Bitcoin: The pioneering cryptocurrency
Updated: Apr 7, 2020
Consensus algorithm: Proof of Work (PoW)
Native blockchain: Bitcoin blockchain
Release date: January 2009
Supply: 21 million (the max supply to be reached by c. 2140)
Official website: https://bitcoin.org
What is Bitcoin?
Bitcoin is the first decentralised digital currency. It is without a central bank or single administrator. Bitcoin can be sent from user to user on the peer-to-peer bitcoin network without the need for intermediaries.
Bitcoin transactions are verified by network nodes through cryptography and recorded in a public distributed ledger called a blockchain. Bitcoin was invented by an unknown person or group of people using the name, Satoshi Nakamoto, and released as open-source software in 2009.
Satoshi Nakamoto stated in his white paper that:
"The root problem with conventional currencies 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."
Bitcoins are created as a reward for a process known as mining. They can be exchanged for other currencies, products, and services.
The Bitcoin Blockchain
The bitcoin blockchain is a public ledger that records bitcoin transactions. It is implemented as a chain of blocks, each block containing a hash of the previous block up to the genesis block of the chain. A network of communicating nodes running bitcoin software maintains the blockchain.
Transactions & Private Keys
Transactions of the form payer X sends Y bitcoins to payee Z are broadcast to the Bitcoin network using readily available software applications. In the blockchain, bitcoins are registered to bitcoin addresses. Creating a bitcoin address requires nothing more than picking a random valid private key and computing the corresponding bitcoin address. This computation can be done in a split second. But the reverse, computing the private key of a given bitcoin address, is mathematically unfeasible.
If the private key is lost, the bitcoin network will not recognise any other evidence of ownership; the coins are then unusable, and effectively lost. For example, in 2013 one user claimed to have lost 7,500 bitcoins, worth $7.5 million at the time, when he accidentally discarded a hard drive containing his private key. As of today (May 2019) about 20% of all bitcoins are believed to be lost. Approximately one million bitcoins have been stolen.
Though transaction fees are optional, miners choose which transactions to process and prioritise those that pay higher fees. Miners may choose transactions based on the fee paid relative to their storage size, not the absolute amount of money paid as a fee. These fees are generally measured in satoshis per byte (sat/b). The size of transactions is dependent on the number of inputs used to create the transaction, and the number of outputs.
Bitcoin Mining & Proof-of-Work
Mining is a record-keeping service performed through the use of computer processing power. Miners act to keep the blockchain consistent, complete, and unalterable by repeatedly grouping newly broadcast transactions into a block, which is then broadcast to the bitcoin network and verified by recipient nodes. Each block contains a cryptographic hash of the previous block, linking it to the previous block.
To be accepted by the rest of the network, a new block must contain a proof-of-work (PoW).The PoW requires miners to find a number called a nonce, such that when the block content is hashed along with the nonce, the result is numerically smaller than the network's difficulty target. The proof-of-work system, alongside the chaining of blocks, makes modifications of the blockchain extremely hard, as an attacker must modify all subsequent blocks in order for the modifications of one block to be accepted. As new blocks are mined all the time, the difficulty of modifying a block increases as time passes and the number of subsequent blocks (also called confirmations of the given block) increases.
On 1 August 2017, a hard fork of bitcoin was created, known as Bitcoin Cash. Bitcoin Cash has a larger block size limit and had an identical blockchain at the time of fork.
On 24 October 2017 another hard fork, Bitcoin Gold, was created. Bitcoin Gold changes the proof-of-work algorithm used in mining, as the developers felt that mining had become too specialised.
The criticisms of Bitcoin include the lack of stability in bitcoin's price, high energy consumption, high and variable transactions costs, the poor security and fraud at cryptocurrency exchanges, vulnerability to debasement (from forking), and the influence of miners.
Trend towards centralisation
Researchers have pointed out a "trend towards centralization". Although bitcoin can be sent directly from user to user, in practice intermediaries are widely used. Bitcoin miners join large mining pools to minimise the variance of their income. Because transactions on the network are confirmed by miners, decentralisation of the network requires that no single miner or mining pool has 51% of the hashing power. Having control over 51% of hashing power would allow them to double-spend coins, prevent certain transactions from being verified and prevent other miners from earning income.
Between 2017 and 2019 over 70% of the hashing power and 90% of transactions were operating from China.
The blocks in the Bitcoin blockchain were originally limited to 32 megabytes in size. The block size limit of one megabyte was introduced by Satoshi Nakamoto in 2010. Eventually the block size limit of one megabyte created problems for transaction processing, such as increasing transaction fees and delayed processing of transactions.
Bitcoin as a currency
Bitcoins have three qualities useful in a currency: they are "hard to earn, limited in supply and easy to verify."
The overwhelming majority of bitcoin transactions take place on cryptocurrency exchanges, rather than being used in transactions with merchants. Delays processing payments through the blockchain of about ten minutes make bitcoin use very difficult in a retail setting. Prices are not usually quoted in units of bitcoin and many trades involve one, or sometimes two, conversions into conventional currencies. Merchants that do accept bitcoin payments may use payment service providers to perform the conversions.
In 2017 and 2018 Bitcoin's acceptance among major online retailers included only three of the top 500 U.S. online merchants, down from five in 2016. Reasons for this decline include high transaction fees due to bitcoin's scalability issues and long transaction times.
Unless these criticisms are addressed and resolved to make Bitcoin more viable as a day-to-day medium of exchange in a retail setting, it is unlikely that Bitcoin will gain mass adoption as a currency, and in the short-term will remain a speculative digital asset investment.