What is Bitcoin - a technical explanation with a detailed look at Satoshi's vision and Bitcoin uses.
- realeconomist@counterculture
- Jun 8, 2022
- 14 min read
Updated: Oct 14, 2024
´The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.´ - Satoshi Nakamoto, Feb 11 2009
What is Bitcoin?
Bitcoin is the world´s most famous blockchain, which can be described as a database/ledger documenting all transactions that have ever been executed on it. The reason for its initial success is that Bitcoin represents a ‘breakthrough’[1] system that allows people to pay each other securely without relying on banks and central banks, and in new forms. It’s anonymous creator Satoshi Nakamoto released a White Paper[2] explaining what Bitcoin is on the 31st October 2009, and subsequently stated he had created Bitcoin for trust reasons as ‘central banks must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.’[3] Bitcoin can be summarised to center upon four key aspects: computer science; cryptography; people, businesses and governments; and economic incentives.
Why is it secure?
The way bitcoin is designed, blocks of bitcoin are mined by competing but co-operative miners. Miners compete to add the latest block of the bitcoin blockchain to receive block subsidies and transaction fees. Miners co-operate because they benefit from sharing information, and checking that each other are following the rules of the game, so that in the case they find the latest block, it is first to be accepted by fellow miners, and so that can start working on adding the latest block to any newly mined block in the blockchain as fast as possible. Pivotally, it is easy to hash the block-header and check that it contains the hash of the past block. In short, Bitcoin is secure as it is based on the ingenious incentivised human co-operation of digital miners.
Orphan blocks occur when two miners discover blocks by chance at the same time, but there’s only one winner as there’s a common ‘Nakamoto consensus’ that there can only be one chain, thus the one that quickly becomes the longest chain wins. Satoshi designed Bitcoin so that there is a fixed supply of 21 million Bitcoins (to be produced by 2140) and in a way that block subsidies (starting at 50 BTC) halve every 210,000 blocks produced, meaning subsidies will be halved 16 times, in order to ensure Bitcoin becomes self-dependent. He wrote (2010) ‘in a few decades when the reward gets too small, the transaction free will become the main compensation for nodes…there will either be very large transaction volume or no volume.’[4] In other words, Bitcoin will be thoroughly in place or it will not be in place at all.
Cryptography secures Bitcoin. The cryptographic hash generator that’s used in bitcoin is the SHA256 (published by NSA in 2001) which turns any messages (not exceeding 2 million terabites) into a 256 bit string. This uses 6 complicated mathematical functions to work and is very secure according to computer scientists, although quantum computers may lead that to change. The Sha 256 is an effective hash algorithm as it follows a fixed set of instructions with a low-cost procedure and crucially is pre-image resistant (given output, it is very hard to guess input) and collision free (it is almost impossible to find 2 messages that produce the same output).
Digital Signatures are used to make Bitcoin payments as they are authentic, non-repudiated and have integrity. Digital signature uses shar 256 and the elliptic curve digital signature algorithm (ECDSA), so that sender’s private key can create a signature that can be verified by combining two of the sender’s public key, message and signed message.[5]
This works as sending public message creates a random private key (that remains always private through wallet software), which then generates a public key, based on the size of your private key. Through the ECDSA the message and the private key then create a signed message that anyone can verify. This is asymmetric Key Encripyption and signifies that it’s remains hard to find a valid block, but easy to check blocks are valid.
Transparency is crucial to Bitcoin. Every transaction is a record of bitcoin inputs from previous transactions linked to a new output, and all this is transparently stored on the blockchain in signed messages pool.
This 1-megabyte bitcoin block image[6] shows that blocks are separated into different parts. The General Information part contains the magic number (file type), block size and version. The Transactions part contains the transaction counter (the count of transactions included within the block) and transaction list. The Block Header contains the all-important summary information of the block: the time stamp, difficulty, nonce, merkle root hash and previous block hash.
Satoshi invented bitcoin to be secure and decentralized through a proof-of work system similar to Adam Beck’s 1997 Hashcash. In his words ‘proof of work has the nice property that it can be relayed through untrusted middlemen… the proof of work speaks for itself’[7].
