Bitcoin is the first decentralised cryptocurrency, invented by the pseudonymous Satoshi Nakamoto, who published a paper defining bitcoin in late 2008 and released the first bitcoin software in January 2009. Containing no central server or central authority, his vision was for a new and entirely digital version of currency on a decentralised peer-to-peer basis and was meant to prevent double-spending on transactions .
Beginning in the 1990s, various early versions of digital currency were attempted including hashcash, created by British researcher Adam Back. Many of the ideas within hashcash were later incorporated into Bitcoin. A computer engineer named Wei Dai created b-money and the American engineer Nick Szabo consulted on both DigiCash and bitgold. These early versions of digital currency were the forerunners of the fully formed product known as Bitcoin . To find out about the development of cryptocurrencies, read the article History of Cryptocurrencies.
Solving the double-spending problem was an important aspect in the creation of Bitcoin. When items are paid for with a coin or a bill in any fiat currency, that coin cannot be spent again for the second time. In a digital transaction, a coin or currency bill is not physically ‘handed over’, hence the problem of creating the scarcity inherent in any form of digital money arises, since digital objects can generally be copied without effort or limit. Prior to the emergence of blockchain-based cryptocurrency such as Bitcoin, financial transactions online were handled by trusted third party intermediaries such as banks, but even transactions performed by those institutions had the possibility of errors being made. Bitcoin solved this problem by specifying that valid transactions must be included in the blockchain. For this to occur, a given amount of computational work must take place, thus assigning a cost to carrying out a transaction and preventing double spending, since users only accept confirmed transactions on the blockchain to be valid .
The original paper by Nakamoto, “Bitcoin: A Peer-to-Peer Electronic Cash System”, emphasised the following points:
- Trusted third party institutions cannot offer an ironclad guarantee that non-reversible transactions will never occur.
- Peer-to-peer transactions done with cryptographic protection such as a unique timestamp per transaction are less prone to tampering or flaws.
- In contrast to a physical coin that you can hold in your hand, a digital coin consists of a series of digital signatures with a chain of ownership.
- Instead of using a bank or mint to verify the authenticity of a transaction, each transaction is dated and timestamped. This verifies that the digital ‘package’ did indeed exist at the given time on the stamp.
- A blockchain is comprised of a proof-of-work record, a block, complete with a verifiable timestamp and digital signature. That block is then firmly linked to the next transaction done in the network, thus creating a blockchain.
- Attempting to circumvent these protections and change anything within a block would require redoing all of the blocks that followed behind in the blockchain.
- The node system consists of any computer that is running on the Bitcoin network. Each node accumulates transaction information and broadcasts the relevant transactions to the network.
- The creator of each new block is rewarded with a new coin that helps to offset the time and energy costs incurred by confirming transactions .
The number of bitcoins is restricted algorithmically to a total number of 21 million, which will be reached in 2140. At present the process of generating a new block, or mining, rewards the finder of the new block with 12.5 bitcoins, and this occurs every 10 minutes. This reward halves approximately every 4 years. This scarcity of supply is a necessary precondition to having the function of money of being a store of value. Since the miners would have to agree to change the algorithm which determines supply, and that they have as earners of bitcoin a strong incentive to ensure bitcoin retains its value, there is therefore a strong disincentive to an increase in its supply.
A bitcoin wallet, such as the definitive bitcoin core software itself, as well as others like Electrum, allow users to store, send and receive bitcoins. Bitcoins can also be stored in hardware wallets such as Trezor, which are separate physical devices where the private keys are stored on a device which is not connected to a network and thus less susceptible to hacking. Paper wallets are simply a bitcoin private key on a piece of paper and therefore also disconnected from an electronic network, thus also being invulnerable to being electronically hacked. Since bitcoin transactions are effectively irrevocable, great care must be taken with all forms of wallet to ensure that no unauthorised transactions take place. In fact, one location used to store cryptographic keys is deep within a granite mountain in Switzerland, in a decommissioned military bunker.
As well as through mining, bitcoins can be acquired through cryptocurrency exchanges, examples of which are Bitfinex (https://www.bitfinex.com/), Kraken (https://www.kraken.com/) and Bitstamp (https://www.bitstamp.net/). Users can deposit and withdraw fiat currency as well as bitcoin, and buy and sell bitcoin. Caution is also advisable when using such exchanges, as they can be hacked and users can suffer losses, such as at Mt. Gox, once the largest but now defunct exchange where 650,000 bitcoins were stolen.
The energy requirements of Bitcoin mining are very high, with an estimated energy consumption at the end of 2017 of 32 TWh, around the amount of Denmark . This figure is an estimate and is highly dependent on the mining hardware. Miners are also incentivised to use the cheapest electricity source available, leading mining companies like Genesis Mining to power mines using sustainable energy sources such as geothermal energy in Iceland . Nonetheless, this implies a very high energy consumption of 250 kWh per transaction, clearly uncompetitive with conventional payment networks such as VISA.
This and other considerations have led to led to various proposals to increase Bitcoin’s maximum transaction rate before Segwit of 7 transactions / second. One such proposal, SegWit, was implemented after much discussion within the community in 2017 . This doubles the maximum size of blocks from 1Mb to 2Mb and also paves the way for a further enhancement of transaction numbers, the Lightning network. The Lightning network is an extra layer built on top of the bitcoin network, and allows smaller transactions to be combined before being confirmed on the bitcoin blockchain, and therefore allows many more transactions to take place much more rapidly than on the bitcoin blockchain itself . After being proposed at the start of 2016, the first payments on the main bitcoin took place at the end of 2017 .
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