What is Bitcoin?
- The name of a global currency which has been around since January 2009. Its abbreviation is BTC (sometimes also XBT).
- The unit of this currency. You may own several BTC or also a part of a BTC. A BTC is divisible down to eight decimal places.
- The name of the protocol and network, through which this currency is realized. By means of the bitcoin protocol, computers exchange information on the Internet regarding the currency and its transactions.
What are the main features of Bitcoin?
- Freedom - Bitcoin does not have any boundaries, anyone with access to a computer and the Internet can receive, own and send bitcoins. No approvals or intermediaries are needed to record, realize and authorize your payments like banks do with your regular money. The software for the transaction realization and the bitcoin network operation is also free and opensource. The currency is not emitted by any government and it’s not otherwise regulated (although some countries are trying to, as a matter of principle, it is impossible).
- Safety - Nobody can take your bitcoins, if you don’t give them your key. Only the key owner (bitcoin recipient) may control any part of the bitcoin that somebody has sent him. This feature has also its problematic consequences. Bitcoins may not be confiscated, for example, in case it gets proved that the bitcoins are derived from criminal activity, or if sent by mistake they cannot not be returned.
- Privacy - Nobody needs to know you own any of the existing bitcoins unless you disclose your part of the key – address to which the bitcoins are bound.
- Speed - The information that somebody is sending you bitcoins will reach you within a couple of 5 seconds. You can be sure that you have control of your bitcoins within a couple of minutes.
- Price - Sending bitcoins anywhere around the world (over the Internet) costs almost nothing.
Where and how is the bitcoin ownership recorded?
The information regarding how many bitcoins belong to a certain key is stored in a blockchain
A blockchain is a kind of great ledger containing pages where there are several transactions
on each page.
always contains how many bitcoins are transferred by a certain key into the ownership of another key. These pages are called blocks. Each block also contains information regarding the preceding block (page).
Thus the blocks are chained into one great ledger – the origins of the name Blockchain.
The blockchain's contains is publicly shared by the computers (nodes, sometimes also called peers) on the Internet.
On average, a new block with new transactions is added to the blockchain every 15 minutes.
And what about the keys?
The keys are used to control bitcoins.
For example, when sending them – transferring the bitcoin ownership onto another owner (to another key). The type of keys used for bitcoins is ECC
(or more accurately secp256k1
Every key has three parts:
A Bitcoin wallet
- Private key - it is used to sign a transaction.
You prove that the given bitcoins are owned by you and you may therefore transfer the bitcoins to a new owner.
- Public key - it is safe to make it public. Public key cannot be used to to transfer your bitcoins anywhere. The public key may be derived from the private one, but not vice versa.
The public key is always present in the transaction on the side of the sender and is used by the others to verify the correctness of the transaction's signature.
- Address - it is also safe to make the address public. It is not possible to transfer the bitcoins anywhere with it. The address may be derived from the public key, but not vice versa.
The purpose of the address is basically practical. It is shorter than the public key and therefore it is easier for anyone to read it and it takes up less space in the transaction. Also, it contains control information and thus it enables to detect a typo in the address.The address is used in the transaction on the recipient side and also for balance queries regarding the amount of bitcoins bound to this address (in other words, how many bitcoins are available with this key).
The address usually begins with a number 1 or 3. E.g.: 1A8b1QNmuH2Ei4PXhCmQby9wMVz6xkzBWY
is nothing less than a place, where your private keys are stored.
The term wallet
is broadly used, however, it is not accurate. To be more precise, the term key chain
should be used. We don’t have bitcoins in a wallet (bitcoin's ownership is recorded on the Internet by peers in blockchain), but we only have keys which entitle us to control the bitcoins.
A bitcoin wallet is usually a software on your computer or a service on the Internet, where your private keys are stored and it shows you how many bitcoins are assigned on individual addresses. And it helps you create, sign and send a new transactions.
A new private key is created easily – you throw a dice in a computer program, just this dice has a large number of sides.
It is a random 256-bit number(2256
). The probability that two people (or other forms of life) in Space roll the same number on a dice is almost null.
If you are going to use bitcoins, certainly you will come across QR codes
A QR code is a machine-readable two dimensional picture containing information.
With bitcoins, QR codes are mostly used so that we don’t have to rewrite addresses or private keys by hand from one device to another.
Mostly you will see an address in a QR code when you want to make or accept a payment.
After reading the QR code, your cell phone will know where to send your bitcoins (sometimes a QR code also contains the amount to pay).
When accepting bitcoins, you show the counterparty, where to send the bitcoins and eventually even the amount to be sent.
You will see a private key in a QR code too but less often.
You print your private key in a QR code when, for example, you want to make a backup of our private key on paper and later you want to load it easily into your mobile phone wallet or different device.
Private keys in form of QR codes are also called paper wallet
How are new Bitcoins created?
In classic currencies there is always a currency emitter – someone who emits/prints it and thus controls it. For example, a king or a central bank.
In case of bitcoins the emitter of newly created bitcoins is not known in advance.
New bitcoins are generated always with the creation of a new block and they are the miner’s
reward for being the first to mine
the next new block.
By mining, we mean a complicated mathematical problem. Millions of computers all over the world are trying to solve this problem and get the reward.
The task is to line up new transactions from other users into a new block so that the hash (software function double SHA-256
) of this new block begins with a certain amount of zeros.
The result may be reached only through many attempts to calculate the hash.
If other peers on the network find out that the results are being found too quickly, the required amount of zeros gets automatically increased. If the reaching the results takes too long, the number of required zeros is reduced.
This regulates the creation of a new block with the aim to generate on average 6 blocks per hour.
Anyone, who installs a relevant software, can be a miner.
