Bitcoin is the most popular and the best-known cryptocurrency. It hit the mainstream media like a bomb at 2017, when the price of Bitcoin moved from 1000 to 20,000 USD. Bitcoin has grown from a small anarchist movement to a global phenomenon. Even if Bitcoin has become somewhat known lately, very few people know the fundamentals and history behind it. So, what is Bitcoin? In this article we have it thoroughly explained.
Bitcoin was created by Satoshi Nakamoto
According to popular belief, a mysterious person called Satoshi Nakamoto created Bitcoin and blockchain technology ten years ago. This is only a half-truth.
Digital currencies have been developed since the dawn of the internet. There have been many cryptographers paving the way for Satoshi Nakamoto’s ideas, which were presented in October of 2008.
Cryptographer David Chaum is probably the best-known pioneer on this field. He developed virtual currency called DigiCash back at 1980s. It became so popular at 1990s that Microsoft founder Bill Gates wanted to integrate it into Windows 95 operating system. Gates was ready to pay Chaum 100 million dollars, but the man said no.
Concept of the blockchain technology has also been presented as early as 1990s by Stuart Haber and W. Scott Stornetta. They build a system, where document timestamps couldn’t be changed after they were created.
Satoshi Nakamoto didn’t invent Bitcoin out of nowhere. There’s a long history of successful and failed experiments in the field of cryptocurrencies, which were paving the way for Bitcoin’s existence.
Eventually, Satoshi Nakamoto was able to put all the pieces together and create a trust less and decentralized system in a way that wasn’t implemented before. His timing was also perfect. There were many people with open ears for such proposals after the financial crisis of 2008.
Bitcoin was born at 2008
The real person behind Satoshi Nakamoto is still unknown to date. Many people have claimed to be Satoshi, but none has successfully proven it. Some think he’d be Japanese, but Satoshi could be also a group of people.Embed from Getty Images
Picture: Japanese physicist Dorian S. Nakamoto was drawn into a media fuss at 2014, when Newsweek “revealed” he was the founder of Bitcoin. These claims were untrue, though.
According to his own words, Satoshi Nakamoto developed Bitcoin since 2007. He published the famous white paper at October 31st of 2018 to a cryptographer’s e-mail list. After this, a big wheel was set in motion.
The genesis block of Bitcoin’s blockchain was created at 3rd of January 2009. This is widely considered as the birthday of Bitcoin. The first transaction took place in the block number 170. It was between Satoshi Nakamoto and the main developer Hal Finney.
Information of Bitcoin started to really spread during 2010 and 2011. Many of the pioneers and long-time influencers in the crypto space got into Bitcoin back then. Satoshi Nakamoto left the project at the early stage himself and just left the project for others to develop. Most people agree that this was the most important decision he made, and it ensured the success of Bitcoin.
The crypto industry grows
The first real world transaction with Bitcoin was made at 2010. A programmer called Laszlo Hanyecz used 10,000 Bitcoins to purchase two pizzas from the local pizza place. This transaction has become so famous, there’s even a Pizza Day celebrating the event yearly.
Mt. Gox exchange was also opened at 2010. It dominated the crypto space and made possible for many people to trade and speculate with the currency. Over 70% of all crypto trades were done via Mt. Gox at the time.
Bitcoin gained even more popularity at 2011, when Silk Road was founded. That was an underground market place, where drugs and other illegal items were sold and bought using Bitcoin. FBI eventually closed the site few years later.
More and more services started to rise to the crypto space. But, the popularity of Bitcoin brought also more bad actors in. Many services and individuals got hacked during the early years and lots of money was lost.
The fall of Mt. Gox at 2014 is still probably the biggest single event in the crypto space. The exchange was hacked and over 850,000 Bitcoins were lost. The whole exchange went bankrupt and people are still waiting for their Bitcoins back.
The entire crypto space started to develop further at 2011-2013. Bitcoin was no longer the only game in town. Litecoin, which is one of the most popular cryptos besides Bitcoin, was founded at 2011.
