The immense value of Bitcoin is incomprehensible to many people. How can a fully digital currency be worth more than an ounce of gold? Why is there so much interest in Bitcoin? In this article we would like to explain everything worth knowing about Bitcoin, its development, the blockchain and mining.
Why was Bitcoin invented?
The Beginnings and Cypherpunks
In the real world, it’s normal for people to have secrets. However, since the digital revolution and the breakthrough of the Internet, human life has continually shifted to the digital realm. Computers, smartphones and the Internet have become an integral part of everyday life.
However, there is one big problem. In contrast to real life, the Internet knows no secrets. Ever since the NSA scandal and Edward Snowden’s revelations, it has been clear that intelligence agencies around the world potentially store and search any information from electronic communications over the Internet.
One movement, the Cypherpunks, had already predicted this development in the early 1990s. They realized that no promise from any government could ensure that there would be no mass surveillance in the digital age. Eric Hughes, an early supporter of the Cypherpunk movement, wrote the famous Cypherpunk Manifesto in 1992, which called on people to fight for their own privacy. However, the fight did not take place in the real world on demonstrations. Instead, the Cypherpunks devoted themselves to programming anonymous systems.
So the Cypherpunks not only discussed, but fought for their vision. They used cryptography to create anonymous mail systems, digital signatures and electronic money to restore each individual’s privacy. Even if you don’t know who the mysterious inventor of Bitcoin is and who is behind the pseudonym Satoshi Nakamoto, it is assumed that Satoshi was at least a supporter of the Cypherpunk movement, shared the political views and invented Bitcoin out of this motivation.
Satoshi Nakamoto Appears
Remarkably, however, Satoshi was not the first to invent a digital currency. For the Cypherpunk movement, anonymous and digital money was a central element in the struggle for monetary privacy and individual freedom. Even before Satoshi Nakamoto there was Wei Dai with his b-money. David Chaum invented DigiCash, which finally failed in 1998. All predecessors of Bitcoin failed because they could not do without a central instance or because they could not solve the double-spending problem (the problem that prevents a digital coin from being issued twice).
On November 1, 2018, Satoshi Nakamoto presented the Bitcoin Whitepaper for the first time on the Cryptography mailing list and thus the solution to all the problems that led to the failure of all digital currencies.
Two months later, on 09 January 2009, Satoshi released Bitcoin version 0.1, but initial interest was limited. There was no sign of a revolution yet. The first Bitcoin transaction, the so-called “Pizza Day“, was still a long way off and only took place on 22 May 2010, when Laszlo Hanyec bought two pizzas for 10,000 BTC.
A history lesson: The value of money
Bitcoin (short: BTC) has been the world’s first crypto currency. All subsequent crypto currencies are referred to as Altcoins (alternative coins). Bitcoin is both a currency and a means of payment. In contrast to Fiat money, e.g. the euro or the US dollar, there is no central bank that prints the money and regulates the cash flow.
At first glance it seems absurd that something intangible, a digital currency, should have a value. However, there is a logical answer to how Bitcoin gets its value. To understand this, it is necessary to understand how the euro or US dollar maintains its value. Both currencies are based on an illusion, a mental construction, that a coin or banknote has a value of 1, 2 or even 50 (Euro or USD). According to Modern Monetary Theory, this value is based solely on the fact that a government determines these values and the government calculates its claims (e.g. taxes and other levies) in this currency.
In history, paper money did not acquire any real value until it was linked to gold. However, the Bretton Woods treaty, which made the US dollar the world’s reserve currency and obliged the USA to hold an ounce of fine gold for 35 dollars, was cancelled by US President Nixon in 1971. The value of money was thus placed on trust in governments. Money became an instrument of economic policy. The exchange rates became free, the value relative. Governments and central banks have started printing unimaginable amounts of money to finance crises.
Since 1971, the price of gold has risen to well over USD 1,000. Paper money has thus lost almost 97 percent of its value compared to gold. Liberal economists therefore doubt that Fiat currencies can fulfil a core function of money, that of a store of value. This is where Bitcoin comes in. Bitcoin is mined similar to gold. However, the number of Bitoin is limited to 21 million BTC, so there can be no inflation. Bitcoin is therefore a perfect value memory.
Bitcoin as a store of value
Ultimately, however, the value of Bitcoin is based solely on the confidence that BTC will continue to have an equivalent value tomorrow. However, Bitcoin does not need to rely on third parties because, for example, banks are not required to carry out transactions.
The basis for this is that the Bitcoin network is a distributed peer-to-peer system (P2P). The advantage of P2P systems over centralised systems is that direct interaction can take place between the parties and no switching instance is required. In contrast to Fiat currencies, Bitcoin is thus resistant to attacks by governments.
The Bitcoin Blockchain records every single transaction performed with Bitcoin, validates transactions and ensures the integrity of the network. Bitcoins trade with decimal places. Bitcoin’s smallest unit is a Satoshi. One Bitcoin corresponds to 0.00000001 Satoshi.
How does the Bitcoin blockchain work?
The Blockchain is the revolutionary technology behind Bitcoin and other crypto currencies invented by Satoshi Nakamoto. The Bitcoin blockchain is a chain of blocks that are connected by cryptographic processes. All transactions ever made over the Bitcoin network are stored in the blockchain. The transactions are considered confirmed if they are stored in the Bitcoin blockchain (in a block).
