Bitcoin Simplified

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Disclaimer: Crypto is a fast-paced economy and things change quickly. Information on this post might be outdated even if written today. Do your own due diligence and stay safe. I might get affiliate commissions for purchases made through links in this post. Read the disclosure.

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It is said that Satoshi Nakamoto (pseudonym) invented Bitcoin, but it is not proven whether it was a group of people or one individual. No one knows for sure. The work for Bitcoin is said to have started already in 2007 (stated by Nakamoto) and not 2008, even though that is said in many sources.

Creator of Bitcoin – Satoshi Nakamoto – though we don’t know who actually created Bitcoin, except that he/she named him/herself as Satoshi Nakamoto.

31st of October 2008, the whitepaper (report/guide on a complex issue) for Bitcoin was created to explain the complex innovation behind Bitcoin.

At the very same time, the world suffered the great financial crisis that lasted for a few years, from 2007 to 2008, and started a great recession. It is speculated that this crisis was a slight motivator to the invention of Bitcoin in the first place.

The core principle behind cryptocurrencies and crypto-assets, in general, is the idea of decentralization, creating decentralized applications and currencies where there is no one owner or a group but a distributed network of individuals like you and me.

When acting in a decentralized network, you do not have to know anyone, and no one has to know you or trust you. The data is intact in a public ledger, and everyone has access to the same data whenever needed. This creates a trustless environment, which is one of the founding ideas for crypto space.

Trustless Environment

No one has to know or trust anyone – Everyone inside the network knows the same information. Creating a system that does not need intermediaries or third parties.

Improved Data Reconciliation

In a decentralized data store, every user inside the network has access to a real-time, shared view of the data.

Bitcoin Specifications

  • Ledger start: 3 January 2009 (12 years ago)
  • Timestamping scheme: Proof-of-work (partial hash inversion)
  • Issuance schedule: Decentralized (block reward)
  • Initially: ₿50 per block, halved every 210,000 blocks
  • Block time: 10 minutes
  • Current circulation of Bitcoin: ₿18,761,656 (as of 20 July 2021)
  • Supply limit: ₿21,000,000

How The Proof Of Work Works

While the invention of Bitcoin is huge and the disruptive effect on “modern” finance is massive. It does come with a cost. The cost comes from the fact that Bitcoin works in the form of (hashcash) Proof of Work.

Proof of work (PoW) protocol is used in Bitcoin for creating a block for the network. For the block to be accepted by the network participants, miners have to complete a proof of work that covers all of the data in the block.

The difficulty of this work is adjusted by a mathematical calculation task to limit the rate at which new blocks can be generated to ONE every 10 minutes. The worker computer that solves the mathematical puzzle before others will win the proof of work and is granted the creation of the next block for the network.

Proof of work is also used to validate data/token transfers from one person to another. So, all in all, mining is a central piece for the Bitcoin network to work. The answer to the PoW problem or mathematical equation is called a hash. As the network is growing, the algorithms need more and more hash power to solve.

This results in environmental concerns. Computers need more and more electricity (power) to compute the mathematical equation, to get the validation work done. For you to transfer your coin to someone else, the hash needs to be done.

It could be that only one computer would mine Bitcoins, which would mean that this one computer would control 100% of the hashing power. However, Bitcoin is seen as a valuable token, and so more and more people/miners want to join the game and earn block rewards which at the beginning was 50 BTC for every block mined/verified.

Block Reward

At the time of writing, the block reward is 6.25BTC/block verified/created. 6.25BTC is roughly valued at $187 500 USD (1BTC being $30 000 USD). By verifying 6 blocks, you would be a millionaire.

When block 840,000 is hit in 2024, the subsidy will drop to 3.125 bitcoins (BTC) per block. This usually has meant a huge price increase for Bitcoin as the supply will decrease, but demand usually stays roughly the same.

  • The first halving event occurred on the 28th of November, 2012 (UTC)
  • The second halving event occurred on the 9th of July, 2016 (UTC)
  • The third halving event occurred on the 11th of May, 2020 (UTC)

The bigger the network grows, the more hash power is needed to verify all the transactions (trading, sending/receiving, mining) inside the network, creating an increase in hash rate, but also an increase in the computational effort needed to process all the transactions.

The interesting part is that the mathematical equation gets easier when fewer computers are validating or creating the blocks —leading to fewer environmental concerns.

Mining Bitcoin

At the time of writing, roughly 144 blocks per day are mined on average, and there are 6.25 bitcoins per block. 144 x 6.25 is 900, so that’s the average amount of new bitcoins mined per day. 900 BTC is worth $27M USD.