Ethereum development started at 2013. This was the beginning of the 2nd generation of cryptocurrencies. Ethereum was launched at 2015. The platform made it possible to program your own decentralized apps (dApps) and use smart contracts.
The birth of Ethereum gave platform for ICOs and helped Bitcoin into a long bull run between 2015 and 2017.
Bitcoin has been also developed further over the years. The software updates are called forks. However, the role of the Bitcoin has remained unchanged. It is (and probably always will be) essentially a digital currency. Projects like Ethereum are ecosystems and don’t compete with Bitcoin directly.
The whole industry moves forward with giant leaps. Since late 2017 we’ve seen the 3rdgeneration platforms such as EOS and TRON emerge. They offer scalability on a level that Bitcoin and Ethereum can’t process yet.
Bitcoin is made possibly by the blockchain technology
How does Bitcoin actually work? Let’s dive into the technology next.
First, one should understand the nature of Bitcoin. The software has always been open source. It means that anyone can use the code and create their own version of Bitcoin if they want. This has been done multiple times. Litecoin and Bitcoin Cash are currently the two most popular versions of the Bitcoin software.
You should also understand that Bitcoin is both a payment system and a currency. There are digital payment systems in the world such as Skrill or Paypal. These systems exist regardless of the currency used in them.
Even if Euro or Japanese Yen would cease to exist tomorrow, Skrill and PayPal would run the same way with dozens of other currencies. On the other hand, if Skrill or PayPal would be shut down tomorrow it’d have no impact on any currency.
These examples don’t apply to Bitcoin, which cannot exist without its payment system called the blockchain. Bitcoin is not a currency, which you can move out of blockchain and print to a piece of paper instead.
The technology behind Bitcoin is a bit fuzzy concept to many. Where is this mystical blockchain? Are my Bitcoins in some cloud service? Who runs the blockchain?
Blockchain technology comes from the fact that it consists of blocks in a chain. One block is in practice a list of transactions. In all simplicity, blockchain is just a form of ledger. There is one key word making blockchain so special: distributed. Hence, blockchain is also referred as DLT – distributed ledger technology.
If you want to dig deeper into DLT, read our in-depth guide: What is blockchain (distributed ledger technology)?
In a traditional model, information is stored in a centralized database. It could be a bank system or Facebook’s database or an e-mail list of a local association.
The underlying problem of a centralized system is trust. All users must trust one single party to control and store the information and access to it. This was the reason why Bitcoin was born after the 2008 financial crisis.
Satoshi Nakamoto (and many others) wanted to create a financial system that wouldn’t be controlled by a centralized operator.
What is Bitcoin? It’s a network of nodes.
Blockchain is a distributed ledger, where all transactions are stored by every member of the network. These operators are called nodes. You can compare them to servers running the internet. A Bitcoin network node is essentially a computer running the Bitcoin software.
There are tens of thousands of nodes in the Bitcoin network and anyone can run one. All you need to do is download the Bitcoin software. This means the network is permissionless and global.
Some of the Bitcoin network nodes are called full nodes. These keep track of the entire ledger since it was born at 2009. That requires quite a bit of space, because the ledger is hundreds of gigabytes and growing fast.
The purpose of nodes is to control all transactions sent to the network. They make sure that the sender has enough Bitcoins to process the transaction. Nodes pass on their information to other nodes if they confirm it is legit.
Nodes are only run by people, who want to support the network by giving part of their internet bandwith and computing power to it. You can buy and store Bitcoin to your wallet without running a node. More nodes there are, safer the network becomes. And more decentralized.
Miners are also nodes, but nodes don’t do any mining. The only purpose of a node is to pass on transactions.
But what is the purpose of these miners then?
You can think of a Bitcoin transaction like sending a traditional letter. You write an address and put a stamp on the envelop and deliver it to the nearest post box. From there it’s delivered to a local sorting centre. From there it’s delivered further to anywhere in the world.
In Bitcoin’s world, nodes are the ones delivering your letter (= transaction) to the nearest sorting centre. This is called memory pool or mempool. It is a virtual pile of thousands of undelivered transactions. If the network is very busy, there could be hundreds of thousands of transactions pending in the mempool.
