Chapter 1: Can Someone, Once and for All Explain to me What Bitcoin is?
One of the main issues of Bitcoin today is that it's still too technical. Just to give you an example, the term "What is Bitcoin?" was the 4th most searched for term in 20141.
Since Bitcoin was built by geeks it's hard to get a good explanation about it without using words like "hash", "secret key" and "inputs". I'm going to do my best to explain to you what Bitcoin is without using any technical terms.
If you're more of a visual person, then perhaps this video will do a good job of explaining to you what I'm going to write about here.
Imagine for a second that you are in charge of the task of inventing money. But you get this task today and not ages ago when money was initially invented. You're basically asked to find a way for people to exchange an agreed value between one another.
I know it's hard, but try to think. If this was done today, would we really be using metal coins and paper for this? Perhaps we can find a better way?
What if we wrote down somewhere, maybe in a file, what value each person has? This way we can keep track of how much each person can spend. So if I, for example, do some work for you, you would probably give me some of your value in exchange. Let's name this value "Bitcoin".
But how will people be defined in this file? How will someone know how to send me Bitcoins?
I guess we will have to give each person a unique address (like an email). We will guard each personal address with some sort of a password. This password is known as a "secret key".
Now it seems only logical to save this secret key somewhere so that we don't forget it....Maybe on a piece of paper, or on our computer or even on a secure website. Wherever we choose to store our secret key, will be our "Bitcoin wallet".
Back to our file.... So we've decided to write down which address holds which amount of Bitcoins and update the file each time a transaction is made. This file is called "The blockchain" - and it keeps a record of all transactions ever made from the beginning of time.
But how can we insure that no one changes our file and say that their address has more Bitcoins then what they actually own?
I know! We'll spread this file around to tens of thousands of people, so whenever someone wants to transfer some of his Bitcoins in order to buy something we can check to see if his story adds up to what everyone else thinks. If he's good for his money, we will let him spend it.
But why would people want to store this file on their computer, and spend time and energy to verify all of this each time a transaction is made?
Well, what if we rewarded people who did this with a small fee from our transaction? Hence the "miners" were born. These are tens of thousands of people who get paid in Bitcoins for going through the block chain, making sure that everything is in order and that no one is cheating (including themselves).
Congratulations! You've just invented a modern solution for money! And that's exactly what Bitcoin is - a digital decentralized currency. Meaning that Bitcoin is a currency that no one controls and it's governed by a specific set of rules or protocol that everyone follows.
Where do I store all of my Bitcoins?
Good question. You're going to need a Bitcoin wallet. I've mentioned it in a nut shell a few paragraphs ago, but I want to dig in a bit deeper into this subject.
Again, if you're a visual person perhaps this video will help you.
To make things simple we'll compare the Bitcoin wallet to email. If you want to receive Bitcoins you'll need a unique personal address, just like an email. Let's call this address your Bitcoin address, and just like your email address anyone can see it and anyone can send Bitcoins to it.
Now you decide that you want to access your Bitcoin address to see how many Bitcoins you own. Well, if this were your email you'd first go to your email program - like Gmail or Outlook. The same program exists for Bitcoin and it's called a "Bitcoin Client".
So you've opened up your Bitcoin Client, and now you need to log in. For email you'd enter your email address and password. When accessing your Bitcoin program you will need to enter your Bitcoin Address and "private key".
It's important to know that every Bitcoin address has only one matching private key. But each private key can be used for multiple addresses. Just think about it this way: each email address has only one password that opens it. but you can use the same password for multiple email addresses.
It's crucial that you keep the combination of your Bitcoin address and private key safe, exactly like you'd guard your combination of email address and password. Some people write it down on a piece of paper and hide it away, others store it in an encrypted file on their computer; there are also dedicated websites that hold your private and public keys for you.
Any place that these two pieces of information are stored on is called a Bitcoin Wallet. Even if you decide to memorize your Bitcoin address and private key by heart, it will mean that your brain is your Bitcoin wallet.
Today most programs act as a Bitcoin client and a Bitcoin wallet together. For example, Blockchain.info will store you public and private keys and also allow you to send out Bitcoins. That's it! You now know what a Bitcoin wallet is.
Keep in mind that my explanations are a simplified version of reality since I don't want to get too technical. I don't think it's that important for what we're trying to achieve.
You can look here for a list of all available wallets today compared to one another.
So who exactly creates all of these Bitcoins? Do they just appear out of thin air??
You can call it that, but the process is actually a bit more complicated.
Can you feel it?
Another explanation is coming up....but as always I've got you covered with a video tutorial as well.
Bitcoins aren't printed out like traditional money; they are mined out of the system. A miner is just a person with a computer that runs a mining program on it.
The reason it's called mining is because:
- Just like any other natural resource, there is a finite amount of Bitcoins. So the maximum amount of Bitcoins that can be generated is 21 million. Today, over 14 million Bitcoins were mined2.
- Just like real world mining, you need to invest energy in order to extract these Bitcoins.The miner's computer needs to solve complex mathematical problems, and once it solves them - new Bitcoins are generated and awarded to him.
But miners don't just generate new Bitcoins. They also use their computers to verify transactions and prevent fraud. So having more miners means faster transaction verifications and less fraud. That's why we want to compensate miners for their hard work.
When verifying a transaction, the miner gets a small fee out of that transaction for his work.
So miners get paid twice - once for verifying the transactions and again when they successfully generate new Bitcoins.
Sounds profitable? Well....not so fast...
Satoshi, the guy who invented Bitcoin, wanted the number of Bitcoins that were mined each time to remain constant, no matter how many miners come on board. That's why the difficulty of mining increases as more miners join the network.
So if in 2009 you could mine 200 Bitcoins with your personal computer at home. In 2015 it will take you about 98 years to mine just 1...
That's why ASIC (Application Specific Integrated Circuit) miners were invented. These are super powerful computers designed just for mining Bitcoins. But since so many miners have joined in the past few years it's still almost impossible to mine alone.
To solve this problem mining pools were invented. Groups of miners formed together to deal with the growing difficulty of Bitcoin mining. Each miner gets paid for his relative share of the work.
So that's how Bitcoins are born, through miners....
By the way, if you think what I'm about to teach you in this book relates to making money from mining - you're dead wrong. Today, there's almost no money to be made through traditional home minings.
