What is Bitcoin anyway?

So, let’s start at the beginning. Maybe you’re already familiar with what Bitcoin, blockchain and cryptocurrencies are. Or maybe you’ve just heard about it on the news, from a family member or overhead it on the subway. In this piece, Bitcoin’s origin, technology, and impact will be explored. Bitcoin can be described as a currency that is not controlled nor given legitimacy by any central authority. However, there is a wide misconception that Bitcoin functions like a virtual currency or gaming token. These misconceptions dismiss the crux of Bitcoin – blockchain technology – that may revolutionize archaic monetary systems, the internet, and give unprecedented anonymity to both good and bad actors.

Blockchain can be described as a shared record of every transaction ever made on a digital accounting book. When person A sends Bitcoin to person B, this transaction is added to an immutable public ledger – the blockchain. This ledger is stored in multiplicity throughout the network, and to update one is to update them all. That’s a big part of what makes blockchain so powerful as a tool and idea – once a record is created on the blockchain, it can’t be reversed or altered, it is forever, and it is verifiable. This is part what is meant when we say trustless. No third party is required to prove your transactions are real and correct, their very existence on the blockchain does that for you. And if you wanted to steal from the blockchain, think of it as not only having to rob one house, but having to rob all the houses in a city at the same time, in the same way. An impossible task. Also, don’t rob houses.

Processing and validating these transactions and then recording them is called mining. Mining can be done by anyone possessing enough computing power to solve mathematical problems required by the system to validate transactions. For their efforts, these miners are given a fee in the form of newly minted bitcoins. Mining is intentionally resource intensive to set up and to maintain, and the mathematical problems required in order to keep the system going are also intentionally difficult and resource intensive. In this way, a type of self-governance is built into the system that automates some of the governing aspects or traditional monetary systems. Miners are only rewarded for properly validating transactions and playing a role that fuels the whole system, which incentivizes the ongoing maintenance, accuracy and growth of the blockchain. Satoshi really nailed it here as you can see. Smart stuff.

The next unique property of Bitcoin and many digital currencies is scarcity. Scarcity means that there is a limited number of Bitcoins that are or ever will be available. Scarcity is part of what gives gold its value, for example. It’s a rare and precious metal, and that combined with its beauty is what has made gold a useful and relatively universal store of value for centuries. Bitcoin is coded to have a fixed supply of 21 million coins. There will never be more than 21 million Bitcoins created, or “mined”. So until that amount has been fully mined, there will still be an incentive for miners to continue validating transactions even if at a decreasing fee. Bitcoins, however, are divisible up to eight decimal points or 0.00000001. This unit is called a Satoshi or a SAT. As the market capitalization grows, which is the total amount of money invested in a particular market or asset, the total quantity of bitcoins remains static, so it’s value rises accordingly. This is how the value of most cryptocurrencies is determined. Total market capitalization, divided by supply. So it’s important to look at those two numbers in relation to each other, looking at it’s dollar amount is only part of the picture and may not be an accurate picture of its actual value. The more scarce a cryptocurrency is, the greater opportunity for its value to increase as its market cap grows. Bitcoin is known for having a relatively low supply at 21 million, so this combined with its popularity and high market cap are what make it the leader of the cryptocurrency pack – both by price, and by total volume or market cap. Again, clever design by Satoshi.

 

History

So who invented blockchain technology? It is widely accepted that the concept was first introduced in a whitepaper by Satoshi Nakamoto – a pseudonym that may represent a person or a group of people. One could say that Nakamoto’s legacy is as immortalized and immutable as blockchain itself.

However, there were many prophets who heralded the idea of decentralization using cryptologic methods. Tim May, former Senior Scientist at Intel and contributor to the Cypherpunk mailing list, wrote the famous 1988 essay titled The Crypto-Anarchist Manifesto [2]. In it was a clear vision of things to come. Tim writes: “Just as the technology of printing altered and reduced the power of medieval guilds and the social power structure, so too will cryptologic methods fundamentally alter the nature of corporations and of government interference in economic transactions.”

