What is Bitcoin and How does it Work?

It is no surprise that Bitcoin emerged in 2008 just after Occupy Wall Street accused large banks of misusing borrower money, tricking customers, manipulating the system, and charging overwhelming fees. The bitcoin pioneers wanted to put the seller in charge, eliminate the broker, cancel interest rates, and make transactions transparent, to cut corruption and eliminate fees. They created a decentralized system, where you can control your funds and know what is happening.

Bitcoin has come a long way in a relatively short time. Around the world, companies, from REEDS Jewelers, a large jewelry chain in the United States, to private hospitals in Warsaw, Poland, accept their currency. Billionaire merchants like Dell, Expedia, PayPal, and Microsoft also do.

Websites promote it, publications like Bitcoin Magazine publish their news, forums discuss cryptocurrency, and trade their coins. It has an application programming interface (API), price index, and exchange rate.

But what the heck is bitcoin? For me, it is a somewhat funny question due to the great diversity of opinions that you find. But it is a very important question that everyone should be looking for an answer to.

So I congratulate you on belonging to the minority, the one that is interested in investigating beyond what the traditional press says.

Normally the types of responses you hear on the street about What is bitcoin ? are within these four groups:

1. Bitcoin is “magic internet money”

This is not such a bad answer because Bitcoin is something magical. In the sense that it allows us to do things that had never been possible until its creation.

2. The second answer you can hear: “Bitcoin is drugs and illegal activities”

And to be fair it is not entirely uncertain, there are drugs and illegal activities that you can pay with Bitcoin. But just like you can pay drugs and illegal activities with Euros, Dollars or the currency of your country.

3.Another type of response: “Bitcoin is betting”. Either through gambling or through speculation with the value of the currency.

And it is true that there are currently a lot of games of chance. Also a lot of speculation with the price of Bitcoin, but this is not its fundamental value.

4. And the fourth type of answer you can hear is the notion that “Bitcoin is normal money.”

That you can do the things you do with traditional money and therefore, Bitcoin is just another form of current money.

Although these 4 types of responses are “somewhat” true, they all fail to capture the full picture. There are tons of things you can do with Bitcoin that you can’t do with traditional money.

What is Bitcoin In-Depth?

Bitcoin is a cryptocurrency or virtual currency. Bitcoin is a decentralized peer-to-peer (peer-to-peer) network. No institution or person controls its emission, expense, or reservation.

It is a self-regulated payment unit without a physical reference or country endorsement, which preserves the anonymity of its owners and whose transactions are carried out through the internet using encrypted codes and confirmed multiple times by the members of the network itself (through the so-called ‘ blockchain ‘ technology, in practice a ledger or shared activity log). Knowing a code makes you the owner of that asset (cryptocurrency). It is a fully digital currency.  Bitcoin (BTC) is the first digital currency, used and distributed electronically.

The production of each Bitcoin is maintained digitally and it is made under a controlled emission policy in which there are only 21 million units.

One of the most controversial aspects is the process of creating bitcoins, which has come to be called mining. In practice, it has come under the control of a few hands, most organized groups based in Asia.

In summary, bitcoin is a virtual currency or reference to technology. You can make transactions by check, transfer, or cash. You can also use Bitcoin (or BTC), where you direct the buyer to your signature, which is an extensive line of encrypted security code with 16 different symbols. The buyer decodes the code with his smartphone to get your cryptocurrency.

In other words; cryptocurrency is a digital information exchange that allows you to buy or sell goods and services. The transaction gains its security and trust by running on a peer-to-peer computer network that is similar to Skype, or BitTorrent, a file-sharing system.

The transactions made with bitcoin are through a union way via the internet, which means that these transfers of the bitcoin currency can be made nationally and internationally, transferring different amounts between two devices, without the need to assist a bank or organization that handles such transaction.

Who Created Bitcoin?

Bitcoin was first introduced as open-source software by an anonymous programmer, or a group of programmers, under the alias of Satoshi Nakamoto in 2009. The economic crisis the financial sector was undergoing due to the real estate bubble and the respective decision that The governments took to print inorganic money to rescue the banks was one of the main motivations of Satoshi to create the currency, and we can see it in the image that was recorded in the Genesis Block of Bitcoin.

