To eliminate some of the confusion surrounding bitcoin, we need to separate it into two components. On the one hand, it has bitcoin-the-token, a code snippet that represents the ownership of a digital concept, something like a virtual IOU. On the other hand, it has bitcoin-the-protocol, a distributed network that maintains a ledger of bitcoin-the-token balances. Both are known as “bitcoin.”
The system allows sending payments between users without going through a central authority, such as a bank or a payment gateway. It is created and maintained electronically. Bitcoins are not printed, such as dollars or euros, they are produced by computers around the world, using free software.
It was the first example of what we now call cryptocurrencies, a growing asset class that shares some characteristics of traditional currencies, with cryptographic verification.
Who created it?
A pseudonym software developer named Satoshi Nakamoto proposed bitcoin in 2008, as an electronic payment system based on mathematical proof. The idea was to produce a medium of exchange, free from any central authority, that could be transferred electronically in a secure, verifiable and immutable way.
To this day, nobody knows who Satoshi Nakamoto really is.
How is it different from traditional currencies?
Bitcoin can be used to pay things electronically, if both parties are willing. In that sense, it is like conventional dollars, euros or yen, which are also traded digitally.
But it differs from fiat digital currencies in many important ways:
1 – Decentralization
The most important feature of Bitcoin is that it is decentralized. No individual institution controls the bitcoin network. It is maintained by a group of volunteer coders and managed by an open network of dedicated computers scattered around the world. This attracts individuals and groups who feel uncomfortable with the control that banks or government institutions have over their money.
Bitcoin solves the “problem of double spending” of electronic currencies (in which digital assets can be easily copied and reused) through an ingenious combination of cryptography and economic incentives. In electronic fiat currencies, banks fulfill this function, which gives them control over the traditional system. With bitcoin, the transaction integrity is maintained by a distributed and open network, owned by no one.
2 – Limited supply
Fiat money (as euros, dollars, yen, etc.) have an unlimited supply: central banks can issue as many as they want and can try to manipulate the value of one currency in relation to others. Currency holders (and especially citizens with few alternatives) bear the cost.
With bitcoin, on the other hand, the supply is strictly controlled by the underlying algorithm. A small amount of new bitcoins are filtered every hour, and will continue to do so at a decreasing rate until a maximum of 21 million is reached. This makes Bitcoin more attractive as an asset: in theory, if demand grows and supply remains the same, value will increase.
3 – Pseudonymity
While traditional electronic payment senders are generally identified (for verification purposes and to comply with anti-money laundering legislation and other laws), bitcoin users theoretically operate in semi-anonymity. As there is no central “validator”, users do not need to identify themselves when they send bitcoins to another user. When a transaction request is sent, the protocol verifies all previous transactions to confirm that the sender has the necessary bitcoin and the authority to send them. The system does not need to know your identity.
In practice, every user is identified by the address of their wallet. Transactions can, with some effort, be tracked in this way. In addition, the police have developed methods to identify users if necessary.
In addition, most exchanges are required by law to perform identity checks of their customers before they are allowed to buy or sell bitcoins, which facilitates another way to track the use of bitcoins. As the network is transparent, the progress of a particular transaction is visible to everyone.
This not makes bitcoin an ideal currency for criminals, terrorists or money launderers.
4 – Immutability
Bitcoin transactions cannot be reversed, unlike electronic fiduciary transactions.
This is because there is no central “adjudicator” who can say “ok, return the money.” If a transaction is registered on the network, and if more than one hour has passed, it is impossible to modify it.
While this may disturb some, it means that you cannot alter any transaction in the bitcoin network.
5 – Divisibility
The smallest unit of a bitcoin is called satoshi. It is one hundredth millionth of a bitcoin (0.00000001) – at current prices, approximately one hundredth of a penny. This could allow microtransactions that traditional electronic money cannot.
Read more to know how bitcoin transactions are processed and how bitcoins are mined, what it can be used for, as well as how you can buy, sell and store your bitcoin. We also explain some alternatives to bitcoin, as well as how its underlying technology, the blockchain, works.
Network image via Shutterstock.
Article Source: http://www.coindesk.com