What is Bitcoin?
Welcome to the Zen Crypto Show where we explain cryptocurrencies and blockchain technology in simple terms so you can feel comfortable interacting with and investing in crypto. I’m your host, Sebastien Couture.
By now, you’ve probably heard dozens of explanations for Bitcoin. Some people call it digital gold, others say it’s the internet of money, and some might describe it as a peer-to-peer payment system. While all these descriptions are in part true, it can be hard to understand exactly what Bitcoin really is.
I’m going to break things down into three parts. First, I’ll explain how money moves around by comparing Bitcoin to something you already know, which is a bank. Second, I’ll explain with a simple analogy how Bitcoin stays secure and why that’s important. And third, I’ll tell you why Bitcoin is such a big deal.
Let’s get started.
Simply put, Bitcoin is a list of names and account balances. It keeps track of all the people who own Bitcoin and how much they own, and it keeps track of how these balances change when money gets sent around.
Think of a piece of paper with two columns. In the left column we have all the people who own accounts like Alice, Bob, Charlie, Dave, and so forth. In the right column, we have their corresponding balances, $5, $10, $2, $20, etc.
At a basic level, this is what the Bitcoin system does. It keeps track of who owns what. In fact, this is very similar to what you might find in the database of a bank. I know this doesn’t sound revolutionary, but Bitcoin's big innovation isn’t about keeping track of balances.
So if Bitcoin does the same thing as your bank, what’s so great about it? Bitcoin keeps track of balances without the need for a bank. And does so in a way that anyone can verify that the balances are correct and that they’re not being tampered with.
Let me give you an example. Alice and Dave have lunch but Dave forgot his wallet. Alice happily pays $20 for the bill and expects Dave to send her $10 for his share. Dave opens his banking app and sends Alice the $10. Easy right? But do you ever wonder what’s happening behind the scenes?
When Dave sends money to Alice, the bank subtracts $10 from his balance and adds it to hers. So Dave, who started with $20, now has $10, and Alice, who started with $5 on her account, now has $15. The bank just updated their list to reflect the new balances after money moved from one account to another. This happens countless times per day in our financial system.
In Bitcoin, there is no bank. All the people using Bitcoin are able to collectively verify that the system is intact. When money moves from one person to another, anyone looking at the system can see that this is happening. And if the balances don’t match or someone is trying to create money out of thin air, these transactions get rejected.
So how can you trust that the system is intact and that no one is making up balances? Bitcoin is built in such a way that anyone is able to do this. In fact, there’s a whole industry of people and companies who participate in verifying that when money moves between accounts, they get updates accordingly in the ledger. These are commonly called miners.
Miners run businesses whose only purpose is to verify and validate Bitcoin transactions. They receive an incentive to do this, which means they make money when they get things right and act honestly, and they lose money when they get things wrong or act dishonestly.
Let me explain. Imagine a jigsaw puzzle. To solve the puzzle, you try different pieces to see if they fit together. Sometimes they do, and sometimes they don’t and you try again. You might come up with some strategies, like grouping similar colored pieces, but essentially, it’s a trial and error game. You can’t compress the time it takes to solve puzzles. If you had to solve 10 in a row, you might solve some quickly, and take longer for others. But it’s essentially random and if you get good enough, the time it takes to solve each puzzle would average out to about the same time.
One thing is certain, verifying the puzzle is easy. When you’re done, any 5 year-old child can look at a puzzle and tell you in 10 seconds whether it’s solved or not.
Puzzles are hard to solve, but easy to verify.
Now imagine a magic room where 100 people are sitting in a circle. In the middle of the room is a notebook, and a box containing 1000 vouchers for a free soda at the concession stand in the back.
In this room, everyone is a professional puzzle solver and is competing to solve different 500-piece jigsaw puzzles. Every 10 minutes or so, someone solves a puzzle and yells out “solved it!”. The 99 others look over to check. If they’re satisfied with the answer, the winner walks over to the middle of the room, writes their name in the book, and takes a soda voucher from the box.
When this happens, anyone who is satisfied with the winner’s answer stops working on their puzzle and starts a new one, hoping to be the next winner and get the prize.
But let’s imagine the presumed winner hadn’t actually completed his puzzle, or some pieces were still missing. In that case, the 99 others would simply ignore his answer and keep working on their puzzles. And if the presumed winner was really dishonest and got up to claim his prize, the next person to legitimately win would simply cross out the previous guy’s name from the book, and the concession stand vendor, who saw the whole thing, would not take his voucher when he tried to get a soda with it. The dishonest winner would need to put his voucher back in the box.
This is essentially what bitcoin miners do. Except, instead of a jigsaw puzzle, it's a math problem which is hard to solve and easy to verify. The entries in the book are the transaction which happened since the last winner, and the voucher is the reward miners get for doing this work.
When a miner solves the complex math problem, he is awarded a prize in the form of Bitcoin and given the right to update the list of balances based on the transactions which happened since the last puzzle was solved. The list of balances gets written on a file which is then shared with everyone using Bitcoin, called a block. The game starts again, and miners begin competing again until the next block is mined.
The Bitcoin code says that there will only ever be 21 million Bitcoins and they get created every time someone finds the solution to the math problem. Because of this, we know exactly when there will be no more Bitcoins to issue. So think of Bitcoin as a sort of central bank. Except that unlike a central bank, which can print money as it wishes, Bitcoin prints issues money at a predictable rate. We’ll talk more about this and the economics of cryptocurrencies in future episodes.
So why is this so important and why are so many people talking about Bitcoin and blockchain technologies. What makes Bitcoin revolutionary is the fact that it can maintain a financial ledger without the need for a trusted institution. It’s been called the great alleviator of the middleman, and in many ways, Bitcoin and blockchain technologies are out to get rid of the countless trusted intermediaries with which we interact on a daily basis – your bank, social networks, AirBnB, perhaps even governments.
Think about it. At the end of the day, our confidence in the value of money lies in our trust that banks are doing their jobs right. In the traditional financial system, we usually trust that everyone is acting honestly, but can’t verify this on our own. If a bank allowed someone to turn on god-mode and send unlimited amounts of money around, who would know?
Bitcoin’s revolution lies in its ability to keep track of transactions and account balances without a central authority, company or institution to rely on.
It’s also an astounding innovation when it comes to sending money around the world instantly and at a low cost. Until credit cards and digital payments became commonplace, cash transactions were essentially person-to-person, or person-to-business. But with modern payments, there’s always someone in between, beit a bank or companies like PayPal, Venmo or Western Union. Bitcoin allows global digital payments without the need for an intermediary taking a profit, and which clear nearly instantly.
So let’s recap. Bitcoin is a financial ledger which records user balances. These balances are made visible to everyone using Bitcoin. However, instead of your name or email address being attached to your money, it’s a random identifier which only you know, which ensures your privacy is protected. The integrity of the balances is ensured by the network of miners who validate transactions. They do this by competing to find blocks, which means using powerful computers to solve a complex mathematical problem. When a block is found by a miner, he is given the right to mint a predefined number of Bitcoins for himself. Anyone who doesn’t follow the rules has their work rejected by the rest of participants, effectively costing them time and the electricity cost of running their computers for nothing. With Bitcoin, you can send money around the world for cheap, and without the need for a bank or payment company.
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