There are still many rumors about the true identity of the creator of BTC. However, all the people mentioned in those rumors have publicly denied being Nakamoto.

Nakamoto himself once said that he was a 37-year-old man living in Japan. However, due to his perfect English, the hours he was participating in the forums, and his unlabeled software in Japanese, reasonable doubts are raised about this. Around mid-2010, Nakamoto moved on to other things, leaving Bitcoin in the hands of some prominent members of the BTC community. Satoshi also appointed Gavin Andresen as lead developer.

The figure of Satoshi Nakamoto is presumed to own around 1 million Bitcoins, representing about 5% of the asset’s global issuance.

How Does Bitcoin Work?

By way of visualization, users only see the amount in Bitcoin they have in their wallet and the results of the different transactions they have made with the currency.

However, behind the scenes, a public book called “blockchain” is being shared on the Bitcoin network and is running 24 hours a day, 7 days a week. This book contains every transaction processed between network users. Digital transaction records are combined into “blocks”.

If someone tries to change just one letter or number in a transaction block, it will also affect all the following blocks. Because it is a public book, the error or fraud attempt can be easily detected and corrected by anyone.

In addition, to make such a change in the Bitcoin network, it would be necessary to have more computing power than all the power connections within the network. Neither Google nor Facebook has such computing power in the world.

Each user’s wallet can verify the validity of each transaction. In order to provide authenticity for transactions, they are protected by digital signatures corresponding to the shipping addresses.

Due to the verification process and depending on the trading platform, it may take a few minutes for a BTC transaction to complete. The Bitcoin protocol is designed so that each block of transactions takes around 10 minutes to extract.

To send a certain amount of bitcoin, you must publish your intention to transfer a certain amount. The verification nodes will then come and scan the entire network to ensure that:

  • You have the amount you want to send
  • You have not already sent it to someone else.

Once this information has been confirmed, then your transaction is included in a “block”. This block is related to the previous block, hence the term blockchain, which means, blockchain. Transactions cannot be changed after the fact because that would mean that each block that came to be attached to it would have to be reproduced.

==> Each transaction is checked and included in a block, which secures the exchange information.

Where Can I Store My Bitcoins?

We need to have a crypto wallet to store these digital currencies.

There are a variety of options, but the main ones can be reduced to an online wallet, also called a hot wallet, and a software wallet called a cold wallet. Both options have their advantages and disadvantages.

On the one hand, we can see that online wallets are susceptible to hacks by computer criminals, being able to compromise our funds at any time, but these wallets allow us to access our funds from wherever we are.

On the other hand, hardware wallets are much more difficult to hack and this implies that our funds are more secure within these wallets. However, if this hardware is damaged or lost, we would lose all the funds we had stored here.

There are also mobile wallets, which are very simplified and are very convenient for users who do not know as much about Blockchain technology but still want to use cryptocurrencies

However, most people use online wallets.

Examples of these wallets are Blockchain wallet, Luno wallet, Coinbase wallet, etc.

The security of your wallet

In reality, your bitcoin wallet does not actually hold your bitcoins. What it contains is your bitcoin address, which holds the record of all your past transactions, and therefore your balance. This address is a series of 34 letters and numbers. It is called the “public key”.

It is, therefore, as its name suggests, public. Anyone can know it without putting you at risk. Any public key has as a corollary a “private key” which corresponds to it. These are 64 numbers and letters. It is therefore private, and it is very important that you keep it confidential to protect your bitcoins. The two keys are certainly associated, which does not mean that anyone can guess your private key from your public key.

Any transaction you make from your address must be “signed” with your private key. This proves that you are behind the transaction. To do this, you enter your private key as well as the transaction details (how much you want to send, and to whom) on your bitcoin software. With this information, the program creates a digital signature, which is sent to the network for validation. At no time does your private key appear publicly. Only the digital signature appears.

==> This double key system, private and public, allows you to protect your wallet and your bitcoins.

Bitcoin mining

The new bitcoins are generated by a decentralized process called “mining”. This process is based on the fact that individuals are rewarded by the network for their services. Those who get the bitcoins are the miners. They confirm the transactions and generate the new blocks. Thanks to these computers that generate computing power that the system is secure.