This system involves miners scanning for a value that when hashed begins with a certain number of zero-bits. The average work required to perform this exponentially increases with the number of zero-bits required, yet this can be verified by executing a single hash. This verification ensures the miner has adjusted the nonce (a number that represents, on average, the time a miner spent on a hash) enough to ensure the hash of this new block header meets the difficulty criteria/ is smaller than the number set by the following difficulty adjustment algorithm:
This algorithm recalculates difficulty every 2016 blocks to a value such that the previous 2016 blocks would have been generated in exactly two weeks had everyone been mining at this difficulty. It is vital in providing stability to Bitcoin as it adjusts difficulty to all collective levels of mining power so that no matter the size of mining power in use it will take always take approximately ten minutes to mine every block and block subsidies always halve every four years.
Merkle roots do not contain a list of transactions, ‘rather a hash of all transactions as a tree structure’[8]. The merkle root makes it is easy to discover if anyone changes any of the information in any transactions, as the Merkle root gets completely changed. This stops individuals from double spending or even from trying to re-write the history of the public ledger.
Thus, it isn’t currently feasible for the Bitcoin network to be hacked. An attacker would have to redo the proof of work of the block and all blocks after it, and then catch up with and surpass the work of honest nodes creating future blocks. It would therefore need at least 51% of the mining network or ideally for no-one to be mining in the Bitcoin network. That’s why the Satoshi Consensus to work only on the longest chain is so vital.
Why Bitcoin is bad for the environment.
However, by having such a long chain, Bitcoin requires immense computer power. Therefore, it is expensive and bad for the environment and potentially our health. Consider the following: according to data from Solana, each Bitcoin transaction requires over 5 Billion joules of energy to complete whilst running the average U.S. household for a year uses 38.6 Billion joules [9]. Bitcoin currently uses nearly the equivalent amount of energy as Ireland and Austria [10] A relevant appertaining question is how cleanly is that energy being produced? China, which gets about 60 percent of its energy from coal, accounts for about half of the power used to mine Bitcoin [11]. However, it has been disputed by Bitcoin company Coinshares that most Chinese Bitcoin mines were in Sichuan and use hydropower [12].
By contrast, the energy output of transactions of debatebly Bitcoin's main competitor Ethereum were reduced on the 15th September 2022 to just 144,000 joules [13]. Whilst, as explained Bitcoin uses the“Proof of work” method, Ethereum uses a “proof of stake” method, the second major consensus mechanism that cryptocurrencies can use to verify new transactions, add them to the blockchain, and create new tokens. Ethereum´s proof-of-stake mechanism eliminates the need for mining new blocks as the network is secured using staked ETH and validators instead. However, when Bitcoin and Ethereum were designed, they were envisioned to provide very different services with some overlapping features, so it is highly unlikely one would ever replace or wipe out the other. Bitcoin functions primarily as digital money, whereas Ethereum is more of a crypto commodity providing scarce digital resources.
Why is Bitcoin becoming more practicable?
Practicability is Bitcoin´s main target to reach, dependent on achieving this for its long-term success. In reality afterall a blockchain network is only as good as its ability to process, validate, and settle transactions efficiently. Bitcoin´s current value is still one overly dependent on speculation and animal spirits, rather than its actual performance as a digital currency and for its non-speculative uses. This indicates Bitcoin needs to become more practicable. The signs are that this is happening, albeit gradually.
1. Bitcoin is getting faster after implementing the Lightening Network.
On its creation, Bitcoin faced a scalability problem, as on its network there was limited capability to handle large amounts of transaction data on its platform in a short span of time. Bitcoin's transaction throughput is limited by two parameters: one being, its block size of 1MB, determining how much data can be added with every block; the other being, its block time of 10 minutes, determining the time scale it takes for a new block to be added to the chain.
On May 22 2010, the first economic transaction using Bitcoin took place in Florida. Laszlo Hanyecz brought himself and his family two Papa John´s pizzas, worth around $25 for 10, 000 Bitcoin and posted a picture, leading to May 22nd being celebrated as Bitcoin Pizza Day ever since. The pizzas cost aproximately $3.5 billion according to Bitcoin´s worth just over a decade later! Moreover, the transaction took more than a year to complete. [14] By 2017, it took an average time of 78 minutes to confirm a Bitcoin transaction. [15] By 2023, that average confirmation time for a BTC payment had been reduced to about 10 minutes.[16].
