Bitcoin has made serious news lately. For those who don’t know, the market value of bitcoin has exploded over the last few months, growing more than 200% between September and December of 2017. Today, the value has started to come back to Earth, but at $11,269.58 dollars per bitcoin, it is still valued extremely high. This massive market value increase has spawned a frenzy of investments and speculation as to why this is happening. But before this question can be answered, it is important to know how bitcoin really works. This article intends to explore the basic concepts behind cryptocurrencies and how they really function.
Bitcoin can be explained most easily if we create a mini-society consisting of four people: Ann, Bob, Carson, and Doug (excuse my creativity). Let’s say Ann wants to give Bob 2 bitcoins (BTC). Physically giving 2 BTC isn’t an option; bitcoin only exists electronically. So instead, Ann sends an electronic message to the entire society that she is giving 2 BTC to Bob, and to verify this she digitally signs the transaction to let everyone know it is legit and that she is willing to give up those two BTC from her account, otherwise known as her electronic wallet. The society needs someone to keep track of these transactions, so Doug volunteers to be the logbook keeper. He will record all of the other people’s transactions, then give out that log to everyone else to use. Everyone’s electronic wallet can then automatically read the log to see how many bitcoins each person has left. So Doug logs the current transaction between Ann and Bob. But before he sends the log out, he solves a difficult math problem using his computer. For doing this work, he rewards himself with 2 BTC, and adds that to the log. In doing so, he has created two new bitcoins in this society. Then he puts the resulting answer to his math problem to the bottom of the log and sends it out. The next time he creates a log for a new transaction, he puts this same answer on the top of the log, before he records the transactions. This connects the last log to the current one.
This may seem arbitrary, but it solves issues. First, let’s introduce some terminology. Doug is considered a miner, and each log entry is a block. The entire chain of logs is then called the blockchain. Under this system, it is now possible to create bitcoin by doing math.
But in order for anyone to earn bitcoin, everyone must be able to be a miner. So let’s say Carson becomes a miner, and instead of logging the events she hears, she logs her own, fraudulent transactions. Then she does the math, and adds it to the blockchain. Doug decides to log real transactions, does the math, and adds it to same blockchain. Now we have a conflict. Whose block is correct? This is where our society breaks down, because it only has four people.
But if this society was scaled up, where there are millions of miners, a solution is possible. In order to figure out which block is legitimate, the blockchain is essentially duplicated. Doug’s block is added to one of them, and Carson’s block is added to the other. Now the rest of the miners keep logging, but now they choose which blockchain to add on to (by either putting Doug’s math solution or Carson’s math solution on the top of their log). Because all the miners got the transaction from Bob to Ann, they see that Doug’s block was correct, and add their own blocks to his blockchain. Eventually, Doug’s blockchain will become much longer and Carson’s illegitimate blockchain will be discarded and Doug’s becomes official. The only way for Carson to cheat successfully is if she literally has control of over 50% of the total bitcoin miners in the world; this will never happen in any decently large society.
The full theory behind cryptocurrencies is mathematically much deeper and more complex than this, but in a very basic sense this is how bitcoin works. The main takeaway from this system is that it is completely decentralized; there is no central bank, no government, no regulatory body at all that oversees any of this. Bitcoin is a currency that is entirely self-sufficient and secure, provided that enough people use it. It is truly a testament to human innovation.
– Amit Rajesh