Bitcoin is a Cryptocurrency, a new and popular approach to money in the digital era. Using complex algorithms, encryption, mathematics, and other sophisticated fields in computer science, Bitcoin allows people to exchange tokens of value, called Bitcoin, with each other over the internet.

Bitcoin is a system that is decentralized, meaning there is no central point of power or command. By using this system, people can utilize money for the first time without any form of authority. Is it scary? Yes, somewhat. Is it necessary? Well, we are not sure yet. What we do know is that Bitcoin gives us the option to use this currency in the event that our traditional currency fails us. Much like how a store will guarantee better customer service in the presence of competition across the street, having Bitcoin as a currency ensures that all other currencies compete to serve the people using said money.

Bitcoin works through several types of computer science driven systems. To summarize this process, the video below can give some valuable insight:

 

 

 

What Makes Bitcoin Different From Other Currencies?

 

Open Source

First and foremost, Bitcoin is Open Source, meaning anyone can obtain a copy of all the code that makes Bitcoin work, study it, and understand exactly what is going on in the system. With enough technical expertise, people can also add their own code to the system to improve it, but this also requires that many others in the Bitcoin ecosystem support that type of code.

In Open Source systems, users can actually download all of the code that makes it work, compile the software into their own system, and run it knowing there are no secrets or tricks hidden in the code. The Open Source Community loves analyzing the work of others to ensure the code presented is fair, trustworthy, and secure.

You can download a copy of the Bitcoin code here. This may be out of your level of expertise, but given that many others can and have compiled this system to verify it is trustworthy speaks a lot about the Bitcoin environment. It isn't important that every single person piece the code together, but rather if one wanted to, he or she COULD do so by learning code. Under this system, there are no "back doors" or features that give one person power over another. The creator of Bitcoin doesn't have a "master password" or anything like it. The code exists in raw form for public inspection. This is similar to how a government organization in the United States operates with a level of transparency. Not everyone analyzes how each tax dollar is spent, but if someone wanted to, they have the option of tracing said tax dollars to ensure the money was being spent in the interest of the citizens (or at least that's the goal).

 

Finite Supply

In the Bitcoin system, there is a limited supply. There can never be any more than 21 million Bitcoin in existence due to a calculated supply being introduced into the system. Every 10 minutes or so, people who put their computers to work have a chance at winning an amount of Bitcoin. At first, the reward rate was 50 Bitcoin every 10 minutes. On average the amount awarded is cut in half every 4 years. The reward went from 50 Bitcoin to 25 Bitcoin and then most recently to 12.5 Bitcoin. After this 4-year period, we will see a reward just over 6 Bitcoin awarded every 10 minutes. This reward amount will cut in half every 4 years or so until the final amount of Bitcoin will be released in the year 2140. At that point, just under 21,000,000 Bitcoin will have been released via this process, and there will never be any more released. Miners are given the incentive to keep contributing to the system through transaction fees (more on that later).

In most financial systems, a government or organization can add more money to their economy, making it an inflationary currency. Over time, as more and more currency is added into a system, the value of each individual unit decreases due to the law of supply and demand (increase the amount of supply, and the currency becomes less rare, and therefore less valuable). There have been situations where a government has hyper-inflated the currency, meaning so much money was added to that financial system that people needed wheelbarrows full of cash to buy something as little as a sandwich. Instead of counting money, it was instead weighed on a scale and the amount was estimated as a means of determining how much to accept for a sandwich. When your wheelbarrow is worth more than the money it carries, you have a problem.

One major complaint of inflationary systems is that you are punished for saving. The same amount of money you hold in savings becomes worth less and less. Here's a chart that shows the decline in buying power over 20 years at a 2% inflation rate:

Initial Money Years Buying Power
1000 1 980
1000 2 960.4
1000 3 941.19
1000 4 922.37
1000 5 903.92
1000 6 885.84
1000 7 868.13
1000 8 850.76
1000 9 833.75
1000 10 817.07
1000 11 800.73
1000 12 784.72
1000 13 769.02
1000 14 753.64
1000 15 738.57
1000 16 723.8
1000 17 709.32
1000 18 695.14
1000 19 681.23
1000 20 667.61

 

With Bitcoin, the currency acts as a deflationary system. Yes, Bitcoin is added to the system every 10 minutes, but since the amount being rewarded diminishes over time we know there will never be more than the 21 million Bitcoin available. Fortunately, we do not have a strict amount of 21 Million units of exchange, as each Bitcoin can be broken down into 8 decimal places. You can break Bitcoin down into amounts of 0.00000001, which is called a Satoshi. In the future, if it is needed, we can add more decimal places if needed through consensus. Imagine if Bitcoin could be broken down to 16 decimal places, or even 32 decimal places! That would give us an astronomical amount of divisions of currency.

When a financial object exists in a deflationary system, the money's value is expected to go up (as long as no other factors influence the perceived value). As noted before, the law of supply and demand is the driving factor (as more people desire Bitcoin and there is a limited supply, the perceived value of Bitcoin rises). People care more about a collectible item if the manufacturer says they will only make 100 of a limited edition as opposed to mass-producing said items to meet demand from everyone.

As of 2017, a population of 7 billion people means there is only 0.003 Bitcoin (or 3 MicroBits) per person in the world. As the internet expands access to all, and Bitcoin becomes accepted as a currency, demand would most likely increase. It is also necessary to mention that not every person in the world will want or need Bitcoin, but calculating the math makes it rather interesting.

 

 

Proof of Work - Play by the Rules or Waste Your Time and Effort!