Smart contracts can be described as scripts that are stored on the blockchain. They are self-executing programs which automate the actions required in an agreement or contract and capable of escrow (to act as an intermediary between two parties involved in a transaction). Once completed, the transactions are trackable and irreversible. Several years after its birth, a paper written by software engineers transformed Bitcoin through smart contracts. It was titled -“The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments” and proposed an innovating Bitcoin smart contract called Hashed TimeLock Contracts (HTLCs) that enabled instantly settling payments without having to wait for the next block to be mined. The Lightning Network ´not only infinitely increases Bitcoin’s capability as a medium of exchange but also allows for innovations such as paying for online streaming by the millisecond´ [17].
It is worth noting there have been disagreements over how Bitcoin solvess its scalability problem, leading to alternative coins. A hard fork is a change to the blockchain protocol that is not backward-compatible and requires all users to upgrade their software in order to continue participating in the network. In a hard fork, the network splits into two separate versions: one that follows the new rules and one that follows the old rules [18]. A hard fork occured to Bitcoin in 2017, which resulted in the split creating Bitcoin Cash which has a greater. maximum block size. Bitcoin XT, Bitcoin Classic and Bitcoin Unlimited each supported an increase to the maximum block size and Bitcoin SV ("BSV") is a hard fork of Bitcoin Cash, implements an unbounded block cap size, enabling the network to produce blocks of unlimited size. Meanwhile, Litecoin produces blocks four times faster than Bitcoin which leads to a proportional improvement in throughput.
2. Bitcoin is reducing its transaction fees.
Bitcoin transactions involve mining, and for their efforts miners requiere payback which explains why Bitcoin transactions typically charge an extra fee called the transaction fee. There’s no official transaction fee required, but miners prioritize transactions with a fee, and the higher the fee, the quicker the transaction is confirmed. All in all, Bitcoin transactions are subject to charges and additional fees.
Twice recently Bitcoin transaction fees have spiked to very high levels, as a result of this system. From September 2017 to December 2017, the average bitcoin mining fee rose from around $2 per transaction to around $37. [19] This was in response to Bitcoin´s price surging from $10,000 to $20,000, leading to an upsurge in Bitcoin users, greater investment and more Bitcoin transactions increasing the demand for miners' services. ´In addition to this mining fees, bitcoin users often have to pay a second fee that ultimately goes to miners, something called a network fee...to move funds from an individual customer's bitcoin wallet address to a bitcoin exchange,´ [20] where the bitcoin can be converted into the merchant’s local currency. Morevover, payment processors such as Bitpay can charge merchant a small percantage (usually around 1%) of each transaction using their services as a processing fee. It was shown in December 2017, the total average transaction cost reached as much as $55.17. However, Bitcoin transaction fees plummeted just as quickly as they had risen in 2018, only for a nearly identical fee increase to occur in April 2021, when the average transaction cost of sending Bitcoin reached $59.87 and when in 10 days alone, the average transaction fee soared by over 300% [21]. This was again as a result of miners fees and supply and demand, triggered by increasing adoption of Bitcoin worldwide.
Neither of these transaction fee rises bode well for a future where Bitcion is envisioned to be increasingly used and to be increasingly practical. However, the good news is that Bitcoin transaction fees seem to have finally settled, at a relatively low price, in spite of continued speculation making bitcoin´s price more and more volatile; that is in spite of changes in supply and demand. Growing adoptions of scaling technologies such as the Lightning Network and Segregated Witness, resulted in efficient block space usage (network-wide efficiency gains) and persistent low fees.[22] Bitcoin users have also realized significant efficiency gains by batching multiple spends into one transaction resulting in less demand driven transaction costs. Thus, Bitcoin is steadily reducing its transaction fees over time and in fact, the average transaction fee reached roughly just $1 dollar by April 2022, helped by China´s ban and crackdown of the cryptocurrency and crypto mining in May 2021.
3. Bitcoin offers a future of micro-payments.
Another, potentially very large effect that Bitcoin will have on the economy is that
as well as being a secure, democrotised (decentralised) payment system, bitcoin makes feasible micro-payments, and thus addresses the issue that banks ‘massive overhead costs make micropayments impossible’ [23]. Websites such as this one for instance could begin to require to users to pay micro-transactions of their choice (e.g. 0 – 1p) through bitcoin cash and tokens to access their content. The would be a preferable method for designers and creators to raise funds than through advertisement, at least ethically. In fact, Bitcoin was designed by Satoshi to support ‘a tremendous variety of possible transaction types… Escrow transactions, bonded contracts, third party arbitration, multi-party signature, etc…’ [24].
