While Bitcoin is the most commonly heard-of cryptocurrency, few know what it actually is, what it does or how it is produced. This blog post will aim to answer these questions.
Bitcoin is a revolutionary digital currency that aims to change the financial system that currently underpins our society, allowing individuals to transact outside of the control of centralised banking institutions.
Historical Context
Throughout history, centralised third parties have always controlled the financial systems that people have used, setting the rules for exchange and issuance of currency. This afforded governments/authorities extraordinary power, but the expectation that such a power was to be wielded in a manner that was competent, corruption free and ultimately in the interests of the people.
Unfortunately, history is littered with examples of such authorities instead acting instead in their own self-interests. Be it Roman emperors devaluing their currencies by up to 90% to fund lengthy wars, or bankers selling sub-prime mortgages for profit thereby crashing the global economy in 2008, time and time again centralised authorities have abused their control over the financial system for their own short-term gain. It was with these repeat abuses in mind that Bitcoin was created, in the aftermath of the 2008 financial crisis.
Early Beginnings
Invented by an anonymous actor or group working under the pseudonym Satoshi Nakamoto in 2009, Bitcoin became the first digital currency of its kind, operating free of centralised oversight through use of peer to peer software and cryptography.
Distributed Ledger Technology
Bitcoin works through use of distributed ledger technology. Rather than relying on a central authority to set the rules of the financial game, the Bitcoin network is made up of hundreds of thousands of data points called nodes (which could be as simple as a computer!).
Each node individually stores a complete record, or ledger, of every transaction that has ever occurred on the Bitcoin blockchain. These nodes cross-reference their records with one another so as to reach a consensus on who owns what, or who has done what with which Bitcoin. Once every ten minutes this consensus is permanently recorded by the production of a block, before being added to the other blocks that had been created up to that point, thus updating the permanently recorded Bitcoin ledger (or ‘blockchain’). The first block created was the genesis block on 03 January 2009, while over 735,000 blocks have been produced since then, displaying every transaction that has ever occurred on the Bitcoin network.
Miners & Mining Rewards
It is the miners who expend computational energy collating and collecting transactional data into blocks once every ten minutes. Miners do this by competing to solve extremely difficult cryptographic calculations that are easy to verify in a process known as 'proof of work'. Once verified by the network as a whole, the miner in question who has completed the work is rewarded with newly minted Bitcoin, known as ‘mining rewards.’ Currently, 6.25 Bitcoin are issued as mining rewards for every new block that is produced, but once roughly every four years such rewards are halved.
Mining & Green Energy
In the early years of Bitcoin, anyone could expend computational energy to solve cryptographic equations and mine Bitcoin, but as the network has grown, ever more energy has been required, resulting in the need for larger mining facilities.
While a common accusation against Bitcoin is its energy use with Bitcoin currently consuming up to 0.55% of global electricity production, the growth of Bitcoin has help to monetised the growth of more efficient energy sources. Those with access to the most efficient energy sources globally have been better suited to mine Bitcoin than those who rely on inefficient energy sources. Indeed, a reported 56% of the energy used to mine Bitcoin comes from renewables, with this figure growing on an annual basis.
Finally, the majority of energy expended on the Bitcoin network comes from mining it, rather than validating transactions. A common misconception is that with time, energy costs associated with Bitcoin mining will continue to grow exponentially, however this is unlikely, especially with the advances in technology that is used to mine Bitcoin.
How much Bitcoin will ever exist?
Only 21 million Bitcoin can ever exist, as originally outlined by Satoshi Nakamoto in his Bitcoin white paper. It is roughly estimated that by 2140, all 21 million will be in circulation.
Coupled with the fall in mining rewards every four years, Bitcoin’s inflation rate, which currently sits at 1.79%, will continue to decline. This arguably makes it a highly lucrative store of value in a time of rising inflation, with the British pound being forecast to potentially see inflation levels rise as high as 10% in 2023 by the Bank of England.
Can the consensus mechanism on which Bitcoin operates be changed?
When the majority of miners agree on fundamental changes to the Bitcoin blockchain, the consensus on which the Bitcoin network operates can be updated. Segwit, a proposal that aimed to introduce technology that would reduce the amount of data needed to be verified in each Bitcoin block by up to 65%, was passed in 2017 as up to 90% of Bitcoin miners voted in favour of its implementation.
When only a minority of miners agree on a proposed change to the Bitcoin blockchain, alternate versions of Bitcoin may be created that run alongside the original Bitcoin in an event known as a hard-fork. An example is Bitcoin Cash, or BSV. None of these projects have ever succeeded in gaining greater market adoption than the original Bitcoin and will likely become worthless over time.
Can the Bitcoin blockchain be hacked?
If ever a malicious group of miners were to gain control of over 50% of the Bitcoin network, they could alter the consensus on which the Bitcoin blockchain operates to their own advantage. This could include giving themselves extra Bitcoin and creating fraudulent blocks from the point at which they gained control, in an event known as a 51% attack.
However, such an attack has never occurred. Furthermore, it would cost any mining group valuable time and resources to successfully conduct such an attack (an estimated $13 billion), which would instantly render the underlying asset worthless. The costs associated with any attack are also steadily increasing as time goes on as the computational power being expended by the Bitcoin network, or the Bitcoin hash rate, increases as adoption continues. This will further dis-incentivise any such attacks in the future.
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