Bitcoin hard fork and almost half of its tokens are held by just one individual.
Bitcoin Satoshi Vision versus BCH
In August 2018 some Bitcoin Cash developers launched a hard fork called Bitcoin Satoshi Vision or BSV. It uses an even bigger block size, 128 MB, in an attempt to provide a global payment system. More recently, they seem to be willing to go back to the original block size of 1 MB. One of the founders of BVS, the Australian Craig Wright, also claims to be Satoshi himself. He didn’t gain much credibility and is involved in troubling judiciary problems. Like BCH, also BSV failed to replace BTC and today is 5th in the list of cryptocurrencies per value.
How do you get a Bitcoin?
There are three possible ways to acquire Bitcoins:
- Buy them from an exchange
- Earn them through your work
- Mine them
There are many exchanges today which provide a convenient and easy way to acquire Bitcoins. They can convert from most common currencies like dollars, euros, yen, pounds, and so on. You will have to provide personal information so that they can keep track of funds transfers.
Exchanges allow storing Bitcoin in their wallets and exchange it for other cryptocurrencies, or back to conventional money. Values fluctuate greatly and also rapidly. Therefore it is possible to gain money and lose money in the flicker of an eye. Some specialize in trading Bitcoin daily so to take advantage of these constant shifts. People have made and lost a lot of money doing so. It is not an approach we suggest unless you really know what you are doing.
It is increasingly possible to be paid in Bitcoin for delivering products or services. Some customers prefer this type of payment because it allows a certain level of anonymity and defies any control. An increasing number of merchants accept Bitcoin because payments cannot be canceled as you can do with a credit card. They also like the potential appreciation of cryptocurrencies.
Finally, mining was the original and most popular way to acquire Bitcoin in the early days. All you had to do was running special software on your computer. By validating other people’s transactions, you would be rewarded with multiple Bitcoins.
Today mining has become so competitive and expensive, that it is affordable only for big organizations with expensive computing equipment. It takes several thousands of dollars of electric power to mine a Bitcoin today. Therefore miners chose geographical locations and countries that provide the cheapest power and have a cool climate.
Bitcoin mining equipment consumes an enormous amount of electricity and generates a lot of heat. Having a cold environment makes it cheaper to run. Today it is very hard to mine Bitcoin individually, even by joining pools of multiple users working together. The rewards are very low and it often takes a very long time to earn anything; while wasting money on your electric bill.
How does a Bitcoin address look like
A Bitcoin address is a continuous string of 26 or 35 alphanumeric characters that have been randomly chosen and which are unique in the whole network. It can be generated for free by any user using existing software. At this time, there are three different formats that can either start with 1, 3 or bc1.
An example would be 1Bv2MSvYst6etqTFn5Au4m4GFg7xJaNVN2
Most of the time the address is case sensitive and therefore you need to be very careful in writing it down otherwise the funds could end up to somebody else or, more likely, in a black hole.
For that reason, addresses are usually managed through wallets, which are software applications sometimes couples with special hardware to increase their security. Bitcoin wallets work a bit like a web browser. They allow you to explore the blockchain and establish how much money you have. They also memorize all of your addresses so that you don’t have to type them every time.
What is a Bitcoin wallet?
It is not an actual container of Bitcoins: they are stored on the central blockchain which can be read by all and updated by miners. Bitcoins are never actually transferred. They simply change the owner and such change is recorded on the blockchain along with the address of the new owner. Therefore a Bitcoin wallet is only used to store the keys (addresses) that allow the transfer and receipt of such ownership. They would be more properly be described as keyrings rather than wallets.
Bitcoin addresses are very difficult to remember and therefore you can use a wallet to memorize them for your a make them available when you are ready to perform a transaction. Some wallets are complete applications that also help you generate new addresses, keep track of your Bitcoin balance and provide the right address at the right time.
Other wallets are just memorizing devices and can be made of plain paper or complex electronic circuits built in the form of a USB drive or embedded into a mobile telephone. Paper is the safest of all forms, provided you manage it and store it securely. Software packages that can access the Internet are the least secure because they can be violated by a hacker.
Electronic wallets are a way in between: they are more convenient to use than paper and are more secure than plain software. They often contain their own software that can help you automate and simplify operations.
You can use multiple addresses, keys, and wallets at the same time. Leaving small amounts for quick transactions on the more vulnerable online wallets and storing the bigger value on paper or electronic devices which are then kept offline, in a safe, and disconnected from the Internet.
Bitcoin was born as an alternative to the crooked financial system created by banks, central banks, big governments, and Wall Street. It has the purpose of giving back control to the individual and making him free to exchange value with anyone on the planet without depending on middle-men.
Its value depends uniquely on the confidence people will gain on it and how much will they be able to use it daily to purchase products and services. It has also some investment and speculative potential, but that is not enough to keep it viable in the long run.