What is Bitcoin?

04 May 2021

Bitcoin is a digital currency that was launched in 2009, following the publication of the now-famous Bitcoin whitepaper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”. Accordingly, Bitcoin can also be defined as a trust-less public ledger, where transactions are conducted without middlemen.

When first created, proponents of Bitcoin lauded it for the following features.

Keeping in mind that sending money overseas was not necessarily the easiest or cheapest thing to do in 2009, Bitcoin was quickly attracted attention for the novel way it approached achieving instant payments in a peer-to-peer system, while keeping the network de-centralised and beyond any one actor’s ability to control.

How Bitcoin Works: Mining

A rudimentary understanding of Bitcoin can be achieved by remembering the following three actors, and how they interact through the process known as mining.

Anyone who uses the Bitcoin network (transactors) is relying on a network of independent individuals and companies who volunteer their computing power (miners) to validate and process their transactions (mining). Successfully validated transactions are recorded in a data block, which is then added as the latest block in an unending chain of “data blocks” (the blockchain). This chain dates back to the first ever block of transactions on the 9th of January, 2009.

An easy way of thinking about this, is that miners are essentially a de-centralised global network of anonymous auditors, all of whom are working on validating an identical set of transactions every ten minutes. However, the twist is that only one auditor gets paid at the end of that ten minute period.

At this point, astute readers will notice that the simplest explanation possible of Bitcoin is that it is simply a very, very long list of transactions simultaneously updated by a network of ledgers.

Bitcoin’s reward system incentivises miners to validate transactions

When individuals conduct transactions through a middleman such as a bank, the middleman always charges a fee to maintain the system, as well as for the provision of that service. Were there no fees, banks and other middlemen would have no incentive to maintain such a payments system, and sending money to other people, especially overseas, would be a tedious and expensive affair.

When conducting transactions over the Bitcoin network however, transactors including a fee generally have their transactions processed faster, but the inclusion of a fee is typically not necessary. Fees will be charged however, should the complexity of the transaction increase – such as sending Bitcoin to multiple addresses at one go. The fees will go to the miner who receives the block reward when the block is added to the blockchain.

Beyond the sporadic payment of fees from transactors to miners, the creators of Bitcoin further devised an incentive system to attract miners to process all Bitcoin transactions of their own volition. Under this system, validators of Bitcoin transactions compete for newly-minted Bitcoin created and distributed by the network every 10 minutes as a mining reward for helping in the validation of data blocks.

Given the astronomical price of Bitcoin these days, Bitcoin rewards are often bitterly contested, with armies of miners armed with incredibly powerful computing rigs fighting for new Bitcoin by helping to validate every transaction going through the network.

Mining rewards are reduced every 4 years

The only way that new Bitcoin can be added to the network, is through the rewards given when new blocks are added to the blockchain (hence the terminology behind saying that new Bitcoin is mined).

Chart: Approximate total supply of Bitcoin annually

While new Bitcoin is minted and distributed as a mining reward every 10 minutes, there is a hard cap on the total amount of Bitcoin that can ever exist – 21 million. As of end-2020, the world had around 18.6 million Bitcoin in existence, meaning that only around 2.4 million new Bitcoin could still be created and distributed as mining rewards at that point.

When Bitcoin was first launched in 2009, miners received 50 BTC tokens when a new block was successfully added to the blockchain every ten minutes. The timing of the disbursement is immutable, and has not changed since Bitcoin’s inception.

However, the amount of BTC rewarded was hard-coded to decline over time, mimicking a slowing rate of inflation. To achieve this, BTC rewards are halved every 210’000 mined blocks, which translates to around every 4 years. The last halving happened in May 2020, where Bitcoin rewards were halved for the fourth time to 6.25BTC disbursed per block mined.

The halving events have become highly watched events, as they tend to be followed by massive rallies in Bitcoin’s price.

Are Bitcoin participants anonymous?

It is a bit of an urban myth that using Bitcoin or cryptocurrencies allows actors to remain anonymous.

The following picture is a publicly viewable block transaction from a real mined block.

Source: Bitcoin.com’s Bitcoin Explorer for Block 676205, transaction at 1554HRS

  1. Sender’s address
  2. Amount of BTC being sent
  3. Receiver’s address
  4. Amount of BTC received net of fees
  5. Fee to send the BTC across the network

Note that the sender and receiver’s identities are represented in an alpha-numeric string. While it would normally be difficult to discern the identity of the sender and receiver, it is far from impossible. Given the transaction amounts, time and date, and by observing other transactions involving the same sender or receiver, it is highly possible that trained professionals with the appropriate methods can deduce the identities of many people conducting transactions with Bitcoin.

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