Bitcoin’s original name was “peer-to-peer electronic cash system”, which sounds difficult, right? Well in this article my objective will be to teach you what is Bitcoin, and how it works as if you were five years old.
At the origin of the internet, you couldn’t make any cash transaction from your bank account to someone else bank account without the intervention of a third party (a bank). Bitcoin is a solution to avoid banks in your transaction, it has been created in 2008 after the financial crisis by an anonymous person (or a group of people) hidden behind the pseudonym of Satoshi NAKAMOTO. But why would you like to avoid banks? The main reason is to avoid large fees and commissions, slow transactions and the fact that you cannot send money to someone who doesn’t have a bank account. Or 20% of the population is poorly developed countries don’t have the access to a bank account which represents 2 billion people who are out of the bank system.
Bitcoin is based on a peer-to-peer transaction model, which means you are directly sending your Bitcoins to someone else without any third party, but how can you do that? The answer is, thanks to blockchain.
What is the Blockchain?
The blockchain is a giant accounting book that anyone can consult at any time. It is composed of computers connected to a network to verify that every transaction is valid. Let’s take a small example to get a better understanding of what it is.
Bob sends 1 Bitcoin to Alice, every computer connected to the blockchain will verify that Bob has 1 Bitcoin and Alice has 0 Bitcoin. Once it is done those same computers will send the message that Bob has 1BTC -1BTC and that Alice has 0BTC + 1BTC. At the end of the day, every computer on the network will notice that Bob has 0BTC and Alice has 1BTC.
This is basically how the blockchain works. In that way, you cannot create a fake transaction because every computer of the Blockchain has an example of the history of past transactions. Thanks to that the more computers are connected to the Blockchain the more difficult it becomes to hijack it. Every 10 minutes a new block is added to the blockchain to actualize the transactions, and miners (the one you are securing the network) are paid in Bitcoin.
Bitcoin can process between 3 and 7 transactions per second, and the fees will depend on how to saturate is the network. But the important thing is that the amount of Bitcoin you are willing to transact does not affect your fees.
What makes Bitcoin so different from a FIAT currency?
Well, the main difference between Bitcoin and a FIAT currency such as USD or EURO is that Bitcoin is decentralized. This means there is no central authority controlling the supply of Bitcoins. Bitcoin is completely autonomous; it is the core code that controls the supply. New Bitcoins are creating by the miners securing the network and the supply is divided by 2 every 4 years, we call that the Halving. Thanks to that the total supply of Bitcoins is limited to 21 million and inflationist policies are impossible, which creates rarity. For example, the FED can “print” new dollars whenever it wants to, this does affect the value of a dollar, which is called inflation. Therefore, the motto of Bitcoin is “vires in numeris” or “strength in numbers”.
What will happen when there will be no more Bitcoins to be mined?
The good is… this will never happen, because the supply is divided by 2 every 4 years, the mining rewards tends to 0 but will never reach 0, which means that miners will always receive at least a small portion of Bitcoin. Only the difficulty to get this reward will increase because miners compete to solve a complex equation. This equation leads to verify and add a new nod of transactions to the blockchain. However, there will never be 21 million Bitcoins in circulation, some of them have been lost and others are stocked on what we call a “cold wallet”. A cold wallet is a physical wallet like a card with a QR code or a ledger wallet in which you can hold cryptocurrencies.
The big question around Bitcoin is its capacity to be a currency. That is what we will discuss that in the following article.
