Bitcoin: The Crypto That Started It All

Jonathan Hobbs

7 mins

Bitcoin: The Crypto That Started It All
  • Bitcoin is a payments system that needs no financial middlemen to operate. And that means you don’t need to trust a financial institution to act in your best interests.

  • Bitcoin mining is how new bitcoin supply is generated. It’s also the reason behind Bitcoin’s impenetrable security.

  • Unless you’re using the Lightning Network, bitcoin isn’t the best medium of exchange for small, everyday transactions. But it’s great for sending, receiving, and storing large amounts of value in a secure and efficient way.

Bitcoin is a payments system that needs no financial middlemen to operate. And that means you don’t need to trust a financial institution to act in your best interests.

Bitcoin mining is how new bitcoin supply is generated. It’s also the reason behind Bitcoin’s impenetrable security.

Unless you’re using the Lightning Network, bitcoin isn’t the best medium of exchange for small, everyday transactions. But it’s great for sending, receiving, and storing large amounts of value in a secure and efficient way.

Mentioned in story

Warren Buffett famously said you should never invest in a business you don’t understand. Of course Bitcoin isn’t a business, and we all know Buffett isn’t its biggest fan. But the core of his message still applies to crypto investing. So if you’re considering buying into the world’s largest digital asset, here are some things you’ll want to understand.

Bitcoin’s origin story

In the subprime mortgage crisis of 2008, distrust in the financial system was rippling across the globe. But this distrust had taken root much earlier for one particular group of cypherpunks – advocates for strong cryptography and privacy-enhancing technologies as a route to social and political change.

On 31st October that year, this group of computer coders received an email that would change the course of financial history. Its sender was Satoshi Nakomoto.

To this day, we don’t know Satoshi’s true identity, but we do know what he (or she, they) wrote in that message:

“I've been working on a new electronic cash system that's fully peer-to-peer, with no trusted third party.”

Satoshi attached the nine-page Bitcoin white paper to the email and clicked “send.” The Bitcoin network spread like wildfire.

Contents of Satoshi Nakamoto’s original email introducing the bitcoin white paper. Source: satoshi.nakamotoinstitute.org.
Contents of Satoshi Nakamoto’s original email introducing the bitcoin white paper. Source: satoshi.nakamotoinstitute.org.

Why bitcoin is such a big deal

Digital payments are nothing new. Online banking, PayPal, and international transfers were all commonplace before Bitcoin came along. But with the Bitcoin network, you can do something radically different: you can securely send, receive and store financial value without using a financial institution. That means you don’t need to trust a financial institution to act in your best interests. Instead, you can be your own bank, holding funds in your complete control.

There are other benefits too. Large or small, international transactions can be slow and expensive when traversing the global banking system. But with Bitcoin, the speed and fees of a transaction don’t depend on how much you’re sending or how far you’re sending it. The Bitcoin blockchain doesn’t care whether a transaction is international or domestic, or whether it’s for $10 or $10 million. Transactions take about an hour to complete and usually cost between $1 and $5 in fees.

Unlike banks and other financial institutions, Bitcoin stays open on weekends and holidays. In fact, it's been constantly open for business since the first bitcoin transaction in January, 2009.

How bitcoin transactions work

As with credit cards and other forms of digital payments, with Bitcoin no actual money moves from point A to point B. Instead, the blockchain is updated after each transaction block to show which wallets own which coins. And even though wallet addresses are disguised to protect user privacy, Bitcoin is terrible for money laundering. That’s because the blockchain records every single transaction – for all eternity.

Transacting in bitcoin (the digital currency, with a lowercase “b”) – is as simple as exchanging email. You can send and receive bitcoin using a crypto exchange (which does involve a financial institution) or directly through your bitcoin wallet (which does not). To send bitcoin from point A to point B, you just paste the bitcoin wallet address of the receiver into the address bar, enter the bitcoin (BTC) amount, and hit the send button.

How miners make Bitcoin secure

Your transaction is now grouped into a block of about 2,000 other transactions. That block is locked by an extremely complex cryptographic puzzle, which can be solved only with powerful computers. Miners compete to solve that puzzle through a process called “proof of work.”

