What is Bitcoin? – The Defiant

Bitcoin is the world’s first peer-to-peer (P2P) digital payment network, producing a limited supply of BTC cryptocurrency. The biggest innovation is the ability to transfer assets – digital tokens – from one party to another without the need for intermediaries such as banks or payment services.

Cornerstone

As a result, Bitcoin has changed the understanding of money. Ever since Bitcoin was released in 2009, more than 10,000 cryptocurrencies have hit the market, including Ethereum, the #2 network and cornerstone of decentralized finance.

To fully understand the implications of Bitcoin as decentralized money, we need to understand how it works.

Bitcoin’s origin and purpose

Computer scientist and cryptographer Nicholas Szabo first laid the foundation for Bitcoin in 1998. He proposed a theoretical construct called Bit Gold. As the name suggests, it would be a digital form of gold, secured by a decentralized network. Bit Gold contained key elements we see in Bitcoin and other cryptocurrencies:

• It all starts with users installing a source code on a computer – network node.
• The user’s node must use its computing power to solve a cryptographic equation.
• Solved crypto problems are sent over the Byzantine Fault Tolerant (BFT) computer network.
• Each solved solution is assigned a public key that identifies the node.
• Transfer details are stored in a public ledger (database).

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With each solution chronologically stamped, the ledger is generated as a chain, each addition being validated as a block depending on the validity of the previous block. So, to fudge the public ledger, one must compromise not just the individual transaction, but the entire record.

Because each network node contains the entire record, it becomes virtually impossible to destroy all nodes. This is where Byzantine fault tolerance (BFT) comes in as the critical cog. BFT is a reference to the Byzantine generals’ problem, where ancient generals had to devise a system where messengers had to relay orders without distortion.

In blockchain cryptography, BFT is an algorithm that allows some nodes to be corrupted, but still allows the network to remain intact. This is why Szabo named this theoretical construct Bit Gold. After all, sound digital money must be as non-fungible as gold itself, and BFT provides that redundancy.

Fast forward to 2009, the pseudonymous Satoshi Nakamoto used these principles to launch the Bitcoin network. He titled it “Bitcoin: A Peer-to-Peer Electronic Cash System.”

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The timing was ripe, when the world was hit by the global financial crisis. Consequently, the Federal Reserve (the central bank) had to bail out commercial banks using taxpayers’ money.

For this reason, Nakamoto embedded the following message in Bitcoin’s first block – the Genesis block.

“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks” was a headline copied from the British newspaper The Times, which announced several bank bailouts. By doing this, Satoshi made it clear what Bitcoin is all about – countering the central banking system.

How does Bitcoin work?

Satoshi Nakamoto made it clear that the only way digital money can work is if it is “an electronic payment system based on cryptographic proof rather than trust.”

Interestingly, the seeds of this thinking were sown over a hundred years ago. In Keynes’ Cambridge lectures of 1912–13, called “Principles of Money I”, it was theorized that the measurement of the value of money would be replaced by units of energy.

To answer the question – how does Bitcoin work? — is to answer the question — how does Bitcoin mining work?

Again, “mining” is a reference to the mining of gold, because gold has been used as an immutable value for thousands of years. As a rare precious metal, gold is both precious and must be paid for in order to extract it. Consequently, Bitcoin must mimic this mechanism with limited supply and mining costs.

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This is how Bitcoin mining achieves this:

• The first prerequisite was to define Bitcoin’s source code: limited to 21M BTC. In addition, a deflation mechanism for BTC rewards was set: every four years the BTC mining reward is halved, going to zero by 2140 when all 21M BTC are in circulating supply.
• When this source code was distributed in 2009, the reward per block was 50 BTC. In 2022 it is 6.25 BTC, and in 2024 it will be 3.125 BTC.
• Miners install this source code on computer nodes, and exert computational power to process Bitcoin transactions and add them as new blocks of data to the chain. This is the miners proof of work to receive rewards.

In other words, Bitcoin mining makes it a self-perpetuating and self-reinforcing trustless network.

That’s the only way it can exist without having to have any CEOs, governance or customer support.

If one can remember all the seed phrases when opening a new wallet address, it is possible for the first time in history to have indefensible wealth in one’s head.

What does Bitcoin mining and transactions look like?

Miners’ computational power to solve cryptographic puzzles is measured as hash rate. For example, a typical ASIC mining machine for Bitcoin, the Antminer S19 Pro, has a capacity of 110 TH/s (tera-hashes per second) at an energy consumption of 3.25 kW.

Hash is a mathematical function that generates unique identifiers, formed as a fixed-length alphanumeric code. Hash functions transform all data into unrepeatable character strings. With Bitcoin, miners need their rigs to mine a powerful SHA-256 hash function.

This hash rate power is pitted against the network’s hash rate difficulty. The higher it is, the more difficult it will be to compromise the network. For miners, hash rate difficulty indicates how difficult and time-consuming it is to find the correct hash (mine it) for each transaction block.

To maintain the fairness of Bitcoin mining, it is impossible to predict which miner will solve the hash first. That means they are randomly picked to receive BTC rewards. For this reason, Bitcoin miners form mining pools, accumulating thousands of transactions per block. The value of each transaction is completely irrelevant. Instead, all that matters is the byte size.

Typically, each block contains 1.6MB of transactions, generated every 10 minutes. Visualized, they look like this.

Named after Satoshi, “rate” represents one billionth of one BTC, just as the cent is one hundredth of a dollar. This is what BTC senders pay as a fee, and goes into the miners’ pockets. Each miniblock represents individual transactions with its own transaction ID (TxID), a 64-character string that looks like this:

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Although BTC transactions are unconfirmed during the 10-minute block generation, one can check the TxID, copy it and send it to the recipient. This way, the BTC recipient knows that the payment was actually sent.

They would simply use a blockchain explorer like blockchain.info or bitfeed.live to paste the TxID and see that it is in a Bitcoin block, irreversible and immutable. Additionally, because all Bitcoin transactions are chained, they can see the entire input-output history.

Even though Bitcoin is an immutable public ledger, that doesn’t mean its source code can’t be tweaked. If all miners agree on the Bitcoin Core upgrade, the entire network runs on new code.

Bitcoin upgrades

The first significant upgrade occurred in 2017 – Segregated Witness (SegWit). The goal was to improve the network’s throughput by reducing the weight of transactions per block. This actually increased the number of transactions that could be collected per block.

Technically, the SegWit upgrade did this by removing the “witness data” that contains transaction signatures.

Finally, another important upgrade is the Lightning Network. Although it does not tamper with Bitcoin Core software, it acts as a Layer 2 network on top of the Bitcoin network. This scalability solution is similar to Ethereum’s Polygon, Optimism, or Arbitrum.

Lightning Networks works by funding a payment channel, through which BTC is sent. Because LN payment channels can perform multiple transactions, without waiting for them to be mined first, this dramatically expands Bitcoin’s usefulness as a daily, almost instantly completed payment system.

Mainnet

When the payment channel is closed, all the transactions are collected and added to the Bitcoin mainnet. As a reason, the Bitcoin network can serve not only as a decentralized storage of wealth, but as a true electronic cash system. Just as Satoshi Nakamoto originally envisioned.

Series disclaimer:

This article series is intended for general guidance and informational purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article should not be construed as legal, business, investment or tax advice. You should consult your advisors for all legal, business, investment and tax implications and advice. The Defiant is not responsible for lost funds. Use your best judgment and perform due diligence before interacting with smart contracts.