What Is Bitcoin Technically?
In my last Education post I explained how Bitcoin was, in my opinion, monetary freedom. I explained several ways in which I believe our current system of money to be broken. I also explained how Bitcoin is different. The question then becomes how can Bitcoin fix it? To answer this question we first have to get into more of the technical side of what Bitcoin is. At first it sounds scary, but follow me through to the end.
Bitcoin is described as the world’s first decentralized digital currency. It is a digital asset and a payment system. It is a consensus network that uses triple ledger accounting. It is a commodity according to the Commodity Futures Exchange Commission. It’s a property according to the Internal Revenue Service. It’s cash according to the Transportation Security Administration and the Financial Crimes Enforcement Network. It’s a currency according to the European Union. It’s a security according to the Securities Exchange Commission. In fact, it’s all of these, none of these, and so much more, all at the same time. Are you confused? Let me see if I can clear some of it up.
Bitcoin is decentralized. There is no central authority like the Federal Reserve that controls the currency. It is controlled by the programming that defines it. It is what it is because everyone that takes part in Bitcoin agrees that it is. And there’s financial incentive to keep it that way. If anyone changes their version of the code to be different than everyone else’s version, their version will not be recognized by the rest of the network and they will be ignored. Trying to gain an advantage that way gets someone nothing.
Bitcoin is a consensus network, meaning that every change, every transaction, every little piece must be verified by every computer, and they all must agree. If they don’t, then the minority gets ignored. If a minority becomes large enough a Fork could happen. I will save Forks for another time. Just know that a Fork would basically mean that, for a time, two different systems would be running backed by two ledgers or two sets of books.
Bitcoin is programmed to have a limit of 21 million units. There will never be more than 21 million whole Bitcoin in circulation because nobody in Bitcoin will agree to inflate that number and make their Bitcoin worth less. 21 million doesn’t sound like a lot to spread around on a planet with 7 billion people. Which is why Bitcoin is highly divisible and can be broken up quite easily. In my second Tutorial I explained a few denominations, which I will recreate here:
- 1 Bitcoin (BTC) = 1000 Millibitcoin = 1,000,000 Bits = 10,000,000 Satoshi
- 1 Millibitcoin (mBTC) = 0.001 Bitcoin = 1000 Bits = 100,000 Satoshi
- 1 Bit or Microbitcoin (uBTC) = 0.000001 Bitcoin = 0.001 Millibitcoin = 100 Satoshi
- 1 Satoshi = 0.00000001 Bitcoin = smallest denomination of Bitcoin
This means that there are 2,100,000,000,000,000, or 2.1 quadrillion individual pieces of Bitcoin that can be traded.
There are a lot more denominations out there as people feel comfortable with different sized numbers, but the ones above are generally the ones you’ll run into. Most places generally stick to the full Bitcoin denominations, choosing to use the fractions. However, Bits are becoming more and more widespread and it’s not hard to see why. Because people are used to two decimal place denominations such as Dollars and Cents, a Satoshi can be easily thought of as a Penny, a Bit easily thought of as a Dollar, and a Bitcoin easily thought of as a million Dollars.
Every 10 minutes on average more Bitcoin are brought into existence. The amount is fixed in the code and halves every 4 years. It started out at 50 Bitcoin every 10 minutes, is currently at 25 Bitcoin every 10 minutes, and next year it will be 12.5 Bitcoin every 10 minutes. It will continue in this pattern until some time in 2140 when all the Bitcoin will be in existence. All of this is coded into the programming and cannot be changed unless everyone on the network agrees to it. Again, the likelihood of that is slim because nobody would agree to devalue their own holdings. It’d be more likely that everyone would agree to increase the divisibility instead.
The process of creating Bitcoin is called mining. Miners are not really mining anything. Their computers are solving very difficult math problems and competing to solve it first, for which they will earn the right to write the next line, or Block, in the public ledger called the Blockchain. The next Block contains all the transactions that have recently happened using Bitcoin. The miner that writes that next Block earns the Block Reward, which is the Bitcoin I mentioned above that comes into existence every 10 minutes on average, along with the transaction fees that may or may not be attached to the transactions. Transactions with fees are more likely to be picked up and confirmed first. Transactions without fees are less likely to be picked up, but will be recorded eventually even without. Over time transaction fees will replace the block reward so that the incentive to mine and validate blocks of transactions remains.
The Blockchain is the public ledger that is a public recording of all the transactions that have ever been made using Bitcoin clear back to the very moment the Bitcoin protocol was started. The Blockchain is the third entry in Triple Ledger Accounting. Debit (sender), credit (receiver), and cryptographic signature (public receipt). Amounts of Bitcoin are listed as being held in Public Addresses. Think of these like bank account numbers. Privately owned computers called Nodes record this public ledger and share it with the rest of the network. I run a Full Bitcoin Node and I’ll post a Tutorial on how to run one yourself in the future. All copies of this ledger must match. Ones that do not match the majority are ignored by the network.
Bitcoin transactions are made up of Outputs and Inputs. Outputs are people sending Bitcoin out of Public Addresses and Inputs are the Public Addresses where the Bitcoin are going. In order to initiate an Output and prove ownership the transaction has to be signed by the person holding the Private Key. Think of this as a privately held password on an account. The network then signs the transaction with the Public Key. Think of this as another password on the account. Both passwords must be used to move the Bitcoin. But the Public Key used by the network is automated as far as the users are concerned. And if both are used amounts of Bitcoin are moved from certain Public Addresses to other Public Addresses. If the Private Key is lost the network will not recognize any other proof of ownership and the amount of Bitcoin in that Public Address is effectively lost.
The current regulatory bodies have a hard time classifying what Bitcoin is because it can function as something each body regulates. It is a form of cash; It can be traded one person to another without any intermediary. It is a commodity; It’s a good that can be traded. It is a security; It’s an intangible investment with a market. It is a property; you can purchase, hold, and prove you own it. It is a currency; It is a medium of exchange. It’s all of the things I listed in paragraph two. So everyone wants to regulate it. The real question is if they can. The reason for this is that it’s a protocol on top of which can be built other functions. It’s been programmed to be able to replace all of those things and more things in the future. But I’ll leave regulation for another time as well.
That’s a more technical yet still simplified explanation of what Bitcoin is. There are more resources out there, like this one. And there are many more if you want to get even more technical. For now I’ll continue digging into it with my next Education post. I will explain Public Addresses and Private Keys.