Miners are in fact sorting machines. They pick transactions from the mempool and place them to a new block. Each block has limited space, so there are only so many transactions that can be processed at the time.
When a block is full of transactions, it’s added to the existing blockchain. There are hundreds of thousands of miners, each trying to be the lucky one whose block gets added. This competition is explained next.
Miners build the Bitcoin blockchain
Mining is in fact blockchain maintenance work. It is required due to the consensus algorithm used by Bitcoin, which is called Proof of Work. PoW is like a decision-making process for a group of entities, in this case: miners. They all try to make a new block and add it to the blockchain. PoW is the process for deciding, which block actually goes in.
PoW is a very energy-consuming method. Each miner must run a special program, which basically means calculating difficult mathematical formulae 24/7. One of them “wins the lottery” eventually and gets to add the next block. This happens in the Bitcoin network every 10 mins by average.
High energy consumption means also high electricity consumption. Mining of Bitcoin uses more electricity than the entire country of Ireland as an example. When each block is mined, the creator is rewarded with Bitcoins. Currently the amount is 12,5 Bitcoins per block, but this gets halved after some years. The next halving comes at 2020, when the reward drops to 6,25 Bitcoins per block.
This is also how new Bitcoins come into existence. Over time, the inflation gets smaller and smaller and it eventually stops. There will be only 21 million Bitcoins created.
Anyone can start to mine Bitcoin. It’s not easy though, because the mining work requires so much computing power. Nowadays it can be only done profitably with specialized machines in mining farms near cheap electricity.
Above is a picture of an ASIC miner built by Chinese manufacturer Bitmain. It’s a specialized computer built only for the mining work. Some cryptocurrencies can be also mined with GPU and CPU, but this hasn’t been profitable with Bitcoin in many years.
The purpose of mining is to create new blocks and new Bitcoins into existence. If miners would stop, the whole network would die instantly. This is very unlikely, though. Even if half of the miners would stop, the rest would benefit greatly by getting a bigger share of the rewards. Free market takes care of this.
The block size of Bitcoin blockchain has been a topic of heated debate for many years. Some developers wanted to increase the block size, which would increase the network capacity. Eventually this group split from Bitcoin in August of 2017 and created Bitcoin Cash.
After that there have been many other forks of Bitcoin, where the block size has been increased. This hasn’t influenced the popularity of the original Bitcoin, though.
It’s often argued that the whole concept of the Proof of Work is simply outdated. The rivalling option called Proof of Stake requires no physical mining machines. The mining is done virtually.
There are no signs that Bitcoin would be moving out of PoW in the future. Instead, solutions like the Lighting Network are built to help the network to scale. PoW might be old, but it’s still the safest and most proven solution.
Private and public key make Bitcoin transactions possible
Let’s see next how a transaction is done in the Bitcoin network by a user like you and me.
Bitcoins are attached in the ledger to public addresses. These are not like e-mail addresses, but random numbers and letters like 1C1semWeD8k3yTTDypxCEXeYfVMbvpg74w. There are certain rules in creating this string.
Each Bitcoin address starts with a number 1 or number 3. They are all case sensitive. Don’t ever try to type a Bitcoin address when making transactions. Always use copy-paste or QR codes to make sure you get it right.
A blockchain is then a list of transactions saying X Bitcoins are sent from address A to address B. This ledger is public for anyone to view. You can see the content of any block from blockchain.info website.
You can also click any Bitcoin address from that website and see its transaction history. The balance of your Bitcoin address is basically a total sum of all transactions you’ve ever done. Even if you can do that, there’s no way of knowing whose addresses you are looking at. Technically, there are some methods available by using AI, but let’s not go that deep.
A public address is like your e-mail address. You can share with anyone, and all they can do is to send something to your address. Private address is like your e-mail password. That gives you access to control the public address and its transactions.
The difference between e-mail and Bitcoin address is of course recognizability. E-mail address is recognizable on purpose, like John.Smith@gmail.com. But you don’t want people to know Bitcoin address is yours, because it’d be like showing your bank account history.