Later in 1991, Stuart Haber and W. Scott Stornetta proposed a secure blockchain for storing documents using Merkle Trees. It was not quite known as blockchain then, but rather a ‘chain of blocks’. Only in 2008-2009 did Satoshi Nakamoto emerge from the woodwork, audaciously claiming to have solved the Byzantine General’s problem in his whitepaper titled ‘Bitcoin: A Peer-to-Peer Electronic Cash System’ [1].

 

The Byzantine General’s Problem

What is the Byzantine General’s problem? It is a fictitious medieval scenario where a general stations each of his armies around a castle he plans to ransack. Now, it would require the full force of his armies to storm the castle – anything less would end in defeat. How then can the general ensure that all armies act together, and act at the same time? He would need to ensure that the same message is sent to the lieutenants of each army and that the integrity of the message remains intact.

Blockchain solves this problem by rendering information immutable. Therefore, if said general uses blockchain technology to store his message, corrupted lieutenants would not be able to tamper with it even if they wanted. This translates into transactions within a cryptologically secure blockchain which are immutable once they are stored and validated.

Critics would argue that this is a flimsy premise and does not truly solve the problem. Theoretically, a 51% attack is all it takes to corrupt the integrity of the blockchain. What this means is that the validity of transactions must be agreed upon by 51% of miners in order for them to be valid, so it would take a bad actor an exponential amount of resources to control 51% of nodes that validate transactions. Despite this deterrent, it is still a very likely possibility with the existence of large mining pools where a great percentage of hash power controlled by very few parties. But it is ironically one of the few solutions that have worked out in practice despite a delicate theoretical underpinning – no 51% attacks have been known to happen to Bitcoin’s network thus far. Satoshi’s solution was ‘good enough’.

 

Potential Applications

Bitcoin, and blockchain-based cryptocurrencies more generally, could revolutionize payments in that they have no intermediaries and are inherently ‘trustless’. This eliminates a lot of middlemen in various industries. There doesn’t need to be a central bank to ensure the integrity of transactions. Make no mistake – reputation and trust still play a huge role in validating transactions, but through the gamification by bitcoin engineers of economic rationality to incentivize playing by the rules.

It also revolutionizes micropayments. Small sums of money can be moved around without hefty fees. However, the erratic rise of Bitcoin’s value has been followed by the ballooning of fees. Unless this is overcome, it is likely that the world would have to look at an alternative cryptocurrency for a solution.

Blockchain transactions in their current state also grant anonymity while preserving transparency. Although every transaction is recorded on the blockchain, there is no name or identity associated with it, only a wallet address represented by a public hash key. While this preserves privacy, it unfortunately resulted in Bitcoin being adopted rather early by bad actors like Silk Road and money laundering syndicates. The perception that Bitcoin is the exclusive domain of bad actors however, is something that continues to shift rapidly as Bitcoin and other cryptocurrencies enter the mainstream conversation. 

 

Barriers to Adoption

Governments have yet to decide what to make of Bitcoin and how to regulate it, and are wary of legalizing something they cannot control. As such, one of cryptocurrency’s biggest hurdles would be government regulation. Powerful banks, which might look at cryptocurrencies as a rival, might not stand idle. However, the more important concern would probably be technological. Blockchain might not be ready for real world adoption due to scalability issues. It takes very little to cause the whole Bitcoin network to lag. Presently, there can only be 4 bitcoin transactions per second. VISA can handle 24,000 per second. Until gaps like these (the rite of passage to real world application) are closed, some of the brightest minds will be working around the clock to one day bring blockchain technology to the mass market.


[1] Satoshi Nakamoto, “Bitcoin: A Peer-to-Peer Electronic Cash System”, https://bitcoin.com/bitcoin.pdf
[2] Tim May, “The Crypto Anarchist Manifesto”, https://www.activism.net/cypherpunk/crypto-anarchy.html