What is Bitcoin? Detailed Introductory Guide For Beginners
Let’s talk about the Bitcoin & Cryptocurrencies around the globe because there’s a lot of excitement about Bitcoin and cryptocurrencies. They are slowly and steadily becoming center of the World economy. Enthusiast claims that Bitcoin will change the stereotype payments in economics, and even politics around the world. Pessimists shouting that Bitcoin will suffer an inevitable and spectacular collapse.
These differing views are significant confusion about what Bitcoin is and how it works. To really understand what is special about Bitcoin, we simply need to understand how it works at a technical level. Bitcoin truly is a new technology and we can only get so far by explaining it through simple analogies to past technologies.
- Introduction to Bitcoin
- History of Bitcoin
- Bitcoin Transaction
- Getting your first bitcoins
- Sending and receiving bitcoins
- Energy Wastage
- Bitcoin Price Volatility
Introduction to Bitcoin
What if I tell you that you can transact your money through the world’s safest technology. You will definitely feel like yes your money is in the safe hands. But what if I tell you that it is done via third party person. I know you would feel like cheated. But don’t worry about this, Now let’s look first why bitcoin is the safest and second how it is the trustworthy process.
The name of the founder of Bitcoin is “Satoshi Nakamoto.” Bitcoin originated with the white paper that was published in 2008 under the pseudonym “Satoshi Nakamoto.” The creator’s original motivation behind Bitcoin was to develop a cash-like payment system that permitted electronic transactions but that also included many of the advantageous characteristics of physical cash.
Bitcoin is unlike anything the world has seen before. By providing fast, inexpensive, international money transfer, it has the potential to revolutionize both the modern day concept of money and commerce.
Bitcoin is made possible by a combination of software and network technologies. A program called the Bitcoin client simultaneously manages and helps you spend bitcoins. This program maintains a long ledger called the blockchain that holds every transaction confirmed by the Bitcoin network. The Bitcoin network, consisting of thousands of machines running the Bitcoin software, has two main tasks to accomplish.
History of Bitcoin
Bitcoin was invented in 2008 by Satoshi Nakamoto with the publication of a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”. Satoshi Nakamoto combined several prior inventions such as b-money and HashCash to create a completely de-centralized electronic cash system that does not rely on a central authority for currency issuance or settlement and validation of transactions.
The bitcoin network started in 2009, based on a reference implementation published by Nakamoto and since revised by many other programmers. The distributed computation that provides security and resilience for bitcoin has increased exponentially and now exceeds that combined processing capacity of the world’s top super-computers. Bitcoin’s total market value is estimated at between 5 and 10 billion US dollars, depending on the dollar/bitcoin exchange rate. The largest transaction processed so far by the network was $150 million US dollars, transmitted instantly and processed without any fees.
Satoshi Nakamoto withdrew from the public in April of 2011, leaving the responsibility of developing the code and network to a thriving group of volunteers. The name Satoshi Nakamoto is an alias and the identity of the person or people behind this invention is currently unknown. However, neither Satoshi Nakamoto nor anyone else exerts control over the bitcoin system, which operates based on fully transparent mathematical principles. The invention itself is groundbreaking and has already spawned new science in the fields of distributed computing, economics and econometrics.
To join the bitcoin network and start using the currency, all a user has to do is download an application or use a web application. Since bitcoin is a standard, there are many implementations of the bitcoin client software. There is also a “reference implementation”, also known as the Satoshi Client, which is managed as an open source project by a team of developers and is derived from the original implementation written by Satoshi Nakamoto.
The three primary forms of bitcoin clients are:
A full client, or “full node” is a client that stores the entire history of bitcoin transactions (every transaction by every user, ever), manages the user’s wallets and can initiate transactions directly on the bitcoin network. This is similar to a standalone email server, in that it handles all aspects of the protocol without relying on any other servers or third party services.
A lightweight client stores the user’s wallet but relies on third-party owned servers for access to the bitcoin transactions and network. The light client does not store a full copy of all transactions and therefore must trust the third party servers for transaction validation. This is similar to a standalone email client that connects to a mail server for access to a mailbox, in that it relies on a third party for interactions with the network.
Web-clients are accessed through a web browser and store the user’s wallet on a server owned by a third party. This is similar to webmail in that it relies entirely on a third party server.
Getting your first bitcoins
It is not possible to buy bitcoins at a bank or foreign exchange kiosks at this time. As of 2014, it is still quite difficult to acquire bitcoins in most countries. There are a number of specialized currency exchanges where you can buy and sell bitcoin in exchange for a local currency.
Crypto-currency exchanges such as these operate at the intersection of national currencies and crypto-currencies. As such, they are subject to national and international regulations and are often specific to a single country or economic area and specialize in the national currencies of that area. Your choice of currency exchange will be specific to the national currency you use and limited to the exchanges that operate within the legal jurisdiction of your country. Similar to opening a bank account, it takes several days or weeks to set up the necessary accounts with the above services because they require various forms of identification to comply with KYC (Know Your Customer) and AML (Anti-Money Laundering) banking regulations. Once you have an account on a Getting Started | 9 bitcoin exchange, you can then buy or sell bitcoins quickly just as you could with foreign currency with a brokerage account.
There are three other methods for getting bitcoins as a new user:
• Find a friend who has bitcoins and buy some from them directly. Many bitcoin users started this way.
