Bitcoin 101

What is Bitcoin?

Bitcoin stands as a decentralized digital asset, encompassing traits of traditional assets like cash and gold. It serves various purposes, enabling transactions for goods and services, exchanges for other assets, repayments to friends and family, and functioning as a store of value akin to gold, stocks, and real estate.

A distinctive feature of Bitcoin lies in its decentralized and "trustless" model, eliminating the need for trusted third parties, such as banks, common in traditional finance. Unlike the complex intermediary-laden transactions in traditional finance, Bitcoin transactions can occur directly, akin to physical cash transactions. In contrast to the electronic nature of most modern financial transactions, both physical cash and Bitcoin can be transacted directly, without intermediaries and without the need for permission to create an account.

While direct exchanges of physical cash don't involve intermediaries, the creation of cash relies on a trusted third party like a central bank. In contrast, the creation of new Bitcoin occurs programmatically and is capped at 21 million units, distinguishing it from traditional currencies. More insights on this aspect will be explored later.

What Give Bitcoin Value?

The value of Bitcoin emanates from two aspects: its inherent features and the resulting network effects that mutually reinforce each other. Analogous to the growth in utility of a telephone network as it expands, the value of money networks, including Bitcoin, intensifies with a growing user base. Historically, various items, from seashells to bottle caps, served as money, but gold emerged as the most enduring form due to its rarity, durability, and divisibility. Gold's utility established a global network of value exchange for centuries.

Bitcoin draws comparisons to gold due to shared characteristics:

  • Limited Supply With only 21 million bitcoins ever available, Bitcoin's rarity distinguishes it from less scarce forms of money like seashells and cash, ensuring enduring value.

  • Divisibility Bitcoin's divisibility into 100 million pieces (sats) prevents scarcity concerns, ensuring perpetual divisibility compared to traditional currencies like the US dollar.

Moreover, Bitcoin surpasses gold's monetary properties with added features:

  • Portability Bitcoin's quick global transactions in minutes enhance its portability.

  • Verifiability The authenticity of bitcoin is easily verified, contrasting with challenges posed by fake gold scams.

Bitcoin's network effects benefit from digital natives, resulting in a growing ownership base, surpassing 100 million individuals. This growth, leveraging the scale and speed of the internet, positions Bitcoin as a formidable digital asset.

How Does Bitcoin Work?

Let's compare it to how money appears in a bank. In a bank, transactions are recorded on a ledger, and you trust the bank to manage it correctly. However, banks can make mistakes. Bitcoin also has a ledger, but it's decentralized. Instead of a single trusted authority like a bank, it relies on a network of people called "nodes" who verify transactions. Anyone can be a node without needing permission.

Bitcoin's ledger only adds new transactions; it can't be edited or changed, ensuring a secure transaction history. Transactions are grouped into blocks, creating a chain called the "blockchain" that goes back to the first one.

In the Bitcoin network, nodes must agree on transaction validity without fully trusting each other. This agreement process, known as consensus, is crucial. Bitcoin uses a method called proof of work (PoW) where participants, called miners, solve complex math problems that require energy. This energy requirement makes it tough for dishonest participants to join.

So, miners, by engaging in proof of work, play a vital role in creating new bitcoins and maintaining the security and agreement within the decentralized Bitcoin network, eliminating the need for a central authority.

Who Controls Bitcoin?

You might wonder, "Where did Bitcoin originate, and who decides its rules?" Bitcoin operates on open-source software initially created by its pseudonymous founder, Satoshi Nakamoto. Since its launch in 2009, thousands of people worldwide have contributed to its development. The individuals who voluntarily run this software collectively form the Bitcoin network.

The Bitcoin protocol is not static; it can change. This change is not dictated solely by those running the software but involves a broader community. This community includes millions of Bitcoin holders, businesses utilizing Bitcoin, developers, and anyone with a stake in Bitcoin. Together, they play a role in determining the evolution of Bitcoin's rules and characteristics.

Why Was Bitcoin Created and is it Needed?

Bitcoin serves as a digital money alternative that isn't issued by governments or corporations, free from control by financial intermediaries such as banks. Those who appreciate this novel form of currency include investors, libertarians, people facing financial challenges regardless of location, and various others.

Can Bitcoin Be Shutdown?

To shut down the Bitcoin network, one would need to disable the entire global internet and cut off all electricity, an extremely challenging task. Hacking or taking over the entire Bitcoin network is technically possible but would require billions of dollars and a massive coordinated effort involving global chip manufacturers. Crucially, even if successful, the hacker wouldn't gain anything as it would undermine the value of the entire Bitcoin network.

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