4. Bitcoin will serve as an ideal tool to catch tax cheats.
Arguably, the biggest question as to how Bitcoin will affect the economy, is the one of how will Bitcoin affect government´s revenue through tax. Milton Friedman, a libertarian, predicted e-cash to revolutionise the tax system in the 1990s, as he felt e-cash would prevent the government from collecting taxes so easily. Opposing economists of thought believe tax is essential, so that fiscal policy can be implemented in a positive and sustainable manner to society’s benefit.
Crucially, Satoshi designed Bitcoin to be pseudonymous, depending on the whether the users reveals his private details. However, the fact that transactions on the block-chain are permanently recorded should theoretically make it easier for governments to collect tax via bitcoin, and prevent tax fraud. Regarding the US, it is widely believed that the CIA/NSA have likely deanonymized most of the bitcoin network to date, and it has been estimated by the IRS tax cheats cost the US government $458 billion a year [25]. Pertinantly, Satoshi built bitcoin to work within global jurisdictions, not to replace them. Therefore, Bitcoin should potentially be an incredible powerful fiscal tool and economic boost for governments in terms of revenue should it be widely used.
5. Bitcoin is playing an especially important role in developing countries
Bitcoin´s trading volume has been shown to have picked up in emerging nations with weakening local currencies as a real alternative. In Venezuela, a country plaugued by hyper-inflation, roughly 3 million people (over 10% of its population) own Bitcoin as an alternative to the Bolivar or black market US dollars [26]. Fast food chains such as Pizza Hut as well as supermarkets accept tokens such as bitcoin and dash as payment there now and the cryptocurrency has been used to buy medical care by desperate civilians. In other words, Bitcoin is being used for its original purpose in these developoing nations, in day to day transactions. Still, it has been reported that ´Bitcoin can be difficult to use and many Venezuelans have instead turned to custodial solutions like AirTM. This wallet allows Venezuelans to spend their Bitcoin within a network, making it easier to send and receive cryptocurrency.´ [27]. Bitcoin is likewise popular in Argentina, as an alternative to the volatile peso and black market US dollars. ´According to Chainalysis, Argentines earned $1.86 billion in cryptocurrency in 2021´. [28]
In Africa, Bitcoin volume picked up in Egypt and Nigeria, when each of the nations devalued their currencies as their economies slumped. In India, the Rupee has experienced severe depreciations and problems over the past 10 years, and there was a cash cris following the Indian government´s ban 500 and 1,000 rupee notes to combat money laundering in 2016. Meanwhile, ´the number of crypto users skyrocketed by 760% between 2017 and 2022 to 134 million´ [29], meaning India has now roughly five times as many crypto users as the United States. Moreover, cryptocurrency investments grew ´from approximately $923 million in April 2020 to a whopping $6.6 billion in May 2021. [30]. ´ Following global trends, Bitcoin (BTC) is the top coin in India [31]. Lastly, Vietnam has ranked first on Chainalysis’ Global Crypto Adoption Index for two years in a row in 2021 and 2022. There are two main reason why Bitcoin is so popular in Vietnam. The first is that unlike in the United States and other major jurisdictions where cryptocurrency holdings are taxed, there are no crypto taxes in Vietnam. The second is GameFi - Blockchain games with financial incentives, usually in the form of nonfungible tokens (NFTs) and cryptocurrencies. GameFi is hugely popular in Vietnam. [32]
From all the data, it is easy to deduce Bitcoin is playing an especially influential role in helping civilians save and spend currency in developing nations hit by inflation and with spiraling national currencies.
Conclusion
The truth is that as Bitcoin is still a nascently invented means of exchange, the true possibilities of Bitcoin really cannot be accurately fathomed; all it requires really is for one incredibly benevolent, imaginative and talented individual or group, or perhaps the opposite, one very destructive individual or group, to completely change how we view Bitcoin, as it’s still pretty untried and untested. It is practically irrefutable that Bitcoin technology has the potential to change the world in colossal ways that no-one has thought of or shared yet, on both a micro and macro level because it provides a very good environment for innovation. Overall, it is exciting that the cryptocurrency is gradually becoming increasingly adopted and I side with the optimists that Bitcoin is going to be a very useful new technology used for good. I believe Bitcoin is a realistic alternative to central banking.
