No introduction to Bitcoin (*) would be complete without reminding the reader of the extraordinary rise of cryptocurrency as a disruptive force in the financial world.
At the beginning of the year the price of one bitcoin was worth $974 USD. Just nine months later, bitcoin is trading at $4154.11. That’s a 400% return in less than 9 months!
This type of return is unheard of in the world of equity investment except maybe for fly-by-night penny stocks. And yet, Bitcoin is no penny stock. In fact, as of today the total market capitalization of Bitcoin is now just under $70 billion dollars.
And if that isn’t enough to get your attention, the richest man in the world, Bill Gates, thinks “Bitcoin is better than currency.”
Virgin Group founder and billionaire entrepreneur Richard Branson is also a huge supporter of bitcoin and believes that blockchain, the technology that powers bitcoin, could bring an “economic revolution” to many nations worldwide. (He’s been taking bitcoins for space travel since 2013!)
People are calling it “digital gold” and professional investors are pouring hundreds of millions of dollars into it.
However, despite the tremendous hype and recent global adoption, most people still do not know what Bitcoin is exactly. And that is completely understandable as it took quite a while for me to fully grasp the concept and understand its benefits.
My goal with this Introduction To Bitcoin is to shed some light on what Bitcoin is, explain how it works and then you can decide for yourself whether or not it’s a big deal.
How Banking Works Today
In order to understand how bitcoin works it will help to first understand how banking currently works in today’s world.
Let’s say that you and I are friends and you were traveling abroad, perhaps Italy, and came across a nice pair of handmade leather shoes and you did not bring enough cash to cover the $200 purchase.
You call me up and ask me to lend you some money. But I can’t physically give you the money because, well, I’m here in New York and you’re over there in Italy. And I can’t simply hand the money over to some random stranger boarding a flight to Italy and assume she will act in our best interest.
So… we have to use a trusted third party.
I go to my bank and submit a request to transfer $200 from my account over to yours. After I submit the transfer the teller at the bank will update the bank’s records; this is called a ledger.
A ledger helps the bank keep track of how much money is in each of their customer’s accounts.
The teller subtracts $200 from my account and then adds $195 to yours. But wait, you were shorted $5!
Well, the bank took it as a fee because the bank has to pay for rent, the teller’s salary, servers and all kinds of other expenses that keeps a bank running.
So involving a trusted third party just cost us $5. But not only is it financially costly, it’s also risky. Yes, most of us don’t really think about it during our day to day lives, because we are simply taught that there is no other option and using traditional banks is as safe as it gets.
But that couldn’t be further from the truth!
This is because the banking system is centralized. All ledger balance and account information is maintained and supported by one company, the bank. No other entity or person has access to that information so no one else can confirm or deny what is in that ledger.
This is called having a single point of failure.
Now that is all fine when that one company is running honestly and accurately, but if it is corrupted then we all go down with it.
Surely Banks Never Mess Up, Right?
Right… but what happens if the bank’s servers get hacked and the entire ledger is compromised by an attack? Then the attacker can simply rewrite my transaction to credit his own account rather than yours.
Then I would be out $200 and you still wouldn’t be able to pay for your new shoes.
Let’s also not completely dismiss the possibility that the bank could simply run out of money and become insolvent, the way they did during the banking crisis in 2008.
These are all huge risks that we take when we rely on a centralized banking system.
Introduction To Bitcoin, Stage Left!
Bitcoin is a virtual currency that is created and held electronically. That means it can be sent from user to user anywhere in the world in minutes without going through a trusted third party and without paying banking fees.
It is run on a decentralized peer-to-peer network of computers around the world. It is neither created nor controlled by any one entity, making it incorruptible.
Bitcoin is divisible up to eight decimal places, meaning you can send someone .00000001 Bitcoin.
It is also fungible; that is, one bitcoin is identical in value to the next bitcoin, wherever its holder might be in the world.