At first, a normal computer was enough to mine bitcoins, but since its price has soared, engineers have developed machines specialized in bitcoin mining. They are very expensive, which means that bitcoin mining is now reserved for people who want to invest in its value. The computing power solves a cryptographic problem called SHA-256, which is extremely hard to find but extremely simple to verify.

What Can Be Done With Bitcoins?

With bitcoins, you can pay for a good or service. You can buy bitcoins at exchange houses or create bitcoins using machines designed for it. But in practice, the number of transactions is minuscule compared to that of other means of payment. Bitcoin would be the result of the payment for the theoretical consumption of the energy required in the process of its creation.

Without having a merchant account you can have bitcoins. Payments are generally made using mobile or computer applications, by entering the recipient’s address (the bitcoin account), the amount to be paid, and pressing send. Once the button is pressed there is no turning back, the virtual currency will have changed hands.

Bitcoin Features

Decentralized

One of Satoshi Nakamoto’s primary goals in creating Bitcoin was the independence of the network from any government authority. It is designed so that any person, company, through the computation that they use in the mining process and the verification of transactions, is part of a huge network. Also, even if a part of the network goes down, the money will keep moving.

Anonymity

These days banks know practically everything about their clients: credit history, addresses, telephone numbers, spending habits, etc. Likewise, the digitized system governed by Google and Facebook is managing to track all our actions with just a couple of clicks. Everything is very different if we use Bitcoin since the wallet we have to store and spend our coins is not linked to any type of personal information.

Bitcoin’s anonymity is relative, as every BTC transaction that has happened is stored on the Blockchain. In theory, if your wallet address was used publicly, anyone can know how much money is in it by carefully studying the blockchain ledger. However, tracing a particular Bitcoin address to a person is still almost impossible.

Those who wish to remain anonymous with their transactions can take steps to stay under the radar. There are certain types of wallets that prioritize opacity and security, but the simplest measure would be to use multiple addresses and not transfer large amounts of money to a single wallet.

Transparency

As we mentioned earlier, transactions within the Bitcoin Blockchain network are kept within a Public Book that is recorded on the Blockchain and is visible to everyone. This implies that all operations within the network are visible but what cannot be traced is the particular property of each Bitcoin that people have within the network.

Speed

Operations within the Bitcoin Blockchain network are intended to be resolved in a matter of minutes, regardless of the location of the participating parties to the operation. Compared to national and international banking services, Bitcoin has a considerable advantage from the point of view of the speed of execution of transactions.

Irreversibility

Once a transaction is made within the Bitcoin Blockchain, there is no way to reverse it. This feature can be a double-edged sword that we must use with great care. On the one hand, it is positive since we can be sure that each Bitcoin we receive cannot be returned to the person who sent it to us, but we must understand that this feature can also harm us when we send our Bitcoin to another address. It is recommended to verify that everything is correct before carrying out any type of operation.

Pros of Bitcoin

1.Freedom

In the guarded world we have today, freedom is presented as an invaluable asset. We cannot say that we are free from the controls and surveillance of government authorities if we have hundreds of taxes and limitations to use our money freely.

Bitcoin is not tied to these controls and offers us freedom that no other asset can give us. In addition to being able to use our money freely, with Bitcoin we are not controlled by the restrictive monetary policies issued by States, nor should we worry about inflation or interest rates generated by government entities. In Bitcoin, only the market rules.

2.High portability

One of the distinctive characteristics of money is portability, which means that it must be easy to transport and use. Because Bitcoin is fully digital, virtually any sum of money can be carried on a flash memory drive, or even stored online.

Cryptocurrencies give people the freedom to send and receive money with just a QR code scan or a click on an online wallet. It takes very little time, there are no outrageous fees and the money goes from person to person without unnecessary intermediaries; all you need is to have internet access.

3.Ability to choose your own commission

Another indisputable advantage of the Bitcoin network is the ability to choose the amount of the transaction fee, or the option to not pay it at all. The transaction fee is received by the miner after a new block with a successful hash is generated. Generally, the sender pays the full commission, while deducting it from the recipient could be considered an incomplete payment.

