What is bitcoin (btc)? The origin story & beginner’s guide

Bitcoin

The immense value of Bitcoin (BTC) is beyond the comprehension of many people. How can a fully digital currency be worth more than an ounce of gold? Why there is so much interest in bitcoin? In this article, we would like to explain the everything you need to know about Bitcoin, its origins, the blockchain and mining.

Why was bitcoin invented?

The beginnings and cypherpunks

In the real world it is a normality for people to have secrets. However, since the digital revolution and the breakthrough of the Internet, human life is continually shifting to the digital realm. It's hard to imagine everyday life without computers, smartphones and the Internet.

However, there is one major problem. Unlike real life, the internet knows no secrets. At the latest since the NSA scandal and the revelations by Edward Snowden it is clear that secret services all over the world potentially store and search any information from electronic communication via the Internet.

A movement, the Cypherpunks, had already foreseen this development in the early 1990s. They realized that no promise from any government could ensure that there would be no mass surveillance in the digital age. Eric Hughes, an early follower of the cypherpunk movement wrote the famous Cypherpunk Manifesto in 1992, which called for fighting for one's privacy. However, the fight did not take place in the real world at demonstrations. Instead, the cypherpunks devoted themselves to programming anonymous systems.

So the cypherpunks didn't just discuss, they fought for their vision. Using cryptography, they created anonymous mail systems, digital signatures and electronic money to restore the privacy of each individual. Even though it is not known who the mysterious inventor of Bitcoin is and who is behind the pseudonym Satoshi Nakamoto, it is assumed that Satoshi was at least a supporter of the Cypherpunk movement, shared the political views and from this motivation, invented Bitcoin.

Satoshi Nakamoto makes an appearance

Remarkably, however, Satoshi was not the first to invent a digital currency. For the Cypherpunk movement, an anonymous and digital money was a key element in the fight for monetary privacy and individual freedom. Already before Satoshi Nakamoto there was Wei Dai with his b-money. David Chaum invented DigiCash, which ultimately failed in 1998. All of Bitcoin's predecessors failed because they couldn't do without a central authority or solve the double-spending problem (the problem that prevents a digital coin from being spent twice).

On 01. November 2018, Satoshi Nakamoto presented the Bitcoin whitepaper for the first time in the Cryptography mailing list and with it the solution to all problems, which is why all digital currencies failed before him.

Two months later, on 09. January 2009, Satoshi then released the bitcoin version 0.1. However, the initial interest was limited. There has been no sign of a revolution yet. The first bitcoin transaction, known as "pizza day," was still a long way off and didn't take place until 22. May 2010 took place, when Laszlo Hanyec bought two pizzas for 10.000 BTC bought.

What is Bitcoin?

The value of money

Bitcoin (BTC for short) has been the world's first cryptocurrency. All cryptocurrencies that followed thereafter are therefore also referred to as altcoins (alternative coins). Bitcoin is both a currency and a means of payment. Unlike fiat money, z. B. the euro or the US dollar, however, there is no central bank that prints the money and regulates the money flow.

While at first glance it seems absurd that something intangible, a digital currency, should have value. Still, there is a logical answer to how Bitcoin maintains its value. To understand this, it is important to understand how the euro or U.S. dollar maintains its value. Both currencies are based on an illusion, a mental construction that a coin or bill has a value of 1, 2 or even 50 (Euro or USD). According to the "Modern Monetary Theory", this value is based solely on the fact that a government has set these values and the government has made its demands (z. B. Taxes and other charges) calculated in this currency.

A real value was given to paper money in history only when it was linked to gold. However, the Bretton Woods Treaty, which made the U.S. dollar the world's reserve currency and required the U.S. to hold an ounce of fine gold for $35, was abrogated by U.S. President Nixon in 1971. This put the value of money in trusting governments. Money has become an instrument of economic policy. Exchange rates became free, value relative. Governments and central banks have started printing almost unimaginable amounts of money to finance crises.

Since 1971, the price of gold has risen to well above 1.000 USD increased. Paper money has thus lost almost 97 percent of its value compared to gold. Liberal economists therefore doubt that fiat currencies can fulfill a core function of money, that of storing value. This is where Bitcoin comes in. Bitcoin is mined much like gold. However, the number of Bitcoin is limited to 21 million BTC, so there can be no inflation. Bitcoin is thus a perfect store of value.

Bitcoin as a store of value

Ultimately, however, the value of Bitcoin is also based only on the confidence that BTC will still have an equivalent value tomorrow. Bitcoin, however, does not require reliance on third parties because, for example, banks are not needed to conduct transactions.

The basis for this is that the Bitcoin network is a distributed peer-to-peer (P2P) system. The advantage of P2P systems over centralized systems is that there can be direct interaction between the parties and no intermediary is needed. Unlike fiat currencies, this makes Bitcoin resistant to government encroachment.

The Bitcoin blockchain records every single transaction made with Bitcoin, validating transactions and ensuring the integrity of the network. Bitcoins trade with decimals in the process. The smallest unit of bitcoin is a satoshi. One bitcoin is equal to 0.00000001 satoshi.

How the Bitcoin blockchain works?

The blockchain is the revolutionary technology behind Bitcoin and other cryptocurrencies, invented by Satoshi Nakamoto. The Bitcoin blockchain is a chain of blocks linked together by cryptographic methods. All transactions ever made on the bitcoin network are stored in the blockchain. Transactions are considered confirmed when they are stored in the bitcoin blockchain (in a block).

