People refer to Bitcoin as a digital currency, virtual currency, or cryptocurrency, but it may be easier to think of it as an electronic asset. The word currency often side-tracks people when they are trying to understand Bitcoin. They get caught up trying to understand aspects of conventional currencies which do not apply to Bitcoin, for example, what backs it (nothing) and who sets the interest rate (there is none). Bitcoin is also sometimes described as a digital token, and in some respects that is accurate; but, alas, the term token is now also used to mean something more specific, which we will cover later, so the ambiguity of this term too is best avoided.
What Are Bitcoins?
Bitcoins are digital assets (‘coins’) whose ownership is recorded on an electronic ledger that is updated (almost) simultaneously on about 10,000 independently operated computers around the world that connect and gossip with each other. This ledger is called Bitcoin’s blockchain. Transactions that record transfer of ownership of those coins are created and validated according to a protocol—a list of rules that define how things work and which therefore govern updates to the ledger. The protocol is implemented by software—an app—that participants run on their computers. The machines running the apps are called ‘nodes’ of the network. Each node independently validates all pending transactions wherever they arise, and updates its own record of the ledger with validated blocks of confirmed transactions. Specialist nodes, called miners, bundle together valid transactions into blocks and distribute those blocks to nodes across the network.
Anyone can buy bitcoins, own them, and send them to other people.
Every Bitcoin transaction is recorded and shared publicly in plain text on Bitcoin’s blockchain. Contrary to many media articles, Bitcoin’s blockchain is not encrypted. By design, everyone sees all details of all transactions. Anyone can, in theory, create bitcoins for themselves too. This is part of the block creation process, called mining, and is described later.
What Is the Point of Bitcoin?
The purpose of Bitcoin is described in its whitepaper—a short document written by a pseudonymous Satoshi Nakamoto, published in October 2008. It describes why Bitcoin exists and how it should work. It is worth reading the whitepaper in full. It is only nine pages long and available online. The abstract says:
A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double spending. We propose a solution to the double spending problem using a peer-to-peer network. The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work. The longest chain not only serves as proof of the sequence of events witnessed, but proof that it came from the largest pool of CPU power. As long as a majority of CPU power is controlled by nodes that are not cooperating to attack the network, they’ll generate the longest chain and outpace attackers. The network itself requires minimal structure. Messages are broadcast on a best effort basis, and nodes can leave and rejoin the network at will, accepting the longest proof-of-work chain as proof of what happened while they were gone.
That first sentence says it all. It sets out the purpose of Bitcoin, and how Bitcoin derives both value and utility. For the first time in history, we have a system that can send value from A to B, without the physical movement of items or using specific third-party intermediaries. It is difficult to overstate how important a milestone this is in the evolution of payments. I get shivers down my spine every time I think of Bitcoin like this. As popularised by cryptocurrency industry commentator Tim Swanson, Bitcoin is designed as censorship resistant digital cash.
There is no mention of a blockchain or ‘block chain’ at all in the original Bitcoin whitepaper, even though we are constantly reminded by the media that Bitcoin is built on blockchain or that blockchain is the underlying technology of Bitcoin. A chain of blocks was not the purpose of Bitcoin, it is just the design that was developed to achieve the objective —the solution to the business problem.
