What the hell is a Bitcoin? Don’t be embarrassed if you’ve been left scratching your head as the new cryptocurrency phenomenon has boomed around you. You’re far from alone. It’s a complex concept that not only requires a working knowledge of the stock market, but a deep understanding of tip-of-the-spear technology, too. But you do need to understand it, make no mistake. And it’s not just because you keep hearing people say things like, “I just picked up some Ripple during a dump and now it’s starting to moon dude, yewww!”
Instead, Blockchain, the technology at the heart of the cryptocurrency movement, has applications that extend well beyond the realms of cryptocurrency. Plus, cryptocurrency itself is becoming more widely accepted as a form of payment, able to be spent at digital stores and withdrawn – as cash – from ATMs. So let’s dive in with a bit of Bitcoin 101 and level-up on cryptocurrency.
We’re going to start with a technical overview, so fair warning. Take a deep breath and stick with us, it will all make perfect sense at the end. The term cryptocurrency refers to a digital currency that is encrypted by a sophisticated algorithm so that it can be securely passed between two individuals. Each unit of cryptocurrency, right down to the smallest possible fraction – in the case of Bitcoin, its 0.00000001 – has a unique encrypted code given to it as it is created. This code looks like a long string of numbers and letters, but you can just think of it as the Bitcoin’s name.
Each individual who wants a particular cryptocurrency is also given a unique encrypted code. This is called their wallet, and it acts as their address in the cryptocurrency world. It’s a location where things can be sent to and sent from, and every fraction of a cryptocurrency is never without ownership. It is given as a reward by the creators of a cryptocurrency to those who contribute their computer’s power to the support of its network. As a result, a cryptocurrency is not a commodity or a product that sits on a shelf waiting for you to come along and buy it. If you want to buy it, then someone else has to be willing to sell it.
This ensures there is always a finite number of units of a cryptocurrency available, which creates a supply and demand environment. As a result, the value of any given cryptocurrency changes continuously, based on the perceived value of those invested in it? Ok, still with us? Now let’s break all that down for you.
If there is only one term from the cryptocurrency phenomenon you’ve heard before, that term is likely “Bitcoin.” As in, “what’s all that Bitcoin stuff about?”
A Bitcoin is a form of digital currency. It’s not the only form: at the time of this writing, there are another 1383 altcoins (so named as they are alternatives to Bitcoin) being traded across the world. But Bitcoin was the first to be decentralised (we’ll explain what that means later) and is what spawned the cryptocurrency industry we see today. Bitcoin was created by an individual or a group – nobody is sure – going by the moniker Satoshi Nakamoto, and it was first released in 2009. It came in answer to the question; how can we take the control of money off the banks?
Traditionally, transactions occur through a centralised bank. Your money is effectively invested in that bank, where it sits in an account. Money comes in; money goes out. The bank holds and controls the ledger of all transactions that occur, and in doing so, it can decide how and when they will occur, what fees it will charge for the privilege, and how it will invest and make a profit off your money. It’s why most people don’t like banks. Banks suck. Bitcoin, on the other hand, is decentralised. There is no central Bitcoin bank. Instead the ledger that stores all the information about transactions in Bitcoin is stored simultaneously on thousands of networked computers all around the world and is therefore controlled by the community. It does this through the blockchain.
A digital currency needs a ledger, too, and it’s called a Blockchain.
Imagine an ordinary paper-based ledger: a book in which you write down all the transactions that happen in your life. Your money comes in and your money goes out. Once a transaction is recorded in the ledger, it cannot be altered. But you can always add a new transaction to its end. All currencies need some form of ledger to document their history and for most of us, it comes in the form of a bank statement. A digital currency needs a ledger, too, and it’s called a Blockchain. The term is literal. It’s a digital construct made up of a number of blocks, all of which are chained together in the order in which they were created. Each block records the transactions that occurred in that moment in time. And when the block is full, a new block is added to the end, lengthening the chain. Just like when you fill up a paper ledger and need to start a new book.
