Bitcoin Beginners Guide: The King Of Code
The King Of Code
Bitcoin is a peer-to-peer electronic cash system that eliminates the need for third parties to verify transactions. Bitcoin refers to two underlying systems working in tandem together. First, there is the Bitcoin protocol, which is a distributed network acting to maintain a ledger of transactions and balances. The other reference is to the token, Bitcoin, which acts as the currency of spending in the system, and both the protocol and the token are referred to as Bitcoin.
“In the cryptocurrency world, Bitcoin reigns supreme as the king of immutable code.”
A peer-to-peer distributed network system allows payments to be sent without the need for passing through a central authority such as a bank or payment gateway — like PayPal. All Bitcoins are minted electronically and they exist electronically as well. Bitcoin, unlike centralized currencies such as the dollar or euro, is not printed out of thin air through a process known as quantitative easing.
It is estimated that only 8% of the world’s currency is actually cash, the other 92% exists only as digital numbers in databases controlled by centralized authorities such as banks. On the other hand, Bitcoins are minted through a process known as mining, which uses computers all around the world, and there can only ever be 21 million Bitcoin in existence ensuring true scarcity.
Bitcoin works through various computer science techniques including
Peer-to-peer networks
Distributed databases
Hashing functions
Merkle trees
Consensus protocols
Cryptographic verification
But that is just a bunch of our fancy computer science talk for terms anyone can understand, and there’s no need to feel overwhelmed. We’re here to break it all down for you.
Peer-To-Peer Networks. What Are They?
A Peer-to-peer network or P2P network as it’s commonly referred to is a network in which interconnected nodes shares resources with one another such as file without the use of a centralized administrative system or server. On the other hand, you have client-server models, which are the most popular network systems in use today. These networks operate by allowing one centralized, powerful computer — called a server — in which many individual personal computers — called clients — can connect to it.
For example, the PC you’re using to read this article is connected to your internet providers central servers. When you visit a website, you send a digital request to those servers, the servers send your request to more servers in the network “pulling” the website and information you want, and sending it back to your computer network to be displayed.
The inherent problem with centralized systems is they act as a single point of failure. Many systems have been hacked and sensitive data has been breached, which exposes users. Here is a notable list of data breaches from IEEE demonstrating one of the key issues with centralized network systems.
Below are artistic illustrations of the structural differences between centralized and decentralized networks, and a p2p network can be seen visualized in the images:
Distributed Databases. Databases, Everywhere…
Two processes that ensure the reliability of distributed databases are replication and duplication. The replication process refers to software that identifies when changes happen in the database — such as Bitcoin being transacted from one wallet to another — once the replication process identifies the changes in the system, it can then update the rest of the database to reflect those changes. In the Bitcoin network, all computers broadcast their transactions to the network as they happen.
Hashing is the process of taking an alphabetical input of any length such as ABCDEFG and changing it into a cryptographic fixed output through a mathematical algorithm, which is to say, a mathematical algorithm is used to scramble words into numbers.
Hashing increases the security of data in a network through the process of encryption. Bitcoin uses SHA-256 as its hashing algorithm to store network transactions in an encrypted state to increase the security of the overall network. So when you hear a blockchain “hashing” a function, you know it’s a fancy of way of saying the data being stored is getting encrypted using mathematical formulas.
Additionally, you will hear the term “nonce” and that refers to the process of generating a completely random number at the end of a hash, which needs to be solved before any hashes of transactions are permanently written to the blockchain.
Merkle Trees
Merkle trees, otherwise known as hash trees, are data structures used in a blockchain to increase network security. The system functions by running a block of transaction data through a hashing algorithm as a means of verifying the validity of that data based on its original transactions.
The entire block of transactions is not hashed at once. Rather, the transactions are hashed and each transaction after the previous one is linked and hashed together. After some time, this process creates one hash for the entire block in a blockchain network.
When referring to a block, you are referring to a block of data consisting of transaction history that took place on the network. Each block stores the history of many transactions by hashing them, and once a block fills up with enough transaction data, the next block is started fresh. That’s where you get the term “Blockchain” from.