An unlimited amount of Bitcoin addresses can be created. It’s practically impossible to create accidentally two similar addresses.
Bitcoin are held in digital wallets
Bitcoins are held in wallets, which are applications. There are mobile wallets, desktop wallets and online wallets. When using wallets, you log into them just like you’d log into Gmail or Hotmail account – with a username and password. The private key is held inside the wallet software and you don’t use it on your normal operations.
Regardless of the wallet used, your funds are always stored in the blockchain. Your Bitcoins are not on your harddrive or in your browser or in some USB sticks. The transaction history is always in the blockchain and it’s immutable.
Remember: whoever controls the private key, controls the Bitcoin. If you don’t control the private key yourself, the access to your Bitcoins can be taken away any time.
If you are storing your Bitcoin in a cryptocurrency exchange or in an online service, this is the case in practice. You login to your account using an e-mail and password. The operator has your private keys and controls your funds. If you use a desktop wallet like Exodus, the private keys are store don your computer.
The safest solution is to use a hardware wallet, which is like a USB stick.
Ledger Nano is currently the most popular option. When using a hardware wallet, you control your private keys all the time. The best thing is that our private keys are offline. No hacker can reach them.
How are Bitcoins being bought and sold?
Bitcoins can be bought nowadays from hundreds of different operators. Coinbase is the most popular one for newbies, where you can easily exchange your fiat currency to Bitcoin. You can see all our recommended exchanges from here.
Buying Bitcoin is very simple. You register an account online, go through KYC and deposit money from your bank account. You can also use credit card. After that you can buy Bitcoins with a couple of clicks.
Bitcoins can be always held where ever you bought them as well. If your portfolio grows to thousands of dollars, it’s recommended to use a hardware wallet like Ledger Nano and store the funds yourself.
Bitcoin is still a reserve currency in the crypt world, a bit like USD in the real world. Many altcoins can be only bought with Bitcoin. If you want to buy some rare cryptos, you must first buy Bitcoins with your fiat currency and then exchange Bitcoin to other tokens.
Selling Bitcoin is no different from buying them. You can exchange your cryptos back to fiat currency by clicking your mouse few times. After that the money can be withdrawn to your bank account instantly.
Bitcoin prices are usually followed in dollars. The official Bitcoin price is merged from the price of all different exchanges. The price you get is the price available in the exchange or service you are using. It might differ a bit from the official price.
Bitcoin explained – to put it all together
Let’s wrap up everything you have read so far and put it together.
Bitcoin is the world’s known cryptocurrency, which was founded by Satoshi Nakamoto in October of 2008. It is the first digital currency combining cryptography and blockchain technology. Bitcoin has had thousands of rivalling currencies and tokes of the years.
The Bitcoin software is open source. Anyone can use it and create their own version of Bitcoin.
Bitcoin is a so called 1st generation cryptocurrency. Almost every single cryptocurrency in the market is more advanced and scalable than Bitcoin. Some of them (like Ethereum) offer smart contracts and many other features.
Scalability issues have split the Bitcoin development camp to two different groups. The path chosen by the Bitcoin is off-chain scaling. It means that small transactions are being processed outside the Bitcoin blockchain. The technology providing this is called the Lightning Network.
The blockchain technology behind Bitcoin means just a distributed ledger. It consists of tens of thousands of nodes all around the world. These nodes take care of all transactions sent to the network.
The Bitcoin network couldn’t function without miners. They are the ones doing the heavy maintenance duties. Miners create each new block of the blockchain. They are rewarded from their work with new Bitcoins.
Bitcoin blockchain is a public ledger – each transaction is visible to anyone. It is showing the public addresses of each sender and receiver. These are like e-mail addresses, but you cannot know who owns each address. A public address can be unlocked with a private key giving access to any funds in it.
Bitcoins are not in your computer or in your mobile or in your browser. There are no physical Bitcoin coins or bills either. Bitcoins exist only in the blockchain, where their ownership is determined from transactions.