A Beginner’s Guide to Understand Bitcoin (BTC) – Salman Ahmad
This four-part series of articles aims to bring a basic understanding of Bitcoin and its underlying technology to a newbie. Part one begins with a general understanding and what the idea stands for? Part 2 will address the common controversies and myths around Bitcoin. Part 3 will give readers brief and concise information about other major cryptocurrencies to expand their knowledge of the industry. Finally, part 4 will explain how Bitcoin as an asset class to invest and various risk factors to consider before making investment decisions.
Part 1: A beginner’s guide to Bitcoin
Part 2: Bitcoin: Debunking the myths surrounding Bitcoin
Part 3: The differences between Bitcoin and other major cryptocurrencies
Part 4: Bitcoin as an investment vehicle. What are the risks involved?
I had only heard about Bitcoin until Sep 2017. Then I read vile comments from people like Jamie Dimon (CEO of J.P. Morgan Chase), Nouriel Roubini (a prominent economist) and other “analysts”, it piqued my interest and I decided to dig deeper independently. After all, learning about Bitcoin from bankers was like discussing malaria with mosquitoes.
I am so proud of myself coming up with this analogy. Let me pat my back before I continue further!
Now, the more I studied Bitcoin, the more the idea fascinated me. Bitcoin’s speculative value aside, the public does not know what it really stands for other than its parabolic rise from a few cents to nearly 20,000 USD in 9 years. Some called it a bubble and a scam but due to the psychology of the masses, these parabolic moves were the perfect way to garner the attention of millions of people across the world. Kudos to the forces and the market makers behind Bitcoin!
The research took me on a journey where I have spent a substantial amount of time reading into what Bitcoin is, the basics of economy, characteristics of sound money, how money evolved from barter, shells, and beads, etc., precious metals coinage, gold-backed currency to paper currency backed by nothing at all and the next thing I know, I was snoozing in my chair.
Oh man! reading is boring.
The world is now looking at a revolution in many areas of the current financial system and more and more people are convinced that a change is necessary. How long do you think bankers’ greed at the perils of the public can go on?
Anyway, I have doubts over my level of expertise so take this article with a grain of salt. These are just my personal beliefs and opinions. So, keep the salt shaker handy and sprinkle it as you read further.
You might be saying now: “Why is he blabbing? Just tell us what Bitcoin is.”
OK, fine. Let’s go!
In its core, Bitcoin is a peer-to-peer transfer of value. Its primary purpose is not to act as a speculative asset class. It is not a fraud, a Ponzi, or a get-rich-quick scheme.
The Bitcoin White Paper states:
“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution”.
Bitcoin was invented by an anonymous person or a group of persons under a pseudonym Satoshi Nakamoto in 2009. It is borderless, and the only type of payment that can be transferred globally within minutes without the need for an expensive third-party verification. A bank transaction involves at least four parties: the merchant, the merchant’s bank, the cardholder, and the cardholder’s bank. The personal and sensitive information is transmitted over the network for processing the payment which is prone to compromise and theft. Bitcoin, in comparison to banks, is cheaper and more efficient to process payments. It is safe, secure and does not require a third-party assurance for the transfers. Bitcoin is global, transfers are irreversible, private, and open (transaction can be viewed by anyone). However, no personal data is exchanged in transfers and there is little possibility of identity theft. There are numerous ways how Bitcoin is a superior payment network than a traditional bank transfer but it needs a whole new article to explain that.
Bitcoin is much more than just a transfer of value. It is a software, a piece of code, and a network. A network which does not need a third party to establish trust among its users. Transfer of value using the network is just one implementation and the potential possibilities of further developments and use cases are endless.
Andreas Antonopoulos -a prominent Bitcoin and blockchain advocate- writes in his book Mastering Bitcoin:
“Behind the scenes, bitcoin is also the name of the protocol, a network, and a distributed computing innovation. The bitcoin currency is really only the first application of this invention.”
Bitcoin is a fully decentralized cryptocurrency which means nobody controls it. The payments are processed by a network of computers called nodes. Currently, there are more than 9,500 nodes across the world at 96 different locations. Even if 500 nodes go down for any reason, the remaining 9,000 are sufficient to keep the network running. It is an unstoppable force. Since Bitcoin’s inception in 2009, its network has never stopped, not even for a single second.
This network has never stopped since its inception in 2009.
