What is Bitcoin?Posted 2/25/20 by Yan Pritzker
Bitcoin is a peer to peer electronic cash, a new form of digital money that can be transferred between people or computers without any trusted intermediary (such as a bank) and whose issuance is not under the control of any single party.
Think of a paper dollar or metal coin. When you give that money to another person, they don’t need to know who you are. They just need to trust that the cash they get from you is not a forgery. Typically people do this with physical money using only their eyes and fingers or using specialized testing equipment for more significant amounts.
The majority of payments in our digital society are made over the Internet using a middleman service: a credit card company like Visa, a digital payment provider such as PayPal or Apple Pay, or an online platform like WeChat in China.
The movement toward digital payments brings with it the reliance on a central actor that has to approve and verify every payment. The nature of money has changed from a physical object you can carry, transfer, and authenticate yourself to digital bits that have to be stored and verified by a third party that controls their transfer.
As we give up our cash for convenient digital payments, we also create a system where we give extraordinary powers to those who would seek to oppress us. Digital payment platforms have become the basis of dystopian authoritarian methods of control, such as those used by the Chinese government to monitor dissidents and prevent citizens whose behavior they don’t like from purchasing goods and services.
Bitcoin offers an alternative to centrally controlled digital money with a system that gives us back the person to person nature of cash, but in a digital form. Bitcoin is a digital asset that is issued and transferred over a network of interconnected computers that each independently verifies that everyone else is playing by the rules.
Where Did Bitcoin Originate?
Bitcoin was invented by a person or group known by the pseudonym of Satoshi Nakamoto around 2008. No one knows Satoshi’s identity, and as far as we know, they’ve disappeared and haven’t been heard from for years.
On Feb 11, 2009, Satoshi wrote about an early version of Bitcoin on an online forum for cypherpunks, people who work on cryptography technology and are concerned with individual privacy and freedom. Though this isn’t the first official release announcement of Bitcoin, it does contain a good summary of Satoshi’s motivations.
I’ve developed a new open source P2P e‑cash system called Bitcoin. It’s completely decentralized, with no central server or trusted parties, because everything is based on crypto proof instead of trust. […]
The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. Their massive overhead costs make micropayments impossible.
A generation ago, multi-user time-sharing computer systems had a similar problem. Before strong encryption, users had to rely on password protection to secure their files […]
Then strong encryption became available to the masses, and trust was no longer required. Data could be secured in a way that was physically impossible for others to access, no matter for what reason, no matter how good the excuse, no matter what.
It’s time we had the same thing for money. With e‑currency based on cryptographic proof, without the need to trust a third party middleman, money can be secure and transactions effortless. […]
Bitcoin’s solution is to use a peer-to-peer network to check for double-spending. In a nutshell, the network works like a distributed timestamp server, stamping the first transaction to spend a coin. It takes advantage of the nature of information being easy to spread but hard to stifle. For details on how it works, see the design paper at http://www.bitcoin.org/bitcoin.pdfSatoshi Nakamoto
What Problems Does Bitcoin Solve?
Let’s break down some of Satoshi’s post to glean his motivations.
P2P stands for peer to peer and indicates a system where one person can interact with another without anyone in the middle, as equal peers. You may recall P2P file-sharing technologies like Napster, Kazaa, and BitTorrent, which first enabled people to share music and movies without an intermediary. Satoshi designed Bitcoin to allow people to exchange e‑cash, electronic cash, without going through an intermediary in much the same way.
The software is open source, which means that anyone can see how it works and contribute to it. We don’t need to believe anything Satoshi wrote in his post about how the software works. We can look at the code and verify how it works for ourselves. Furthermore, we can evolve the functionality of the system by changing the code.
Satoshi mentions that the system is decentralized to distinguish it from systems that do have central control. Prior attempts to create digital cash such as DigiCash by David Chaum were backed by a central server, a computer, or a set of computers that was responsible for issuance and payment verification under the control of one corporation.
Such centrally controlled private money schemes were doomed to failure; people can’t rely on money that can disappear when the company goes out of business, gets hacked, suffers a server crash, or is shut down by the government.
Bitcoin is maintained by a network of individuals and companies all over the world. To shut Bitcoin down would require shutting down tens to hundreds of thousands of computers around the world, many in undisclosed locations. It would be a hopeless game of wack-a-mole as any attack of this nature would simply encourage the creation of new Bitcoin nodes, or computers on the network.
