Bitcoin 101: The Most Comprehensive Way to Understand Bitcoin
The only Bitcoin guide you'll ever need.
Understanding Bitcoin might just be the single most important piece of knowledge that you need to unlock the rest of the crypto-verse.
Bitcoin is like the great grandmother that gave birth to all the other cryptos. Even though some of the more modern cryptos may seem like really distant offspring that were cross-bred with other industries, models, and technologies, you can still see traces of Bitcoin's DNA.
This article will be focused on exploring the ins and outs of Bitcoin. This will not help you to explain price movements. But it will help you to assess the fundamental value that Bitcoin brings to the table.
I know what you're thinking.
"Oh no... not another bitcoin explainer."
Yes, this is another bitcoin explainer.
But this is an attempt at the simplest and clearest bitcoin explainer out there (for newbies). When I first started learning about bitcoin, almost every article or video left me with more questions than answers. I suspect most explainers out there are created by either people who are underqualified (they don't yet fully understand) or overqualified (techies). So yes, I am going to try to create a better one.
Let me know at the end if I managed to do it.
Let's get started.
I will not be covering:
Origins of Bitcoin (Who is Satoshi Nakamoto?)
History of Bitcoin
Bull case for Bitcoin (future article)
I will be covering:
Almost everything else
Why create Bitcoin?
Bitcoin is an innovation.
Innovation is a solution to unsolved problems in the world.
So what problem is Bitcoin solving?
“The root problem with conventional currency 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. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.” — Satoshi Nakamoto, Creator of Bitcoin 2009
I couldn't have written it better than Nakamoto himself.
Our current monetary system requires full trust in the central authorities managing it. Bitcoin is an alternative, trustless money system.
With the birth of Bitcoin, we have alternative money to the one that's cast upon us by default.
bitcoin or... Bitcoin?
When most of us talk about "bitcoin" or read about it on the news, we are typically referring to this:
This is bitcoin, the native token that exists on Bitcoin, the software. The native token is also often referred to as $BTC.
Although it's more than likely that the media won't bother making this distinction, it's an important distinction to be aware of.
The bitcoin token
Understanding the bitcoin token is simple. It basically works like any other physical coin, except that it only exists digitally. The price (relative value) of a bitcoin is constantly changing and determined by the market.
A bitcoin aims to have the same qualities as what makes a good form of money. If you haven't read my previous post about money, good money has the following qualities:
Store of value — It reliably retains the value you paid for it for future use
Medium of exchange — It is an intermediate instrument used to facilitate transactions between parties
Unit of account — It is the unit by which things are priced
There is currently no universal agreement on whether bitcoin fulfills all three conditions.
Some notable properties of this token:
It is hardcoded to have a maximum supply of 21 million
Currently ~19 million bitcoins are in circulation. You can check real-time stats here
New bitcoins are created through the process of proof-of-work, better known as mining. More on this later
The rate that bitcoin is mined/created is halved every ~4 years
What is Bitcoin then?
Borrowing from the book Cryptoassets by Chris Burniske and Jack Tatar,
Bitcoin is a distributed, cryptographic, immutable database using proof-of-work to keep the ecosystem in sync
Defining a concept you don't understand with five other concepts you don't understand isn't helpful. So let me break it down.
First and foremost, Bitcoin is a database or a ledger.
A ledger is just a fancy word for a record of transactions.
The Bitcoin ledger records bitcoin token transactions between parties.
This database is immutable, which means you can only add to it. The technical term for this is append-only.
However, instead of just being a never-ending list, Bitcoin groups transactions into blocks. And blocks are added one after another and linked in a chain. Blockchain.
Don't get confused, the fundamental function of a blockchain is no different than a long-running list. Think of the blockchain as a way to organize transactions.
Once a block is added to the chain it will live on forever. It cannot be edited or removed. Similar to a list, the chain of blocks can only get longer.
This immutable database uses cryptography to secure it.
Cryptography is the practice and study of techniques for secure communication in the presence of third parties called adversaries. — Ronald Rivest, Cryptographer
Simply put, cryptography is a way to maintain the integrity of information when it moves from point A to point B.
Imagine if you want to pass a secret note to your friend who sits across the classroom. But you don't want all your other classmates to be able to read the message as they help to pass it along. So you encrypt the message in a code that is only known by you and your friend e.g. A = 1, B = 2, C = 3, and so on, which your friend can use to decrypt. This is an extremely simple form of cryptography.
Bitcoin uses cryptography in two ways:
It uses “hash functions” to make the data tamper-resistant
It uses “digital signatures” for authentication in the execution of transactions
You don't yet need to know the meaning of these terms. For now, just replace the words above with “complex mathematics” and read it again.
💡 Fun fact: Cryptography is widely used in computer science and is not particular to Bitcoin. The websites we use every day employ cryptography to secure our passwords and data.
Instead of having this immutable database stored in one place, this database is distributed across a network of nodes. A node is a computer that stores the entire database, and anyone can become a node.
