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Bitcoin – What is it and How it works?
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Bitcoin – What is it and How it works?

Recently, Tesla announced that it has invested $1.5 billion in Bitcoin and the price of the digital currency has been soaring ever since. If the world’s fifth most valuable company is betting big on this digital currency, we need to be talking about this. Although, I will dedicate this post only to the basics of Bitcoin and the technology behind it.

Now the question that befuddles a lot of computer illiterates is that what exactly is Bitcoin? In the literary definition, Bitcoin is a type of decentralised digital currency which can be transacted from user to user without any intermediaries. It is a type of cryptocurrency that has no physical presence but only present in a public ledger. Bitcoins are not issued or backed by any banks or governments, nor are individual bitcoins valuable as a commodity.

Before we delve into how the software actually works, let’s talk about the history of Bitcoin. On 31 October 2008, a whitepaper authored by the mysterious and pseudonymous Satoshi Nakamoto titled Bitcoin: A Peer-to-Peer Electronic Cash System was published on “bitcoin.org”. The identity of the person or persons behind the pseudonym still remains unknown.

The first commercial transaction of Bitcoin was made to buy two Papa John’s pizzas for ₿10,000. Today, this amount equals $489.5 million.

Suppose you want to buy a bitcoin. You can get Bitcoin by accepting it as a payment for goods and services or you will first have to find a person who is willing to sell you a bitcoin. Now, for the transaction to go through, the seller and buyer need to be on the Bitcoin network and will have unique BTC addresses (think of it as a bank account number). Each BTC address has a public and a private key. For easy understanding, consider public key as your email id and private key as your password. In order to make a transaction, the seller will send a bitcoin from his wallet to your wallet by entering your public key. Once the transaction goes through, your wallet will have a balance of 1 BTC. Now, if you want to use this 1 BTC to make a transaction, you will have to use your private key to authorise the transaction.

How do the transactions take place?

Before we talk about the process behind transactions, we need to understand the concept of blockchains. Although, it may seem complicated, but in simple terms, blockchain is a type of database. A database is a collection of information that is stored electronically on a computer system. A blockchain collects information together in groups also known as blocks. Blocks have certain storage capacities and, when filled, are chained onto the previously filled block, forming a chain of data known as the “blockchain”.

For any bitcoin transaction to take place, it must be verified by miners on the blockchain. When you transfer 1BTC that you received earlier to another address, the transaction is broadcasted to the bitcoin network where miners verify that your private key is able to access your public key (where the 1BTC was received). This is done by solving complex equations to confirm the validity of the transaction. This confirmation process is known as mining. Since it requires resource-intensive computational labour, miners are rewarded in Bitcoins for each block solved. This is also the process by which new Bitcoins are ‘created’.

How much are bitcoin transaction fees?

Bitcoin transaction fees are calculated using a variety of factors. Many wallets allow users to manually set transaction fees.  Any portion of a transaction that isn’t owed to the recipient or returned as ‘change’ is included as a fee. Fees go to miners and can be used to increase speed on confirmation by incentivizing miners to prioritize your transaction(s).

Use in Black Markets

The first major adopters of Bitcoin were the online black markets such as Silk Road. Silk road was an online marketplace on the dark web for selling drugs and other illegal items. Silk Road exclusively accepted bitcoins as payment, transacting 9.9 million in bitcoins. It was shut down by the FBI in 2013 and arrested the site’s founder. In November 2020, the United States government seized more than $1 billion worth of bitcoin connected to Silk Road.

Regulations in India

Since the bitcoin network is decentralised, i.e. not controlled by a central bank or a single administrator, its use in illegal transactions and price volatility, many governments and regulators around the world have issued alerts or banned Bitcoins. Many governments around the world, including India, have been mulling over creating their own centralised digital currency. The “Cryptocurrency and Regulation of Official Digital Currency Bill” seeks to prohibit all private cryptocurrencies such as bitcoin in India.

Even though, it is impossible to cover everything about bitcoin in a 5 min post, but I have tried to share enough to understand the basics and explain it in a coherent manner. I promise to write more on this in future blog posts. Until then keep reading.

Don’t forget to share this with all your friends who might be interested in this topic…

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