December 2, 2018

The heart of the bitcoin algorithm

December 2, 2018
|
4 min

While once confined to the techiest and darkest corners of the Internet, bitcoin is no longer a niche interest. In 2017, the digital currency hit the mainstream, becoming the ultimate buzzwords and the king of the cryptosphere.

And then, as the crypto market went south, Bitcoin lost headway as well. But soon enough, the original digital currency stabilized, while prices for altcoins continued to plummet. Why does Bitcoin hold its value, while runner-up Ethereum lost more than 90 percent of its value?

Let’s start with the basics.

What is Bitcoin anyway?

To put it simply, Bitcoin is a digital currency. It began circulating in 2009, when the pseudonymous author of the Bitcoin Whitepaper, Satoshi Nakamoto, mined the first-ever block of bitcoins (known as the genesis block). It was originally intended as an alternative to traditional financial institutions — a “trustless” system that functions free of third-party governance.

Initially, this newly conceived digital currency appealed to a niche group of technophiles who could mine hundreds of bitcoins with only a personal computer. By 2010, the first-ever real-world bitcoin transaction valued each coin at $0.0025 USD.

Now, nine short years later, there are hundreds of different cryptocurrencies. And while this plethora of altcoins sprang from efforts to improve upon Bitcoin, it nonetheless maintains its status as the créme de la crypto.

For all these attempted improvements, it seems that nothing beats Bitcoin’s inherent scarcity. Though other features — faster confirmation times, different signature algorithm, and enhanced privacy — have attempted to fix the few problems with Bitcoin, no alternative has come close to displacing the foremost crypto. Bitcoin’s large network constantly attracts new investors, giving it greater utility. Plus, its fast network also increases the coin’s security.

And of course, as the oldest coin on the market, Bitcoin has already withstood the test of time — at least more so than any other crypto out there. Thus far, no Bitcoin contemporary has measured up.

Another key to Bitcoin’s success is its decentralized governance. There is no company that produces bitcoins, and no founder calling the shots. All altcoins created since Bitcoin, on the other hand, have a creator or company at the helm. And while this may help altcoins adapt to the market more quickly, a centralized authority subjects coins to policy and technology changes.

Ultimately, immutability and scarcity matter more than auxiliary features.


How does Bitcoin work?

Now, we’re gonna take the tech talk up a notch.

Bitcoin’s functionality is primarily composed of different cryptographic technologies. The first is public key cryptography, where each coin is associated with its current owner’s public ECDSA key. So when you transfer bitcoins, that transaction will be attached to the new owner’s public key, and the amount is signed with your private key.

Blocks are “mined” by bitcoin miners — a network of millions of computers that basically functions as a decentralized federal reserve. This network records transactions on the public ledger, adding a new block for every transaction. Those transactions form a chain — hence, the name “blockchain.”

With each new block, miners confirm the accuracy of the previous block. After a certain number of confirmations, the transaction is considered to be officially confirmed. This mechanism protects the entire bitcoin network from double-spending (i.e. spending the same bitcoin twice) by ensuring that all past transactions have been confirmed by the network. Until a block receives a confirmation, the block remains “unconfirmed,” leaving the transaction uncompleted.

To make Bitcoin as secure as possible, Satoshi employed cryptography. At its most basic definition, it’s the use of code to make sure that even if a message falls into the wrong hands, it can’t be deciphered. Cryptography is nothing new: it’s been used in some shape or form for centuries. But technology, particularly blockchain technology, has infused it with entirely new meaning.

Bitcoin uses a Hashcash cost-function — the first secure and verifiable cost-function or proof-of-work function. As a non-interactive function, there are no secret keys that need to be managed by a central server or third party, so it can remain fully distributed and infinitely scalable. The function takes input data of any size and transforms it into a virtually uncrackable compact string (32 bytes) or a “nonce.” No one can create a different set of data with the same exact hash.

After a bitcoin is created, everything can come together. All interactions with Bitcoin are kept on the blockchain, the distributed ledger that records each and every ledger in a chain of blocks (hence the name). This ledger is publicly accessible — so each and every computer in the network can view the most up-to-date version. Each block builds upon the previous one, constantly validating the transactions that came before it. No one person can alter existing records since blocks must meet requirements that cost a tremendous amount of time, effort, and energy.

How are bitcoins made?

Generating bitcoin is an arduous process. Adding blocks to the chain takes time and requires processing power. In fact, it’s estimated that each year Bitcoin mining consumes as much energy as Switzerland.

All in all, 21 million total bitcoins will ever exist. Currently, we’ve collectively mined 17 million of those bitcoins — more than 80 percent.

However, the pace of production is designed to gradually decrease. In 2009, when the Bitcoin was created, the first million coins were mined in approximately 200 days. The next 16 million were mined over 500 days. Now, the remaining 4 million coins are not expected to be finished for another 122 years.

To mine the block, miners must solve a complex mathematical equation. The solution is combined with the data in the block, then passed through the hash function, making it impossible to solve. So, miners (which are computers) guess until someone solves it. Then, that miner will inform the network, and everyone can get started on mining the next block. To incentivize participation, the victor will be rewarded with bitcoins.

This bounty is paid out to the producer as an agreed-upon amount by the network (currently at 12.5 bitcoins, which will halve every 210, 000 blocks), and any transaction fees from the block are paid to the producer. Essentially, these miners are “minting” new cryptocurrency.

As more and more people make an effort to excavate bitcoins, the network adjusts the difficulty accordingly. While at bitcoin’s birth, coins could be mined with a personal computer and the right software, now bitcoin mining requires far more computing power because larger warehouses sport devices with much more hash power than the common user.

Bitcoin and blockchain technology are the new wave of payment systems. Most people hear these term without fully understanding how it works or what it means. But this is the bottleneck in pushing for its more widespread use — teaching people about blockchain is an essential step in ending their fear of the unknown.

How can I trade bitcoin?

Today, you can trade bitcoin against hundreds of different crypto and/or fiat currencies.

There are a number of exchanges and brokers to get started with bitcoin trading, including Binance, HitBTC, Bitrex, and Bitmex. Some exchanges, like Bitmex, even allow users to trade Bitcoin Perpetual Contracts, a swap that doesn’t expire by creating an ongoing chain of eight-hour future contracts.

And there’s no need to store all your bitcoin in one place. Now, with the maturation of the crypto space, there are tools that allow you to simultaneously trade on multiple platforms, like Capitalise.

Capitalise is an automated trading platform that connects to all your trading accounts, so you can set up trades on various exchanges. Just enter your conditions and actions using plain English sentences, and the platform will make the execution for you — so you can sit back, relax, and reap your crypto rewards.

Alma Vilcov

Head of Customer Success

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