This is what makes Bitcoin decentralized.
For a distributed money ledger to function it has to overcome two problems. Proof-of-Work is the answer to these
The double-spend problem
Every digital money faces this problem — how do we prevent the same "piece" of money from being spent twice?
This problem doesn't exist for physical forms of money. If you buy a coffee for $4 and pay in cash, you hand over the bills in exchange for the coffee and you can no longer spend it again.
However, digital money exists only on a ledger as a record. After executing a transaction, it is easy to delete the record afterward, putting the balance back under your name (coffee in hand). The same problem applies to duplicating a single record of someone sending money to you.
Today most of our fiat exists digitally as well. But they solve the problem by having the ledger (database) stored in one single location. Central banks act as both gate and bookkeepers, bearing the responsibility of preventing double-spending.
But for a ledger that's distributed across multiple computers that aims to remove the need for trust in a central entity (Bitcoin), this problem is pertinent.
The Byzantine Generals’ (BG) problem
The next problem is one on achieving consensus across a distributed network.
Instead of reading another chunk of text, here's a really good short video explaining the BG problem. Watch it before reading on.
One-line summary: In a distributed network like Bitcoin, how can we achieve trust?
Bitcoin solves both these problems by combining cryptography with this process called Proof-of-Work (PoW).
Here's an analogy for understanding PoW:
Instead of having anyone be able to just add a new transaction to the ledger, the right to add to the ledger is secured by a lock. Behind the lock lies a reward, and the right to add a new transaction to the ledger.
The key to the door is hidden in a huge digital sandbox. There are no hints, clues, or shortcuts to finding the key. You just have to dig one spot at a time.
Finding the key is a global open competition, anyone and everyone in the world can join. The first one to find it gets the reward and adds the block to the existing chain.
This new block is then broadcasted across the nodes and all the separate databases get updated with the new transactions.
Digging through the sandbox is the work that needs to be done to add blocks of transactions to the chain, thus the name Proof-of-Work.
How does this solve the two problems?
The full picture can only be understood through more technical knowledge of the mechanisms at play which will be covered next week.
Since the goal of this is a high-level conceptual understanding. Here's a conceptual answer:
Any malicious actors that want to manipulate the transactions must also join in the hunt for the key since it's the only way to add transactions to the block.
Since finding a key in a sandbox is a game of chance nobody has an edge over the competition, except having better tools that cost money.
The reward attracts many good/neutral actors to the competition.
Without going into the technicalities, the Bitcoin mining game is set up such that to take control and manipulate the data, you not only have to win once but multiple times.
This means that malicious actors need to invest a lot of resources to get tools and enough minors such that they win multiple times in a row
Since there are many good/neutral actors, the amount of resources needed to launch a successful attack far outweighs the benefit
Even if attackers hijack the network successfully and gain control of all the bitcoins, once word of the hijack spreads, bitcoins will be perceived as useless on a compromised network and the value will fall to 0. Attackers will then be left with useless bitcoins.
TLDR: PoW works because of game theory, it makes it pointless to attack the Bitcoin network at least purely for economic gain. Theoretically, someone whose goal is to make Bitcoin worthless would be motivated to do so, but it would cost ALOT of money.
This analogy is not perfect. But there's no better way to explain it without going into great technical detail. Even in school, chemistry teachers teach technically wrong concepts that eventually have to be unlearned at the graduate level.
At the conceptual level, this analogy is accurate.
The layers of bitcoin
Here's a final framework for thinking about Bitcoin to help tie it all together.
Think of the concepts in Bitcoin as a stack of hardware, software, applications, and users akin to a personal computer.
The miners that build Bitcoin's blockchain with the PoW process are the hardware, just as a MacBook Pro provides the hardware for a personal computer.
The hardware runs an operating system (OS). In the case of Bitcoin, the OS is the open-sourced software that facilitates the running of the whole ecosystem.
The applications run on the hardware and software like how Safari runs on Apple iOS. For Bitcoin, applications like exchange interface with the Bitcoin OS and push and pull information to and from the blockchain as needed.
And finally, the users use the applications to access and interact with the whole Bitcoin ecosystem.
Full credit to the writers of the book Cryptoassets for introducing this framework. It was extremely illuminating for me to be able to map new technology to parts of a familiar framework. I hope you found it helpful as well.
Done. You now have basic knowledge of Bitcoin, its properties, and how it works.
This is probably enough for most people.
After all, how many of you actually know what's under the hood of the devices, apps, and websites that you use every day? I sure don't. When blockchain technology goes mainstream, everyday users likely won't ever have to know what a blockchain actually is.
Read this once, twice, thrice, or as many times as you need to understand the concepts here fully. Write down any questions you have (or type them in the comments) and search for the answers to those knowledge gaps. That’s how you begin the process of learning.
Once you understand Bitcoin go to Ethereum. After that, the crypto world will feel significantly more accessible to you, I promise.