You’ll recall earlier in this article, we spoke about how each fraction of a Bitcoin has its own unique name. And also, that each individual in the Bitcoin world has their own unique wallet address. When one individual buys a Bitcoin from another individual, a transaction needs to be recorded in the ledger, which is the Blockchain. It effectively reads, the Bitcoin with [this name] was in the wallet with [this address], but now it is in the wallet with [this other address].
Bitcoin was the first decentralised digital currency, but what does that actually mean? With a traditional bank, it holds the ledger and it keeps it secure. With a cryptocurrency, anyone can have the ledger. It can be on your neighbour’s computer; it can be on your computer. The entire history of every transaction that has ever happened, everywhere. Bitcoin exists in a network of peer-to-peer connected computers, owned and run by the community itself. If you connect your computer to this network – which is as simple as downloading some software from the Bitcoin website and letting it run – you will be referred to as a Node. The combined computer power of these Nodes not only power the transactions that occur in a cryptocurrency, but they also store the Blockchain.
Now you may be wondering how such a setup could be secure; surely you could just change the Blockchain so it looks like every transaction leads to your wallet. But here’s the critical trick that makes the decentralised model work. Whenever someone puts up their Bitcoin for sale and another person buys it, that transaction must be confirmed. To do this, the network examines the Blockchain sitting on random Nodes in the network to ensure the purity of that transaction. If it determines that all is ok – as in, the coin’s unique name has not been used in another transaction at the same time – then the trade goes through. As a result, if you wanted to alter the Blockchain for your own reward, you’d have to alter it in the same way, at the same time, on more than 50% of the Nodes in the network. Not likely!
As you can imagine, allowing your computer to connect to this network and contribute its power to the cause taxes your hardware. And your electrical bill! So the makers of Bitcoin want to reward you for chipping in. If you act as a Node, each time you help confirm a transaction you earn a tiny bit of Bitcoin. This is called mining. When you hear of people “mining for Bitcoin” what they are doing is letting their computer be a Node in the network, in order to earn some Bitcoin. This is how the loop is closed. Bitcoin is gifted by the currency’s makers to miners as a reward for sustaining the network. These miners then take the Bitcoin and can sell it into the market.
We mentioned earlier the 1383 other altcoins currently on the market, and there are more appearing all the time. The ones you may have heard of include Ethereum, Ripple, and Cardano. There’s been an explosion in interest through the end of 2017 and into 2018, with a number of coins growing in demand – and therefore price – as they fight to be second behind Bitcoin. In order to get a market edge, these coins often offer alternative selling points to the standard set by Bitcoin. Variations in the way they use the Blockchain, for example, or their security measures, or the anonymity of the transactions. It’s important to note that each altcoin uses its own Blockchain and exists as its own defined community.
Meet Casey – say hi to Casey everyone! Casey would like to buy a Bitcoin. She does a search online and finds a popular exchange that trades in Bitcoin. An exchange in the cryptocurrency world behaves much like an exchange in the real world. A place where you might take your wad of U.S. dollars and exchange them for another currency. She signs up, goes through the detailed verification process where she must prove she is who she says she is, and is then given her wallet code. Casey then uses her bank account or credit card to deposit $500 into her wallet. Once it appears in her wallet, she uses that cash to buy some Bitcoin. Some time passes while the transaction is being confirmed by the community, and then it appears in her wallet.
That night Kim Kardashian tweets about how much Bitcoin she just bought and it goes viral. Demand goes up, and with it the price – a whole 16%. The next day Casey logs onto the exchange and sees her Bitcoin is now worth $580. She decides to get out while she is in the black. She withdraws the amount back to her bank account, and heads to the shops. Way to Bitcoin, Casey!
This is Chris Stead’s first freelance feature for IGN. Say hi to Chris, everyone.