April 2018

Bitcoin Made Super Simple


Did you know you don’t need to own a whole bitcoin? Parts of a bitcoin can be bought and sold.

If you mention Bitcoin or people hear about it on TV, they will ask ‘What is a bitcoin?’ The answer can be simple, or at least it seems like it should be.

What is Bitcoin?

Bitcoin is a decentralized cryptocurrency. Decentralized means there is no bank, government or individual who controls it. Instead, it’s powered by a network of computers that share information.

A cryptocurrency is a digital asset based on cryptography. You can think of cryptography as complicated math.

When people think of currency, they often imagine something they can hold in their hand, like a coin or paper. Handling with your hands is not the case with bitcoin, in fact, you can never have a bitcoin.

Bitcoins are on the block-chain. You can’t ‘have’ or ‘own’ bitcoins, rather you hold the ‘password’ to send and receive them .

You might be wondering, what is the blockchain. It is a chain of blocks. For bitcoin, a block is 10 minutes of transaction time. During this time transfers of bitcoin are recorded in a ledger. A ledger is a digital record of the ins and outs from different accounts. To keep things simple, you can see it as an online spreadsheet.

Say I send 0.005 bitcoin to my mom. The ledger would record: Rob -0.005 -> Mom +0.005 (March 5, 7:18 am)

The ledger keeps a record of all the transactions that occur over the 10 minutes of a block. During this time bitcoins are created, and the transaction is recorded.

During the block, math is done to create a long, complicated number called a hash. The hash then represents the block.

That number is created using the hash from the previous block. It also uses some other input numbers, but the details are not crucial for this explanation.

This new number and the previously created number are now chained together. You can look at one block and figure out the previous block number or hash. The linking goes on forever, all the way to the first block.

Where are bitcoins?

When people have bitcoins, it sounds like they are stashed on a computer or cell phone. On the ‘Big Bang Theory’ bitcoin episode, the guys talked about their bitcoins being on a USB drive.

This is a good metaphor but isn’t correct. You can not hold bitcoins, or put them on a USB drive. Bitcoins only exist on the blockchain, the ledger we talked about earlier.

Bitcoins are exchanged from person to person, but they never go anywhere. The thing that changes is the account or the keys.

When someone has bitcoins, they only have the ‘key’ or ‘password’ for a bitcoin address.

It may seem confusing but think of it like online banking. Your money is in an account. When you make an online payment, the money is transferred from one account to another. But along the way, no one ever holds or sees the money. For the most part, it is stored on computers and is only numbers on screens.

When you use bitcoin, you ‘sign’ transactions with your private ‘key.’ You then use the public ‘key’ of the person you are sending them too. In this case, the ‘key’ is like an account number. Afterward, the blockchain ledger is updated, and the coins are ‘moved.’ In reality, only the permissions on who can move the bitcoin changes.

There are many ways to store bitcoins, but all of them are secure ways of saving the ‘keys’ to your account.

The non-physical aspect could be a problem for some people. Bitcoin isn’t something you can hold, touch or see. But then again, any money in a bank account is the same.

How do you mine Bitcoins?

At the risk of making things complicated, let’s stick to the basics. Bitcoin works on something called proof-of-work. What this means, is that a computer on the network proves its dedication by doing work.

Every ten minutes or so, new blocks are created, for this, work needs to be done. The work consists of trying to figure out a huge number. The number is massive, but it doesn’t need to be perfect, only close enough.

During this time bitcoin transactions are recorded. A unique transaction is written showing new bitcoins that got mined.

There are lots of computers doing this at the same time, so whoever gets there first wins. If many computers get there at the same time, there is a little bit of randomness to determine who wins.

Proof-of-work means showing all the attempts or guesses at getting the right number. That processing is the work, and you could see it if you wanted to.

One way that people make this more manageable is by joining a pool. A pool is a group of computers that pool their computing power and distribute the work. The idea being that with more computers, it takes less time, as one computer doesn’t need to do all the work.

The rewards of mining is an incentive to keep the network alive. You can make money by supporting the system.

One last thing, every four years or so, the size of the reward gets cut in half. Smaller production, in part, limits the number of coins, but could also push up the price.

Who created Bitcoin?

Satoshi Nakamoto is the creator of bitcoin. But, no one knows who he is. The prevailing view is that his name is a pseudonym for someone else or a group of people.

No one knows for sure, and there are lots of theories but nothing substantial. Regardless, whoever they are, they must be smart and knowledgeable.

Part of the mystery of bitcoin is the story of who created it, for now, no-one knows. But if that were to change, that could take away some of bitcoins magic.

How does the price get set?

People are more concerned about the price of bitcoin than anything else. But how does the price get set?

The idea is that there is a limited supply. At the same time, in the future, fewer will come into being each day. In time, there will be no more new coins.

With regular money, more is made whenever the central bank decides it needs it. With bitcoin, there is a predefined limit to the supply. In total, 21 million bitcoins can exist, and only that many will ever be.

The supply is also limited because many bitcoins have been misplaced forever. Meaning whoever owned them, lost the ‘keys’ to the account and will not be able to move them.

Scarcity is part of what drives the price, and people want to have something when there is a limited supply. Others believe that bitcoin is the currency of the future, so they keep it with the hope of getting rich.

It is hard to know how much bitcoin is worth. But for diehard fans, that is not the goal. They want to see a future where Bitcoin is part of our day to day lives. They want to be able to trade bitcoins for products and services, not money.

In this view, the price of bitcoin won’t matter. What will be more critical, is the price of things in bitcoin.

Should you buy bitcoin?

Don’t ask me! Bitcoin is too complicated for most people at this point.

Will it be worth something in the future?

If you are into the technology, it might be worth playing around. And if it stays around, it will get easier to use, and more people will jump on board.

If you want to become rich, that is another question. Some people believe bitcoin will be worth a million dollars, while others see it going to zero.

If you believe in the technology, it is something to try out. And at least if you understand it, you can make a better choice.