What are cryptocurrencies and what is Bitcoin?

What are cryptocurrencies and what is Bitcoin?

Cryptocurrencies are decentralized currencies which serve any number of purposes. The originator of the cryptocurrency movement was Bitcoin. Bitcoin is meant to serve as an alternative decentralized, trustless, currency. No one controls the supply of it like with fiat money, there is no central bank, there is only people (like you and I).

The Bitcoins are produced by computers solving complex mathematical problems. Bitcoin is popular because it was the first and most well-known.

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Aren’t these just like normal currencies?

Bitcoin and other cryptocurrencies can be used just like normal money to exchange for goods and services or as a store of value. The major difference is it’s all digital.

However, there’s three really nice things about most cryptocurrencies.

  1. They are decentralized and no single institution controls the bitcoin network (excluding 51% attacks).
  2. They are deflationary. Almost all currencies produced by governments are inflationary and lose value over time as more money is printed. That is not the case with bitcoin and many cryptocurrencies. Once the final bitcoin has been produced there will never be another bitcoin minted.
  3. Bitcoins can be programmed to represent anything. A single bit can represent any item in the real world from a deed of a house or stocks from a company.

Who created it?

A software developer called Satoshi Nakamoto proposed bitcoin in a cryptography newsletter. The software was an electronic payment system based on mathematical proofs. The idea was to make a currency independent of any central authority, transferable electronically, trustless transactions, with instant processing, and low transaction fees.

Who mints the coins?

The coins aren’t physically produced but they are electrically produced. Bitcoins are produced by a community of people, anyone can join and mine, all you need is a computer. Bitcoins are mined using computing power to solve mathematical equations called proof of work algorithms.

The network processes transactions and in reward for processing the transactions the miners are rewarded with some bitcoins. The amount or block reward is agreed upon by the network and the amount decreases over time. This is the only way new bitcoins are created.

Sounds like Bitcoin’s supply is limited?

If you’re thinking that you are correct. The bitcoin protocol allows for only 21 million bitcoins to ever be created by miners. These coins can be divided into smaller parts. The smallest amount is one hundred millionth of a bitcoin, it’s called a Satoshi, after the founder, so there’s plenty to go around.

The network halves the block reward every 210,000 blocks. The bitcoin difficulty adjusts to the amount of hashing power and makes the block reward happen every 10 minutes. This means that a halving happens every 4 years. Eventually, the block reward becomes so small there will be no more bitcoins mined. This event is set to happen around 2140.

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What is bitcoin based on?

Bitcoin is based on mathematical proofs. The issue with a completely anonymous, decentralized network is trust. Why trust a system to run transactions for you? The exchange is normally handed by a bank as the middleman processing transactions for us. But with a trustless exchange system there is no bank in the middle.

If there’s no bank, there has to be fraud, right?

No; that’s where the consensus protocol comes in. The consensus protocol is just what it sounds like, how will the system produce an agreement on which blocks to add to the ledger and which to reject? As anyone can mine a block, it’s important the correct one is picked to be added to the blockchain (public ledger).

Bitcoin handles it with a proof of work protocol to reach a consensus and pass the consensus test. Proof of work requires time, computing power, and energy to process and create a new block. Using Bayes’ Theorem and the laws of Thermodynamics to prove that a given block has a certain amount of work to be mined. That way the system can pick the user with the highest amount of work as the correct block.

Other proofs to reach consensus exist to but the proof of work algorithm is the most common.

What are its characteristics?

Bitcoin and other cryptocurrencies have a few qualities that set them apart, I’ve mentioned some already.

  1. It’s decentralized

The network isn’t controlled by one authority. Every computer or mining rig that processes blocks makes up the network, the machines work together to process transactions and mine bitcoins. That means, baring a 51% attack, one central authority can’t take control and alter transactions being made, produce fake ones, or double spend.

  1. It’s easy to set up

No questions are asked when you set up a wallet. No bureaucracy, no fees, and it’s extremely secure (some options are more secure than others, still more so than a traditional bank).

  1. It’s anonymous

Bitcoin users can hold multiple bitcoin wallet addresses. These aren’t linked to any addresses, names or any other identifying information.

  1. It’s completely transparent

So I lied, sort of. The blockchain (ledger) stores all the details of every transaction which has ever taken place.

If people wanted they could track down every transaction made into and out of a specific wallet address and they’d be able to tell how much is in it. But that’s the only information they’d gather.

There are methods to make transactions even more anonymous by spreading coins throughout different wallets, not using the same wallet, or not moving all the coins into one wallet. Other cryptocurrencies offer even more anonymity like Zcash, Dash, and Monero.

  1. The transaction fees are tiny

Someone moved 45 million us dollars in a cryptocurrency called Ethereum for 9 cents.

  1. It’s fast

You can send money anywhere in the world and it will arrive in minutes. Bitcoin has a bit of a backlog (8,000 unconfirmed transactions at the time of writing, Blockchain.info) at the moment due to the massive demands on the system. However, you can always pay bigger fees to move the amounts faster.

  1. It’s non-repudiable

If you send your bitcoins to the wrong address you are screwed. You’ll never get them back unless the recipient returns them to you.

Bitcoin is an awesome currency. Although, other cryptocurrencies are even better and offer more at better speeds than bitcoin. Bitcoin was the first… of hundreds and thousands. And more are being developed all the time.

Conclusion:

This was just a very small portion of the cryptocurrency world. As the crypto-world grows in popularity and media attention it will continue to advance, evolve, and spawn new technologies. And even this article doesn’t cover everything about bitcoin. It’s exciting and you’re taking the step down a rabbit hole of really interesting stuff.

3 Replies to “What are cryptocurrencies and what is Bitcoin?”

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