On 22nd of May 2010, a programmer by the name Laszlo Hanyecz made financial history when he bought two pizzas. There was nothing really special about the pizzas. What made the transaction historical was what Laszlo used to pay for the pizzas. He paid for the two pizzas using 10,000 Bitcoins, marking the first time the virtual currency was used to pay for something in the real world. Had Laszlo decided to forego that meal and held on to his Bitcoins, they would have been worth over 23 million dollars today. What an expensive meal! Well, you might not have heard about Laszlo’s historical transaction, but you have definitely heard about Bitcoin. So, what is Bitcoin?
Bitcoin is the first and the most popular form of cryptocurrency. A cryptocurrency is an electronic or virtual currency that uses cryptography as a security feature, making it difficult to counterfeit. The digital nature of Bitcoin means that Bitcoins aren’t printed like regular currency. Instead, Bitcoins are produced by people running computers with software that solves mathematical equations, in a process known as mining. Bitcoin was developed back in 2009 by an anonymous programmer using the alias Satoshi Nakamoto. Bitcoin allows for payments between two parties without the need for middle parties or a central authority. Instead, it uses a system known as the Blockchain to keep track of all transactions between users. This means that the cryptocurrency is theoretically immune to any kind of interference or manipulation by any government.
Below are some of the characteristics of Bitcoin that differentiate it from normal government backed currencies:
- It’s decentralized: The cryptocurrency is not controlled by any one central entity. Instead, transactions are processed by individual machines working together to make a network. This means that no central authority can tinker with the virtual currency. Additionally, if some part of the network goes offline, other machines fill in to keep the money flowing.
- Easy to set up: With conventional banks, you have to go through a number of checks before you can open an account. However, with Bitcoin, you can easily set up a Bitcoin wallet from wherever you are in a matter of seconds and start transacting, without paying in fees.
- It’s anonymous: It is possible for a user to have multiple Bitcoin addresses. The addresses are not linked to names, physical addresses or any other kind of personally identifying information.
- Its’ completely transparent: Despite being anonymous, the details of every Bitcoin transaction that has ever taken place are publicly stored in a huge ledger-like database known as the blockchain. This means that for any publicly used Bitcoin address, anyone can find out the number of Bitcoins stored at the address. However, they have no way of knowing who the address belongs to.
To make their activities less transparent, there are measures uses can take, such as not storing lots of Bitcoins at a single address and not using the same address consistently.
- Minimal transaction fees: While conventional banks may charge you some fees for transferring funds between banks or internationally, Bitcoin does not. The direct approach used by Bitcoin gets rid of the fees associated with transferring traditional money and makes it much faster and easier to transfer money across the planet. Bitcoin’s efficiency over traditional currencies can be compared to the efficiency of email over snail mail.
- It is fast: All it takes for a transaction to reflect is verification by the network. It only takes a couple minutes for money sent to arrive to any part of the globe.
- It’s non-repudiable: Once Bitcoins are sent from your address to another, there is no way for you to get them back, unless the recipient decides to return them back.
How does Bitcoin work?
If Bitcoin is not controlled by any government or central bank, then how does it work? Where do Bitcoins come from and how are they controlled?
With traditional currencies, the central banks simply print more money as needed. However, Bitcoins cannot be printed. Instead, they are discovered by ‘miners’ who are in competition with each other. When a Bitcoin transaction takes place, someone has to record the transaction, else it would be impossible to keep track of who has what amount of Bitcoins. The Bitcoin network keeps track by recording all transactions made during a particular period into a list known as a block. The miners are tasked with the responsibility of confirming the transactions and recording them onto a general ledger which is publicly accessible to everyone who participates in the mining process. To do this, they have to use computers running special Bitcoin software to solve complex mathematical equations in a process known as hashing.
The miners are in competition with each other to verify each block and record it onto the blockchain. Every time someone successfully verifies and records a block, they are rewarded with a certain amount of Bitcoins. The mathematical puzzles which have to be solved before each block can be verified get increasingly complex as more Bitcoins are created. The rewards miners get for maintaining the blockchain are also reduced by half at regular intervals. This means that the rate at which new Bitcoins are created will continue slowing down gradually. Bitcoin has a built-in limit of only 21 million Bitcoins, meaning that the production of new Bitcoins will stop completely once 21 million Bitcoins have been mined.