Understanding Bitcoin: What is it and how it works?

Continuing from the previous blog which presented the history of cryptocurrency, it is time for Understanding Bitcoin.

Invented in 2009 and claimed by Satoshi Nakamoto, whose identity is still debated, Bitcoin has revolutionized the idea of decentralized currency circulation and usage system. In the honor of the inventor, one-hundredth millionth of a bitcoin is named as the smallest unit, Satoshi.

Bitcoin: What is it? And how different is it from a nominal currency?

Bitcoin, usually referred to technology (bitcoin with a lowercase ‘b’ refers to the currency), emerged as a by-product of another invention. The original invention had to be a peer to peer network, P2P electronic cash system according to Satoshi.

The technology claims to be a decentralized one i.e. there’s no governmental institute or multi-lateral international body regulating the circulation and keeping a record of the bitcoin. Let’s say that that’s the USP of the technology or maybe, its biggest flaw!

In a white paper published just after the invention of Bitcoin technology, Satoshi ruminates and highlights the possible flaw in the supply of nominal currencies by raising a fundamental issue, “Currency is just a number which you see in your account. What are their numbers more than entries in a database- a database which can be changed by people you don’t see & rules you don’t know.”

And Satoshi challenged [this]system with its Bitcoin technology which eliminates this problem by offering a fast and globally acceptable cryptographically secure peer-to-peer monetary transaction technology which is permissionless and requires no buffer layers like the erstwhile currencies.

What is meant by Cryptocurrency?

Understanding Bitcoin: How does it work?

Understanding the functioning of Bitcoin technology is fairly easy; however, we do have some doubts regarding it. Let’s throw some light on basic doubts regarding Bitcoin technology.

How to generate bitcoins? Generation of bitcoins (the currency, notice lowercase b), is extremely simple. You just have to install Bitcoin wallet in your smart-phone or computer system and it will automatically generate your Bitcoin address and next time you can create on your own for transferring or accepting funds. It’s analogous to using an e-mail address. You just have to send this address to receive funds or need to have your peers’ address to transfer fund. Then it must be occurring in your mind how does it really work!

What’s an encrypted address? A cryptographically secured address consists of two keys: public and private. It can be understood with the help of Public-Key Cryptography, in a laypersons’ language, the process can be defined as handing over a public key to the beneficiary and using the private key to authenticate the ownership.

Also, an electronically generated coin can be thought of as a chain of digital signatures. For a new coin to be produced a coin should be mined & the previous one should be added in the block. (One of the key features of Bitcoin is that transactions are fairly secure because transactions are computationally impractical to reverse would protect sellers from fraud which in turn makes it highly secured.) First ever block on the chain is known as the Genesis block and the note which Satoshi placed on it worked as a timestamp. Explaining in its white paper, Satoshi notes a condition to be a miner, “they have to find a hash-a product of a cryptographic function that connects the network with its predecessor. This is called the proof-of-work. In bitcoin, it is based on the SHA-256 Hash algorithm.” Further that Proof of Work (PoW) is unlike the one-IP-address-one-vote it is essentially one-CPU-one-vote. Many have presented alternative technologies to PoW because of security concerns however Satoshi seems to have already pointed out in the white paper, “To modify a past block, an attacker would have to redo the PoW of the block & all blocks after it and the catch up with & surpass the work of the honest nodes. The only way to confirm the absence of a transaction is to be aware of all transactions.”

Alright, it is cryptographically secured. But who maintains the track of transaction and how? Well, that’s the obvious question which strikes anyone when he/she compares the track of transactions like we have in the centralized system, for example, a passbook. In this decentralized P2P network, the usual ledger is the blockchain. Blockchain can be considered as a series of transactions which are recorded in the forms of blocks. Blocks are nothing but are having a hash pointer, a timestamp and the details of the transaction data. So, a record is duly maintained but it’s not an organization it is a supercomputer which does that

Overall, what makes bitcoin, our digital currency, different?

Some of the functions of this technology are alluring and they beat the debate over their contest with erstwhile technologies hands down: it has no intrinsic value; no physical harm; supply isn’t determined by a central authority and principally everyone can be a miner.

By now, we have learned a great deal about the Bitcoin, the technology, and bitcoin, the currency.  In our next blog, we shall discuss the burning issue of Bitcoin being a speculative bubble.