Everything You Need to Know About Bitcoin & Other Cyrptocurrencies
In this last couple of weeks, Bitcoins have taken the world by a storm. Just the fact that bitcoins could’ve made one a billionaire in a matter of years, every person young or old, now wants to jump on the bandwagon and get their money to make money too.
Just to give you some perspective on how much bitcoin has grown, an investment of a meagre $25 in Bitcoins in 2010 could make you afford the shiny new Bugatti Chiron worth $3 million today! As of today, the market cap of Bitcoins is bigger than those of companies like Wal-Mart, Visa, Intel, Coca-Cola, Toyota and even Walt Disney!
But as simple as this money-making mechanism sounds, there’s a lot more to Bitcoins than it might seem. It has been the very complex nature of how bitcoins are made and the nascence of the thought of bitcoins being a future currency, that have largely kept people away from investing in them.
So before we get to know Bitcoins better, let’s get to know a bit about crypto-currencies.
What are Crypto-currencies?
To start with, the main difference between crypto currencies and fiat currency, is not backed by any central agency. There is no organization whatsoever that decides when to make more of this currency, figures out how many to produce or even keeps a track of where they are. Everything is decentralized and trading and mining of bitcoins happens in a global peer-to-peer network.
What are Bitcoins?
Bitcoins is a global currency that’s completely digital. But unlike digital files like mp3 or a video file, a bitcoin cannot be duplicated. This is because a bitcoin isn’t a string of data. A bitcoin can be considered as an entry on huge global ledger called the ‘blockchain’. The blockchain records each and every transaction of bitcoin that takes place in the world. So a transfer of bitcoins, is not an actual transfer of data between two parties. Instead, the exchange is basically written down in the big ledger (For e.g. Lily sends Ryan 07 bitcoins).
It’s important to notice that although the blockchain can be considered to be a central group of record, there’s no official set of people who maintain it. The only reason bitcoin works is because there are lots of people who are tracking the same thing, to make sure all transactions are accurate.
To better understand this, let’s think about a poker game where no one has got chips or money to the table. So everyone writes their wins and losses down and keep a track of the others too. If someone tries to cheat that discrepancy is caught since everyone is writing the same piece of information. At the end of the game, each player has a page of this information, which we can refer to as a blok of transaction. Eventually there will be a book full of these pages and hence a chain of these blocks, which is exactly the concept of block chains.
With the help of the above analogy we can think of the peer-to-peer worldwide bitcoin network where there are millions of people on the table. Out of these some are transacting while the others are just recording the transactions that take place. So whenever a transaction takes place, it has to be announced to everyone at the table so the ones keeping record can jot it down. A bitcoin transaction essentially requires the account number of the person sending the bitcoin, the person receiving the bitcoin and the number of bitcoins that are being sent. But if this is publicly available, what’s keeping fraudsters from robbing you of your stash? The answer to that is cryptography which is the reason why bitcoin is known as a cryptocurrency. So with every bitcoin account, better known as a bitcoin wallet to us a user is made available two keys; a private and a public one. The private key can be considered to be a ‘signature’ which is unique to the user and cannot be replicated. So let’s say, if Adam wants to transfer 7 bitcoins to Eve, he will send a message out which will be signed with the help of his private key. Now this message can be verified by people who maintain copies of block chain with the help of Adam’s public key. So this ensures that the Bitcoin that Adam wants to send to Eve is actually going to her.
With bitcoins there might arise one more problem. In traditional banking systems, the bank maintains records for all accounts and processes a transaction only if the payer account has sufficient balance in it. But since Bitcoins are completely decentralized, how does this work? Bitcoin systems and wallets both have an inbuilt mechanism that checks all the previous transactions to make sure that one has enough bitcoins to transfer.
There’s also one more problem that might seem like a problem at first. If you deal with a traditional bank, the order of the transactions decide which transaction to be approved and which one to be declined based on the available balance in the account. For e.g., if Louis has 100$ in his bank account and he decided to buy two things worth $100 each, the bank would only process the first transaction and cancel the second.
But, with bitcoins, since there is no central record keeper for bitcoins things get a bit confusing out here. As we read earlier, there are thousands and thousands of people maintaining blockchains (or as we know it, ledgers) which makes it difficult to replicate the same order for transaction requests. So how do you solve this? Well it turns out that Bitcoin has a solution for this too. Ironically, this problem is solved by actually solving a mathematical problem. To add each transaction to a block chain, a cryptographic hash function has to be solved by the ledger keeper. The first one to solve it gets to add it to their block chain.
But wait, what’s a cryptographic hash function? A hash function is a program or an algorithm that converts an input of any size or length to convert it to an output of a fixed size. For e.g. let’s imagine you had a string of numbers 1 2 5 3 4 and the hash function says to add all these numbers. The answer would be 15. Hence this hash function can similarly get a fixed output for different strings of numbers with varying length. But the problem with a hash function is that it’s very difficult to reverse the output and get back to the input. For example from the above output i.e. 15 there could be numerous inputs like 1 3 4 7 or 2 5 8 or 1 4 6 4 etc. So the only one way for computer systems to solve this is to guess this input sequence until they’re right.
The hash function that Bitcoin uses is SHA256 (Secure Hash Algorithm 256-bit. But the SHA256 that is designed by NSA, is so resource insensitive that even a computer designed for solving a SHA256 takes more than 10 minutes to solve each problem.The person who solves this hash function first gets to add the block of transactions to the blockchain. But since solving these hash functions requires expensive machinery why would someone be interested in solving them and adding their block to the blockchain? The answer is bitcoins!