A consensus protocol acts as an irrefutable system of agreement between devices or “nodes” in a distributed network, the purpose of which is to prevent the exploitation of that system. Blockchain consensus protocols are the coding police of the blockchain network, they ensure that nodes are synchronized. These fancy pieces of code work to keep all computers on the Bitcoin network in agreement about which transactions are valid, and most importantly, true.
If you’ve heard of Bitcoin, then you’ve heard of the process known as Bitcoin mining. Without getting too far off track, the process of mining is when nodes (such as your computer or any other device) use their computational power to solve for nonce by testing unique numerical values. This process is often compared to your computer trying to solve a really tough puzzle that consists of a large string of numbers. If your computer solves the equation, then it is rewarded a portion of Bitcoin, and the current block being mined is written to the blockchain, and the next block is then “mined”.
When you send Bitcoin to another user and pay for fees, these generally go to the miners using their system to keep the network safe. Because you’ve sent Bitcoin, you’ve initiated a transaction on the blockchain that needs to be confirmed. Your transaction is hashed and put into a block, which is then confirmed by miners who receive a portion of the transaction.
Therefore, a consensus protocol keeps all of the nodes on the Bitcoin network in agreement on which chain to mine, what transactions are true, the next block, etc. Nodes broadcast all transactions to the network. Network transactions are hashed. Miners confirm the transactions consisting of a block. The consensus protocol keeps all nodes in agreement.
Cryptographic Verification
Cryptography is the method of encrypting and decrypting information using complex mathematical formulas. In symmetric-key cryptography, encrypted data, such as random text is encrypted using a mathematical algorithm known as a cipher, which produces a ciphertext — completely useless information — because it’s encrypted. The Bitcoin network uses a similar process of cryptographic verification known as public-key cryptography.
Public-key cryptography is an improvement of the older symmetric-key cryptography because it allows information to be transferred through a public key that can safely be shared with anyone. Rather than using a single key for the encryption and decryption process, the method of public-key cryptography uses separate keys — a public key and a private key.
A combination of both a user’s public and private key are used when encrypting transaction information. On the other hand, the recipient of that transaction needs their private key, and the public key of the sender, which keeps the sender’s private key information safe. Therefore, anyone can send their public keys to anyone without having to worry that someone could gain access to their funds.
Why does Bitcoin work? — Economic Breakdown
Our financial systems rely on a trust-based model. In the words of Satoshi Nakamoto, himself directly from the Bitcoin Whitepaper .
“Completely non-reversible transactions are not really possible since financial institutions cannot avoid mediating disputes. The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for nonreversible services.
With the possibility of reversal, the need for trust spreads. Merchants must be wary of their customers, hassling them for more information than they would otherwise need. A certain percentage of fraud is accepted as unavoidable.
These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.
What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party”
- Satoshi Nakamoto
Satoshi Nakamoto, the visionary behind Bitcoin, was propelled to create an alternative financial system following the uncertainties witnessed during the financial crisis of 2008. The aim was to establish an electronic payment system that operates independently of central banks. This innovative system seeks to replace the conventional trust-based model with a cryptographic proof model, ushering in a new era of transactions between parties.
Historical market crashes often highlight vulnerabilities in centralized financial systems, shedding light on the potential misuse of authority by individuals in powerful positions. Learning from history is essential to avoid repeating past mistakes. Bitcoin emerged as a solution to some of these challenges, offering a transparent and decentralized financial system. For instance, the HSBC money laundering scandal underscored the necessity for a more transparent and accountable financial infrastructure.
The accountability in traditional banking scenarios has been questioned, especially when grave misdeeds go unpunished due to fears of global economic repercussions. The reluctance to hold individuals accountable in such high-profile cases suggests a need for a system where transactions are transparent and verifiable, minimizing the chances for such abuses of power.
The History Of Money & Value
The concept of money and the mediums used to represent value have evolved significantly through the ages. From the ancient times when barter trade was the norm, to the adoption of metal coins and paper currency, and later to digital money, the journey depicts humanity's relentless quest for more efficient and secure ways to transact and store value.
