What Is Bitcoin and Will It Be the Next Gold?13 min read03/01/2019
Bitcoin has been one of the most discussed topics for the last few years. This technology created numerous misconceptions about its origins and destination. One of them is that it’s just another currency that is easy to replicate and counterfeit. However, the idea behind Bitcoin is much deeper than that. It was supposed to be a gold analog with its stability and inflation protection. Is it?
What is Bitcoin? – Based on the blockchain technology, Bitcoin is a peer-to-peer (p2p) payment system that uses the eponymous cryptocurrency and transfer protocol. Created by Satoshi Nakamoto (Craig Wright) in 2009, the system uses cryptography to protect transactions within blockchain. In other words, Bitcoin (BTC) is virtual money in the form of a digital code that nobody has ever managed to break.
The quantity of money should be limited. Otherwise, it will lead to extreme inflation growth if it’s easy to print additional bills. That’s why Bitcoin has a set of important characteristics that make it a suitable payment instrument.
The longer you mine gold, the more resources it requires to mine it. This keeps the inflation is under control. To ensure the same characteristic, Bitcoin relies on the function that defines the total number of coins mined over time. This function is inversely proportional, that is, the speed decreases with time and tends to zero. The graph for the integral of this function forms an exponent.
Therefore, the total number of coins mined tends to 21,000,000. This makes Bitcoin a limited resource just like U.S. dollars used to be pegged to gold.
One gold bar can’t be used for a purchase twice at the same moment. At one point of time, it can belong either to a seller or buyer. To be reliable, the cryptocurrency also should have the same quality. Bitcoin ensures it with its transaction mechanism which we will cover in details further.
How Bitcoin works
The difficulty of mining, limitation, cryptography, and materiality allow Bitcoin to be a payment instrument. The cryptocurrency has all these characteristics incorporated by design. What is this design? How does Bitcoin work?
Any electronic payment system requires a place to store transactions. When it comes to Bitcoin, the system stores data in the blockchain that refers to a chain of data blocks. These data blocks have the JSON format. Each data block has a title and a list of transactions. The title contains a few properties such as a hash of the previous block. Thus, the whole blockchain stores all the transactions within the Bitcoin ecosystem.
Each block contains a header and list of transactions.
The header consists of the following properties:
- hash – The SHA-256 hash is a random value with the predictable calculation time which doesn’t depend on the number of transactions in the block.
- ver – a version of the block scheme. As for now, all blocks have a single version 1.
- prev_block – A hash of the previous block in the chain. This property ensures security for transactions since no block can be replaced because it depends on the previous block. To alter one block, you also need to change all the rest blocks in the chain.
- mrkl_root – A merkle root or list of transaction hashes. The block hash should depend on transactions so that they cannot be modified. But it will take much time to calculate it the hash if the number of transactions is large. That’s why the system first hash transactions and then use their hashes to calculate the hash of the entire block.
- time – uint32_t is the block creation time.
- bits – are ones of the most important features. They’re a shortened form of the target hash value. The system considers a certain block as valid when its hash is lower than this target value. The target value determines the difficulty of creating a block. The smaller it is, the less likely it is to find a suitable hash in one iteration. This property gets updated every two weeks. The system calculates the number of generated blocks and compares it with the standard value. If there are too many blocks, then it becomes more difficult to generate a new block. This is why you now need more powerful computers to mine Bitcoin than a few years ago.
- nonce – A number that becomes higher after each iteration of the hash calculation. To generate a new transaction, you must ensure that at least one property of your block differs from one belonging to a previous data block in the chain. Bitcoin miners target the nonce property since all other properties take too much time to get updated. For example, a hash gets updated when somebody generates a new block, merkle root gets updated with each new transaction, and bits get updated every two weeks.
- n_tx – The number of transactions in the list.
- size – The block size in bytes.
Blocks in the chain contain transactions in the form of a list. Like blocks, they’re lined up in chains. Each transaction indicates where it comes from and where it’s going. The system indicates the recipient with the public key. To use the money received, the recipient has to create a new transaction using a digital signature. This signature will ensure the transaction safety and validity.
