A Bottom Up Guide to Bitcoin (No Prior Knowledge Necessary)

This article aims to give its readers a clear, concise and easy to conceptualize understanding of Bitcoin without any previous background or knowledge.

Whether this is your very first time on the internet or if you’ve overheard your co-workers discussing it but still aren’t sure what it is or why it matters (if it even does); this article will help you get up to speed with the world and/or help complete your understanding of what Bitcoin is without any industry jargon or prerequisite technical knowledge.

Physical representation only (not actual Bitcoin)

Global Financial Crisis

Our story begins in 2008, the year that marked the beginning of the global financial recession; arguably the worst since the 1930s Great Depression. Too-large-to-fail banks were named the culprits due to their unrestrained appetite for risk. Public trust in our long standing financial paradigm began to shift yet we had no other alternative.

Rather than let the global investment banks crumble from the weight of their own ill-judgement; the US Federal Reserve decided to print trillions of dollars as financial bail-out. By doing so, the Feds effectively allowed the banks to privatize profits and socialize losses.

Satoshi Nakamoto

Artist rendition of Satoshi Nakamoto (his/her/their true identity is unknown)

On Halloween of the same year, an anonymous actor or party known online as the pseudonym Satoshi Nakamoto just published a white paper titled: “Bitcoin: A Peer-to-Peer Electronic Cash System”.

In early 2009, Satoshi released the first working, open-source Bitcoin protocol. Without getting into specifics, the Bitcoin protocol requires a genesis-block; think of it as a digital seed required for the rest of the Bitcoin protocol to start growing. Included inside is a message from Satoshi.

The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.

No doubt that Satoshi intended for Bitcoin to be an alternative to fiat currency. But digital money has already been invented. We have Paypal, Visa and even online banking. What’s special about Bitcoin? Why should I care?

Enter Bitcoin

Prior to Satoshi’s invention, all financial transactions online had to go through a third-party intermediary, otherwise known as a middleman. In order for Jack to send Jill $20 over the internet, he has to let his financial-middleman of choice know, so that the third-party would subtract $20 from Jack’s account and add it to Jill’s.

The reason why we have always relied on a centralized middleman for online transactions is because of something called the “double spend problem”. What’s to prevent Jack from keeping his version of the online $20 after sending it Jill?

The nature of information online is that it can be easily shared but also duplicated; not a property you’d want for money. The traditional solution was to rely on a middleman to create a centralized ledger of all transactions, ensuring that at the end of the day, the balance sheet always equates to zero. Once Jack’s online $20 is handed to this middleman, the middleman subtracts $20 from Jack’s account and adds the same amount to Jill’s. The middleman ensures that no one is cheating because only the middleman is in control of the ledger. Now we’ve arrived at a new problem; If the middleman is in control, who is in control of the middleman? what if the middleman chooses to freeze Jack’s account? or prevent Jack from sending money to Jill?

Bitcoin solves both problems by creating an open ledger called the blockchain. Transactions are bunched together every 10 minutes into a block and over time they from a chain of transactions. Every single transaction ever is recorded and is transparent on the blockchain, anyone can view it however no one can edit it. Jack does not need to ask permission or trust a third-party in order to send money to Jack. He is able to do so directly with the Bitcoin protocol.

A non-technical analogy is that rather than rely on a single bookkeeper, every single user is a bookkeeper, each with an up to date version of the tab which is non-editable. Should a bad actor try to make a false transaction or double spend, all the other book keepers would find out since everything is out in the open. Every single Bitcoin can be traced on the blockchain back to when it was first created, therefore no one is able to make duplicate Bitcoins or spend them twice.

Who is in control?

OK cool, anyone can send anyone Bitcoin without anyone stopping them. How can it work if no one is in control?

A common misconception of Bitcoin is that it is a company or is owned and controlled by a group. The truth is Bitcoin is more like e-mail; it is simply a new way or new protocol of doing things online. Although it has an inventor, it does not have a master. This means that no one is able to stop anyone from sending or receiving money and if you lose your Bitcoins there is no customer support to call; a double edged sword.

Another misconception is that the Bitcoin developers are in charge, however each change or “fork” to bitcoin is completely democratic and is opt-in only. If users disagree with a developer’s vision of Bitcoin, they can simply choose to use the original or even create their own vision of what Bitcoin is or could be.

The Money supply

If Bitcoin really is decentralized, then who prints the money? Where do new Bitcoin’s come from?

Bitcoin miners are those who lend their hashing/computer power to the Bitcoin blockchain or network which helps the protocol process transactions.

Anyone is free to participate and in turn for using your computer power to help process transactions, the Bitcoin protocol rewards you with some Bitcoins relative to the amount of computer power you’ve lent the network.

Every 10 minutes, a block or a group of transactions is mined or processed. Inside the block is a batch of transactions that have yet to be processed. Whoever is able to offer the Bitcoin network the most processing power to mine or process these group of transactions get the block reward.

This means that every 10 minutes, miners around the world are competing against each other to win this block reward. This is the only way new Bitcoins are introduced.

Since the introduction of Bitcoin in 2009, every 4 years the number of Bitcoins rewarded per block is divided by 2. Initially it was 50 Bitcoins per block/per 10 minutes, currently it is 12.5 Bitcoin. If we continue with this trajectory, there will only ever be just 21 million Bitcoins in circulation.

This is done to model Bitcoin as a precious metal such as gold and makes the currency both deflationary and mathematically predictable in its supply.

As Bitcoin prices increase and more users transact on the network, more miners enter the game and compete with each other, thus increasing the network hashing/transacting power.

Each element is dependent on each other and is in symbiosis. Without an economic incentive for miners to lend their hashing power, no one would mine. Without a predictable deflationary money supply that halves every 4 years, Bitcoin would not be scarce. And finally, without decentralization, Bitcoin would be no different from its predecessors.