The Internet, and indeed most modern computer systems, are built on cryptography, a method of obscuring information so that only the recipient of the information can decode it. How does Bitcoin get rid of the requirement of trust? Instead of trusting someone that says “I am Alice” or “I have $10 in my account,” we can use cryptographic math to state the same facts in a way that is very easy to verify by the recipient of the proof but impossible to forge. Bitcoin uses cryptographic math throughout its design to allow participants to check the behavior of everyone else without trusting any central party.
Unlike using your bank account, digital payment system, or credit card, Bitcoin allows two parties to transact without giving up any personally identifying information. Centralized repositories of consumer data stored at banks, credit card companies, payment processors, and governments are giant honeypots for hackers. As if to prove Satoshi’s point, Equifax was massively compromised in 2017, leaking the identities and financial data of more than 140 million people to hackers.
Bitcoin decouples financial transactions from real-world identities. After all, when we give physical cash to someone, they don’t need to know who we are, nor do we need to worry that after our exchange, they can use some information we gave them to steal more of our money. Why shouldn’t we expect the same, or better, from digital money?
Fiat, which is Latin for “let it be done,” refers to government and central-bank issued currency, which is decreed as legal tender by the government. Historically, money emerged from things that were hard to produce, easy to verify, and easy to transport, such as seashells, glass beads, silver, and gold.
Any time something was used as money, there was a temptation to create more of it. If someone came along with superior technology for quickly creating lots of something, that thing lost value. European settlers were able to strip the African continent of its wealth by trading easy to produce glass beads for hard to produce human slaves. The same happened to the Native Americans when the colonists discovered the ability to quickly produce wampum shells, which were considered previously scarce by the natives.
Over time and throughout the world, people realized that only gold was scarce enough to act as money without fear that someone else could create lots more of it. We slowly shifted from a world economy that used gold as money to one where banks issued paper certificates as claims on that gold. Nixon ended the international convertibility of the US dollar to gold in 1971 with a temporary order that quickly became permanent.
The end of the gold standard allowed governments and central banks full permission to increase the money supply at will, diluting the value of each note in circulation, known as debasement. Although government-issued, redeemable for nothing, pure fiat currency is the money we all know and use daily, it’s a relatively new experiment in the scope of world history.
We must trust our governments not to abuse their printing press, but we don’t need to look far for examples of breaches of that trust. In autocratic and centrally planned regimes where the government has its finger directly on the money machine, such as Venezuela, the currency has become nearly worthless. The Venezuelan Bolivar went from 2 Bolivar to the US dollar in 2009 to 250,000 Bolivar to the US dollar in 2019.
Satoshi wanted to offer an alternative to fiat currency whose supply is always expanding unpredictably. To prevent debasement, Satoshi designed a system of money where the supply was fixed and issued at a predictable and unchangeable rate. There will only ever be 21 million bitcoins. However, each bitcoin can be divided into 100 million units now called satoshis, producing a final total of 2.1 quadrillion satoshis in circulation around the year 2140.
Before Bitcoin, it was not possible to prevent a digital asset from being infinitely reproduced. It is cheap and easy to copy a digital book, an audio file, or video and send it to your friend. The only exceptions to this are digital assets controlled by middlemen. For example, when you rent a movie from iTunes, you can watch it on your device only because iTunes controls the delivery of the movie and can stop it after your rental period.
Similarly, your bank controls your digital money. It is the bank’s job to keep a record of how much money you have. If you transfer it to someone else, they authorize or deny such a transfer.
Bitcoin is the first digital system that enforces scarcity without any middlemen and is the first asset known to humanity whose unchangeable supply and schedule of issuance is known entirely in advance. Not even precious metals like gold have this property since we can always mine more and more gold if it is profitable to do so. Imagine discovering an asteroid containing ten times as much gold as we have on earth. What would happen to the price of gold given such abundant supply? Bitcoin is immune to such discoveries and supply manipulations. It is simply impossible to produce more of it.
Our current methods of securing money, such as putting it in a bank, rely on trusting someone else to do the job. Trusting such an intermediary not only requires confidence that they won’t do something malicious or foolish, but also that the government won’t seize or freeze your funds by exerting pressure on this middleman.
