What is Bitcoin?
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We spoke about the technology that powers Web 3.0 so it’s only right for us to talk about the first implementation of blockchain in a cryptocurrency. Today, we’re going to discuss Bitcoin.
Created in 2009 by an anon (anonymous person) or a group of anons using the alias Satoshi Nakamoto, Bitcoin is the first successful attempt at a decentralised and deflationary cryptocurrency that is powered by cryptography. It is decentralised because it uses blockchain technology instead of a centralized database and it is deflationary in nature as it has a cap of 21 million tokens. There are no physical bitcoins, only balances stored on a distributed ledger (blockchain) that everyone has access to.
According to the white paper, Bitcoin was created with the motive of having ‘digital cash’ that would allow online payments to be sent from one party to another without an intermediary (banks) to verify the transactions. The creators of this digital currency envisioned a future where trust based payment systems would be replaced by systems working on cryptographic proof.
So essentially, you and I could transact in Bitcoin using our wallets on a decentralised exchange without involving a financial institution.
To get this system up and running, a few tools were required. The most important ones are:
blockchain
hashes
mining
halving.
There’s 2 more tools that we require to transact in bitcoin; keys and wallets (not the ones in your pocket). More on them in the future!
If you’ve been following this newsletter closely, you’d know about the first 2 important tools i.e. blockchain and hashes. If you haven’t been able to catch the previous post then here’s your chance!
Before we dive into the details, let’s understand the dumbed down version of how bitcoin works. Let’s say you and I are initiating a transaction on the network and you’ve agreed to pay me 100 bitcoins for this article. (Wouldn't that be nice!) To validate this transaction on the network, the rest of the readers operate as validators, we call the miners. These miners validate the transaction and create a new block in the blockchain.
Like the Joker said,"If you’re good at something, never do it for free". The miners need an incentive to validate our transaction. They get it in the form of bitcoin. Now every miner wants to validate the transaction in order to get the rewards but mining is like a fastest fingers first competition for the computers they are using. In order to validate a transaction and create a block on the bitcoin chain, the miners’ computers must solve a complex puzzle. The first miner to solve the puzzle gets the reward. This completes the transaction. I am 100 bitcoins richer, you have gained valuable knowledge and the miners have received their deserved reward!
Having understood the basic flow of how a transaction takes place, allow yourself to slip further down the rabbit hole. Let’s start with what we already know. Remember how every block in a blockchain required 3 key elements? The transaction data, the hash for that data and the hash of the previous block. Now bitcoin adds another element called the work number. Finding it is the complex puzzle that we just spoke about. Getting the right work number is a process of trial and error. The miner’s system needs to generate such a number that it matches the target hash for that block. The miner who does this wins the right to add the block along with the mining reward. This acts as a Proof of Work (PoW) for validating the transactions and is the working principle on which bitcoin operates.
Every time a new block is created, new bitcoin is mined (created) from the 21 million total supply. The current circulating supply is 18,951,337 which is roughly 90% of the total supply. But don’t worry, the rest of the supply isn’t going to be mined anytime soon.
To understand why, we will look at the next tool in the bitcoin toolbox. It’s called halving. As the name suggests, the mining rewards generated from validating a new block are halved every 4 years or 210,000 blocks. Whichever comes first. In 2009, a miner received 50 bitcoins to mine a block. This was halved to 25 bitcoins in 2012, 12.5 bitcoins in 2016 and now every miner receives 6.25 bitcoin to mine a new block since 2020. At this rate, the total supply of bitcoin will be mined by the year 2040. You can follow the halving here.
Bitcoin mining requires a lot of computational power which requires a lot of energy which requires a lot of money. It also is a lengthy process which takes anywhere between 10 minutes to an hour to mine a block. This compared to the instant transactions that we are used to makes it an unattractive mode of payment.
So what does this mean for bitcoin? It means that while bitcoin has been able to revolutionize the way payments can take place, it hasn’t been successful in implementing the perfect solution. However, it has laid the foundation for others to build upon by making a few changes to how other cryptocurrencies can operate.
Having said that, the business case for bitcoin has shifted from a medium of exchange to a store of value. For any asset to be a good store of value it needs to be durable (last for a long period of time) and scare (limited supply). Both of which bitcoin meets. It is durable as it is secured by a large decentralised computer network and it’s scarce because of it’s limited supply of 21 million coins. This distinguishes bitcoin from Fiat currencies that are inflationary in nature and therefore can purchase fewer good as time passes. The harsh truth is that a dollar is worth 65% less now than it was 35 years ago.
I could go on and on about bitcoin but I think it’s time for y’all to DYOR! If you think that I have missed on something important then please do drop a comment down below so other readers can benefit from your insights!
Happy reading y’all, I’ll see you on the next one. Don’t forget to drop a like if y’all learnt something valuable today. It helps the substack algorithm to show this newsletter to more people!
DISCLAIMER: This article presents my own learnings based on personal experience. It should not be considered Financial or Legal Advice.