Not long ago, Bitcoin was the new buzz of the town and all everyone wanted was to get their hands on this new currency which continues to rock the world economy even today. But a very few people are aware of what exactly is Bitcoin and how it works.
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What is Bitcoin?
Bitcoin is a cryptocurrency, which began as a decentralised digital currency in the year 2008. The currency was introduced by an unknown individual/organisation using the pseudo-name of Satoshi Nakamoto. The motive of creating the Bitcoin was to introduce a secure, immutable and verifiable means of currency exchange without any central regulatory authority (bank or payment gateway).
Operating with the help of Blockchain (a decentralised and open digital ledger that records all Bitcoin transactions), Bitcoin has changed the way we transact and has been considered as a revolution by several tech enthusiasts.
How does it work?
Bitcoins are self-contained digital currency tokens that have a value of their own. There is no need for any bank to store them or maintain their value. This self-regulating currency works on the principle of Blockchain and several different cryptographic technologies.
Public key cryptography is one of the most fundamental cryptographic technologies that make up the essence of Bitcoin. Each of the Bitcoin is associated with the owner’s ECDSA (Elliptic Curve Digital Signature Algorithm) key. When a transaction is made, the key gets attached to the number of coins and the message thus formed is signed with the owner’s private key. This message is then broadcasted to the Bitcoin network (network based on Blockchain) for the peers to know that the new owner of these coins is the individual who possesses the new key. The signature of the previous owner ensures authenticity and the transaction is stored as a record with everyone for future verification.
These transaction records are stored in the form of blocks, forming the complete Blockchain ledger. All participant computers in the network keep a copy of the Blockchain which is updated by passing new blocks. In order to ensure that the blocks are secured and immutable, each new block confirms the integrity of its predecessor, back to the very first addition in the chain – the genesis block. The chain, therefore, remains protected as no party can overwrite any record.
An added layer of security
The Hashcash cost function is used in regulating the generation of bitcoins. The Hashcash function, first of its kind, is a verifiable and secure cost function which happens to be non-interactive. It has no secret keys that need to be managed. Hashcash uses the widely known SHA1 or SHA-256 symmetric key cryptography.
The Hash Function (not to be confused with Hashcash function used in regulating the generation of bitcoin) is one of the most secure ways of protecting the integrity of the blocks in the blockchain. The input data is transformed into a compact string through an irreversible method. The slightest change in the data completely changes the hash or the compact string, ensuring that no one can create a block of data with the same hash code. Each hash matches one unique input stream, which is why Bitcoin blocks need not contain serial numbers for identification. Using the hash function ensures both identification and integrity verification of the blocks.
The generation and Mining
When Bitcoin circulation first began, only a limited number of Bitcoins were released and distributed. Bitcoins are constantly being generated, even at this very moment. The generation of the bitcoins can be understood from the process of Bitcoin mining, which helps in the production and addition of a valid block.
Adding a block to the existing Blockchain requires time as well as processing power, making it a difficult task. In order for a successful addition of a block to the Blockchain, the miners or users need to solve a hard mathematical puzzle/problem, which requires high computational abilities, thus the time and the processing power. However, the addition of the block is necessary to ensure that the transactions are updated regularly. As a reward or incentive for contributing electricity, processing power as well as time to achieve the same, the individual gets a few numbers of bitcoins (the number is fixed by the Bitcoin network). Apart from that, the transaction fees present in the block’s transaction is also claimed by the producer of the block.
The unlocking of Bitcoin bounty by contributing processing power is known as ‘Bitcoin Mining’. The rules of mining are fixed and the difficulty adjusted to limit the block production rate to 1 block per 10 minutes. Thus as the number of contributors or minors increases, it becomes increasingly more difficult for each of the participants to add a block. The increased difficulty also ensures higher security of the transactions.
