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In 2009, Satoshi Nakamoto altered history by creating the world’s first decentralized, cryptographically secured digital currency: bitcoin.
Bitcoin operates on a distributed database called a blockchain, which acts as a universal ledger recording and verifying transactions. It allows for peer-to-peer transactions which are protected by cryptographic, yet publicly visible, techniques. This establishes a secure, transparent, and trustless network of value exchange. Bitcoin/satoshis are the units of exchange on this network; the blockchain ledger records the value transferred between network users.
The blockchain is secured, and bitcoin is issued, by a process called mining, which is performed by specialized computer systems, called central processing units (CPU), to solve computational puzzles. By completing these puzzles, miners verify registers of transactions called “blocks” and connect them to a chain of previous entries to win bitcoin.
This incentivizes people who engage in the mining process, aka “miners,” to mine bitcoin, and in doing so, contribute to maintaining the security of the bitcoin ecosystem.
To understand more deeply how bitcoin works, first, a grasp of how an average user would send and receive bitcoin using a digital wallet is helpful.
A User’s Journey
The casual bitcoin user can think of their digital wallet analogously to a physical one; it’s what they’ll use to store, receive, and send digital currency. Behind the scenes, however, a digital wallet is doing something very different.
A digital wallet has two parts: a public and private key. The public key is a string of characters that identifies one’s personal wallet amongst millions. It’s just like a home address that can be shared with anyone to allow them to send anyone something directly. Hence, this is called the wallet address. The private key is also a series of characters, but these are more like a passcode that only the user will know.
To send or receive bitcoin, a wallet address is all most people need to know about. Popular digital wallets store the private keys of their users themselves, while users instead access funds via their third-party application with a normal username and password. Here, sending and receiving bitcoin is as easy as inputting someone’s wallet address via a QR code, or sharing a code.
A Transaction’s Journey
To understand what makes blockchain so groundbreaking, one needs to dive deeper than the user experience and look at what happens after the user submits the transaction. Besides the sender and receiver’s address, the transaction requires the sender’s private key to prove that the sender owns the funds. This is done by leaving a signature in the transaction with the private key.
Nodes then verify the transaction; they ensure the sender has enough bitcoin in their wallet for the transaction and that the signature is correct. Now verified, the transaction sits in a pool waiting to be selected by a miner and included in a block. A block is just a digital file for recording transactions.
Due to the limited block size (1mb), miners can’t include all the transactions waiting in the pool; therefore, they naturally pick the transactions with the highest transaction fees (many wallets allow users to raise or lower the amount of this fee, according to high or low priority on confirmation time). Once selected, miners race to add their block of transactions to the blockchain.
A Miner’s Work
This race is just as much a test of strength. To make an addition to the blockchain, miners must solve a complex mathematical puzzle. This sounds complicated, but it’s really a brute-force guessing game. To solve the puzzle, miners try to discover the correct hash (a string of characters) by simple trial and error. Therefore, the miner with the most sheer computational power tends to win the race. This type of system is called a proof-of-work consensus mechanism.
A consensus mechanism allows various network participants to reach an agreement about the ledger’s state. Different types of consensus mechanisms are essentially different ways of choosing who gets the privilege of adding a block to the blockchain. In proof-of-work, the right to add a block is given to whoever discovers the correct hash first.
Once a miner finds the hash, they broadcast their solution to the rest of the network. The other nodes readily verify that this is, in fact, the correct hash. If everything is verified, the block is added and the winning miner is rewarded the newly mined bitcoin plus the transaction fees. Now that the contest is decided, the community of miners sets out to work on adding the subsequent block based on this new addition.
Blockchain: The Big Picture
Keeping in mind this image of miners adding blocks of data to a long series of blocks and agreeing to add the correct block, one will have a general picture of a blockchain. To further clarify this image, consider the hash the winning miner needed to solve. This hash connects the blocks; the hash generated to solve each block is determined by both the transactions in the block and the hash of the previous block in the series. Changing any transaction in an earlier block will change the hash of all future blocks.
They are effectively “chained” together. This is the most basic picture of a blockchain. It’s a decentralized public ledger of transactions distributed amongst a network of nodes constantly verified, added to, and connected.
Now you have a grasp of what blockchain is, but the big picture is really all about the why. Two words sum up the point of blockchain: security and transparency.
Security
Transactions are spread across all nodes in the network, meaning there is no single point of failure or control that could compromise the network. This is the value of decentralization. Moreover, each block connects to the historical chain through its hash. Tampering with any previous transaction is impossible without invalidating the resulting hash. This means the blockchain is immutable. Any attempt to alter even a single transaction would require modifying all subsequent blocks–a computationally impractical and nearly impossible feat.
Transparency
The cryptographic method of proving ownership via a private key means senders remain anonymous while the transactions are public. The visibility of the blockchain transactions allows all users to verify the on-chain information independently. Further, constant public verification is baked into the very system of adding a block to the chain; the community of nodes must verify all the transactions recorded along with the addition of those in the new block.
What Makes Bitcoin Different
Much of the above discussion applies to proof-of-work blockchains, but what makes bitcoin unique?
The cornerstone of bitcoin’s advantage is its unmatched security. Remember, a blockchain network is only as decentralized as the participants in its operation are diverse. Here, bitcoin has an edge over other PoW chains; it has by far the largest community of miners and nodes around the world. Successfully attacking the bitcoin network (meaning controlling over half the mining power, i.e., over half the computers) would be so costly that acquiring the needed computational power is practically impossible.
New bitcoin can only be created by the block reward given to miners. The amount of new bitcoin issued with every new block is halved every four years, and eventually the reward will cease altogether, leaving miners only the transaction fees as a reward for their work. Given this system, we know the total amount of possible bitcoin to be mined is 21 million. Therefore, the value of bitcoin can’t be diminished over time by inflation, thus allowing the bitcoin network the power to preserve any user’s wealth, indefinitely.
The trifecta of security, scarcity, and history (as the first blockchain) make bitcoin a uniquely universal store of value. Think about its value in terms of supply and demand. Its fixed supply restricts the number of coins in possible circulation, the desire to securely transact stabilizes demand for the network, and finally, the historical value of bitcoin gives it an edge well out of reach for competing blockchains.
The Future of Finance
Bitcoin’s inception marks a paradigm shift in the financial world. Its underlying technology, blockchain, ensures a secure, transparent, and immutable system for transactions, setting a new standard for financial exchanges. The mining process not only secures the network but also introduces a novel way to create and distribute currency, governed by the principles of scarcity and computational work, rather than central authority.
Bitcoin has paved the way for numerous other digital currencies and blockchain applications. However, its unique combination of security, scarcity, and history has cemented its place as the leader of this financial revolution. Bitcoin stands as a testament to the innovation of decentralized technology, allowing the essential elements of value exchange to persist liberated from their previous material conditions in a new realm of computational abstraction.
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