Sources [1] Marc Andreeson, January 21st 2004, ‘Why Bitcoin Matters’, https://dealbook.nytimes.com/2014/01/21/why-bitcoin-matters/?_php=true&_type=blogs&_php=true&_type=blogs&ref=marcandreessen&_r=1&&mtrref=undefined&gwh=9C3342BE951A75E21A74F80D81919F7F&gwt=pay&assetType=REGIWALL [2] Satoshi Nakamoto, 31st October 2009, ‘White Paper’, http://satoshinakamoto.me/bitcoin.pdf [3] Satoshi Nakamoto, 11th February 2009, ‘Bitcoin open source implementation of PtoP currency’, http://p2pfoundation.ning.com/forum/topics/bitcoin-open-source [4] Satoshi Nakamoto, February 14th 2010, ‘What’s with this odd generation’, https://bitcointalk.org/index.php?topic=48 [5] Digital Singature Certificate Provider in Delhi, 5th January 2015, ‘Steps Involved In Obtaining Digital Signature Certificates’, https://digitalsignaturescertificates.wordpress.com/2015/01/05/steps-involved-in-obtaining-digital-signature-certificates/ [6] Kiran Vaidya, 8th December 2016, ‘Bitcoin’s implementation of Blockchain’, https://medium.com/all-things-ledger/bitcoins-implementation-of-blockchain-2be713f662c2 [7]Satoshi Nakamoto, 7th August 2010, ‘Bitcoin minting is thermodynamically perverse’, https://satoshi.nakamotoinstitute.org/posts/bitcointalk/327/ [8] Kiran Vaidya, 8th December 2016, ‘Bitcoin’s implementation of Blockchain’, https://medium.com/all-things-ledger/bitcoins-implementation-of-blockchain-2be713f662c2 [9] Anonymous, 10 October 2022, 'How Bitcoin Is Damaging The Environment, And How Ethereum and Big Eyes Coin Are Fighting back', https://www.outlookindia.com/outlook-spotlight/how-bitcoin-is-damaging-the-environment-and-how-ethereum-and-big-eyes-coin-are-fighting-back-news-228865
[10] Bitcoin's Growing Energy Problem, Alex de Vries, 2018 https://www.cell.com/joule/fulltext/S2542-4351(18)30177-6
[11] Coal into bitcoin? Dirty secret of 2017’s hottest market https://www.mining.com/web/coal-bitcoin-dirty-secret-2017s-hottest-market/
[12] Surprise: Majority of BTC Energy Sourced from Hydro / Wind / Solar, 2019 https://blog.coinshares.com/surprise-majority-of-btc-energy-sourced-from-hydro-wind-solar-49f73839aec6
[13] This article is more than 2 years old Ethereum cryptocurrency completes move to cut CO2 output by 99%, 2022 https://www.theguardian.com/technology/2022/sep/15/ethereum-cryptocurrency-completes-move-to-cut-co2-output-by-99
[14] https://cointelegraph.com/learn/what-is-bitcoin-a-beginners-guide-to-the-worlds-first-cryptocurrency
[17] Layered Money, From Gold And Dollars To Bitcoin And Central Bank Digital Currencies, Nik Bhatia, 2021
[23] Chris Matthews, April 29th 2016, ’Here’s How Much Tax Cheats Cost the U.S. Government a Year’, https://fortune.com/2016/04/29/tax-evasion-cost/
[24] Satoshi Nakamoto, 11th February 2009, ‘Bitcoin open source implementation of PtoP currency’, http://p2pfoundation.ning.com/forum/topics/bitcoin-open-source
[25] Satoshi Nakamoto, 17th June 2010, ‘Transactions and Scripts: DUP HASH160 ... EQUALVERIFY CHECKSIG’, https://satoshi.nakamotoinstitute.org/posts/bitcointalk/126/
[26] https://triple-a.io/crypto-ownership-venezuela-2021/#:~:text=It%20is%20estimated%20that%20over,total%20population%2C%20currently%20own%20cryptocurrency.
[29] https://beincrypto.com/india-crypto-users-million-users-2023-5x-more-us/
[30]https://www.indiatoday.in/business/story/decoded-why-more-indians-are-investing-in-cryptocurrencies-bitcoin-ether-dogecoin-1845122-2021-08-25
[31] https://timesofindia.indiatimes.com/business/cryptocurrency/bitcoin/cryptocurrency-that-indians-holds-the-most-bitcoin-dogecoin-ethereum/articleshow/96396486.cms
[32] https://cointelegraph.com/news/vietnam-s-crypto-adoption-factors-driving-growth-in-southeast-asia
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