Rise in popularity
Whenever something revolutionary is introduced, it takes time for people to accept it. However, Bitcoin has risen to popularity very fast. The rise in popularity of this cryptocurrency can be attributed to its new approach towards currency distribution.
Here are a few reasons that made Bitcoin very popular and continue to attract new investors –
Decentralised nature: There is no regulating authority. Each participant computer or individual contributes to the maintenance of the Blockchain and hence, no financial policy or fraud can ever take away the value of Bitcoin.
Anonymity: Another beauty of using the bitcoins or being a part of the blockchain is that you do not need to confirm your identity. You can be anonymous and still control or use bitcoin and trade with them.
Easy to set up and transact: Bitcoin system is fairly easy to adapt and set up. No questions are asked of any authority and you can become a part of the network within a few minutes or even seconds. Another advantage that attracted a lot of investors, as well as individuals, is that Bitcoin has negligible transfer fees. This means that all international transfers are easy and cheaper to conduct through Bitcoin.
Transparent, and fast: The Bitcoin ledger is an open record, that maintains the record of all transactions held till now, accessible to all members of the network. Also, the transactions are quite fast.
And Bitcoin doesn’t happen to be the only cryptocurrency in the market today. Following in the footsteps, are more than 1500 listed cryptocurrencies, out of which some have managed to gain support and popularity. These include names like Ethereum, Bitcoin Cash, Ripple and Litecoin. Each of these currencies is focused on different motives but function on the same Blockchain Technology.
The Road Ahead
History shows that Bitcoin’s value has been very volatile and continues to fluctuate throughout. Its rising popularity and the revolutionary Blockchain technology has already promoted several firms to embrace the change. However, it is too early to say whether Bitcoin will remain and prevail as the universal digital currency. Like any other venture, it needs time to mature. But one thing is for sure – our financial system and the economy are never going to be the same.
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How are cryptocurrencies different from Blockchain?
The feature that enables Bitcoin, one of the most prominent cryptocurrencies, to work is known as Blockchain. It's a form of technology that focuses on data storage and protection via decentralized networks. Cryptocurrency and finance, supply chain management, healthcare, and retail use it. Whereas, Cryptocurrencies are a sort of digital money that may be used in the same way as regular money to buy goods, services, and investments. Cryptocurrencies utilize blockchains to keep track of transactions and ensure interoperability. Another difference between Blockchain and cryptocurrencies is that, while Blockchain is a decentralized and distributed technology, cryptocurrencies are provided remotely via mobile wallets. Finally, despite the anonymity provided by cryptocurrencies, Blockchain is an evident technology.
What are the advantages of Bitcoin?
Bitcoin as a form of digital currency offers a wide range of advantages. Firstly, it provides the feature of accessibility and versatility to all its users. This means that a user with a Bitcoin wallet can avail of its services irrespective of the place and the type of currency used. Transactions on a platform supporting bitcoin are fast, which helps in reducing the wastage of time. Secondly, Bitcoin provides its users with complete transparency as all the records of the transactions are readily available, and there is no tracking. It also provides its users anonymity as they are identified with the help of number codes instead of their names or other credentials. Lastly, since Bitcoin is a decentralized technology, no central authority will ask its users to maintain certain balance or demand coins. This form of currency also has a high return potential.
What are the disadvantages of Bitcoin?
Every form of technology has its own set of disadvantages. The same goes for Bitcoin. When Bitcoin was founded, the number of coins was limited to 21 million bitcoins. This figure cannot be exceeded, making Bitcoin very scarce in nature. Also, Bitcoin is volatile as its nature is affected by tiny instances. Another disadvantage of Bitcoin is that it follows no government regulations. This means that bitcoin is not legally protected, making it prone to scams. All the records on the Bitcoin platform are permanent. This means that the records cannot be changed and are irreversible, so users cannot correct any issue with the transaction, and there is no solution to wrong transactions. Lastly, even though it is being widely used, many companies are still left to use Blockchain, making its use limited.