Transactions have the following properties:
- hash – a random value for transaction identification. The system sets a hash for a transaction twice: during the transaction hash calculation and block hash calculation process. Like blocks, each transaction refers to the hash of the previous transaction. To modify the hash of a certain transaction, you need to alter hashes of all transactions which is rather impossible.
- ver – Transaction schema version (equal1).
- Vin_sz – The number of previous transactions involved in the current transaction.
- vout_sz – The number of recipients.
- lock_time – The number of blocks the system has to skip in order to add the transaction to a certain block in the chain. Currently equal to 0. This property will allow users to create pending transactions. This makes it possible to modify these transactions and resign them.
- size – The transaction size in bytes.
- in – The in property contains the list of transaction inputs (sources). Inputs are outputs of previous transactions (prev_out). Each intput has the following properties:
- hash – The hash of the previous transaction.
- n – The position of the previous transaction.
- scriptSig – The public and private key. This ensures a proof-of-concept for bitcoins in the transaction. Then the system lists of outputs for the transaction. Each output has the following properties:
- value -The amount of money transferred. One transaction can have two recipients in the case where it involves bitcoins received from a few previous transactions. Unlike traditional p2p payments with a credit card, the Bitcoin system can send only the total amount of money received from certain previous transactions. Therefore, when you need to send less money, the system sends the change to your account as a means of change.
- scriptPubKey – The script written in the Forth-like language that validates the transaction. It enables a sender to make a recipient enter a password instead of using a public key.
To make transactions with Bitcoin, each user should download the blockchain which makes the system completely decentralized. All users have access to the information about transactions in the system which makes cryptocurrency transactions transparent. To check a transaction, you can visit the Bitcoin Block Explorer. As of the time of writing this post, the number of blocks in the chain is 554,502.
How Bitcoin mining works:
- Users create a new transaction and send it to other ones who generate new blocks.
- The latter ones add this transaction to their current block and continue generating. Sooner or later someone will generate a complete block.
- Once generated, this block hosts no new transactions.
- Then the system sends it to each user in the blockchain network.
- Users validate the block.
The total amount of money of incoming transactions is always equal to the total amount of bitcoins sent. Otherwise, it means that the money either has appeared from the air or disappeared from the system. However, the amount of bitcoins is exponentially growing. How does mining Bitcoin work?
The first transaction in each block always has one input that has the coinbase property instead of scriptSig. This property can contain anything. The output of this transaction is also always the same which is sending 50 coins to the user who has generated the block containing this transaction. This is a reward for time and resources spent on generating the block. By creating a new block in the chain, the client contributes to Bitcoin.
Every four years, this reward becomes twice smaller which stabilizes the total number of bitcoins. Therefore, even if some attacker creates a new block using malware to get 50 coins, the system won’t add the block to the chain since other network members will reject it. The system stability relies on the number of users who have official software. If they’re a majority, Bitcoin is safe.
The advantages of Bitcoin
Despite other cryptocurrencies provide additional services like market forecast or anonymous purchases, Bitcoin still remains the most popular among them. Its ecosystem offers many exchange platforms, vendors, software packages, and supported hardware. It also involves numerous development teams, Bitcoin startups, and open source projects. Furthermore, for a decade of its existence, it had no failures when it comes to value storage.
Benefits for ordinary users
Bitcoin has a wide range of benefits for ordinary users.
Traditional transactions via international payment systems like VISA and Mastercard with a credit or debit card are often associated with fraud. When purchasing something online you should avoid fraudulent retailers, when using an ATM, you should make sure it doesn’t have a skimmer installed. The U.S. card fraud losses are expected to reach $21 billion by 2020. Contactless payment systems like Google Pay and Apple Pay provide a high level of security, but they’re still imperfect. When it comes to Bitcoin, it ensures an extreme level of security due to encryption algorithms, wallet back-ups, and passwords.
Cheap transfers worldwide
Banks charge clients per each transaction because they need to ensure security every time someone sends money. This includes storing records, checking the absence of duplicate payments, etc. However, these measures are the same for either $100 transferred or $10,000.
With Bitcoin, you can transfer funds anywhere in the world for a meager cost regardless of the amount.