A major problem for digital currencies and virtual items in general is double spending ("double spending problem"). Unlike physical items, which can only be spent once, digital goods can be used multiple times, in two different places (simultaneously). As we have learned, previous variants of a digital money, such as b-money and DigiCash failed to provide a viable solution to this problem. Satoshi Nakamoto has come up with a solution for this. Blockchain technology stops this problem by requiring that the every participant in the network ("full nodes") verify every transaction.

Only when the majority of participants confirm that the transactions in the block are unique, they are added to the blockchain. Further, each new block is "linked" to the previous block, ensuring a chain of accepted transaction histories.

To incentivize the validation of transactions, each block attached to the blockchain will have a reward, called the "block reward". The current reward (in 2018) for "mining" is 12.5 BTC. In 2020, the reward will be halved to 6.25 BTC, as every 200.000 blocks a halving takes place (about every 4 years) until all 21 million bitcoin are mined. Mining solved the second major problem of Bitcoin's predecessors, as the consensus of "miners" replaced a central institution (central banks and banks).

What is mining?

How does bitcoin mining work?

Within the Bitcoin protocol, Satoshi Nakamoto has determined that a block of pending Bitcoin transactions will be written to the blockchain approximately every ten minutes. A block can contain an indefinite number of individual transactions, the limit is only the block size. This is 1 megabyte (MB).

Miners compete for the generation of these blocks. The proof-of-work here is a cryptographic puzzle that determines which miner gets to write the next block to the Bitcoin blockchain. In return, the miners take the transactions (resp. their Merkle tree) and add a random string (the "Nounce") to them and hash both values. The miner compares the result with a condition. If this is not met, the miner tries a new string until it finds a hash. Transactions are thus verified by matching a 64-digit hexadecimal hash. For solving this task, the block reward is awarded to the successful miner. Every 10 minutes this process repeats.

In the early days, it was still possible to mine Bitcoin using a regular computer or laptop (with the CPU). However, GPUs (graphics cards) replaced CPUs as early as 2010, until 2013, when GPUs were also displaced from Bitcoin mining by even more specialized ASICs ("application-specific integrated circuits"). ASICs are computer chips that are specifically designed for mining Bitcoin and just cannot perform any other function. With the advent of entire mining farms using ASIC, the hash power and mining difficulty of the bitcoin network became too great to mine bitcoin as an individual.

The bitcoin mining difficulty

To meet the block-halving timeframe, the bitcoin network aims to verify a new block every ten minutes. However, as the number of miners in the Bitcoin network increases, so does the computing power, which means there is a higher chance that someone will solve the crypto puzzle in less time. This is why there is bitcoin mining difficulty.

As the hash rate increases, so does the degree of difficulty. Every 2016 blocks (about every two weeks), therefore, the bitcoin mining difficulty changes. If the block time is less than 10 minutes and the hash rate is high, the difficulty level is adjusted upward accordingly to meet the 10-minute rule.

What happens when all 21. Millions of Bitcoin are mined?

One of the most common questions about Bitcoin is what happens when all 21 million BTC are mined. As early as 2032, the "block reward" will be less than a whole Bitcoin. At a certain point, mining will stop just because of the reward, even if the Bitcoin rate is still well above 100.000 euros will rise, as some experts consider realistic, will no longer be profitable. As we have learned, however, miners are essential to the security of the network. What will happen then?

Two scenarios are basically conceivable. We have already hinted at the first. Bitcoin price will rise with every halving of block reward. This tendency has already been observed in the Bitcoin halvings that have taken place so far. The second scenario are makes use of the transaction costs that are necessary for each Bitcoin transaction. Transaction costs are expected to take over the payment of miners in many years to come. This is also why many Bitcoin developers are in favor of keeping the 1 MB block size, so that due to the scarcity of this resource, transaction costs can be used to pay miners.

What is a Bitcoin Hard Fork?

Another topic that has become interesting, especially in 2017, are hard forks.

Bitcoin Cash, the very first and most controversial hard fork of Bitcoin emerged in 2017 amid a dispute over how to scale the Bitcoin blockchain. So: how can it become possible for Bitcoin to be used by a wide mass, by millions of people. At the center of the discussion was the block size of 1 MB, which has been controversial since the beginning and limits the number of transactions that can be included in a block. Remarkably, bitcoin did not have a size limit at the very beginning. As recently as September 2010, Satoshi changed the code for it to 1 MB.

Back in 2013, the discussion came up to increase the block size. On the one hand, there was the faction that wanted to leave the original bitcoin protocol as unchanged as possible and scale "off-chain" through the lightning network. On the other hand, there was the faction that was in favor of increasing the block size in order to scale Bitcoin as quickly as possible.

On 01. August 2017, the "block size war" that lasted for more than two years culminated with the fork of Bitcoin Cash (BCH). Simply put, Bitcoin Cash "copied" the original blockchain and changed the code immediately after the hard fork to a new block size limit of 8 MB.

For bitcoin investors, this event proved to be a windfall. Those who owned Bitcoin (BTC) at the time of the snapshot received the same amount of Bitcoin Cash (BCH). Over the course of 2017, numerous other Bitcoin hard forks followed, but apart from Bitcoin Gold, they no longer had any significance and were predominantly classified as scams.

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