Now, the first miner to prove to the network that he or she has solved the puzzle – which takes 10 minutes on average to crack – wins freshly minted bitcoins. The miner will also bank the transaction fees of every transaction within the block. In doing so, the miner “confirms” the transaction block on the network for the first time. At this point, a thief would need more than half the computing power of the entire Bitcoin network to wind back the blockchain and reverse your transaction. That would be known as a “51% attack.” And while they’re theoretically possible, they’ve never happened, and are highly unlikely to happen in the future.

For one thing, it would be insanely expensive to conjure that much computing power – so it wouldn’t make financial sense to hijack a bitcoin transaction. And for another, vigilant Bitcoin developers would notice the breach and immediately remove the thief from the network. Your attacker would be short billions of dollars in hacking expenses with nothing to show for it.

But here’s what really makes Bitcoin safer than Fort Knox: while the first block confirmation secures your transaction, each block after that adds another layer of protection. Block by block, your transaction is buried deeper into the blockchain, becoming exponentially harder to dig out.

And once five more blocks have been added – about an hour after you hit send – your transaction becomes mathematically impossible to reverse. It’s trapped on the blockchain forever and will never be undone, and the receiver’s bitcoin becomes impossible to steal through a network attack.

Bitcoin is slow compared to other cryptos, but there’s a reason

Bitcoin can only process up to seven transactions per second. That’s a snail's pace compared to Visa, Paypal, and a range of other cryptocurrencies, but it’s for good reason. See, Bitcoin blocks can store only one megabyte of data, which limits the number of transactions in each. And those small block sizes actually make Bitcoin more secure.

That’s because bitcoin transaction fees go up when there’s more demand for block space. If the blocks were bigger, they wouldn’t be as full, so transaction fees would be lower. While that may seem good for you and me, miner rewards would go down, giving them less incentive to mine bitcoin.

The Bitcoin hash rate is the amount of computing power dedicated to mining bitcoin. If that drops because fewer miners mine, an attacker needs less computer power to commandeer the network through a 51% attack. In other words, higher transaction fees (caused by smaller block sizes) make Bitcoin more secure.

Bitcoin hash rate. Source: blockchain.com.
Bitcoin hash rate. Source: blockchain.com.

Here’s what those fees are like

Depending on the volume of bitcoin transactions at a given point in time, as well as the current dollar price of bitcoin, transaction fees usually range between $1 and $5. But in times of extreme transaction demand – like near the peak of the 2021 bull run – those fees have been as high as $60.

US dollar fee per bitcoin transaction. Source: blockchain.com.
US dollar fee per bitcoin transaction. Source: blockchain.com.

Given those high transaction costs, bitcoin isn’t the best currency for buying a cup of coffee. But for safely storing and transferring large sums of wealth, it works like a charm.

Think about the time and cost of sending $50 million through the international banking system, or transporting a ton of gold across the sea. That’s going to take way longer than an hour, and set you back a lot more than a bitcoin transaction fee. Not to mention the expenses you’d rack up trying to store your gold safely before you sent it.

Just because Bitcoin’s slow and expensive right now, doesn’t mean it always will be. More and more, bitcoiners are using the Lightning Network – a separate technology applied to Bitcoin – to make transactions cheaper and faster.

Why bitcoin is like “digital gold”

Like gold, bitcoin is in finite supply. But unlike with gold, we can mathematically predict how many bitcoins will be mined each year. In the first four years of Bitcoin’s existence, miners received 50 coins each time they solved a transaction block. Then in 2012, the block reward halved to 25.

The reward’s been halving every four years since, and will continue halving at that rate until the year 2140. At that time, bitcoin will reach its maximum supply of 21 million coins, and miners will no longer receive new bitcoin from mining. That said, they’ll still mine to earn transaction fees – so long as those fees aren’t too low.

As of right now, around 90% of all bitcoin has already been mined. Of course, we can’t say the same for fiat currencies like the dollar, which are being printed at an exponential rate.

If you recall the economic relationship of “too many dollars chasing too few goods,” you can see why Bitcoin is built to be a long-term store of wealth and inflation hedge. And while bitcoin’s price is volatile right now, I reckon it’ll stabilize as its market size grows.

When that happens, bitcoin truly will be digital gold.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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