Understanding Bitcoin

Bitcoin is the business. It has directly or indirectly enabled every technology I write about. While most people have heard of it, few people understand the true innovation and extent of its significance.

You could well be a die-hard bitcoin fanatic by the time I’m done with you.

The Bitcoin network is simply a gigantic accounting ledger of all bitcoin transactions that have ever occurred. This ledger is known as the block chain and every participant of the Bitcoin network has a copy.

The block chain is the accepted truth as to what bitcoin transactions have happened and when. It is necessary to have such a database in place so people can only send units they have a claim to, and only once. It’s the same deal with your bank; it holds a record of who owns what. When you send or receive money the bank updates its ledger to reflect the change. You trust the bank with the task of keeping an authentic record.

You’re not impressed, and you shouldn’t be. Here’s the kicker.

Bitcoin’s network reaches consensus on the correct state of the block chain not through reliance upon a trusted third party (like a bank), but does so in a decentralized manner by allowing the community to manage the task. Consequently, Bitcoin’s protocol has allowed a network of untrusting individuals to transact with one another without the oversight of an omnipotent, centralized, third party.

That’s all you really need to know about Bitcoin, distributed consensus is the revolutionary feature that is supplemented by a number of secondary positives, such as:

  • Security: the network is very reliable in terms of resistance to double spend attempts on a bitcoin balance or disruption to the network in general. Security has been achieved through a distributed process known as mining.
  • Transparency: due to being fully open source, anyone can inspect Bitcoin’s code to verify the software does exactly what it is supposed to do.
  • Fast transfers: transactions are near instant and can be confirmed as authentic within minutes.
  • Anonymity: through the use of public-key cryptography and the fact that a near infinite amount of new addresses can be generated by a user, partial anonymity is achieved. Full transactional anonymity can be achieved using a combination of TOR and a mixing service or using software such as Dark Wallet.
  • Regulatory resistance: the Bitcoin network cannot be raided or shut down. Usage can be discouraged but it is notoriously difficult for authoritative bodies to do anything other than demand people don’t use it.
  • Capped supply: limited to 21 million units that are divisible to the eighth decimal point. Because supply is limited, bitcoin price will tend to increase over time (in lockstep with adoption) rather than decrease as we are accustomed with traditional currency.
  • Micro transactions: allows for tipping and the purchase of low value internet content, which is not really feasible using PayPal for example.
  • User responsibility of funds: balances on the network are cryptographically secure, and stored locally by the user. The only way your funds can be stolen is if someone gets access to your private key. There is no central body that holds access rights to your funds.
  • Unbanked market: many people in the world don’t have bank accounts and would benefit greatly from access to financial markets.
  • Transactional functionality: with the use of bitcoin exchanges or merchant processors, bitcoin price volatility issues are mitigated. Options for rapid conversion in and out of bitcoin to fiat currency are readily available, meaning that people can capitalise on the benefits of bitcoin (security, privacy, speed, low cost) while disregarding the pitfall of price uncertainty.

How is bitcoin worth something?

Bitcoin is completely abstract and has an entirely digital existence; a bitcoin unit is not backed by anything, and yet the Bitcoin network now has a market cap in the billions. How did Bitcoin miraculously manifest value out of what was initially nothing?

Bitcoin’s software was released to the public as open source code in 2009 by the pseudonymous, Satoshi Nakamoto. The software started to release bitcoins to participants in a predictable, gradual manner over time. New bitcoins continue to be minted every ten minutes by people that commit computing power to the security of the network. These bitcoins can be seen as a reward to people who help make the network more resilient. In this way, bitcoins are able to be drip feed slowly to the public allowing currency supply and community size to grow in tandem.

I believe there was a combination of factors that encouraged people to start denoting value to bitcoin units:

  • Growing appreciation of Bitcoin’s technology as being revolutionary;
  • The fact that bitcoins are generated by computational work (which has an associated monetary energy cost);
  • Predefined scarcity of bitcoin units and;
  • Political, economic and monetary idealism. People who viewed our current institutions as inequitable and corrupt saw the disruptive potential of bitcoin and supported the project.

Bitcoins had to be worth something to do anything useful. Once an initial value was bootstrapped, bitcoin’s transactional benefits were enabled and the community started experiencing a positive feedback loop. Capital started flowing in which boosted liquidity and reputability which in turn attracted more investment in the currency and infrastructure.


Bitcoin continues to prove its legitimacy and the ecosystem gains strength and diversity by the day. While I am optimistic about the network’s future, I still hold some concerns:

  • Governments could ban the use of bitcoin. This could be very disruptive depending on how many countries prove to be hostile towards the technology.
  • The costs of regulatory compliance, specifically for exchanges and merchants, could be made prohibitively high by regulatory bodies, eroding cost savings of using bitcoin.
  • Continued centralization of mining interests could be expose the community to corrupt behavior.
  • New technologies could emerge that make Bitcoin redundant.
  • The underlying bitcoin protocol could fail or be exploited.

Wrapping it up

Bitcoin’s block chain technology permits the decentralization of trust, removes the need for oversight and allows a remarkable amount of man power to be replaced by unbiased, hardworking, mathematical code.

Bitcoin is a hugely successful financial experiment with some obvious efficiency benefits. It’s still finding its feet, and it will be very interesting to see how the technology is implemented in future years.

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