A major problem for digital currencies and virtual objects in general is the double spending problem. In contrast to physical objects, which can only be issued once, digital goods can be used several times, in two different places (simultaneously). We have learned that earlier variants of digital money, such as b-money and DigiCash, failed to provide a workable solution to this problem. Satoshi Nakamoto has found a solution for this. Blockchain technology stops this problem by requiring that each member of the network (“Full Nodes”) checks each transaction.
Only if the majority of the participants confirms that the transactions in the block are unique are they added to the block chain. Each new block is linked to the previous block to ensure a chain of accepted transaction histories.
In order to provide an incentive for the validation of transactions, each block attached to the block chain is rewarded with a “block reward“. The current reward (in 2018) for “mining” is 12.5 BTC. In 2020, the reward will be halved to 6.25 BTC, since every 200,000 blocks will be halved (approximately every 4 years) until all 21 million Bitcoin are mined. Mining solved the second major problem of Bitcoin’s predecessors, as the consensus of the miners replaced a central institution (central banks and banks).
What is Mining?
How does Bitcoin Mining work?
Within the Bitcoin protocol, Satoshi Nakamoto has specified that a block with outstanding Bitcoin transactions is written to the block chain approximately every ten minutes. A block can contain an indefinite number of individual transactions; the limit is only the block size. This is 1 Megabyte (MB).
The miners compete for the production of these blocks. The proof-of-work is a cryptographic puzzle that determines which miner is allowed to write the next block into the Bitcoin blockchain. The miners take the transactions (or their Merkle tree) and add a random string (the “Nounce“) to them and hashen both values. The Miner compares the result with a condition. If this is not true, the Miner will try a new string until it finds a hash. The transactions are thus verified by matching them with a 64-digit hexadecimal hash. To solve this task, the Block Reward is awarded to the successful miner. This process is repeated every 10 minutes.
In the early days it was still possible to mine Bitcoin with a normal computer or laptop (with the CPU). However, GPUs (graphics cards) replaced CPUs as early as 2010, until GPUs were replaced by even more specialized ASICs (“application-specific integrated circuits”) from Bitcoin mining in 2013. ASICs are computer chips that have been specially developed by Bitcoin for mining. They cannot perform any other function. With the emergence of entire mining farms using ASICs, the hash power and mining difficulty of the Bitcoin network became too great to mine Bitcoin as an individual.
The Bitcoin Mining Difficulty
In order to meet the time frame for block halving, the Bitcoin network aims to verify a new block every ten minutes. As the number of miners in the Bitcoin network increases, so does the computing power, which means that there is a better chance that someone will solve the cryptographic puzzle in a shorter time. Therefore, there is the Bitcoin mining difficulty.
With increasing hash rate also the degree of difficulty rises. All 2016 blocks (about every two weeks) therefore change the Bitcoin mining difficulty. If the block time is less than 10 minutes and the hash rate is high, the level of difficulty is adjusted upwards to comply with the 10 minute rule.
What happens when all 2 million Bitcoins are mined?
One of the most common questions about Bitcoin is what happens when all 21 million BTCs are mined. As early as 2032, the “block reward” will be under a whole bit coin. From a certain point on, mining will no longer be profitable simply because of the loan, even if the Bitcoin price will still rise well over 100,000 euros, as some experts believe to be realistic. As we have learned, however, the miners are essential for the security of the network. What’s gonna happen then?
In principle, two scenarios are conceivable. We have already hinted at the first. The Bitcoin price will increase with each Bitcoin halving of the block reward. This tendency has already been observed in the halving that has taken place so far. The second scenario uses the transaction costs necessary for each Bitcoin transaction. The transaction costs are to take over the payment of the miners in many years. This is another reason why many Bitcoin developers are in favor of maintaining the 1 MB block size, so that due to the scarcity of this resource, the transaction costs can be used to pay the miners.
What is a Bitcoin Hard Fork?
Another topic that has become particularly interesting in 2017 is hard forks.
Bitcoin Cash, Bitcoin’s very first and most controversial hard fork, emerged in 2017 in a dispute over how the Bitcoin blockchain should scale. So: How can it be possible that Bitcoin is used by a broad mass, by millions of people? At the centre of the discussion was the controversial block size of 1 MB, which limits the number of transactions that can be included in a block. Remarkably, Bitcoin had no size limit at the very beginning. Only in September 2010 Satoshi changed the code to 1 MB.
Already in 2013 the discussion came to increase to the block size. On the one hand, there was the faction that wanted to leave the original Bitcoin protocol unchanged as far as possible and scale “off-chain” through the lighting network. On the other hand, there was the faction in favor of increasing the block size to scale Bitcoin as quickly as possible.
On 01 August 2017, the “Blocksize War”, which lasted more than two years, culminated with the spin-off of Bitcoin Cash (BCH). Simply put, Bitcoin Cash “copied” the original blockchain and changed the code immediately after the hard fork to a new blocksize limit of 8 MB.
This event proved to be a stroke of luck for Bitcoin investors. Those who owned Bitcoin (BTC) at the time of the snapshot received the same amount of Bitcoin Cash (BCH). In the course of 2017, numerous other Bitcoin Hard Forks followed, but apart from Bitcoin Gold, they are no longer significant and were predominantly classified as scam.
If you are now interested in buying Bitcoin, have a look at our tutorial on how and where to buy Bitcoin.