What is Bitcoin?

Bitcoin
BTC – or bitcoin – is a revolutionary new digital currency first introduced in 2009. It has no physical presence, and is instead just computer bits. The transactions made are done through a public ledger, allowing full transparency into where the coins are located (at least in terms of the address that holds them) and where they came from and were transferred to. This system has created a way to have a decentralized currency that is both safe and secure, along with having great utility.

How Coins Are Created

Bitcoins are created through a process called mining, which uses an algorithm dubbed SHA-256 to try and solve blocks of transactions through a method called hashing. When a block is solved, the computer that solved it gets a reward (flat-rate, which right now is 25 bitcoins), as well as all transaction fees that were paid by those that wanted their transactions added. What this does is ensure that the coins are being created at a pretty much constant rate (the difficulty of solving a block rises and falls depending on how much power is pointed at it, in order to keep an average rate of about one block per 10 minutes), thereby limiting the effects of inflation. On top of this, it allows for a maximum coin cap of 21 million, after which no new coins will be created.

The Move to Decentralization

A big question that is always asked by onlookers is what decentralization of currency means. Everyone is used to the currencies that are used locally, termed fiat. These are created and controlled by a central system; usually the government. As such, people that reside in each country are bound to the government’s decisions as to how much money should be created or destroyed, over which period it should happen, etc. In essence, the government has all of the control and the people have none: they can simply use the currency under the rules that are given.

By decentralizing currencies, such as with bitcoin, the shift of power is not in any specific person or group of people’s hands. Instead, everyone, as a whole, is able to vote. In this sense it is a lot like a democracy. The way this voting works is through the blockchain. Being that all transactions must go through the blockchain to be verified, and computer systems are used (in a distributed fashion) to resolve those blocks, everyone that is mining is casting their vote for how things should work. As an example, if miners wanted the transaction fees to raise or lower, over half of them could alter their bitcoin clients such that the only transactions they would include in a resolved block are those with higher transactions, or just include everything. As long as over half of the miners are in agreement and make the change, the theory is that they should be snagging enough blocks to make it happen.

Pooling Hash Power

A huge issue with bitcoin mining is that it takes a lot of power. As each new system is added to the network, the amount of hash power it requires in order to resolve a block and get a reward increases. While this is going on, electricity costs are racking up, so it is important to at least be earning something. Luckily, a system called pool mining was introduced to help combat this.

Pool mining works by having the miners get work from a pool and submit their results to that pool. This is contrary to solo mining, where miners would just do the work on their own and report back only when a new block was found. The pool mining has a couple of different benefits (and caveats).

First of all, mining with a pool is great because it helps reduce variance. When anyone on the pool finds a block, the rewards are shared by everyone that helped work towards it (equal to the fraction of work each miner did). For example, if there are three miners and one is twice as powerful as the other two, that third one would get 50% of the rewards for each block solved, while the others would each get 25%. This would be irrelevant of who actually solved it. While variance wasn’t a problem in the beginning, as more people jumped on board and started mining it became more difficult to find blocks solo.

The second thing the pool brings is the ability to get rewards even if a system shuts down or has other issues just before the block actually being found. For example, if someone is mining for an hour and then their system goes offline, they will still have the shares they earned counted when it comes to payout time.

The negative side of the mining pools comes from the fact that they create a sense of centralization. While the mining itself is still handled in a decentralized manner, all of the work is being done through the pools. The pool itself, therefore, is like a collective group, or a centralized system. The way this is usually fought is by increasing pool fees or otherwise talking miners into spreading out across many different pools, but this does not always work as intended. Often times, a single pool will get close to the dreaded 51% mark (which essentially means they have more voting power than the rest of the mining collective and could, theoretically, make changes that others disagree with). With that said, so far this has not posed an actual problem yet; just a theoretical one.

Conclusion

Bitcoin is a decentralized virtual currency that allows people to send wealth back and forth without dealing with a government or other central agency. Votes are handled through miners that deal with creating new blocks of transactions and therefore verifying them. This creates a sort of voting system, while at the same time keeping the integrity of bitcoin and ensuring that no one party can take over the system or make changes to it. The software itself is based on an open source model, and if new additions or changes are agreed upon by the majority, they can be implemented at any time.