Bitcoin Demystified: A Primer to the Largest Cryptocurrency Today
Albert Nuel Navarrete
Social + Content | Strategy + Creation | Blockchain + Finance + Tech
In 2021, the world saw the crypto market heat up, as Bitcoin and cryptocurrency exploded into mainstream consciousness. From influential figurehead Elon Musk tweeting the meme coin Dogecoin into relevance to the deluge of crypto commercials that took over during halftime of Super Bowl LVI, crypto had become the “next big thing,” and everyone wanted a piece of the pie.
The market frothed to a feverish peak in November 2021, when crypto market capitalization breached $3 trillion - of which Bitcoin represented $1.28 trillion. People were “buying in” without even knowing what they were getting into. It was a narrative-driven trend that induced widespread FOMO or Fear of Missing Out.?
Looking back at it now, one of the biggest lessons that I believe we could take away from the crypto tsunami of 2021 was to DYOR or Do Your Own Research. Cryptocurrency and blockchain technology are incredible innovations that could transform the way we instil and transfer value. However, before one decides to invest in Bitcoin and other cryptocurrencies, it is important to at least gain a fundamental understanding of Bitcoin and how it comes about.?
What is Bitcoin?
Bitcoin, as envisioned by its inventor the mysterious and elusive Satoshi Nakamoto, is a kind of electronic currency that can be exchanged between peers in a form of transaction, without the mediation of a third-party regulator or financial institution.
Nakamoto, the now legendary pseudonym of the person or group of people behind Bitcoin, published the white paper “Bitcoin: A Peer-to-Peer Electronic Cash System” on the website Bitcoin.org, which formed the technical and philosophical bedrock of Bitcoin as we know it today.
However, while it is considered a first mover in the space and the grandfather of cryptocurrency, Bitcoin is not the first attempt at creating a digital version of money. One particularly important precursor of Bitcoin is B-Money.
B-Money was a concept for an anonymous electronic cash system posited by computer scientist Wei Dai back in 1998. The concept envisioned an untraceable network that enables participants to send and receive digital money into their accounts while maintaining complete anonymity behind digital pseudonyms or “public keys.”
Every transaction that would have occurred between parties or public keys would be broadcast throughout the network. The broadcasted information would be recorded into databases such that there are records detailing how much money currently belongs to each public key.
However, while incredibly innovative and ahead of its time, b-money was faced with one critical obstacle that beset similar earlier iterations of digital money – preventing double spending.
With physical money, when you spend money to purchase an item at a store, the cashier takes your cash at the POS and keeps it in the cash register. This simple interaction renders your money “spent” and prevents you – the “sender” of the money – from using the exact same bills in a different transaction with another “recipient,” whether a store or another individual.
On the other hand, due to their intangible nature, earlier digital currencies such as b-money could be duplicated in the same way files in a computer could be copied multiple times. This means that the same “digital token” could be spent on many different transactions.
What makes Bitcoin a revolutionary innovation is its elegant solution to this dilemma.
Building on the concept of b-money, Bitcoin uses a peer-to-peer (P2P) network to enable transactions between anonymised parties without the need for third-party intervention.
However, on top of this P2P layer of value transfer, the Bitcoin blockchain also implements an automated independent confirmation mechanism, in parallel with its universal network of digital ledgers, to prevent double spending.?
How does this work?
Let’s say, for example, that Person A has 1 BTC, and he owes Person B and Person C exactly 1 BTC each. To pay off Person B and Person C, Person A could attempt to double spend his 1 BTC by sending it to the unique Bitcoin wallet addresses of both his creditors.
If attempted, this request would be sent to the “mempool,” which is essentially a list of transactions pending confirmation. When the confirmation mechanism comes across the first of the two transactions, it would see that Person A has enough in his wallet to execute a 1 BTC payment to Person B. Thus, the mechanism would approve this transaction and verify this into the next “block” for perpetual record keeping.
When the confirmation mechanism comes across the second transaction, it would see that Person A no longer has enough balance in his account to make a 1 BTC payment to Person C. Therefore, this request would be recognised as invalid and would not be verified.
