Oct 20, 2020
Introduction to Bitcoin
In this article, we will come back to the origins of Bitcoin, the motivations for its creation, and the characteristics that make it so unique and innovative. Presenting how Bitcoin works should leave the reader with the necessary knowledge to dig deeper into the subject.
The origins of digital currency
Originally, Bitcoin was simply yet another attempt to create an independent digital currency. In the 90s, cryptographers trying to do this came up against several obstacles:
- the double spending problem
- controlling the quantity of money
- decentralization
The double-spending problem is being able to ensure that a digital currency is not spent more than once. It’s trivial with bills, but much more complicated online.
Then, if the quantity (supply) of money is not controlled, whoever issues a large quantity for his own benefit would totally devalue it (cf. the Mark crisis in the 1920s).
Finally, having a decentralized system is necessary to ensure that no entity can validate fraudulent transactions or take over control of the money supply.
The appearance of Bitcoin
The global financial crisis of 2007–2008 confirmed to Satoshi Nakamoto the need to create an electronic money, decentralized and independent from the current financial system. He therefore published Bitcoin’s white paper, titled “Bitcoin: A Peer-to-Peer Electronic Cash System”.
Its publication solves the problems discussed above by taking advantage of several technologies already known at the time, such as asymmetric encryption, peer-to-peer networking, proof of work mining, and distributed ledger.
Difficulty adjustment and monetary policy
One of Satoshi Nakamoto’s great innovations with Bitcoin is the adjustment of new bitcoins’ creation, which adapts to take place about every ten minutes, no matter what (it’s actually an adjustment of the problem’s difficulty that miners need to solve in order to create those bitcoins, which we discuss a little below). This solves the problem of money creation control mentioned above, with an issuance which is non-modifiable, planned in advance, and known to all.
In addition, this creation is divided by two every four years, a phenomenon called halving. Over the years, the issuance of new bitcoins will become almost zero, with the total amount of bitcoins increasing up to around 21 million. Bitcoin is therefore characterized by an immutable monetary policy, decreasing inflation, and a limited total quantity.
A balanced network
Another strength of the Bitcoin network is the balance between its different actors:
- users
- developers
- validator nodes
- miners
While the roles and responsibilities of users (exchanging bitcoins) and developers (improving the system) seem natural, those of validating nodes and miners are not. They both play a unique, simple, yet essential role.
- Validator nodes check the validity of the transactions they observe, transmit them if they are valid and reject them if they are incorrect. The cost of these operations is very low. In practice, anyone can download the Bitcoin Core software and participate in the validation of network transactions. You simply have to buy a dedicated mini computer (about 150 €), and install a software that takes care of everything, like this one. Not much to “be you own bank”.
- Miners group together sets of valid transactions into a block, which they then publish on the blockchain. In order for a miner to obtain the right to post a block, he must solve a simple problem that cannot be optimized, and that requires a certain energy consumption. The miner of each block is then rewarded by the issuance of new bitcoins. Minors are thus incentivized by the very structure of the network to keep it running smoothly.
An open and decentralized network
Bitcoin has several other characteristics that make it a unique currency network:
- It’s an open network. Anyone with an internet connection can start using Bitcoin. The code of the protocol is also visible and searchable by all.
- It’s a decentralized network. There is no central governing body, no CEO or board of directors. This has two main advantages: no single point of failure, and censorship resistance. No one can prevent a valid transaction from happening.
- It’s an autonomous network. All of its participants maintain it and decide how it should develop.
A currency in the making?
Driven by technical, economic, and ideological motivations, Satoshi created in 2008 an electronic cash model which has all the fundamental characteristics to function as such. Contrary to what some speeches suggest, Bitcoin does not necessarily have to be a democratic currency and replace sovereign currencies, but rather a “ […] free, international currency”, as Yorick de Mombynes said recently. As it is gradually more accepted and used by the general public, it will naturally continue to assert itself as a currency.
If you want to continue your exploration on the subject, here are some resources that may help you:
- Explain Bitcoin Like I’m Five, the most educational article I’ve read on the subject.
- This guide in the form of slides, very complete while remaining easily understandable. You will be familiar with the topics of parts 1 and 2, and parts 3 and 4 will give you new, more practical knowledge.
