What is Bitcoin? BTC origins, transactions, and other key features explained
In 2008, a mysterious entity ‘Satoshi Nakamoto’ published the Bitcoin (BTC) whitepaper.
In the document, they proposed a “purely peer-to-peer version of electronic cash” that would “allow online payments to be sent directly from one party to another without going through a financial institution.”
But who is Satoshi? Nobody knows, even today.
Satoshi could be one person, or a group of developers or technocrats. The name is of Japanese origin, but the Bitcoin whitepaper is written in flawless English, leading people to infer Satoshi could be from an English-speaking nation.
Not only did Satoshi publish the Bitcoin whitepaper but they also created the software around the Bitcoin blockchain before disappearing in 2010.
The impact of Bitcoin
Satoshi’s work came as a response to the 2008 global financial crisis, which saw numerous banks and financial institutions fail. With governments bailing them out at the expense of taxpayers, the crisis brought into focus the fragility of the existing, centralised financial system.
Bitcoin — which proposed a form of payments that eliminated centralised entities like banks and governments — was seen as a possible solution or alternative to the status quo.
As one of the first use cases of blockchain, Bitcoin has led interest in this emerging technology, which is proving to be a transformative force in private and public sector operations. Besides enabling cryptocurrency transactions, blockchain tech has been applied for facilitating cross-border payments and building digital asset marketplaces to supply chain management, etc.
And in 2021, on April 14 to be exact, BTC reached an all-time high of $64,863 per token.
Basics of Bitcoin explained
Why does Bitcoin have value? And what is it used for? Here’s why the world is going gaga over this virtual currency.
Bitcoin is built on top of a blockchain, which is essentially a chain of blocks. When data is added over time in blocks, new blocks are built on top of previous ones.
Transactions are recorded on multiple computers or devices across the world (also referred to as nodes).
These characteristics make it impossible to retrospectively alter a block without altering all subsequent blocks.
Satoshi Nakamoto wrote in the whitepaper:
“The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work. The longest chain not only serves as proof of the sequence of events witnessed, but proof that it came from the largest pool of CPU power.”
If a majority of computational power (51 percent and more) is controlled by nodes that do not harbour a malicious intent to cooperate to attack or corrupt the network, the Bitcoin blockchain grows longer and outpaces attackers.
This makes it a safe and secure platform for transactions to occur.
Further, the Bitcoin blockchain network’s code has assigned a predictable issuance rate and upper limit.
The total number of BTC can never exceed 21 million. Almost 19 million BTC has been mined (or created) so far.
As BTC has limited supply, it is seen as a store of value and a hedge against inflation, similar to gold. It can also be used in transactions wherever it is accepted.
To understand why Bitcoin and other cryptocurrencies don’t have intrinsic value, and yet are valued at thousands of dollars, refer to this article.
Image: Daisy Mahadevan
Decoding Bitcoin transactions
How does the Bitcoin network really work? And how can transactions be made on the Bitcoin blockchain? Let’s look at a simple example comparing regular financial transactions with Bitcoin transactions.
Conventionally, if User A wants to send Rs 1,000 to her friend User B, she notifies her bank (a centralised entity) by initiating the transaction. Once the bank verifies that User A has the necessary funds, it updates its database.
User A’s bank balance is reduced by Rs 1,000 while User B’s balance is increased by the same amount. In this example, we are assuming both users have the same bank.
However, a similar transfer of Bitcoin follows a different path. Here, a centralised entity like a bank does not perform checks, and does not update balances. Instead, all the nodes of that particular blockchain will have to be involved in the transaction due to its decentralised design.
For User A to send one Bitcoin to User B, they must broadcast a message in the network so that other nodes can see it.
The nodes, or the users, then set out to solve a puzzle set out by the protocol, which requires them to hash transactions and other information in the block.
This is referred to as mining, and those performing this task are called miners. The miners must keep hashing data (slightly modified each time) until a valid solution is found to the puzzle and then, a Bitcoin token can be sent to User B.
Finding a valid solution for the successful transfer of Bitcoin creates a new block, and generates a block reward (in Bitcoin) for the miner responsible.
Once the transaction is added to the Bitcoin blockchain, all other nodes can see and validate it, and update their copies of the ledger to reflect it.
At the same time, User A’s crypto wallet (where she stores her Bitcoin) is updated to show it has sent one Bitcoin, while User B’s wallet is updated to show it has received one Bitcoin.
Further, as the network knows about the transaction, User A cannot send the same Bitcoin to somebody else (known as double-spending).
For more information on the basics of blockchains and how transactions work, refer to this article.
Challenges in adoption
So far, one of the major arguments against Bitcoin is the amount of energy expended in its creation.
The process of creating Bitcoin to hold, trade, or spend reportedly consumes 91 terawatts of electricity per year – which is more than what Finland, a nation of 5.5 million, uses annually.
Nevertheless, BTC is seeing an uptake in adoption. In the last few weeks, the crypto world has been talking about the adoption of BTC as legal tender in the Central American country of El Salvador.
There, Bitcoin transactions work largely in the manner described in the above example. But there is an additional step designed to make BTC transactions more efficient – the Lightning Network.
Traditionally, Bitcoin’s biggest challenge has been scalability. Owing to its distributed, decentralised design, the network can only handle around seven transactions per second and create additional blocks every 10 minutes.
In comparison, Visa can handle around 1,700 to 4,000 transactions per second on average (although it claims a far higher number).
So for Bitcoin to service a population of 65 lakh in El Salvador, the government has employed the Lightning Network, which adds a secondary layer to the BTC blockchain and allows citizens to settle transactions off the main blockchain.
As such, transaction speed isn’t constrained by the main blockchain’s block limits or involve high transaction fees or slow settlement times.
The El Salvador government also launched an official Bitcoin wallet named Chivo for users to transact in BTC.
Going forward, it remains to be seen whether Bitcoin will continue to become legal tender in more underbanked countries like El Salvador, or largely remain a store of value.
As it is decentralised, censorship-resistant and borderless, it is increasingly becoming popular for international remittance and payments, allowing users to transact without revealing their identities.
Other cryptocurrencies such as Ethereum, Dogecoin etc and their origins and use cases will be explained in future articles.