Bitcoin is the buzz word today. Everybody is talking about it, buying, trading, investing and mining them. But, what exactly is a bitcoin and why is everyone interested in it? Is it any good? How different is it from other currencies? In this article, we will be discussing the same. At the time of writing this article, value of one bitcoin is $17044.99 and before 3 months it costs $3686. Price of a bitcoin is highly volatile.
What is bitcoin?
Bitcoin is the first cryptocurrency invented by Satoshi Nakamoto in the year 2009. A cryptocurrency is a digital currency which uses cryptography for securing the currency. It only exists electronically! Unlike actual currencies, cryptocurrencies are not backed by any government or central authorities. Which means the production, valuation and transfer of these currencies are not determined by any organization. Bitcoins are exchanged in a worldwide peer to peer network and the faith of these peers on bitcoin determines the value of bitcoin.
So if there is no central organisation that regulates bitcoin, then who keeps check on the transactions and how is it safe? Answer is BLOCKCHAIN! Blockchain is one of the four pillars on which bitcoin is built on. It is nothing but a chain of blocks. Blockchain is a public ledger (database which stores transactions). Each block contain verified transactions made using bitcoins and blocks are attached to the blockchain. Each block is encrypted with the data in the block and hash of previous block. So when the block is added to the blockchain, it cannot be altered. Transactions are verified and added to the block by special nodes in the network called “miners”. Detailed discussion will be in later section.
Why bitcoin exist?
Simple, because of flaws in current financial institutions. Central Banks regulate and monitor currencies in a country. This is a trust based model and the government can print more number of notes when needed or can withdraw all the notes if they want (Demonetization of certain Indian currency notes in December 2016 is a prime example for this.) By printing more notes, value of currency is lowered. Fraud and counterfeiting is another issue with current banking system. In bitcoin, this is eliminated as each transaction is verified by multiple miners and transactions are not reversible. Banks charge heavy transaction charges for their operational needs and this is significantly low in bitcoin. Transaction fees of bitcoins varies from wallet to wallet. Also bitcoin eliminates double spending problem.
Transparency and neutrality is the main advantage of bitcoin. To explain this, have you ever wondered what happens to the money you deposit in banks? Some of us might know that, it is given as loans for others. But do you know to whom your money was lent? No! Because the bank doesn’t let you know that. Your money is used for various other purposes and you have lost all control over the money that you actually own. This is because, there is no transparency in banking sector. What if, the person to whom your money was lent couldn’t return it. Money is lost but your amount is compensated by giving you someone else’s money. Financial crisis and inflation are byproducts of current banking sector. In bitcoin, every transaction ever happened is recorded and stored in blockchain and can be verified at any time.
What is mining?
Consider person A sends bitcoins to person B. This transaction is broadcast to the network. Miners receive this transaction and verify this transaction. Every transaction has the address of the payee and payer along with the amount of coins and timestamp. Every bitcoin user has a public key and a private key. Private key is used to sign the transactions and using public key of the user, others can view the transactions by the user. Miner checks the validity of this transaction by checking whether the payer has the amount of bitcoins to transfer. Once transaction is verified, block is added to the blockchain. After filling the block, it is added to the blockchain after encrypting the block. SHA256 is used to encrypt the block. Hash of the previous block and content in the new block is used to generate hash of the current block. This is called mining. SHA256 uses any length of data and convert to unique string of length 256 bits. This hash cannot be reverse engineered. Let us look at a simple example. 1+2+3+4+5+6+7+8+9=45. But given sum = 45, chances of predicting the variables is very less.
Who are miners?
Miners are volunteers who keep blockchain updated. And each miner has the same blockchain ledger on their machines and there are over 100,000 miners. Every miner gets transactions and they add to their block. Since there are multiple miners creating blocks to add to the blockchain, there will be a possibility of having same transactions in different orders because of network delays. This is solved by solving a mathematical puzzle associated with the block. Which ever miner solves the puzzle first, block from that miner is added to the blockchain. But what if two miners solve the puzzle at same time? Blockchain will accept the block from the miner which has more trust and keep on adding blocks. These tasks are computational heavy. Current size of bitcoin blockchain is more than 100GB. Miners use high end ASIC machines and GPUs to verify transactions and hash blocks to add into blockchain. Energy consumption of these devices are huge. Then why do miners volunteer to keep blockchain updated? When a block is added to the blockchain, the miner is awarded few bitcoins. Also miners get a small amount of bitcoins as transaction fees for verifying transactions.
How bitcoins are generated?
New bitcoins are generated when a miner adds a block to blockchain. Total number of bitcoins that can be mined is 21 million and is estimated that last bitcoin will only be mined in the year 2140. At present, new block is added to the blockchain in roughly 10 minutes. So every 10 minutes new bitcoins are mined. Reward for mining is not fixed. In early stage, 50 bitcoins were rewarded for every block added. For every 210,000 blocks created, reward becomes half. At the time of writing this article, reward for mining a block is 3.125 bitcoins. This decrease in rewards keep the price of bitcoin increasing (One of the several reasons!)
In the next article, will discuss on, how to purchase bitcoins, limitations and few other things related to bitcoins.