Not only is Bitcoin (BTC) the first cryptocurrency, but it’s also the most well-known among the 19,000 cryptocurrencies estimated to be in existence today. Bitcoin is more than a cryptocurrency used as a payment or for investors to hold and hope for value increases.
There is an entire ecosystem at work behind a cryptocurrency and as a matter of fact, there are many of these ecosystems working on the internet today. But because Bitcoin was the first, it's essential to understand what it is and how Bitcoin works.
What Is Bitcoin?
Bitcoin is a digital form of cash. But unlike the fiat currencies you’re used to, there is no central bank controlling it. Instead, the financial system in Bitcoin is run by thousands of computers distributed around the world. Anyone can participate in the ecosystem by downloading open-source software.
Bitcoin was the first cryptocurrency, announced in 2008 (and launched in 2009), providing users with the ability to send and receive digital money. What makes it so attractive is that it can’t be censored, funds can’t be spent more than once, and transactions can be made at any time, from anywhere.
How Bitcoin Works
Now that you have an idea of what it is, here’s an analogy of how Bitcoin works:
When Cheryl makes a transaction to Drake, she’s not sending funds in the way you’d expect. It’s not like the digital equivalent of handing him a dollar bill. It’s more like her writing on a sheet of paper (that everyone can see) that she’s giving one dollar to Drake. When Drake goes to send those same funds to Esther, she can see that Drake has them by simply looking at the sheet.
The sheet is a particular kind of database called a blockchain. Network participants all have an identical copy of this stored on their devices. The participants connect with each other to synchronize new information.
When a user makes a payment, they broadcast it directly to the peer-to-peer network – there isn’t a centralized bank or institution to process transfers. In order to add new information, the Bitcoin blockchain uses a special mechanism called mining. It is through this process that new blocks of transactions are recorded in the blockchain.
What Is The Blockchain?
The blockchain is a ledger that is append-only, which means only data can be added to it. Once information is added, it is extremely difficult to modify or delete it. The blockchain enforces this by including a pointer to the previous block in every subsequent block.
The pointer is actually a hash of the previous block. Hashing involves passing data through a one-way function to produce a unique “fingerprint” of the input. If the input is modified even slightly, the fingerprint will look completely different. Since we chain the blocks along, there is no way for someone to edit an old entry without invalidating the blocks that follow. Such a structure is one of the components making the blockchain secure.
What Is Bitcoin Mining?
Bitcoin mining is the process by which Bitcoin transactions are validated digitally on the Bitcoin network and added to the blockchain ledger. The process involves the verification of new transactions against the Bitcoin network, which results in the production of new bitcoins.
How does Bitcoin Mining Work?
By mining, participants add blocks to the blockchain. It is done by solving complex cryptographic hash puzzles to verify blocks of transactions that are updated on the decentralized blockchain ledger. Solving these puzzles requires powerful computing power and sophisticated equipment. In return, miners are rewarded with Bitcoin, which is then released into circulation, hence the name Bitcoin mining.
It’s expensive to generate a block, but cheap to check if it’s valid. If someone tries to cheat with an invalid block, the network immediately rejects it, and the miner will be unable to recoup the mining costs.
What Makes Bitcoin Valuable?
Bitcoin is decentralized, censorship-resistant, secure, and borderless. These qualities have made it appealing for use cases such as international remittance and payments where individuals don’t want to reveal their identities (as they would with a debit or credit card).
Many don’t spend their Bitcoins but rather, choose to hold them for the long-term (also known as “hodling” in cryptocurrency terms) since some investors view Bitcoin as a store of value. Because it’s scarce due to a finite supply of coins available and difficult to produce, it has been likened to precious metals like gold or silver – often dubbed digital gold.
Holders believe that these traits – combined with global availability and high liquidity – make it an ideal medium for storing wealth for long periods, and that Bitcoin’s value will continue to appreciate over time.
Closing Thoughts
People use Bitcoin for a number of reasons. Many appreciate it for its permissionless nature – anyone with an Internet connection can send and receive it. It’s kind of like cash, in that no one can stop you from using it, but its digital presence means that it can be transferred globally with complete transparency.
Now that you’ve obtained an understanding of what it is and how Bitcoin works, do you see yourself using Bitcoin anytime in the near future?
