If you’ve ever read the financial news, you’ve heard of Bitcoin. Bitcoin has captured the attention of the financial community and enjoys the passionate support of cryptocurrency enthusiasts worldwide. Bitcoin suffered a dramatic drop in value at the start of 2019 but the cryptocurrency appears to be stabilizing in recent months. But what is Bitcoin, and how does it work? This article will tell you everything you need to know to understand Bitcoin and the cryptocurrency markets.
In order to understand Bitcoin it’s first necessary to learn about the Blockchain, the technology that makes cryptocurrencies possible. The Blockchain is a decentralized transaction ledger that allows any member of the network to view previous transactions. Each new transaction becomes a “block” on the chain once it’s verified by the other computers on the network. Once a block is added to the chain, it cannot be deleted or altered. Since the network is decentralized, it’s very difficult for a single actor to compromise the network. The most common example of the Blockchain is the process of mining cryptocurrencies. As miners solve for new “coins” the network verifies the completed work, and adds a new block to the chain.
What Is Bitcoin?
Bitcoin was created in 2008 by a software developer going by the alias “Satoshi Nakamoto”. There has been speculation as to whether several well-known tech entrepreneurs are in fact “Satoshi Nakamoto” but the founder of Bitcoin remains a mystery. Bitcoin is a cryptocurrency that lets users make electronic payments. It is similar to traditional fiat currencies but differs in some important ways:
First, Bitcoin is decentralized; there is no central Bitcoin bank or institution that manages the currency. The cryptocurrency is maintained by a global network of volunteers who verify transactions and self-police the system.
Second, there is a controlled supply of Bitcoin. In theory, any national government can print currency to address budget shortfalls. Bitcoins are released on an hourly basis at a diminishing rate; only 21 million Bitcoin can ever be in circulation. This theoretically helps Bitcoins retain their value better than a fiat currency.
Third, Bitcoin allows for anonymity during transactions. Both parties must validate that they have enough Bitcoin in their wallets to execute the transaction but otherwise do not provide their identity. Transactions can be tracked back to a user’s wallet address but generally speaking, cryptocurrency markets prize anonymity.
Finally, Bitcoin allows for micro-transactions. A Bitcoin can be divided into a virtually infinite number of pieces with trading value, down to one hundred millionth of a Bitcoin. This allows for small transactions that otherwise wouldn’t be possible with fiat currency.
Any transaction will require two Bitcoin wallets and a Blockchain to record the transfer of funds. Each wallet is secured with a “private key” to validate transactions. Transactions are broadcast to the broader network and are confirmed through “mining”. Mining is a decentralized consensus system used to confirm transactions before they are added to the Blockchain. Mining ensures that blocks are added in a specific sequence and requires a majority of the network to approve the transaction. Cryptographic rules prevent tampering with the Blockchain. Any attempt at tampering is immediately apparent because it “invalidates” all subsequent blocks. This ensures the security and integrity of the Blockchain and individual transactions. The first member of the network to verify a transaction is rewarded with a set number of “coins” for that labor.
Other Major Cryptocurrencies
Bitcoin is the most well known cryptocurrency but there are many others in active circulation: here are some of the major cryptocurrencies and what differentiates them from Bitcoin:
Ether: This cryptocurrency was launched in 2015 and enabled smart contracts: protocols that verify, facilitate, and enforce digital transactions. Ether is used on the Ethereum decentralized software platform. Following a cyber attack in 2016 Ethereum separated into Ethereum and Ethereum Classic.
Ripple: a real-time global settlement network launched in 2012 that facilitates international payments. Ripple is specifically designed to help banks process and clear cross-border transactions securely and at lower cost. Ripple doesn’t require mining, unlike most cryptocurrencies, reducing network latency and computational horsepower.
Litecoin: Litecoin launched in 2011, making it one of the oldest cryptocurrencies. The cryptocurrency was created by Charlie Lee, a former Google engineer. While Litecoin is similar to Bitcoin in many respects, it has a faster block generation rate and can more quickly confirm transactions.
Cybersecurity is a threat for virtually every industry and that’s especially true for financial firms. Major banks have more formal security procedures than cryptocurrency networks but are more frequently subjected to cyber attacks. Cryptocurrencies offer greater security than traditional currency transactions because of their emphasis on transparency. Hackers typically need to compromise private keys or other credentials to steal cryptocurrencies. If hackers steal a private key or compromise a hot wallet they can carry out transactions and transfer money to another account. In response, cryptocurrency traders can use cold wallets, which are not connected to the internet. Cold wallets are typically physical hard drives that store cryptocurrencies. The downside of such a device is that physical damage or destruction of the hard drive can result in the loss of the stored cryptocurrency. There are plenty of stories of crypto enthusiasts accidentally throwing out cold wallets and a lot of money in the process.
The Blockchain is a truly revolutionary technology; Bitcoin is only the most notable example of the Blockchain in action. Bitcoin has the potential to be the most secure, democratic form of currency. Transactions are transparent and secure, provided the right security measures are undertaken. Bitcoin transactions occur in developing economies and coffee shops in Manhattan. Financial inclusion is baked right into the system and Bitcoin usage will only grow in time. While 2019 hasn’t been kind, Bitcoin isn’t going anywhere.