Digital Money: Bit Coin, Cryptocurrencies and the Block Chain - Part 1

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Bitcoin?

Unless you live on Mars, you've definitely heard of Bitcoin. Its value against other major currencies has exploded this year. It started out trading at $1000-1 Bitcoin and has peaked at $20,000-1 Bitcoin as at the time of writing this Blog post.

So what is Bitcoin and why is everyone losing there minds over it?

Bitcoin is simply a currency like US Dollars, Chinese Yuan, Zambian Kwacha or Mexican Peso's. Its a medium of exchange for goods and services. Like any currency its value lies in the belief by its users that it has value.
It is however different from regular currencies in several ways. 

Lets break it down, shall we?

A Bitcoin  (abbreviated BTC) is a digital currency, meaning it exists as 'data' on a computer[computers] and not in paper or coin form like other currencies. All aspects of the Bitcoin ecosystem are protected/guaranteed by mathematical encryption - hence it is referred to as a crypto-currency. 

The Bitcoin ecosystem consists of 'Peers' who send money to each other as payment for goods and services and 'Book Keepers' who keep a public ledger of all transactions. No single entity or organization controls the Bitcoin ecosystem (No Bank, No regulator, No government). The Peers send money (Bitcoins) to each other and the Book Keepers keep a public record of each and every transaction that happens in the entire ecosystem. 

Lets say a guy named Wana wants to send 1 BTC to his friend Jose as payment for a 2nd hand car sold to him. From his Bitcoin Wallet Wana will send out a message encrypted with his unique private encryption key to all the Book Keepers in the ecosystem. Each Book Keeper will first verify the authenticity of Wana's message using a the public decryption key (which happens to Jose's receiving address), record it in their ledger and pass on the message to other Book Keepers in the ecosystem. Hence it takes a few minutes for every Book Keeper to receive and log the message, once that is done the transaction can be counted complete.

Without getting too mathematical (the math behind Bitcoin is insanely complicated) it is important to note that Bitcoin's security is underpinned by mathematics, effectively preventing;
  • Impersonation of senders and receivers - by using private keys and public keys.
  • Double  Spend - where a sender sends money to one recipient and while that message propagates to all Book Keepers sends out the same money to a different receiver so that some Book Keepers have the money going to Recipient A  and others have the same money going to Recipient B.
  • Alteration of messages as they travel through the ecosystem by using digital signatures.
In this way Bitcoin is secure without requiring trust of anyone in the Bitcoin network and remaining completely peer-to-peer.

How does the Block Chain fit in to all this?

Now I'm sure you understand why the Peers have an incentive to be part of the ecosystem, but what incentive do the Book Keepers have for all that toil?

To understand the incentive for Book Keepers in this ecosystem we must first understand something called the Block Chain.

The Bitcoin ecosystem groups transactions into blocks of transactions which the Book Keepers are to record as having happened at the same time. Each block contains a reference to the previous block allowing blocks to be strung together right up to the first block of transactions at the very beginning of Bitcoin. Any Book Keeper can receive a group of transactions from senders, organize them into a Block and send them out to the other Book Keepers as a suggestion for the next set of transactions to be worked on.

Now in a busy network like Bitcoin several Book Keepers may broadcast suggestions for the next Block simultaneously. How do they all agree which block of transactions to work on next?

To be selected as the next Block, a Block must contain in it the answer to a mathematical function. This answer is arrived at by computing through an encryption algorithm the text of all the transactions in a suggested Block and adding a randomly guessed number.  The output [answer] given must be less than a value less than a given value, say 1000. It takes several [possibly million] guesses of the random number to produce a an answer under 1000. This requires a lot of computing power. The first successful Book Keeper receives a reward, for arguments sake 1 BTC.

This intense number crunching to solve blocks is called Bitcoin Mining and it acts as an incentive to be a Book Keeper who effectively helps secure the ecosystem.

If all this seems a bit confusing just remember;
Bitcoin is a decentralised digital currency with an ecosystem consisting Peers  who send Bitcoins to each other as a medium of exchange and Book Keepers  who keep a public ledger of all transactions. Its ecosystem is secured by mathematical cryptography. Anyone can buy Bitcoin by trading it for other currencies.

In the next Blogpost we'll discuss who invented Bitcoin, why its a revolutionary concept, its competitors, weaknesses and as always what needs to happen to take it to the next level - universal acceptance.

Here some links to more detailed descriptions of Bitcoin and how it works.

https://www.youtube.com/watch?v=Lx9zgZCMqXE&t=1095s

https://www.youtube.com/watch?v=kubGCSj5y3k

https://www.youtube.com/watch?v=SSo_EIwHSd4

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