Proof of Work is a concept on the Bitcoin network that translates to "I had to use energy, time and computing resources to verify my part of the network. Here is my finished work". In doing so, there is an incentive to play by ALL of the rules of the Bitcoin network. A computer that tries to change their computing work in order to disrupt the integrity of the network will be rejected by the network, thus wasting their "work" (that time, energy and computing resources). If a user decides to use a large amount of processing power (they would need to contribute more than half of the entire network's computing being done) to try and disrupt the process, they would get rejected for not following the rules set in place. As a result, the user loses all of the time/money invested to try and disrupt the system. Had they instead contributed to the network in the intended way, they would have made a profit from their contribution of power. This game-ified system gives people an incentive to play by the rules, and if anyone thinks they can disrupt the system, they will arrive at the conclusion that their efforts could have been profitable if they played by the rules.

 

Distributed Ledger, Tamper-Proof

Now that we understand how the Proof of Work component encourages people to play fairly and by the rules set in motion, we now want to look at the Distributed Ledger aspect. In this system, the Blockchain, the list of who has how much Bitcoin in their Wallet, is saved on many, many computers called Nodes. Nodes help enforce the integrity of the Blockchain by having each one hold a copy of the Blockchain on it. In doing so, these nodes can verify all transactions.

You can download a copy of the Blockchain from day 1 of this system being launched. In addition, you can verify all of the transactions that have ever taken place through the mathematics and coding used. However, this may take some background knowledge in the matter. As an introductory tutorial, you will just need to take my word for it until you research the mathematics and coding behind it.

Since many, many computers are holding copies of the Blockchain (and are constantly updating), it becomes extremely difficult to forge a copy of the Blockchain... but what if we were to go into the Blockchain file we have, change some numbers from a transaction a few months go, and try to redistribute it? Well, this is where we will learn a little bit about SHA256. This is a function, or a process in computing, that gives us a code which describes a piece of text. Look at the example below:

Brian gives Josh 4 Bitcoin

Sarah gives Walter 2 Bitcoin

John gives Alex 17 Bitcoin

If you take these three lines and type them in EXACTLY as shown (actually type them, one on each line) into a SHA256 generator, you will get a result of:

1E89F038CF841FB9BECB068C8989B5C332973CCBD1EA1C973B2E1F4F6AE2B24D

This is a code that summarizes that exact list of three transactions.

Now, let's try to alter the original three lines of code so that John only gives Alex 16 Bitcoin:

 

Brian gives Josh 4 Bitcoin

Sarah gives Walter 2 Bitcoin

John gives Alex 16 Bitcoin

If you take these three lines and type them in EXACTLY as shown (actually type them, one on each line) into a SHA256 generator, you will get a result of:

BB6790135A6DA27F8461199389262627481F3CC65A3E42998E81C02F6FC98071

Entirely different code for such a minor change.

 

The interesting thing about SHA256 is that it is near impossible (I'm willing to confidently claim it actually IS impossible with today's computing power) to work this equation backwards to find the original input. When it does become possible, the algorithm will change to protect the integrity of the network.

Now, if you tried to change an entry for the Blockchain, you would get a different SHA256 output. On the Blockchain, the clever act of doing a SHA256 of each previous block is embedded into the current block, guaranteeing each block has a tamper-proof system embedded into it, hence the term "chain". Each block links back to the previous block with the SHA256 of it, but then THAT block also has a SHA256 of the one before that, following all the way back to the first block created (the Genesis Block). This is where the "chain" in Blockchain comes from. Each block is attached to all of the previous blocks through a "chain" of SHA256 calculations.

 

 

Therefore, not only is this distribution near-impossible to destroy due to being on thousands of thousands of computers, but it is also impossible to alter the history of it in any way.

 

To display my confidence in the strength of SHA256, here is the calculation of my first name, last name, phone number, address, social security number, mother's maiden name, and username/password for Amazon, credit card accounts, and email:

BCE171F8A2A135ED26BFEA15A7E863C1693819055C05C9B208436C099027C12A

 

 

Decentralized System

As noted before, Bitcoin is not controlled by a company, person, organization, government, or other entity. Bitcoin has a decentralized nature, meaning there is no single point of power. Each person and their computer operates on the network with the same rules and policies as everyone else. While a user can have a stronger computer or multiple computers on the Bitcoin network, there are a set of rules that apply to everyone to make sure the system is fair.

This type of digital system is very closely related to a democracy, where each member of a country has a say in their system. In traditional financial systems, a central authority made the rules and set permissions. Computers on the Bitcoin system vote for changes to rules with their processing power via mining, running nodes, and many other ways, and as long as no single computer has 51% of the computing power, the system will operate just fine. Even at 51%, it is incredibly difficult to do any major damage to the network that would cause long-term problems. At most, a 51% could inconvenience users for a few hours before becoming extremely expensive. At this point, it is extremely difficult to even obtain 10% of the total computational power on the Bitcoin network (difficult as in a $10 billion budget might come close). Currently, a pool (large collection of users networking their machines together) has about 17% of the total mining power, with other pools trailing close behind. As noted before, one would benefit more from simply participating in the network as opposed to trying to obtain the 51% to attack the network (and that attempt would fail miserably as the system adapts).

Another way of describing this network is a peer-to-peer network. This Wikipedia article gives a thorough explanation of it. In contrast, here is the Wikipedia article on Client/Server networks. A client/server model explains the opposite of the Bitcoin network.

 

 

 

Summary Video:

Please enjoy a narrated presentation I created.

 

 

Up Next: How to Get Bitcoin