In the event that both transactions are pulled from the mempool at the same time, the transaction which has the higher number of confirmations will be considered verified and the other will be discarded.
With all this happening in real-time, one might wonder where the computing power is coming from. That’s where Bitcoin mining comes in.
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A [Highly] Simplified Look into Bitcoin Mining
Bitcoin mining is a process by which new bitcoins are “minted” and made available for circulation into the crypto market. Just like additional supply of the U.S. Dollar is injected into circulation by the U.S. Treasury Department, Bitcoin miners can collectively introduce additional supply of bitcoins through crypto mining.
However, unlike the U.S. dollar, there is no central governing body that dictates when and how much fresh currency should be introduced to the market.
Instead, a complex algorithm regulates the minting process, ensuring the market is not oversupplied with new bitcoins. This algorithmically determined mechanism protects Bitcoin mining from control or manipulation by a third party.
In addition to minting new coins, Bitcoin miners also ensure the accuracy and truthfulness of transactions by performing the role of “validators.” Bitcoin miners essentially power the confirmation mechanism that verifies the legitimacy of transactions and maintains a historical record of all past transactions. This maintains honesty amongst Bitcoin users and prevents the issue of double spending, as mentioned earlier.
How do Bitcoin miners do this?
Basically, every Bitcoin miner constantly works to verify 1 megabyte (MB) worth of transactions stored in a “block.” Each new block includes records of some or all recent transactions that happened on the Bitcoin blockchain. Additionally, each new block contains a reference to the block that preceded it. This is represented by what’s called a hash.
The Bitcoin miner competes in a “race” with other Bitcoin miners around the world to validate this block by solving a highly complex mathematical puzzle associated with it. When a miner manages to solve the puzzle, the new block is “completed.” The transactions are then placed in this block and considered confirmed and verified.
Subsequently, when a Bitcoin miner arrives at the correct answer or hash, it is shared with the other mining nodes, who then validate it. This verification mechanism is what’s called Proof of Work (POW).
By continuously verifying past records against the most recent transactions, and utilising the collective computing power of all Bitcoin miners around the world in a peer-to-peer network, the Bitcoin mining network effectively:
When a miner is successful at being the first to solve the mathematical equation associated with the latest block and effectively validates the transactions inside, it becomes eligible to earn a Bitcoin reward. The element of time is important in this case, as not all miners will receive a reward for trying to solve the latest puzzle – that only goes to the Bitcoin miner who arrived at the answer first, and therefore “completed the current block.” Every time a miner successfully completes the current block, they are rewarded with newly minted Bitcoins, which then enter circulation.
At Bitcoin’s inception in 2009, miners were rewarded 50 BTC for each completed block. However, as a built-in mechanism to prevent inflation, block rewards are “halved” after the creation of every 210,000 blocks.
The first halving event was in November 2012, and the second took place in July 2016. In May 2020, block rewards went through the third halving event, reducing to 6.25 BTC per completed block. However, even as BTC rewards for miners have reduced due to halving events, the value of Bitcoin has only gradually increased over time.
As such, there remains a strong incentive for miners to continue competing for Bitcoin rewards, even as the amount of BTC rewards reduces and competition becomes more difficult due to more miners coming online.
Conclusion
Hopefully, this simple blog has helped give some clarity to what Bitcoin is and what role Bitcoin mining serves within the Bitcoin blockchain. A fully autonomous system of finance and value transfer that is powered by pure algorithm and computation is an innovation that is truly revolutionary. With time, it will be interesting to see whether Bitcoin can transform into a global system that fulfils Satoshi Nakamoto’s vision of truly borderless and permissionless finance.
If you like this content and would like to read more about cryptocurrency and blockchain, please like this post, follow me on LinkedIn, and share it to your network as well! Additionally, if you have any feedback on my content, please feel free to reach out to me here on LinkedIn. I would appreciate every bit of new knowledge gained as I continue on my personal cryptocurrency journey.?