One of the most unique elements of Bitcoin is that there is a limited supply of it. Just like gold… which is why people are calling it digital gold. Only 21 million bitcoins can ever be digitally created, and just under 17 million have already been ‘mined’.
Bitcoin is anonymous such that, a user can hold many bitcoin addresses and none of them are tied to their identity. No names, addresses, emails, or any other personally identifying information.
However… despite being anonymous to a degree, it is also completely transparent! Every single transaction ever made is recorded on the blockchain and open for everyone to see. We just don’t know who sent what.
The Blockchain Makes Bitcoin Possible
Let’s refer back to our previous analogy—you need money for new shoes and I am willing to send you some money. Now we can follow what happens with a bitcoin transaction.
We will assume I already have money in my bitcoin wallet online (more on how to get bitcoin later, and you might also see this Introduction To Bitcoin Acquisition).
I log into my wallet online and I input the amount of bitcoin I want to send to you, along with your personal bitcoin wallet address.
Next, this transaction gets sent to what’s called a node. A Bitcoin node is simply a piece of software that sits on a computer that is connected to a network of other nodes through the internet.
Imagine a node being the digital equivalent of the teller at my bank. It takes my transaction and adds it to its own digital ledger, instead of a bank’s central one. It then broadcasts it to the entire network so every other node also has a record of the transaction and they in turn add the transaction to their own digital ledgers.
Every 10 minutes a special type of node, known as a miner, will take the most recent ten minutes’ worth of transactions and package them into what is called a block, and send it out for everyone to verify.
If all the nodes in the network agree that the transactions in the proposed block is accurate, then a consensus is established. Only then will the block will be added to the end of the previous block—which was created ten minutes ago—thus forming a blockchain.
After a block is added to the blockchain, it can never ever be changed or removed. It is immutable and all the nodes will have a copy of the full blockchain. If one of these nodes is compromised, or is intentionally dishonest and tries to change the transaction history, all the other nodes will reject their change.
This distributes the risk and there is no longer a single point of failure.
Basically, if my teller’s ledger is somehow compromised, a bunch of other tellers in the network who still have a copy of my transaction in their ledger will reject the compromised version.
This makes the blockchain a super-secure distributed ledger.
In order for someone to compromise the network they would have to take control of at least 51% of the nodes around the world. At this point, the probability of this happening is near zero as there are millions of nodes around the world pooling their resources together acting in the best interest of the network.
So you see, the blockchain makes banking safer, more secure, and cheaper, by decentralizing record keeping and removing the middleman. I no longer need to trust a single third party entity, or bother tourists at JFK airport with the $200 I want to send you!
Blockchain technology can revolutionize the world – and it’s just beginning.
And as amazing as that is, this is only ONE application of blockchain as a technology. Here, the blockchain simply records and upkeeps the transactional history of Bitcoin as a currency. Namely, how many bitcoins everyone owns.
But the reality is, blockchain technology has an unlimited number of applications. As I hope my Introduction To Bitcoin has demonstrated, the blockchain can be programmed to record pretty much anything of value and importance to humankind. From real estate deeds, to citizenships, to identities.
In fact, I have actually found it a bit more challenging trying to come up with areas in society that absolutely cannot benefit from a cheaper, trustless, and more secure way of record keeping.
So is it too late to get involved in Bitcoin, or the blockchain in general?
“I predict the Internet will soon go spectacularly supernova and in 1996 catastrophically collapse.” – Robert Metcalfe, inventor of Ethernet, in 1996.
History is littered with famously-wrong predictions (like Decca, passing on The Beatles). But technologists are worse than most. The blockchain is just getting started and now’s the time to jump in. Consider this quote: at least Mr. Metcalfe had the good grace to literally eat his words later… he pulped the paper in a blender and drank it as a smoothie!
* ‘Bitcoin’ with a capital ‘B’ refers to the blockchain protocol, while ‘bitcoin’ with a lower-case ‘b’ refers to the actual unit of currency.