To add every block to the blockchains the system awards these ledger-keepers, or what we may know as miners, bitcoins. And this process of solving the hash functions is known as mining. Miners also get additional tips in the form of bitcoins to add more transactions to the existing block. All the bitcoins that are in existence today, were created to award miners to maintain the ledgers.
The system halves the number of bitcoins awarded to miners approx. after every 210,000 blocks. It first started with 50 and has now come down to 12.5 bitcoins over the years as transactions have increased. In the future, miners are expected to earn out of the tips they get on adding transactions to the block chain as completing a block won’t yield much.
Also there will only ever be 21 million Bitcoins in the world, giving it the characteristic of rarity like expensive metals (Gold, Platinum etc.). And since the supply is limited, possibly, the demand for Bitcoins will only ever increase pushing the price even further. The last bitcoin i.e. 21 millionth bitcoin is expected to be mined in 2140!
But who founded Bitcoins?
Ummm….no one knows. Yes, you read it write. The world still hasn’t been able to relate a face to the founder of Bitcoins. All we know is that Satoshi Nakamoto founded bitcoins in 2009. Satoshi Namakoto could be a person or the name of a group of people that founded Bitcoins. Out of both, the possibility of the former is higher. But according to many cryptograph specialists, the Bitcoins network is way too sophisticated to be created by an individual.
The writing of the code for Bitcoin began as early as 2007. In October of 2008 Satoshi Nakamoto published a paper describing the bitcoin digital currency titled “Bitcoin: A Peer-to-Peer Electronic Cash System”. Nakamoto then went on to release 0.1 Version of the bitcoin software on Sourceforge. Then a website was created to collaborate and work with other developers until 2010 when Nakamoto handed over the admin control to Gavin Andersen.
As to who Nakamoto Satoshi actually is, is a question that deserves a separate article on its own. But there’s one thing that we know for sure, he/she/they is/are filthy rich now. Satoshi Nakamoto is known to own more than a Bitcoins as of now whose standing value is roughly around 15 billion dollars!
Wait wait wait. We talked about what bitcoins are, how they work and who founder them. But why were they invented in the first place?
The foundation of the thought of inventing bitcoins is a fairly sensible one. Currency has continuously been evolving over passage of time to make it more robust, secure and easy to use. What started as cattle and food grains has eventually turned into the paper and digital currency that we have today. The transition from one kind of currency to another has always been because of the inherent problems the previous currency had. And bitcoins, too, are walking the same path.
Bitcoins were invented to trump the failures of the Fiat money that we have today. What is Fiat Money you ask? Fiat Money is the legal tender that is issued by the central government of a country. But unlike currency money that was backed by gold, fiat money doesn’t have any backing as such. It’s only in circulation and accepted by everyone because of the faith in the government.
With the advent of digital transactions physical exchange of actual currency has reduced substantially. And with the increase in online network transactions there are certain problems that have arose which never existed with physical transactions.
An online transaction today requires a third party to facilitate the transactions. This third party makes sure that both parties can make good to the transaction. We know the third parties as commercial banks, credit card companies, etc. And obviously, with the rise of digital transactions these third parties became powerful, so powerful that they started setting their own terms on how people could transact. Banks could bar people without enough cash balance to use their services to transact. This is one foundation problem bitcoin always intended to solve.
Hyperinflation was another problem that Bitcoin wants to get done with. In fact, you might now know but, the world has faced this phenomenon more than 55 times in the last century itself. For instance, in Zimbabwe, the situation got so worse that 100 Billion dollars in the local currency would only fetch you 3 eggs! This is an inherent problem of the concept of Fiat Money actually. Since government doesn’t necessarily have to back its new currency with rare metals, the supply might become unsustainable. But with Bitcoins this won’t be a problem as there will only ever be 21 million bitcoins in existence. Additionally, the divisibility of bitcoins (up to the 8th decimal) should make sure that the world has enough money to transact with.
TL;DR : Why Bitcoins?
- Boasts benefits of both physical and digital currency; it doesn’t require 3rd party validation, safeguards identity and personal information
- Since a Bitcoin account can be opened only with the help of smartphone, costs decrease a lot as physical branches need not be setup
- It is a global currency, no one owns it. Its robust, no one can shut it down.
- Its also resistant to hyperinflation, since supply is limited.
- Perfectly divisible, without any efforts like required in metals
So where does this leave us with bitcoins?
Well, it’s really difficult to speculate regarding where the Bitcoin is headed. A lot is dependent on whether governments will accept the working of such cryptocurrencies or regulate them out of existence. If governments co-opt blockchain technology for their own purposes, cryptocurrencies have a future brighter than what it seems. Also, with Bitcoin Futures, Bitcoins have also made it to the formal financial market which cannot not be considered to be a serious accomplishment.
But all in all, the entire Bitcoin story is still in its nascent stage, and the world is yet to wrap its brains around the blockchain technology. As we all know, it’s difficult to adopt or use something if you don’t understand how it works. This technical know-how gap is a bridge that Bitcoins will have to cross in order for retailers to mass adopt this booming technology. Only with mass retail participation will the layman start using Bitcoins and actually become serious about it. Bitcoin as an investment or a speculation phenomenon is unlike anything that has been seen in a long time. A little more time, and a little more knowledge is maybe all that’s required for people to actually be unalieanted from Bitcoins.