What is Bitcoin?
Bitcoin is popularly known as a high-growth and high-volatility cryptocurrency, but there still remains confusion as to what it exactly is a Bitcoin.
To understand what exactly a Bitcoin is, we must first understand the motivations behind its creation.
With the advancement of financial technology and the advent of e_commerce, online transactions have primarily relied on third party institutions such as banks to approve electronic payments.
Although this system has sustained fairly well, there is a large amount of trust and dependency placed on these institutions.
A downfall of this is the presence of fraud and disputes that is entirely settled by the bank/institution which not only increases costs and payment processing time, but also places pressure on merchants to receive payment for sales. As such, the third party financial institutions act as a single point of failure (SPOF) in the electronic transaction world.
Money stored in banks that is used to make online purchases is controlled by the bank and can be used in many ways such as loans. The substantial trust placed on these institutions creates the opportunity for failure.
In fact, this is exactly what happened in the 2008 financial crisis where unregulated banks became greedy and took excessive risks in private mortgage loans which bursted the real estate bubble, resulting in bankruptcies and an economic collapse.
Dangers of the centralization of these financial institutions were recognized far before the creation of bitcoin; these early attempts to address this problem were conceptualized by never fully developed.
In early 2009, an anonymous individual or group known as Satashi Nakamoto proposed the use of a peer-to-peer electronic payment system known as Bitcoin. Bitcoin was inspired by many of its predecessors such as B-money and HashCash that introduced a system for decentralization and security. This system enabled a currency system controlled completely by the peers in the Bitcoin network.
The algorithms and technology behind Bitcoin came to be known as blockchain and is now used to develop different types of decentralized applications (dApps) other than currency. Blockchain systems have made significant advancements over the past few years, but we will focus on the proposed blockchain framework for Bitcoin. A hashing function (SHA256) generates a hash for each transaction that occurs which then gets added to a block. Each block is connected to its previous block through a previous hash pointer, with the exception of the genesis block, which is the first block in the chain.
Third party institutions like banks are able to prevent double-spending of money by verifying all transactions that occur. This is a problem in decentralization that is addressed by Bitcoin using a peer-to-peer network.
A group of miners approve transactions to the Bitcoin network through a consensus algorithm known as proof of work, a zero-knowledge proof, where they attempt to generate the hash using large amounts of computation. This system has the benefit of keeping a single immutable record of transactions that is agreed upon by the majority of miners in the network. This record of transactions is shared across all users in the Bitcoin network and prevents people from double spending their Bitcoin.
Miners are offered an incentive (a certain amount of Bitcoin) for being honest and computing hashes.
To break the system, an attacker would have to redo all the proof of work and alter the hashes for each block.
This is probabilistically infeasible as long as the majority of nodes are honest.
Bitcoin was intended to be an alternative form of payment that allowed both privacy and security.
Satoshi Nakamoto capped the Bitcoin supply to 21 million; this would prevent high rates of price inflation and allow for steady growth over time.
Ultimately, Nakamoto’s goal was to align Bitcoin’s eventual price with present fiat currencies.
As with any asset, Bitcoin’s value is determined by the demand for it. Despite its benefits, its use has been controversial with regards to the types of transactions it facilitates and has recently come to be regulated by government entities.
These factors along with news and heavy speculation affect the demand for Bitcoin which results in its high volatility compared to other types of assets.
To purchase Bitcoin and send it to others, one must create a Bitcoin wallet that is composed of a public and private key unique to the user.
In essence, a Bitcoin is really just a digital currency stored on a user’s Bitcoin wallet that can be used to make digital transactions without the mediation of a third party.
The Bitcoin in your wallet is completely yours to control (unlike banks where money is lent out) given that your wallet’s private key (used to verify transactions) is secure.
Of course, Bitcoin is also a popular investment vehicle and heavily traded on the markets. With its liquidity and uncertainty about its future wide-spread use, its value has wildly fluctuated over the past few years.
Currently, the miners introduce new Bitcoin into the network through the reward of proof of work. There will be a point in the future when all 21 million coins are mined by the miners. Although only 3 of the 21 million existing Bitcoins are left to be mined, an event known as halving is present in the current Bitcoin system: for every 210,000 blocks added to the blockchain, the proof of work reward for miners is cut in half. This was another precaution implemented by Nakamoto to prevent price inflation.
Although it only took a few years to mine most of the Bitcoin, it will take until at least 2140 to mine the remaining amount because of halving. Once that point has come, miners will only be incentivized to verify transactions by the transaction fees that occur rather than the reward. Until then, it is possible for the Bitcoin infrastructure to change and add more coins. However, the impact on the markets when that time comes still remains a mystery.
In the present day, its value has recently skyrocketed to around $40,000, the highest it has ever been. Compared to its price of 8 cents when it was first traded in 2010, Bitcoin has revolutionized financial technology and has led to the creation of thousands of other cryptocurrencies.
It is one of the hottest alternative investments to date and is expected to continue its rise; JPMorgan investment bankers have predicted Bitcoin’s price to grow up to $146,000 in the long term as an alternative to gold. Sentiments about Bitcoin have been increasingly optimistic as more and more investors have decided to enter the crypto world.
Undoubtedly, Bitcoin will continue impacting technology, financial markets, and investments, but its future is still uncertain and remains to be discovered.
Written by Samson Qian
Edited by Alexander Fleiss,
Bitcoin whitepaper: https://bitcoin.org/bitcoin.pdf