Countless Bitcoin primers exist on the Internet today. What, with the increased interest in Bitcoin and other cryptocurrencies. Flawed as they may be in the present, it is becoming apparent with each passing day that cryptocurrencies such as Bitcoin are going to be an important part of our digital future. A lot of these Bitcoin primers read like doctoral theses, replete with technical minutiae. Those that seek to simplify matters , simply do not have enough meat on their bones and are often fraught with plain misinformation. In this article,and others in my Bitcoin primer series, I will attempt to explain technical concepts in simple terms and at the same time convey as much of the essence of Bitcoin as possible.
It would serve anyone reading this piece well to understand four basic facts clearly. First off, Bitcoins do not exist. You cannot point to a file or an object and call it a Bitcoin. What exist are records of transactions of Bitcoin in a sort of master ledger called the block chain. Secondly and more importantly, Bitcoin is cash. Bitcoin is not a form of electronic banking. Making payments with Bitcoins is a lot more like paying with cash than paying with your credit card or debit card. Thirdly, much like you do not require a graduate education in monetary studies to spend fiat currencies, you do not require an advanced understanding of cryptography or indeed technology in general to spend or accept Bitcoin. Fourth, there is no central bank that issues Bitcoin.The purpose of Bitcoin is to eliminate the need for such trusted third parties as central banks. Wiith these popular misconceptions about Bitcoin out of the way, the rest of this primer will read a lot easier.
So, what pray tell is Bitcoin? A bit of history is in order here. In 2008, Satoshi Nakamoto authored a paper that proposed the creation of a peer to peer electronic cash system.. The system would allow online payments to be sent directly from one party to another party, eliminating the need for trusted third parties such as financial institutions by creating trust by cryptographic means. Questions still abound as to the true identity of Satoshi Nakamoto, or whether Satoshi is indeed one person or various people. Satoshi has remained anonymous despite numerous attempts over the years to uncover her real identity. Satoshi is credited with the invention of Bitcoin and the burgeoning number of other cryptocurrencies in existence today.
As any banker or financier will tell you, all money is virtual. Money largely does not exist in the physical sense. Millions are transacted through banks daily simply by changing figures in the bank’s ledger, debiting and crediting accounts. What exist are physical tokens such as paper notes and metal coins. These paper notes and coins are referred to as currency or cash. They serve the important purpose of keeping money current, allowing people to reassign ownership of money. In fact the Miiddle English root of the word current “curraunt” means simply “in circulation”.
Bitcoin is a cash system created in 2009 that utilizes digital tokens called unspent transaction outputs (UTXOs) in lieu of physical tokens such as paper notes and metal coins. Think of these unspent transactional units as digital coins. When you pay with Bitcoin, you reassign ownership of one or more of your digital coins to the recipient. When you accept a Bitcoin payment you receive one or more of these digital coins.
Unspent transactional outputs or digital coins are held in a Bitcoin address. If you were to think of your unspent transaction outputs as cash notes and coins, think of your Bitcoin address as an envelope where you stash your notes. On terra firma , a single envelope may hold one or more currency notes and coins. Likewise, a single address can hold multiple coins at the same time. And just like having multiple envelopes to stash your cash in is possible, albeit unwieldy at times, you may generate multiple Bitcoin addresses to hold multiple coins in at the same time. When making a payment,you may draw notes from different envelopes. Much in the same way a Bitcoin transaction may draw coins from different addresses.
One Bitcoin is currently divided into 100 million smaller units called Satoshis. One satoshi is defined by eight decimal places. That is 0.00000001 BTC. The point here is, Bitcoin is infinitesimally divisible. Ensuring that a single Bitcoin can be divided into much smaller units is important in two ways. First, it makes it easier to price goods and services in Bitcoin and enables people to transact with Bitcoin when paying for every day goods. As at the time of writing this, Bitcoin was exchanging for USD 570.65 on Bitcoin exchanges. Being able to divide a Bitcoin means you would be able to pay BTC 0.001 for bread in Kenya. More importantly, by design only a finite number of Bitcoin will ever exist. This number , 20,999,839.77085749 , is baked into the protocol. It is not hard to imagine a future where Bitcoins would be spread so thinly as to make 0.00000001 BTC valuable. Should further subdivisions be needed in the future, the protocol may be updated to allow for this.
I have mentioned Bitcoin addresses, the virtual “envelopes” you stash your digital coins in. But where do these addresses come from? In explaining this in a later post, the cryptographic underpinnings of Bitcoin will become apparent, but how would one acquire Bitcoins in the first place?
One may mine coins, either alone or in league with others. New Bitcoins are generated by the Bitcoin network through a process called mining. One of the specific limitations of virtual currencies that Bitcoin sought to address is that the person accepting an unspent output or a “coin” can not verify that the owner did not spend the coin twice. This is called double spending . Without the existence of a trusted third party, cases of double spending would be rampant. Bitcoin overcomes this problem by recording every transaction in a global public ledger, the “block chain”. By necessity and design, every Bitcoin transaction is appended to, and remains permanently viewable in, a global public ledger of past transactions called the “block chain”. In case of any doubt, or attempts at double spending, the first transaction recorded stands. Mining is simply the process of adding transaction records to this ledger or “block chain”. Those processing these transactions each receive a subisidy that is proportional to their share of the Bitcoin network’s total computing power.
The process of mining is intentionally designed to be resource intensive to ensure the steady flow of blocks of Bitcoins. The value of a block for the first 210,000 blocks or the first four years was 50BTC. As the amount of processing power present in the network changes, the difficulty of creating new blocks and consequently Bitcoins changes. The difficulty is calculated every 2016 blocks and is based on the time taken to generate the previous 2016 blocks. Anyone can be a miner. That is anyone, with sufficient computing power and wherewithal. Mining was the primary way to acquire Bitcoin in the early days. At the moment though, this process is so difficult as to warrant looking at other ways of obtaining coins.
Accepting Bitcoin as payment for goods sold or services rendered would be an obvious way to acquire Bitcoins. Alternatively, you may purchasing Bitcoin on the hundreds of Bitcoin Exchanges that have sprouted online all over the world. These exchanges allow one to exchange Bitcoin for other currencies. South African Bitcoin exchange BitX are currently setting up shop in Kenya. The BitX Kenya exchange will allow you to deposit and withdraw funds via Mpesa. As mentioned earlier, at the time of writing this 1 BTC was exchanging for USD 570 or approximately KES 51,300.
In the next part I will delve into Bitcoin’s cryptographic roots; examining private keys, and cover the secure messaging system at the core of the Bitcoin payment system.