• Use a classified service like localbitcoins.com to find a seller in your area to buy bitcoins for cash in an in-person transaction.
• Sell a product or service for bitcoin. If you’re a programmer, sell your programming skills. If you have an online store, see (to come) to sell in bitcoin.
Sending and receiving bitcoins
Alice has created her bitcoin wallet and she is now ready to receive funds. Her wallet application randomly generated a private key together with its corresponding bitcoin address. At this point, her bitcoin address is not known to the bitcoin network or “registered” with any part of the bitcoin system. Her bitcoin address is simply a number that corresponds to a key that she can use to control access to the funds. There is no account or association between that address and an account. Until the moment this address is referenced as the recipient of value in a transaction posted on the bitcoin ledger (the blockchain), it is simply part of the vast number of possible addresses that are “valid” in bitcoin. Once it has been associated with a transaction, it becomes part of the known addresses in the network and Alice can check its balance on the public ledger.
Alice meets her friend Joe who introduced her to bitcoin at a local restaurant so they can exchange some US dollars and put some bitcoins into her account. She has brought a printout of her address and the QR code as displayed in her bitcoin wallet. There is nothing sensitive, from a security perspective, about the bitcoin address. It can be posted anywhere without risking the security of her account.
Alice wants to convert just $10 US dollars into bitcoin, so as not to risk too much money on this new technology. She gives Joe a $10 bill and the printout of her address so that Joe can send her the equivalent amount of bitcoin.
The traditional banking model achieves a level of privacy by limiting access to information to the parties involved and the trusted third party. The necessity to announce all transactions publicly precludes this method, but privacy can still be maintained by breaking the flow of information in another place: by keeping public keys anonymous. The public can see that someone is sending an amount to someone else, but without information linking the transaction to anyone. This is similar to the level of information released by stock exchanges, where the time and size of individual trades, the “tape”, is made public, but without telling who the parties were.
As an additional firewall, a new key pair should be used for each transaction to keep them from being linked to a common owner. Some linking is still unavoidable with multi-input transactions, which necessarily reveal that their inputs were owned by the same owner. The risk is that if the owner of a key is revealed, linking could reveal other transactions that belonged to the same owner.
Much like any other key innovation, blockchain technology introduces some risks. The following sections will consider some of these risks.
Bitcoin protocol can be altered if the network participants, or at least a sufficient number of them, agree on the suggested modification. It can happen (and in fact has happened) that a blockchain splits because various groups cannot agree about a modification. A split that persists is referred to as a “fork.” The two best-known examples of persistent splits are the Bitcoin Cash fork and Ethereum’s ideological dissent, which resulted in the split to Ethereum and Ethereum Classic.
Proof-of-work mining is expensive, as it uses a great deal of energy. There are those that criticize Bitcoin and assert that a centralized accounting system is more efficient because consensus can be attained without the allocation of massive amounts of computational power. From our perspective, however, the situation is not so clear-cut. Centralized payment systems are also expensive. Besides infrastructure and operating costs, one would have to calculate the explicit and implicit costs of a central bank. Salary costs should be counted among the explicit costs and the possibility of fraud in the currency monopoly among the implicit costs. Moreover, many crypto assets use alternative consensus protocols, which do not (solely) rely on computational resources.
Bitcoin Price Volatility
The price of Bitcoin is highly volatile. This leads us to the question of whether the rigid predetermined supply of Bitcoin is a desirable monetary policy in the sense that it leads to a stable currency. The answer is no because the price of Bitcoin also depends on aggregate demand. If a constant supply of money meets a fluctuating aggregate demand, the result is fluctuating prices. In government-run fiat currency systems, the central bank aims to adjust the money supply in response to changes in aggregate demand for money in order to stabilize the price level. In particular, the Federal Reserve System has been explicitly founded “to provide an elastic currency” to mitigate the price fluctuations that arise from changes in the aggregate demand for the U.S. dollar. Since such a mechanism is absent in the current Bitcoin protocol, it is very likely that the Bitcoin unit will display much higher short-term price fluctuations than many government-run fiat currency units.
Bitcoin is a completely new, unprecedented and complex technology. Over time we will develop better security tools and practices that are easier to use by non-experts. For now, bitcoin users can use many of the tips above to enjoy a secure and trouble-free bitcoin experience. The Bitcoin creators’ intention was to develop a decentralized cash-like electronic payment system. In this process, they faced the fundamental challenge of how to establish and transfer Berentsen and Schär Federal Reserve Bank of St. Louis REVIEW First Quarter 2018 15 digital property rights of a monetary unit without a central authority. They solved this challenge by inventing the Bitcoin Blockchain. This novel technology allows us to store and transfer a monetary unit without the need for a central authority, similar to cash. Price volatility and scaling issues frequently raise concerns about the suitability of Bitcoin as a payment instrument. As an asset, however, Bitcoin and alternative blockchain-based tokens should not be neglected. The innovation makes it possible to represent digital property without the need for a central authority. This can lead to the creation of a new asset class that can mature into a valuable portfolio diversification instrument. Moreover, blockchain technology provides an infrastructure that enables numerous applications. Promising applications include using colored coins, smart contracts, and the possibility of using fingerprints to secure the integrity of data files in a blockchain, which may bring change to the world of finance and to many other sectors.