When sending money from your credit card, you share your personal information with third-parties. This forms an additional risk of your sensitive data to be compromised by cybercriminals or even disclosed by your financial service provider. Unlike traditional money transfers, third-parties can’t intercept any personal data when it comes to BTC transactions.
With Bitcoin, you can send money while remaining anonymous. The system contains all transactions in the form of amounts and generated abstract addresses. It takes many resources for hackers to identify a person behind a set of numbers.
You can pay with BTC using a mobile app on your smartphone. Along with the NFC module, you can make payments in brick-and-mortar stores in the fast and easy way.
No incoming payments confirmation
You don’t need to confirm the transaction when somebody wants to send money to your BTC account. The system automatically delivers funds to your electronic wallet.
The Bitcoin system is designed in the way to eliminate any inflation since the total number of coins is limited.
Benefits for businesses
Commercial organizations can greatly benefit from Bitcoin-based transactions.
Protection from chargeback fraud
“Chargebacks were a $31 billion problem in 2017 — a burden that extends far beyond the liability for
disputed transactions”, Javelin
According to Javelin, a research agency, businesses paid about $31 billion for chargeback management. When customers decide to dispute the purchase they’ve made by approaching their bank, stores lose money, their transaction fee, and even product. This phenomenon is called friendly fraud or chargeback fraud and refers to cases where consumers strive to get a product for free. Bitcoin has no chargeback mechanism which protects businesses from friendly fraud.
Since Bitcoin transactions require smaller fees, businesses have no need for setting higher product prices thus remaining competitive in the market.
All nodes in the network validate a single transaction. Since the network includes a global log of all transaction, you can demonstrate a proof-of-concept for each transaction in your account.
The Bitcoin exchange rate doesn’t depend on political conditions in your country. No government can directly influence it either.
Despite all Bitcoin advantages including security and transparency, it still has significant drawbacks.
“Cryptocurrencies like Bitcoin, we should be looking at these very seriously precisely because of the way they can be used, particularly by criminals,” Theresa May
The anonymity of Bitcoin transactions, on the other side, may be a huge disadvantage in the cases where criminals make transactions. This is one of the reasons why the cryptocurrency is often associated with fraud.
BTC high volatility
The demand regulates the Bitcoin price. From almost $20,000 at the end of 2017, the price of Bitcoin has dropped to over $4,000 for less than one year. Those who had timely invested in the cryptocurrency, they won. When investing in BTC, you can’t be sure you will get your money back.
Blockchain is a decentralized system, but scientists from Princeton and Florida International Universities say that China has control over the entire Bitcoin network which enables the country to manipulate its price or even destroy it.
While it’s hard to find a person who doesn’t know how to use a credit or debit card, Bitcoin is a relatively new technology hardly learned by most ordinary people. It will take over a decade until typical users become familiar with this system.
The cybersecurity of Bitcoin may turn out to be its disadvantage. If you forget your PIN, you can easily change it using two-factor authentication or even block your credit card and then get a new one in your bank with all your money left. With a Bitcoin wallet, if you lose your private key, it’s almost impossible to recover it. That’s why your coins may disappear too. According to Chainalysis, a research agency, about $25 billion in BTC are either lost or probably lost.
Based on the technology behind smart contracts, Bitcoin has a few things in common with gold. Over time, it becomes more difficult to generate a new data block while gold is also a limited resource. Inflation is what can’t influence both payment instruments. Furthermore, a single coin and gold bar can’t belong to multiple owners. It looks like Bitcoin has many chances to become the next gold. However, there are too many obstacles.
While gold is what you can touch and take, coins are only the code. The price of gold depends on many conditions including the efforts applied to mine it while this is users who influence the Bitcoin price. The more people trust it, the more expensive the cryptocurrency is. As for now, the price graph describes the decreasing trust to it among our society.
No doubt, blockchain is a revolutionary technology that has opened new horizons for many industries like fintech, Ecommerce, and even automotive while cryptocurrencies don’t experience their best times. In June 2018, Jack Ma, the owner of Alibaba, said that blockchain would change the world while Bitcoin would likely to turn out to be a bubble.