Bitcoin Basics: How Does Bitcoin Work and Where is it Headed?

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Abdulaziz AlYaqout

January 31, 2019

Bitcoin is arguably the most widely used digital currency to date. It was developed in 2009 to allow peer-to-peer monetary transactions to occur without regulation from a third party like a bank or the government.

People exchange Bitcoin for goods and services much like traditional “fiat” currencies, but that’s where the similarities end. Unlike fiat currencies, which are tied to national economies, Bitcoin is not linked to any specific institution, entity, or geographic location. Using a networked model based on blockchain technology and digital cryptography, Bitcoin built a system of trust and verification that makes it a viable medium of exchange worldwide.

A Brief History of Bitcoin

In 2008 a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” was authored and published by a mysterious person named Satoshi Nakamoto. The paper outlined many of the issues with fiat currency and offered a new digital currency based on blockchain technology called “bitcoin” as a solution.

A lone computer in the dark with the screen on

In early 2009 the first Bitcoin blockchain network was created by Satoshi Nakamoto. He mined about 1 million Bitcoins before he handed over the operation to a developer named Gavin Andresen and disappeared never to be heard from again. For the first few years, Bitcoin’s price increased gradually and began to be accepted by more and more online retailers.

As the technology grew in popularity other cryptocurrencies deemed “Altcoins” began to emerge onto the market. As the trade on the Bitcoin network increased, so did the security of the network. After a few hacks, forks, and other hiccups, Bitcoin saw an unprecedented jump to around a $20000 peak in 2017. It swiftly fell afterward and has yet to recover a stable price. For an in-depth history of Bitcoin, check out this full breakdown.

How Does Bitcoin Use Blockchain Technology?

The reason traditional fiat money works is because it’s difficult to copy and banks keep a strong record of digital exchanges between parties. The system was built to ensure that money cannot be counterfeit easily and someone can only spend a unit of money once. In the past, virtual currencies fell prey to the double spend problem which made early iterations unusable. Double spending is essentially paying for something with a virtual currency and then undoing the transaction record so you still have the money in your account, you are then free to spend that money again.

Cryptocurrencies, including Bitcoin, combat the double spend problem by using blockchain technology. The blockchain is essentially a public ledger or record of transactions, that is available to everyone in the network at all times. A “block” is a group of transaction records that are bundled together. As new transactions are recorded, they get added to a linked chain of blocks known as the “blockchain.”

Ropes connected to form a network

Whenever a Bitcoin transaction is made, it’s instantly recorded and timestamped both locally and on every other device in the network.

Multiple systems simultaneously confirm each block transaction, making the ledger practically invulnerable to hacking and errors. Because every block is instantly visible to everyone, each transaction is permanent, and that Bitcoin can’t be spent again by the same person.

Why Does Decentralization Matter To Bitcoin?

Because the regulation of Bitcoin is outsourced to everyone in the network instead of one central authority, Bitcoin can function without governmental or institutional oversight. Trust is placed in the accuracy and security of the blockchain instead of the ability of a banking institution to keep a precise record of how much everyone has in their accounts.

Just as the internet allows information to flow freely without the mediation of newspapers or printing presses, the blockchain network allows money to be exchanged without any middle-men like banks or credit card companies.

Bitcoin behaves like a digital item making it is possible to trade fractions of a Bitcoin in a way that isn’t possible for something like the dollar. Bitcoin also enables people to conduct transactions instantly, with little administrative cost, from all over the world.

It can also be more anonymous than other forms of digital currency. When you own Bitcoin, you essentially act as your own bank or ATM, and no one else can see how much you have (unless you get hacked!). Only your transactions are made public to network members when they become part of the blockchain.

Why is Bitcoin Becoming So Popular?

Bitcoin offers transparency, independence from local economic conditions, secure transactions safe from government interference, and a level of anonymity not found with other currencies. Because Bitcoin offers a lower-cost way to conduct transactions, some experts believe that it and/or other cryptocurrencies may replace cash, central banks, and even regional monetary authorities in the not-so-distant future.

Audience of people interested in bitcoin

Global political and economic instability contribute heavily to the success of decentralized currencies like Bitcoin. Because it’s value is not attached to the success of anyone local economy, Bitcoin is protected from things like war and government seizure of assets. Countries with rampant inflation and instability, such as Venezuela, have already turned to using cryptocurrency. As Bitcoin grows in trust and reach, it’s becoming conceivable that small countries might start adopting it as a national currency.

Globally, Bitcoin transactions are well into the billions of dollars, and the value of a single Bitcoin has increased dramatically over the past five years. In addition to its use value, Bitcoin trades as a finite resource. Like other resources which must be “mined,” Bitcoin’s value is a function of its popularity and rarity.

It becomes mathematically more difficult to mine Bitcoin over time. As the number of available coins decreases and the number of people using it grows, the value of each Bitcoin increases in response. As more people become bought into the system, the more trust, respect, and value it will gain.

Is Bitcoin a Bubble Waiting To Burst?

Because of its sheer newness, it’s hard to know exactly how Bitcoin will continue to impact market systems and mature over time. As new cryptocurrencies are developed to compete with Bitcoin, it’s future is both secured and brought into question. More cryptocurrencies mean that more people believe in the blockchain which strengthens Bitcoin’s position in the economy. At the same time, the risk that a new cryptocurrency will be developed to completely replace Bitcoin grows with each passing year.

At its core, Bitcoin was an experiment in blockchain technology designed to test whether a cryptocurrency could be traded like a fiat currency. It’s important to note that Bitcoin’s current value and popularity is at least partially due to the media and investor attention it has recently received.

Compared to other cryptocurrencies, Bitcoin does have a few downsides. Each transaction adds to the amount of data in the chain; as the chain becomes longer, transaction times become slower. Bitcoin can currently only support a few transactions per second, which is thousands of times slower than credit card companies can process transactions. During times of peak trading, it might take hours of waiting to trade Bitcoins.

All currencies depend at least partially on faith; if everyone decided the dollar was worthless tomorrow, it would have no value. As long as there are practical reasons to use Bitcoin, it will retain at least some of its value. Other, more efficient cryptocurrencies may ultimately replace it. However, the technology works, and the Bitcoin blockchain is here to stay.

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