The miner who mines the new block as first gets the newly created bitcoins as a reward. This transaction is always recorded in the first place in the block and it is called coinbase
Nowadays, mining is so power demanding, that specifically designated chips are being produced for it. Since the probability that you will be the one who finds the solution is very low (once every X years), the miners unite into groups called pools
. In this pool they seek the solution together with the other miners and then divide the given reward on the basis of the executed work (number of trials). They do not have to wait years to earn money for the electricity bill, but they get a lower, but regular income which covers their computer runtime (elecricity) and Internet costs.
On the basis of the above mentioned, it can be said that the price of the bitcoin depends on the electricity prices and that the part of bitcoin we own is a share on the solution of a mathematical equation.
Every transaction may contain (and usually contains) a fee
pro minera.or the miner. Apart from the reward for the newly mined block, the miner receives also the fees from all the newly included transactions into the block. In case of a big number of transactions (the size of the block is limited and not always all the new transactions accommodate into it) then the fee motivates the miner to record transactions with the highest fees into the new block. You may set your fee when you create your transaction. With the fee you regulate the priority of your transaction.
The reward for the miner is set by bitcoin protocol programmed regulations. At the start of this currency, the reward for a new block was 50 BTC. This reward gets reduced by half around every 4 years. It is calculated that in total there will only be 21 million BTC around 2140. Then, the rewards for the miners shall only be the transaction fees and not newly generated bitcoins.
From the above mentioned, it is clear that the bitcoin is rather a deflationary currency. The classic currencies are usually inflationary. By the inflationary mechanism (de facto currency owners’ wealth redistribution) the central banks regulate the economy performance (full employment policy). It is questionable what impact will the deflationary feature have on the bitcoin economy (why should I spend my bitcoins today, when tomorrow they will be worth more).
Other use of Bitcoin
Bitcoin may be used not only to transfer value (amount of money), but it also has other utilization.
The fact that information recorded in the blockchain may not be modified retrospectively (for each block, a great math calculation has been made) and that each block contains the relevant time allow for example:
- Proof of Existence - the possibility to prove that certain information was already known at a certain time.
Example: You have a contract. You scan it. You calculate the hash of this picture. From the hash you calculate the address and you send a certain amount of BTC to this address. Then in the future you may, at any time, verify this document already existed at that given time and it was an unmodified original.
In the future, this feature may become more important as defense against digital censure. You will always know if the government or anybody else withholds any information from the document.
The keys used for sending bitcoins may be also utilized to encrypt messages
or to log in
to various services without having to use a name and a password as we are used to doing today.
Other interesting facts
Why do certain addresses begin with number 1 and others with 3?
Bitcoins from the address beginning with number 1 may be sent using only one key.
Bitcoins from the address beginning with number 3 may be sent using a key combination. For example, the transaction must be signed by at least 2 keys out of 3. This enables safe collective control of the funds when each key is owned by someone else.
What happens when more new blocks are mined by more miners at the same time?
It is possible and it happens.
The information regarding a new block is sent by the miner to all of his peers around and these send it further. It is possible that before this information gets from one side of the network to the other, another miner finds a competitive solution on the other side.
It has already been said that each block contains a link (hash) of the previous block. Which hash are the miners going to use for the next new block?
They will use either the one which is most convenient for them (from which they get more fees – if they were the ones to mine it) or the one which creates a chain with the most work done. The biggest count of 0 in hashes of all blocks (difficulty).
What is the number of confirmations on a transaction?
The number of confirmations represents the distance in the number of blocks in the blockchain from the block, in which the transaction was included.
0 confirmations mean the transaction hasn’t been included in a block yet.
1 confirmation means the transaction was included in the last mined block.
This distance gives you degree of certainity that the bitcoins have been transferred.
E.g. When there are 0 confirmations it is not sure the transaction is really going to be included into a block. The bitcoins become yours only when the transaction gets included into the blockchain.
Who invented Bitcoin?
An unknown group or individual existing under the pseudonym of Satoshi Nakamoto
, who in 2008 published a paper
how bitcoin should work and assigned selected programmers to code it.
Who controls Bitcoin?
Bitcoin doesn’t have a central authority. Bitcoin follows only the rules programmed in the bitcoin peer/node software.
We can say that those who control bitcoin are:
- Developers who develop the software being used.
- Miners who operate this software (by installing the software they accepted the changes prepared by the developers).
- Those who propose changes through BIP documents. These documents get discussed passionately and in case of general agreement these changes are accepted by the developers.
What is a deterministic wallet?
Nowadays, deterministic wallets are actually a standard which enable an easier storage and backup of keys and a better anonymity.
Although bitcoin enables a certain level of anonymity (nobody knows who owns which bitcoins), it is not completely ideal.
In case you are using one key for all your funds and you pay for a beer at a pub, then the pubkeeper can check your balance in the blockchain on the address you sent the bitcoins from.
To prevent this from happening, it is recommended to use more wallets (keys) in which your bitcoins are divided. The ideal case is when a new wallet is generated with every payment (new key – also called change address), the remaining part of your wallet shall be transferred to this new wallet.
Like this, you can get even a 1000 keys in a short period of time. The loss of any of the keys to which your bitcoins are bound to, may cause the loss of these bitcoins. It is impossible to expect that user will backup his keys with each payment.
The deterministic wallet solves this problem.
After the installation, the wallet generates a so called master key, from which one may deterministically calculate other private keys. It is therefore necessary to backup only this master key.
The backup of the master key is usually made by writing down 12 or 24 words on paper. Whenever in the future a wallet gets lost (broken harddisk or stolen phone) the backed up master key enables to re-calculate all the private keys and to get to all your bitcoins.