New bitcoins are created as a reward for verification of transactions to anyone who participates in the network as a miner. A miner refers to an individual or a company which provides computing power to verify transactions over the network. Bitcoin transactions are added together into a block; and after every 10 minutes, one block is added on top of the other blocks (creating a blockchain), thus finalizing all the containing transactions. This process is referred to as mining. Miners compete and use their computing power to solve a mathematical problem to win the right of mining a block. The winning miner adds the block to the blockchain and earns the reward in bitcoins.
In the early days of Bitcoin, mining was possible with a standard laptop. However, as the network progressed, miners introduced more powerful machines such as gaming laptops and specialized GPUs contributing more computing power to the network. Currently, the difficulty level of mining is so high, only expensive and specialized hardware such as ASICs can successfully compete to mine bitcoins. The computing power of the bitcoin network is more than the world’s top 500 supercomputers, combined. This makes the network nearly impossible to take over by malicious entities.
Just like how the supply of gold and other precious metals is declining, and the mining becoming harder and more expensive with time, the supply of bitcoins and mining rewards are set to decline too. Initially, mining rewards were set at 50 bitcoins per block. The rewards are set to halve (referred to as Halving) after every 210,000 blocks are mined. One block is mined every 10 minutes, so this makes the rewards halving after every 4 years. The next halving event is set to occur after the block 630,000, approximately on May 24, 2020, reducing the rewards to 6.26 bitcoins from the current number of 12.5 bitcoins. At this diminishing rate, all 21 million bitcoins will be mined by the year 2140. There will be only 21 million bitcoins. However, one bitcoin is further divisible to eight decimal places (100 millionths of one bitcoin), also referred to as a Satoshi (named in the honor of its creator).
Bitcoins are completely virtual and have no physical form. They are stored over the network in ledgers. The owners of bitcoins have keys which enable them to unlock bitcoins and transfer to other users. A digital wallet is used to store public and private keys (more on keys later), which also maintains a record of all the past transactions by the user. A wallet can be downloaded to a mobile device or a laptop. Bitcoin (BTC)s always remain in the bitcoin ledger over the network. A wallet address is used to transfer value in the form of bitcoins to another user. A bitcoin wallet is free to obtain, and a user can generate as many addresses as they want.
A wallet address is a combination of 26–35 alphanumeric characters and generally looks like this:
1BvBMSEYstWetqTFn5Au4m4GFg7xJaNVN2
Public keys:
The public key is mathematically related to the wallet address. It is used to verify the ownership of the wallet receiving the coins.
Private keys:
The private key is a secret key to unlock and spend bitcoins. The private keys function as the code of a vault or as an ATM PIN. If someone else knows or steals your private keys, they can transfer or steal your bitcoins. If you lose your private key, there is currently no way to retrieve your bitcoins and they are lost. James Howells accidentally threw away a hard drive containing 7,500 bitcoins. Had he printed the private keys or backed them up in some ways (it is possible to print the keys, make copies and store at different locations), it would have been easy to unlock those bitcoins.
A wallet, it’s public and private keys are related but are nearly impossible to reverse engineer the private keys if someone knows your wallet address and/or public keys.
An example private key:
E9873D79C6D87DC0FB6A5778633389F4453213303DA61F20BD67FC233AA33262
Storing bitcoins in a wallet gives 100% control of funds to its owner. However, it comes with some security issues. If you lose your private keys, bitcoins are permanently lost and there is currently no way to unlock the lost coins. However, if you decide to store bitcoins over an exchange such as Coinbase, Binance, or Bitfinix, the exchanges store the public and private keys, which comes with a risk of losing bitcoins in case of an exchange hack.
Bitcoins are transferred by using the wallet address of the receiver. What a transfer is initiated by the sender, any node which received the transaction first transfers the information to other nodes and these nodes to other nodes. Since Bitcoin is a peer-to-peer network, the transaction is propagated to all participants of the network within seconds. At this point, the number of bitcoins transferred should appear in the receiver’s wallet, but it remains unconfirmed until the transaction is added to a block through the mining process. After the block containing this transaction is added on top of the previous block, it adds trust and confirms the validity of the transaction. This payment has one confirmation now. As more blocks are mined and added, it becomes even harder to reverse the transaction. Generally, 6 confirmations or after 5 more blocks are mined, the transfer becomes irreversible owing to the amount of computational power required to reverse 6 blocks (more of this in later articles).
There is much more happening behind the scenes of the transaction which is too technical to add in this article and irrelevant for someone trying to grasp only the basics.