Commissions are completely voluntary and serve as an incentive for miners to ensure that that particular transaction is quickly included in a new block that is generated. This incentive also works as a source of income for miners and usually brings more money than traditional mining, especially if we consider that mining activity will stop completely in the future when the Bitcoins production limit is reached.

Therefore, the cryptocurrency market asks users to choose between cost and waiting time. A higher commission means faster processing, whereas if we decide to pay a low commission, the transaction will take longer.

4.PCI Free

PCI refers to the Payment Card Industry and involves debit, prepaid credit, electronic wallet, ATM and point of sale, and associated companies. It is made up of all the organizations that store, process, and transmit cardholder data and are regulated by strict security and control standards.

While unified rules and regulations may be good for large companies, they may not take into account each person’s needs. By using Bitcoin, there is no need to comply with PCI regulations, which can allow users to expand into new markets, where credit cards are unavailable or fraud levels are unacceptably high.

By not being regulated by this organization, users get lower commissions, reduced administrative expenses, and the opportunity to expand their markets.

5.Security and Control

No one can control Bitcoin transactions for us, which means that no one can withdraw money from our account unless they have our authorization to do so. All of our funds are safe within the Bitcoin Blockchain network and no one can steal or touch them.

Furthermore, our identity and personal information is kept totally secure in these spaces since we do not need to reveal any type of information in order to use Bitcoin within its Blockchain network. What we will have to do with our personal information is go through an identity verification process required by exchanges and different portals where Bitcoin is bought and sold by FIAT currency.

6.Transparent and neutral

Every transaction within the Bitcoin Blockchain, as well as every bit of information about it, is always available to everyone on the Blockchain, which can be verified and used in real-time. The BTC protocol is encrypted, which implies that no human being or organization can control or manipulate it at their will. The network is decentralized, so no one can ever have full control over it. All this implies that Bitcoin will always remain neutral, transparent, and predictable.

7.It cannot be falsified

One of the most popular forms of counterfeiting in the digital world is using the same money twice, which makes both transactions fraudulent. It’s called ‘double spending’. To counter this, Bitcoin, like most other cryptocurrencies, uses Blockchain technology as well as the various consensus mechanisms built into all BTC algorithms.

Blockchain technology and its irreversibility allow that once a Bitcoin is spent, it cannot reappear in the wallet of the person who has spent it.

Cons of Bitcoin

1.Legal issues

It can not be said that there is a single universal regulation for Bitcoin, each country has its own and considerable variations can be seen. In some countries, the use and trade of BTC is encouraged, while in others it is prohibited and considered illegal.

Different countries have determined that Bitcoin can be used for different illegal activities and that is why they have sought to control it in some way. Some are concerned about its use within the deep web as a payment method for illegal activities such as drug trafficking or the illegal purchase of weapons.

Other countries also claim that the use of BTC is being implemented for money laundering and tax evasion activities, leading to a loss of capital for the coffers of countries around the world.

2.Recognition level

Bitcoin does not need a law to function, it remains active regardless of whether the law considers it a financial asset or not, however, the lack of regulation and regulation of Bitcoin still generates some uncertainty for its use.

As long as there is no entirely clear regulation regarding its legality or illegality, companies around the world cannot determine its use within their different financial systems. In addition, many investment funds have not yet decided to participate in this market until governments make a clear statement regarding this currency.

3.Lost keys

A key is a unique alphanumeric password required to access a Bitcoin wallet. Losing that key essentially means losing your wallet. However, most of the current wallets have a backup and restore mechanisms, but obviously the user needs to configure them before they can be used.

4.Volatility

Bitcoin has been somewhat erratic in its prices, presenting strong ups and downs, going through several cycles of plummeting rises and falls. Throughout its history, BTC has been conquering new heights, only to have a massive drop immediately afterward. Its value is unpredictable, it changes rapidly and drastically, which can cause significant financial harm to a reckless investor who doesn’t really know how the market works.

In conclusion

Bitcoin technology has not yet been fully developed, it continues to grow as developers are added to the project. Likewise, the currency has not yet been adopted in a really massive way, which implies that we do not know how this currency will work when everyone is using it. We do not know if the network will really be able to support mass adoption or if, on the contrary, it will collapse.

See Also
How do Credit Cards Work?
How much money is there in the world?