However, it has we have seen time and time again that governments can and do shut down access to money when they feel threatened. It might sound silly to someone living in the United States, or another highly regulated economy, to contemplate waking up with your money gone, but it happens all the time. I’ve had my funds frozen by PayPal simply because I hadn’t used my account in months. It took me over a week to get restored access to “my” money. I’m lucky to live in the United States, where at least I could hope to seek some legal relief if PayPal froze my funds, and where I have basic trust that my government and bank won’t steal my money.
Much worse things have happened, and are currently happening, in countries with less freedom. Banks shut down during currency collapses in Greece. Banks in Cyprus used bail-ins to confiscate funds from their customer. The government declared certain banknotes worthless in India.
The former USSR, where I grew up, had a government-controlled economy leading to massive shortages of goods. It was illegal to own foreign currencies such as the US dollar. When we wanted to leave, my family was allowed to exchange only a limited amount of money per person to US dollars under an official exchange rate that was vastly divorced from the true free market rate. Effectively, the government stripped us of what little wealth we had by keeping an iron grip on the economy and the movement of capital.
Autocratic countries tend to implement strict economic controls, preventing people from withdrawing their money from banks, carrying it out of the country, or exchanging it for not-yet-worthless currencies like the US dollar on the free market. This allows the government free reign to implement insane economic experiments such as the socialist system of the USSR.
Bitcoin does not rely on trust in a third party to secure your money. Instead, Bitcoin makes your coins impossible for others to access without a unique key that only you hold, no matter for what reason, no matter how good the excuse, no matter what. By holding Bitcoin, you hold the keys to your own financial freedom. Bitcoin separates money and state
A network refers to the idea that a bunch of computers are connected and can send messages to each other. The word distributed means that there is not a central party in control, but rather that all the participants coordinate to make the network successful.
In a system without central control, it’s essential to know that nobody is cheating. The idea of double-spending refers to the ability to spend the same money twice. Physical money leaves your hand when you spend it. Digital transactions, however, can be copied just like music or movies. When you send money through a bank, they make sure that you can’t move the same money twice. In a system without central control, we need a way to prevent this kind of double-spending, which is effectively the same as forging money.
Satoshi is describing that the participants of the Bitcoin network work together to timestamp (put in order) transactions so that we know what came first. Therefore we can reject any future attempts to spend the same money.
Satoshi tackled several interesting technical problems to address the issues of privacy, debasement, and central control in current monetary systems. In the end, he created a peer to peer network that anyone could join without revealing their identity or having to trust any other participant.
How has Bitcoin evolved over the last decade?
When Bitcoin launched, only a handful of people used it and ran the Bitcoin software on their computers to power the Bitcoin network. Most people at the time thought it was a joke, or that the system would reveal serious design flaws that would make it unworkable.
Over time, more people joined the network, using their computers to add security to the network. People started exchanging Bitcoins for goods and services, giving it real-world value. Currency exchanges emerged that swapped Bitcoin for almost every traditional fiat currency in the world.
Ten years after its invention, Bitcoin is used by millions of people with tens to hundreds of thousands of nodes running the free Bitcoin software, which is developed by hundreds of volunteers and companies worldwide. The Bitcoin network has grown to secure more than a hundred billion dollars worth of value.
Computers that participate in securing the Bitcoin network are known as miners. They operate industrial operations across the world, investing millions of dollars into specialized mining hardware that only does one thing: ensure that Bitcoin is the most secure network on the planet.
Miners expend electricity to make Bitcoin transactions secure against modification. Because miners compete with each other for scarce number of bitcoins produced per day, they must always find the cheapest energy sources on the planet to stay profitable. Miners operate in places ranging from hydroelectric dams in the far reaches of China to wind farms in Texas, to Canadian oilfields that produce gas that would otherwise be vented or flared into the atmosphere.
Although Bitcoin is highly publicized and debated in the media, we estimate that only a few million people in the world have started saving Bitcoin regularly. For many people, especially those who have never lived under oppressive regimes, this invention of a new form of digital money outside the control of government can be very challenging to understand and appreciate. That’s why we’re here. We want to help you understand Bitcoin and own your future!
Featured photo by Marko Ahtisaari, cropped.
This blog offers thoughts and opinions on Bitcoin from the Swan Bitcoin team and friends. Swan Bitcoin is the easiest way to buy Bitcoin using your bank account automatically every week or month, starting with as little as $10. Sign up or learn more here.