What Is Bitcoin?
The Beginner’s Guide
Bitcoin is an invention that, for the first time in history, enabled a group of software users to create and manage a digital money supply outside the control of any government or bank.
A revolutionary idea when introduced in 2009, Bitcoin continues to have implications that are just beginning to be understood and explored by technologists and economists today.
This means that, depending on who you ask, you might get different answers to questions like “What is Bitcoin? and “Why do bitcoins have value?”
To begin, it helps to think of Bitcoin as a software protocol like those you interact with everyday – think SMTP (which helps route your emails) and HTTP (which ensures the web content you request from your browser is delivered to you by servers).
The Bitcoin protocol enables computers running its software to manage a data set (the blockchain) and enforce a set of rules that make this data (bitcoins) scarce and valuable.
As its essential building blocks, the Bitcoin protocol uses:
- Public-key cryptography – Wallet software assigns bitcoin owners both a public key (which is used by the protocol to prove you own bitcoin) and a private key (a kind of password that, if secured well, guarantees your bitcoins can only be accessed by you).
- Peer-to-peer networking – Nodes (computers running the software) review transactions to ensure the software’s rules are being followed. Miners (nodes using special computer chips) then compete for the right to batch these transactions into the blocks periodically added to the blockchain.
- A finite supply – According to the software rules, only 21 million bitcoins can be produced, a limit that gives bitcoins value.
The Bitcoin blockchain is a full record of the network’s history validated by individuals running the Bitcoin software (nodes). This ensures that unlike most digital data, which can be freely copied and modified, bitcoins cannot be.
Because bitcoins are scarce, divisible and transferable, bitcoins are used as money.
Who Created Bitcoin?
While Bitcoin can safely claim to have created the world’s first successful cryptocurrency, its technology is built on decades of ideas for how cryptography could help create digital money.
This includes such formative projects as:
B-money – A proposed anonymous, distributed digital cash system
Bit Gold – An attempt to create a type of scarce online commodity
eCash – The first major attempt to create anonymous online payments
HashCash – A proof-of-work system designed to prevent email spam
In 2006, “Satoshi Nakamoto,” a still pseudonymous person or group, began writing the code for a new digital cash system called “Bitcoin.”
This was then followed by the publication of a white paper explaining this proposed system in 2008, and the release of Bitcoin 0.1, the first version of the software, on January 9, 2009.
Nakamoto authored a trove of emails and forum posts offering his or her thoughts about the future of Bitcoin prior to leaving the project in 2011. Today, hundreds of developers contribute to Bitcoin’s code, where they make everything from routine bug fixes to efficiency improvements.
What Makes Bitcoin Decentralized?
It is the belief of many technologists that Bitcoin’s fundamental property – i.e. what makes it different from other digital money systems – is that it’s network is decentralized.
To fully understand the idea behind decentralization and why it’s so important, it’s helpful to consider how banking works today.
You likely deposit your paycheck regularly into a bank account. In this case, the bank provides you the means to use your money (via its ATMs, payment cards and checks), while keeping it safe from theft (with security guards, vaults and alarms).
In our example, banks act as central authorities. They are third parties that facilitate transactions between individuals and businesses. Essentially, banks act as middlemen to your transactions. They then provide this same service for all customers, which gives them control of a giant supply of other people’s money.
With this power, they can easily change the rules. Your bank might lend your money without your permission, decide not to process a transaction for you or even deny you access to your money. Governments and criminals can also seize your data and money from banks.
The idea behind Bitcoin is to have a system where there is no middleman or central authority. Only you have control of your money and your transactions cannot be denied.
Bitcoin is “decentralized” because its software allows anyone to trustlessly verify the authenticity and scarcity of the bitcoins they are receiving. In this way, Bitcoin’s decentralization solves the trust issue inherent with centralized money managers. If any one computer stops performing its function, another can take its place.
Bitcoin developers tend to consider the network more or less decentralized depending on how much it costs for the average user to synchronize a node with the network, and they propose changes to the protocol according to how it might impact this process.
How Does Bitcoin Work?
True to its design, bitcoins can today be sent between two users without the need for any trusted intermediary.
If you hand someone a dollar bill in person, they now have a dollar and you don’t. You’ve given the other person something of value, and they’ve received it. It works the same with bitcoin.
But you might be asking, what about all those computers operating the network? What keeps them from breaking the software’s rules and stealing my money? Essentially, incentives.
For Bitcoin’s ledger to be manipulated, a hacker would need to be in control of at least a third of the mining hardware. But as this miner would then be winning the lion’s share of new bitcoins, it wouldn’t be in their best interest to attack the network.
For one thing, Bitcoin’s high value makes mining very costly. To compete for new BTC, miners must use specialized hardware and cheap electricity to solve hashes and propose new blocks.
This isn’t an easy race to win – the computational power competing to mine new BTC is now greater than that of Google’s data centers. In practice, this means that while it is technically possible to manipulate the Bitcoin blockchain, it is economically impractical.
What Gives BTC Value?
Bitcoin shares many of the characteristics that give traditional commodities and government monies value – scarcity, durability, portability, divisibility, fungibility and acceptability.
It can even be argued that BTC has an advantage over government monies and commodities in many of these categories.
BTC supply is more limited than silver and gold supply, as there will only ever be 21 million BTC introduced to the network’s economy.
When the first block was mined in 2009, 50 BTC were released. Through this process, more than 18 million BTC have been made available as of 2020.
The number of BTC released in each block is cut in half roughly every four years to keep the total supply finite, in an event known as the halving (or halvening).
Any form of cash needs to be durable enough to be used over and over again. BTC private keys are numbers and letters, which can be stamped into stainless steel, backed up or divided into pieces, adding to their durability.
With BTC, you can carry around all your wealth on a flash drive, memorized in your brain or transfer it instantly via the internet.
All currencies carry denominations so people can purchase goods that carry differing values. U.S. dollars, for example, are divisible from $100 bills down to pennies.
BTC, too, is divisible, and is able to subdivided up to the eighth decimal place. The smallest unit of currency is called a Satoshi after Bitcoin’s creator. 1 BTC equals 100,000,000 satoshis (sats).
All units of money must be as uniform and interchangeable.
Like paper cash or gold, depending on how you received your BTC it will have varying degrees of fungibility. BTC that was involved in a crime, for example, may not be accepted by exchanges or merchants. (This remains an active area of research for Bitcoin developers.)
For something to store value, people need to recognize and accept that it’s worth something.
Kraken's Crypto Guides
- What is Bitcoin? (BTC)
- What is Ethereum? (ETH)
- What is XRP? (Ripple)
- What is Bitcoin Cash? (BCH)
- What is Litecoin? (LTC)
- What is EOSIO? (EOS)
- What is Stellar? (XLM)
- What is Cardano? (ADA)
- What is Monero? (XMR)
- What is Dash? (DASH)
- What is Ethereum Classic? (ETC)
- What is Zcash? (ZEC)
- What is Basic Attention Token? (BAT)
- What is Algorand? (ALGO)
- What is Icon? (ICX)
- What is Waves? (WAVES)
- What is OmiseGo? (OMG)
- What is Gnosis? (GNO)
- What is Melon? (MLN)
Now you're ready to take the next step and buy some Bitcoin!