What Does Bitcoin Mean?
Bitcoin is the first decentralized cryptocurrency created. There is no central authority that controls Bitcoin. It uses blockchain technology to create secure digital currency transactions. Instead of trusting a bank that an account has funds available to transfer, Bitcoin makes account information and transaction history public. This allows users to confirm the availability of funds before making a transaction.
Bitcoin is not tied to any countries’ currency or subject to regulations, which along with the potential for a criminal element to flourish has caused some countries to move to ban it and other cryptocurrencies. This can make international transactions easier with bitcoin. There isn’t even a central server that stores the information. The bitcoin network uses a peer-to-peer network. The ledger that tracks bitcoin transactions is distributed and anyone can obtain a copy.
Anyone can create a bitcoin account or bitcoin address. There is no approval process. Transactions are tied to this bitcoin address. The owner of the bitcoin address is not recorded in the transaction record. The owner is also not required to link real-world information to their account. This makes purchases with bitcoin private.
But bitcoin is not completely anonymous. If public information can link someone to their bitcoin address, then all their transaction can be linked back to them. Similarly, if a transaction can be traced back to an IP address, location information can be linked to a bitcoin address. Therefore, bitcoin is considered pseudonymous because a user’s identity is hidden, but it is not truly anonymous.
Techopedia Explains Bitcoin
Bitcoin was created in 2008 by Satoshi Nakamoto. It is widely believed that the name Satoshi Nakamoto is a pseudonym, so the true creator or creators are unknown. Nakamoto released a white paper that outlined the structure of Bitcoin and explained the benefits of cryptocurrency.
In the paper, Nakamoto argues that the problem with current banking systems is that they rely on trust. Financial institutions act as a trusted third-party intermediaries to process payments. The flaw of this system is that financial institutions can not make non-reversible transactions. Because the financial institutions act as a trusted intermediaries, they also have to mediate any disputes that arise over a transaction. So, financial institutions can reverse a transaction.
Such a system requires a lot of trust in our financial institutions and is expensive to maintain. It also requires a lot of personal information as that information is used to establish trust. When Bitcoin was created, there was no way to make a digital payment more analogous to a cash transaction without a trusted party facilitating the transaction.
Bitcoin was created to meet this need. Nakamoto explained, “What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party. Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers.”
Payments are verified using blockchains. Each transaction links to the next in the chain using a cryptographic hash. The hash is created using information from the transaction record it links to. This means that if any information in the record is changed, the link would no longer be valid. This mechanism protects against fraud.
All the transaction records are public. This allows anyone to verify that a transaction was processed. In fact, all bitcoin addresses are public. This allows anyone to check the balance of an account before a transaction is made. Allowing users to check account balances and verify transaction on their own remove the need for a trusted intermediary to vouch for someone when making a transaction.
To make transactions too “computationally impractical to reverse,” Bitcoin uses Proof-of-Work (PoW). For a transaction to be posted to the ledger, a problem that is difficult to solve but easy to verify must be computed. The problems require substantial processing power and a network of computers race to solve the problem. The first computer to solve the problem adds the transaction to the ledger and receives a small payment.
This system makes the cost of creating fraudulent transactions much more than the possible reward. To reverse a transaction, the attacker would have to not only redo the problem required to post the transaction but also do that work for every subsequently linked record.
One of the criticisms of Bitcoin, and cryptocurrency, is the energy required to complete the PoW process and to mine it (the process by which bitcoin are “created.”) The electricity required to support the processing power required creates carbon emissions. Some estimate that cryptocurrency may create as much as 43.9 million tonnes of carbon dioxide equivalent annually.
By the beginning of 2021, BItcoin had gained popularity and held an interesting spot in finance as not just a transactional medium to pay for things, but as an investment. The high prices of a single bitcoin has rocketed to price many people out of owning even a fractional bitcoin. The volatility of the value makes it riskier than some investors are comfortable with, while its price fluctuations happen independent from the stock market, making it a good way to diversify for others.