WHAT IS A BITCOIN?
At its core, money represents value. Earlier, people used gold to represent value. Over time, paper money was invented. But in October 2008, a document was published online by a guy calling himself Satoshi Nakamoto. The document suggested a way of creating a decentralized currency called Bitcoin.
Bitcoin is a digital transparent ledger without a central authority. And it mimics the limited resources like gold, for instance. Also, bitcoin is a cryptocurrency, meaning that it is encrypted in a way that prevents it from being copied. Sometimes, people describe Bitcoin as the world’s first cryptocurrency. The current price of one Bitcoin is $19,390.
Blockchain acts like a ledger that is encoded onto the Bitcoin itself. It prevents people from spending the same bitcoin more than once since everyone else on the currency’s peer to peer network knows that it was just spent. Bitcoin is essentially a number associated with an internet address. You can store it on your phone or a hard drive until you use it again.
HOW DOES BITCOIN WORK?
Bitcoin does not work like most money. It is not attached to a state or government, so it does not have a central issuing authority or regulatory body. For instance, when Barry sells Chris a lawnmower for 5.2 Bitcoins, Barry’s balance goes up by 5.2, and Chris’s down by 5.2. Barry is only willing to trade his real-life lawnmower for a higher number in his digital file because he has faith that other people will also trust the system. That means that there is no organization deciding when to make more bitcoins, figuring out how many to produce, keeping track of where they are, or investigating fraud.
The blockchain is more than 107 gigabytes of data. When you send someone bitcoins, it is not like you are sending them a bunch of files. Instead, you are writing the exchange down on that ledger. It is decentralized.
For every transaction, you need to announce a couple of things to the bitcoin network. They are:
- Your account numbers
- The account number of the receiver
- Number of bitcoins you want to send
WHO MAINTAINS THE LEDGER AND MAKES SURE NO ONE CHEATS?
For instance, imagine you are playing a game of poker with some friends, but none of you have poker chips, and you left your cash at home. There is no money on the table, so a few of you get out some notebooks and start writing down who bets how much, who wins, and who loses. You do not completely trust anyone else, so everyone keeps their ledgers separately.
And at the end of every hand, you all compare what you have written down. Hence, blockchain works similarly. One surprising consequence of this is that everyone can see everyone else’s balances, even though the original system only uses account numbers and not names, so there is some level of anonymity.
HOW ARE ALL LEDGERS KEPT IN SYNC AS MONEY IS TRANSFERRED?
When you want to send money, you tell everyone else by broadcasting a message to everyone with your account number, the receiver’s account number, and the amount. You can also use the system to send or receive money, though, without maintaining a ledger.
Like a pen and paper check, Bitcoin requires a kind of signature to prove that the sender is the real owner of the account. But it is based on math. When you create a new account number, it comes along with a private key mathematically linked to that account number. It helps to create a signature. Unlike the handwritten versions, these signatures cannot be copied and reused in the future, as they are unique to each transaction.
ORDERING TRANSACTION
While the mathematical signatures prove who sent a transaction, they cannot show when it was sent. And this can be problematic. In the traditional banking system, if Amy wrote two checks but only had enough money to cover one of them, the bank would pay the first person attempting to cash her check but refuse the second because Amy’s account would be empty.
In Bitcoin, network delays might cause transactions to arrive in different orders at different places, and frauds could lie about timestamps. Two recipients might both think their transaction is first and ship a product, effectively allowing Amy to spend money twice.
The linking problem is based on a unique function called a cryptographic hash. It mixes up the inputs and spits out a number. But it is unique because it is irreversible. There is no easy way to start with an output and then find an input that generates it other than making lots of guesses. And this is what people are doing in Bitcoin, i.e., feeding this function random numbers until the output meets particular criteria.
