THE BITCOIN AND AMAZING BLOCKCHAIN
Bitcoin and blockchain in general are extremely revolutionary concepts, but it takes a bit of time to grok them and their significance. Before we begin, I’m going to define two terms.
1.Blockchain — a database, spread across the globe, of which there are thousands of copies. Significantly, it has the properties of being immutable (impossible to change) and highly replicated (we can lose many or even most copies without losing any data).
2.Bitcoin — the first major application built on blockchain technology, which provides a gold-like digital currency.
What is Bitcoin?Bitcoin is basically a digital currency — a way for us to store value and send it to other people.
Why is Bitcoin valuable?Most if not all forms of currency derive value primarily from their usage. Same as gold or fiat currency (paper money based on our faith in government). The value is established through supply (digging up gold, or printing paper money which is “carefully” controlled by governments) and demand (usage for transactions).
If it’s digital, can’t it be forged?Ok, here’s where we go through the looking glass.
Gold is difficult to forge because there are relatively simple tests to detect its chemical structure and there is no known way to produce gold other than to dig it up. USD is difficult to forge because it’s printed on fancy fiber with special inks and holograms. Nonetheless, forged USD and fake gold circulates all the time. Bitcoin is just some bits on a computer. How come it is impossible to forge it?
Bitcoin is created through a Proof of Work algorithm. Imagine that this is a very difficult problem for a computer to solve but once you have a solution, it’s very easy to check. Consider prime number factorization. If I gave you the number 282943 and asked you to find which two prime numbers were multiplied to get it, you’d be working for a really long time. But if I told you those numbers are 541 and 523, it’s easy to multiply them to see that the answer is correct. Turns out there are problems like this one which are also hard (take an unreasonable amount of time) for computers, but that are very fast to verify.
Bitcoin works on the same principle. Your computer solves a very hard problem, which is called Mining. The process of Mining acts to validate the transactions of others and whoever solves the problem first gets awarded some bitcoin defined by the bitcoin algorithm itself (importantly not a central authority). Everyone else can quickly look at your answer and validate it and know that it took a specific amount of work to get there. Work in this case is basically electricity spent solving this problem.
The beauty of this system is that “creating bitcoin” is actually related to mining a valid block on the blockchain. In order for your block to be considered valid, everyone else has to agree that its valid. Therefore the only way you can counterfeit a bitcoin is by having control of a huge portion of the world’s electricity resources in order to control the decision of what is valid.
If there are thousands of copies of this blockchain database, how can we ever prevent double-spends? Can’t everyone modify their database to look like whatever they please?
Remember how we said there is no central authority and everyone has a copy of the database. This creates a very fun distributed systems problem — namely, how do we actually know which copy of the data is correct? Here we go further down the rabbit hole…
When we are mining (solving the Proof of Work algorithm), we are actually trying to write transactions into this Blockchain Database that everyone has a copy of. All machines on the bitcoin network around the world are taking transactions that have been announced to the network, putting them into a “block” which is just a piece of data, and then solving this difficult Proof of Work problem against this block. If they succeed in solving the problem, they have created the next Real Block. This One True Block is the only real block that will be allowed to be written to the blockchain.
Once someone has solved their problem by expending enough electricity (and therefore money), they announce to the network that they have the next block, and because it’s easy to validate, everyone can confirm that this block is legit even though it took an inordinate effort to produce it. This block is then attached to the previous block in the blockchain.
Everyone starts mining against this latest block again, to write more transactions into the database. When you create a block you get a Block Reward (some bitcoin) and you also earn some Transaction Fees (based on what went into the block).
In this way we are essentially ensuring that only one person can write to this database that there are thousands of copies of. So now we have reproduced what our central bank did with a single database but we’ve spread the data across the globe.
Over time, Bitcoin is designed to release a hardwired 21 million total bitcoins on an exponentially slowing curve meaning the block rewards will get less and less as we are “creating” less bitcoin with every new block, while the fees will go up because bitcoin will be presumably in higher use. All of the available bitcoin will be released by approximately the year 2140. Every 2016 blocks (approx two weeks), the difficulty of mining bitcoin adjusts so that if hashpower joins or leaves the network, bitcoin is still produced at an average of one block every 10 minutes, which is what controls the release rate of bitcoin over time. No central authority can change this release rate, unlike with centrally controlled fiat currencies.
-original credits goes to yan pritzker-
