Introduction to Bitcoin and the Blockchain

Introduction to Bitcoin and the Blockchain

Read an updated and more detailed version of this article here.

You believe that you don’t have any use for the term “cryptocurrency”? Well, you probably have. Bitcoin is currently the largest cryptocurrency when it comes to market capitalization and popularity. Now you might say: Yeah, Bitcoin is the thing you use for buying drugs and weapons on the internet. But Bitcoin is much more than an anonymous way to pay digitally. You can see Bitcoin more as a technology which might substantially impact our future – in a pretty positive way.


Let me explain you some Bitcoin basics and what the heck a blockchain is.

Bitcoin

Halloween 2008: Trick or Treat! Banks obviously made the wrong choice. On 31st October 2008 a guy named Satoshi Nakamoto published an academic paper to an expert forum for cryptography introducing a revolutionary new concept of digital money. Who is Satoshi Nakamoto? It came to light that Satoshi Nakamoto is actually an alias which disappeared in 2011. Nobody actually knows who created Bitcoin.
Well he, she, it, or they published a paper called “Bitcoin: A Peer-to-Peer Electronic Cash System”.
In the paper, Satoshi Nakamoto describes a revolutionary new electronic payment system called Bitcoin.

Bitcoin is combining many years of cryptographic research and several prior existing technologies making it a revolutionary new electronic cash system. Bitcoin and the underlying blockchain technology is solving problems like double spending – where digital money is spent twice – the reliance on trusted third parties, and high transaction costs.

What made Bitcoin very special is the newly introduced concept of the blockchain: a public transaction ledger. The digital currency Bitcoin is not saved on a server anywhere but it is recorded in the so-called Blockchain. Everyone who is holding bitcoins is also holding the whole transaction history on their hard drive. Bitcoin thus runs on your computer as well as it does on mine and any other computer provided by the community. There is no central database which might be hacked. And as all transactions are stored on millions of ledgers (a ledger is basically any device connected to a network) this makes the blockchain technology very trustable.

Bitcoin is not backed by any state or institution. It is completely decentralized. There is also no real physical value behind bitcoins. It is not backed by gold, silver, or any other precious metals. So how can a currency exist if there is nobody controlling neither backing it?

Nakamoto describes Bitcoin as an “electronic payment system based on cryptographic proof instead of trust”. So what does cryptographic proof mean? Let’s have a deeper look onto the blockchain.

Bitcoin’s Blockchain

You can imagine the blockchain like a public Excel spreadsheet which is available to everyone in the world. Every single transaction which takes place anywhere in the world is added to this spreadsheet. Every one thousand transactions a miner will collect all those payments and put them in a block by solving mathematical problems. This process is called proof-of-work and miners are some kinds of infrastructure managers of the whole blockchain. Solving the proof-of-work involves a lot of trial and error as it is a process of very low probability. Imagine int like a Sudoku puzzle where it is very hard to find the solution but pretty easy to check if the Sudoku puzzle is solved correctly. It takes miners around 10 minutes to solve this mathematical puzzle. Every 10 minutes a miner will put approximately 1000 payments into one block and add it the chain. This chain holds all other blocks which have been collected and verified before, thus it is called the blockchain.
Miners are rewarded partly with newly issued bitcoins and partly with payments processing fees. By the year 2140 no new bitcoins will be issued anymore and thus Bitcoin is a deflationary currency.
Every Bitcoin user is holding the exact copy of the blockchain locally on his own hard drive. This implies that with every block that is added to the blockchain it is very hard or nearly impossible to change or alter it as it is stored on millions of computers worldwide. All Bitcoin transactions are recorded in a public ledger. Every Bitcoin user can check and verify every single transaction himself.
While all transactions are publicly available only aliases are visible in the blockchain. Imagine having access to everyone’s online banking while not seeing the name of whom the bank account actually belongs.

How a the blockchain works
Bitcoin Transaction (Economist.com)

Bitcoin has been released more than seven years ago and since that date, many other cryptocurrencies evolved relying at least partially on the Bitcoin source code. The blockchain is a revolutionary new technology which opened the doors for many new innovative solutions which are not only limited to the financial industry.

Any questions or comments? Leave a comment! What do you think, will our future live be based on the blockchain technology? Leave a comment and I will join the discussion!

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