The interesting question is, what if Bitcoins value drops and the mining reward is halved roughly every 4 years. The situation could become such that it wouldn’t make sense to mine BTC blocks anymore, which would collapse the whole network —making the network pretty fragile.

However, if the BTC value increases to 1-2 million USD, then even small rewards through the halving procedure would make the mining operation worthwhile. So, all in all, it’s a gamble whether the value will be high or low in the future.

51% Attack In Proof Of Work

Proof of Work is vulnerable to a situation where a user or a group of users control the majority 51% of the mining power. This enables the users to reverse transactions, which can lead to lost blocks and/or double-spending the same coins.

This kind of scenario has happened for Bitcoin cash (though it is said that it was made to help the network) and for Ethereum Classic. Even Bitcoin almost got into a similar situation when Gash.io’s mining pool got so big that 51% was nearing and created a panic among the Bitcoin community. It was quickly sorted out, but we can only conclude that it’s always a possibility that a mining pool gets too big and misuse its mining power.

The Energy Consumption Of Bitcoin

While the hash rate is growing by transaction activity (people sending and receiving BTC) and miners wanting to get new Bitcoins (money), so will the need for more electricity. This is one of the biggest reasons why investors, institutions, and other major parties are worried about Bitcoins’ future.

We can always compare how much electricity regular banks use, and we can easily conclude that while Bitcoin uses a lot of electricity, so does regular banks. But what is also important to notice is that what is the amount of renewable energy being used to mine the BTC? According to some sources, it could be roughly 56% already.

Annualized Total Bitcoin Footprints

  • Carbon (CO2) 64.18Mt
  • Electrical Energy 135.12TWh

The Bitcoin network currently uses roughly the same amount of electricity as the country of Sweden.

However, when compared to the production and mining of gold. The electric energy consumption is 240.61 TWh. Significantly more than what Bitcoin uses, and when compared to the 100 top global banks, the consumption is even greater 263.72TWh.

When thinking about crypto, we have to remember that Bitcoin isn’t the only cryptocurrency out there. Ethereum also uses proof of work protocol on its layer 1 network and uses electrical energy in the amount of 57.4TWh.

The Lightning Network

The Lightning Network is a layer-2 payment protocol designed to be implemented on top of a layer-1 network solution. Bitcoin’s core network is called layer-1. The lightning network enables instant payments, scalability, low cost, cross blockchains, etc., but the most interesting part of the lighting network is its ability to do transactions off-chain. 

While transactions are handled off-chain, the enforcement process of transactions is still made on-chain, making the use of Bitcoin more accessible and more manageable as a usable currency. However, the security of the off-chain transactions is somewhat debatable. Something to also notice is that when Bitcoin is thought to be a store of value, why would you use Bitcoin? When in fact holding Bitcoin long-term could lead to higher gains and wealth.

Bitcoin And Gold

Bitcoin is so often said to be the digital gold, referring that Bitcoin is as valuable as gold in the physical world or it holds value the same way as physical gold. Bitcoin is nothing like gold.

However, if we think about gold, it was first used by different cultures in Eastern Europe in 4000 B.C. to make decorative objects. Only until 1500 B.C. in ancient Egypt was it used as a medium of exchange. 

Gold has this long-lasting idea of value, but in reality, gold is just a metal that shines. You can’t really use gold to buy yourself things or transfer it to your friends or anything. You can’t basically do anything useful with gold these days. You can pretty much only sell it in your local jewelry shop or online through a reputable buyer.

So when people compare Bitcoin to gold it truly doesn’t make that much sense. Bitcoin can be transferred instantly to anywhere in the world and can also be used to buy things online.

The only reason why it could be seen as valuable as gold is that Bitcoin seems to store value. There will only ever be 21M Bitcoin in circulation and that means that if the demand grows, the value of Bitcoin grows. Because at some point there is no more supply and thus the value of Bitcoin can be huge.

However, probably the biggest reason Bitcoin has value is that it was the first cryptocurrency ever invented and also the first coin that gained a good amount of adoption. Bitcoin is known worldwide and that creates value for Bitcoin for now. What makes it interesting against gold, is the fact that Bitcoin is not so usable, creating a nice irony with the usage of gold.

Countries That Have Adopted Bitcoin In Some Form

  • El Salvador
    • The first country that made Bitcoin a legal tender. Making Bitcoin a currency for the country.
  • Argentina
  • Brazil
  • Paraguay
  • Mexico
  • Panama
  • Venezuela

Companies That Accept Cryptocurrencies In Some Form

  • Microsoft
  • Wikipedia
  • PayPal
  • AT&T
  • Burger King
  • Twitch
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Written By Juha Ekman

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