Bitcoin’s initial idea was released in 2008 when the world was suffering from a severe financial crisis and many fiat currencies were rapidly losing their value. The idea behind bitcoin is to address the shortcomings of the existing financial system and not to invent a whole new one. The governments and central banks are engaged in printing money out of thin air to fund their out-of-control expenses and wars. Commercial banks are creating loans out of their computer screens for profitability, further ballooning the supply of money in the market. The policy of printing money out of thin air is treacherous and could collapse an entire economy. The recent hyperinflation events in Venezuela and Zimbabwe; and Germany during World War I are only some examples. The US dollar was worth 4,210,500,000,000 German marks in 1923. Zimbabwe had a 100 trillion dollar note in 2009 worth close to 40 US dollars only. What a joke!
Do you think these hyperinflation events cannot occur in the first world countries? Think harder and read history.
During the financial crisis in 2008, central banks adopted quantitative easing- printing and injecting money at an unprecedented rate in a bid to provide liquidity to the market. The governments had to bail out banks to prevent them from collapsing by printing money too. These greedy banks were the reason why the world was at the cusp of a total financial meltdown in the first place. On top of that, the very first organization (banks) to receive the new and additional supply of money is the only beneficiary. As banks spend this cash, it gets injected into the market. Every time more currency notes are inserted into the market, all the existing money in circulation is devalued and the effects are ultimately shifted to the public. In addition, several countries have engaged in currency wars since 2008. Some of them are systematically devaluing their own currencies to make their goods and services cheaper as compared to other competitive countries in a move to boost their economy. US Treasury has officially designated China a currency manipulator in August 2019.
Bitcoin’s monetary policy is rather deflationary as opposed to the inflationary policy of governments and central banks. The maximum limit of 21 million bitcoins is written in the code and cannot be changed. Supply is decreasing over time through halving as explained in detail in How Bitcoin (BTC)s are Created section above. I do not believe that Bitcoin is here to challenge the current financial system. It intends to run parallel to it, and that’s for the best. I don’t believe that anything or anyone challenging the governments and banks could survive as these entities are too much power and resources to be called out.
However, Bitcoin can act as a safe-haven asset class such as gold against inflation in the future. But this technology is still in its infancy stage and not ready for global adoption. The price is also too volatile to act as a safe-haven asset. It needs to develop ease-of-use and stabilize in value before the public start trusting it. It’s also uncertain how Bitcoin will fare in case of a financial crisis as it has not faced any economic crunch since its birth.
Bitcoin could be a disruptive force to the bankers’ business model though. The battle is hard, and bitcoin is bound to force strong resistance if it threatens the banks and their monopoly on the financial markets. Bitcoin and blockchain are open source and decentralized. It does not belong to anyone but belongs to everyone as opposed to the current financial system which is controlled by governments and central banks and built to serve the elites only. Many banks are looking into the technology and building their own coins on the blockchain tech. J.P. Morgan has their own JPM coin for payments. Facebook is gearing up to launch Libra with the collaboration of Visa, Mastercard, eBay, Uber, and several other giants. You can live in a fools’ paradise and deny what this technology has to offer. People like Nouriel Roubini mocking and calling the blockchain technology “a glorified spreadsheet” will not deter the developments around this tech. He has been mocking Bitcoin when it was only $53. Maybe he is salty because he missed the chance to buy it cheaply.
Bitcoin’s other use case (my favorite one) is its potential to bank the unbanked population of the world. According to the world bank, around 1.7 billion adults have no access to a bank. Bitcoin provides an easy and quick way to bring those people into the financial system as well as protect their working rights. A smartphone and an internet connection are the only requirements to connect to the Bitcoin ecosystem. It is not necessary to open a shiny bank shop made with expensive glass and giving fat paychecks to the owners and the bankers at the expense of the public. Some Bitcoin proponents also argue that Bitcoin will do the same to banks what the internet did to brick-and-mortar stores. Only time will tell what the future hold.
Now you should have a broader understanding of Bitcoin, its underlying network and the ideology. If not, read this article again. I have tried my best to keep this as simple as possible. There are numerous books and thousands of articles trying to explain Bitcoin. Mastering Bitcoin by Andreas Antonopoulos is one of the best books to grab. Also, google any area you want to clarify, and read. That is the best way to understand Bitcoin. It’s a black hole and a lot of people are sucked into it (including myself) once they get too close. As final words, whether Bitcoin succeeds, fails, or gets replaced by a better tech, it has done a phenomenal job educating millions of people how they think about money and what governments are central banks are doing behind the closed curtains.
See you in the next article with debunking the most common myths and addressing controversies surrounding Bitcoin.
Published at Thu, 08 Aug 2019 04:30:30 +0000
Bitcoin Pic Of The Moment
By btckeychain on 2014-02-08 11:20:00
