Chances are you’re seeing the terms ‘Bitcoin’, ‘cryptocurrency’ or ‘blockchain’ appear in your regular news source with increasing frequency. While Bitcoin (aka BTC) has been around since 2009, recently interest in it has shot up. More and more people are jumping aboard the Bitcoin train as its value skyrockets.
That said, you certainly aren’t alone if you’ve skipped over these articles – the terms are still new and their explanations are often complex. While we might be lawyers by day, some of us are also nerds by night and are here to give you a simple explanation of this complex tech.
What is Bitcoin?
Put simply, Bitcoin is a cryptocurrency or digital currency that allows for transactions between people who have no reason to trust one another and does so without the need for a central authority (i.e. a bank or government). Despite existing in a digital environment, this decentralised structure means BTC has more in common with cash than electronic transactions. With cash there is no need to involve a central authority because it is clear the money exists and is exchanging hands. There is no chance of someone attempting to pay for an item with money they no longer have. Think about how you might normally purchase something online, the exchange of money requires a trusted 3rd party, like a bank, Paypal, or credit card to verify you’re not double spending.
Why mess with a good thing?
You might be wondering why, if we already have a system that works, do we need a new payment method? Keep in mind our third parties are not infallible. They can be hacked and they can be irresponsible. If we hadn’t been wary before, then the 2008 Global Financial Crisis certainly exposed the fragility of the system. A different arrangement was needed.
In the wake of the GFC, a person (or group) using the pseudonym ‘Satoshi Nakamoto’ released a detailed description and source code for Bitcoin. Once that source code took hold, Nakamoto vanished from sight. To this day, nobody knows who Nakamoto is… though plenty of people have tried to take credit.
The ability for two strangers to complete transactions with total security is thanks to the incredible technology underlying Bitcoin: the blockchain.
The blockchain is like an old accountant’s ledger used to record many lines of data. The key feature of blockchain technology is that this ledger is shared. It is distributed amongst a large number of people each receiving an identical copy. As the ledger is updated, everyone’s copy is also immediately updated.
When someone buys or sells Bitcoin, they are initially merely sending out a proposal to do so. In order for their transaction to be completed, it must get verified as being an authentic transaction and not the result of double spending. This is done by multiple parties checking the shared ledger to ensure that the requesting person does indeed have the money to spend.
For efficiency, transactions get verified in clumps (imagine a page in the ledger), known as a ‘block’. Once all the transactions in a block are verified, that block gets attached to the previous blocks making a chain. Hence the term: blockchain.
How do the transactions get verified?
All over the world, computers (known as ‘Miners’) are connected to the Bitcoin network, working to verify transactions. Miners are the ones that accept or reject transactions onto a block. The miners ensure all transactions follow specific rules, such as ensuring the coin has not been double-spent. Miners compete to be the one to mine the block, that is accept or reject the transactions.
The competition involves solving a complicated algorithm attached to that block which is difficult to work out but easy to check. (Kind of like that algebra problem you hated in school; once you thought you knew what ‘x’ was, anyone could easily check your answer.)
The first miner to solve the problem ‘wins’ and gets to verify the transactions. But the miner’s new-found power is not unchecked. At least 51% of the miners in the network must agree that the winner has solved the problem correctly and has followed all the rules in verifying the data. Only then will the block of transactions get added to the chain.
There is a huge financial incentive for miners to mine: they earn Bitcoin, both from transaction fees and from newly minted Bitcoins that are attached to each new block. At the moment, 12.5 new Bitcoins are attached to each block, which by today’s exchange rate totals about NZ $120,000.
Unhackable and Immutable
Once a block is added to the chain it is there forever. It can never be removed or changed. In fact, every single bitcoin transaction can be traced back through the chain to the ‘genesis coin’.
Part of what keeps the system honest is the sheer computing power and energy expenditure the process requires. It is far more profitable to use that energy to solve the chain and earn Bitcoins than it is to hack the system. In order to double-spend, that is make a false transaction, one would also need to alter every single previous block on the shared and distributed chain to make that transaction look valid. It would be like someone, in the middle of the Olympic flame lighting ceremony, with the world watching, replacing the torch with a bunch of roses and expecting to go unnoticed.
Future of the blockchain
Bitcoin is just the beginning for blockchain technology. Blockchains have the ability to hold any type of data and across the globe are being tested in nearly every area you can think of, including peer-to-peer energy trading allowing consumers to sell excess energy, providing the bankless with a secure means of exchanging money, and giving us the control to manage our own identity information.
In our next article we’ll discuss the more practical side of Bitcoin – safe buying and storing practices and thoughts as to where Bitcoin’s future looks to be heading.