Barter and Seashells: In the ancient Mediterranean, the Phoenicians revolutionized trade with their "silent bartering" method, requiring no mutual language. They'd display their goods on foreign shores, signaling locals to place a fair exchange beside the displayed items. This process of negotiation would continue until a satisfactory exchange was reached. Bartering, however, faced challenges in scaling and abstracting trade. Over time, diverse items like cowrie shells became mediums of exchange, only to be later replaced by standardized currencies issued by central authorities like the Roman Empire and Chinese dynasties.
The Reign of Precious Metals: Precious metals emerged as dominant currency forms, minted into bullion and coins by civilizations like Ancient Greece, Persia, and India. The rarity, durability, and aesthetic appeal of metals like gold, silver, and bronze made them invaluable. King Croesus of Greece notably introduced bimetallism, establishing a fixed exchange rate between gold and silver.
Paper Notes and Fiat Currency: Despite the allure of precious metals, their weightiness birthed a new money form: paper notes. Originating from China, paper money initially served as a receipt or promissory note, later evolving into a formal currency backed by a promise of redemption for precious metals. The transition to fiat money, value established by government decree, marked a significant shift, notably led by the USA. Fiat currency allowed better economic management but also exposed economies to risks like hyperinflation.
The narrative takes a significant turn with the advent of electronic money (e-money). The idea of e-money was first realized in 1871 when Western Union launched its money transfer service, heralding the era of electronic fund transfers. This service was facilitated via an extensive telegraph network that the company had constructed, enabling people to transfer funds across vast distances.
Fast forward to 1949, an anecdote known as "The First Supper" marked the embryonic stage of what we now know as credit cards. On a fine evening, a well-known bank executive named Frank McNamara was dining with an associate when the bill arrived. To his chagrin, Frank realized he was short on cash and had to call his wife to bring him more money. By the time she arrived, the bill had been settled, but the experience triggered an idea in Frank's mind. He envisioned a card that could be used in restaurants to make purchases on a line of credit. The first iteration of this idea materialized as the Diner Club Card, marking the advent of modern-day credit cards.
The financial world saw another paradigm shift in 2008, with the unveiling of the first whitepaper for Bitcoin by an enigmatic figure known as Satoshi Nakamoto. Amidst the global financial crisis, Satoshi introduced Bitcoin to the world in 2009 as a digital, decentralized, and secure form of currency with intrinsic scarcity. This programmable currency presented a new rung on the financial evolution ladder, offering a novel way to transact and store value outside the traditional centralized financial systems. As we delve further into the chronicles of financial evolution, the emergence of Bitcoin stands as a testament to the continuous quest for more equitable, secure, and efficient systems to manage and transfer value in our ever-evolving global economy.
Cryptocurrency Era: The narrative pivots with Bitcoin's advent, igniting the cryptocurrency revolution aimed at decentralization, user empowerment, and bypassing banking or governmental control. However, cryptocurrencies face hurdles like usability, scalability, institutional resistance, and volatility.
Stablecoins and The Future: To address volatility, stablecoins emerged, pegging their value to traditional currencies or assets. Stably, a fintech innovator, not only introduced stablecoins pegged to various currencies but also envisioned backing stablecoins with precious metals. This blend of ancient and modern symbolizes a promising frontier in financial technology, potentially leading to the tokenization of a plethora of assets, paving the way for a new era in the financial ecosystem.
Bitcoin Conclusion - Making Money Right Again
The journey from seashells to Bitcoin exemplifies human innovation in shaping mediums of exchange. This evolution underlines a continuous quest for convenience, trust, and security in transactions. As we traverse from the tangible to the digital, from centralized to decentralized systems, we are redefining the essence of value.
Bitcoin and its blockchain technology propose a novel form of trust—trust in code and consensus over centralized authorities. It invites us to envision a financial landscape where transactions are as seamless as sending a text, yet secured by a fortress of cryptographic algorithms.
As we stand on the cusp of this digital financial frontier, the choice extends beyond merely adopting digital currencies. It's about embracing a paradigm where our transactions are bound by transparency, immutability, and autonomy, mitigating the age-old adversities of greed and error.
This transition isn't just a technological shift, but a societal one. It beckons a reevaluation of trust, urging us to place faith in collective consensus and mathematical verity. As we look ahead, the tale of Bitcoin is more than a chapter in monetary history; it's a prompt to reimagine the narrative of value in the digital age.
