Monday, May 10, 2021

Bitcoin for Dummies

What is Bitcoin?

Bitcoin is a peer-to-peer version of digital cash created in 2009 by the mysterious and pseudonymous Satoshi Nakamoto. It was created to allow online payments to be sent directly from one party to another without relying on trust1.

Website: https://bitcoin.org/en/

Whitepaper: https://bitcoin.org/bitcoin.pdf

Official sub: r/Bitcoin

How does it work?

Bitcoin is the first ever cryptocurrency. Unlike fiat currency, bitcoins are created, distributed, traded, and stored on a decentralized ledger system known as a blockchain. If you don't know what a blockchain is you can learn in 5 minutes with this video by Simply Explained.

Is it safe to use?

The Bitcoin network uses a security system, or "consensus mechanism" called Proof-of-Work.

Consensus mechanisms are algorithms that regulate the process in which transactions between users are verified and added to a blockchain's public ledger, all without a central entity being in control.

Proof-of-Work was introduced in the early 90's to mitigate email spam. The idea was that computers would be required to perform a small amount of work before sending an email. This work would be trivial for one person sending a legitimate email but it would require a lot of computing power and resources to send mass emails (spam).

It was Satoshi Nakamoto, the creator of Bitcoin, who first applied this Proof-of-Work method to a digital money system utilizing blockchain technology.

Blockchain technology at a glance.

Quick refresher: a blockchain is a decentralized ledger consisting of a string of blocks that are chained to each other by way of cryptography1.

The genesis block (block "0") is the first block in a blockchain. It's hardcoded into the blockchain software and is, by definition, unable to reference previous blocks.

You can think of blocks as digital containers of information.

Subsequent blocks added to the genesis block will always refer to the previous blocks, each of which contain a full copy of the updated ledger.

How Proof-of-Work relates to blockchain.

Proof-of-Work algorithms determine who can adjust a blockchain ledger through a race in which miners2 expend computational energy in order to propose valid blocks to the network.

You can think of miners like the record-keepers of a blockchain network. They check and prove that no one is cheating.

In order to create a new block, miners compete against each other to solve complex mathematical problems in a process called hashing3. These puzzles are very hard to solve, but easy for the network to verify the correct solution.

The winning hash is broadcasted to the network for other miners to verify whether the solution is true or not. If it's correct the block gets added to the blockchain and the miner gets compensated with the block reward.

A block reward is the reward a miner gets for solving the cryptographic puzzle required to validate a new block, and is awarded in the native cryptocurrency of a given blockchain. Block rewards are responsible for introducing new coins into the economic system. They incentivize miners to participate in the network and validate the data within the blocks.

So in other words, the work miners do and the rewards they receive keep the Bitcoin network going.

How do I buy Bitcoin?

To purchase a bitcoin (or a fractional amount of one, since at the time of writing this 1 single bitcoin is worth $55,000) you'll want to find an exchange that offers the $BTC coin and sign up. Some well-known exchanges are Coinbase, Binance and Kraken. There are a lot more ways to buy Bitcoin than exchanges, though. Read this for more information.

Unlike physical versions of global currencies like the US dollar, cryptocurrencies can be broken down into extremely small units as they only exist in the digital world. How small is small?

A one hundred millionth of a single Bitcoin (0.00000001 BTC) is called a satoshi (as an homage to its creator). The ability to be broken down into the one hundred millionths helps to ease and facilitate smaller transactions and is a huge advantage over traditional fiat currency.

What's the Bitcoin halving I keep hearing about?

Remember block rewards? Every 210,000 blocks, or roughly every 4 years, the total number of coins miners can win is halved.

So, a Bitcoin halving event is when the reward for mining Bitcoin cuts in half. Why does that matter? Because it also cuts in half Bitcoin's inflation rate and the rate at which new coins enter circulation.

Take a look at this diagram to understand why this is so important. Keep in mind the diagram is on a logarithmic scale.