The traditional financial system is built on fiat currencies. These are assets backed by a country’s government. Examples include the United States dollar, the Euro, and the Japanese Yen. Governments have full control over the issuance of their currencies, and they can decide to print more or less money based on economic conditions. Through this mechanism, among others, they exert control on factors like the value of the currency and the rate of the currency’s inflation. Banks, credit card companies, and other traditional financial institutions store and facilitate fiat currency transactions for the general public.
However, in the aftermath of the 2007-2008 global financial crisis, many people were disillusioned with the state of the world economy and the institutions (e.g. governments and banks) that manage it. As frustration mounted, a pseudonymous person (or group) called Satoshi Nakamoto published a timely whitepaper on the Internet. Totaling only 9 pages, the paper proposed a revolutionary, peer-to-peer electronic cash system called Bitcoin, which would be based on a chain of blocks containing all network data. (Curiously, the word “blockchain” is not mentioned once in the whitepaper.)
The creation of Bitcoin
As a new kind of digital currency, Satoshi’s proposed Bitcoin would not require trust in the financial institutions that many now questioned. Instead, it would be trustless, irreversible, secure, and it would maintain a public record of transactions using CPU power. Governments could not create new Bitcoin as they can their own fiat currencies, unilaterally exerting pressure on its value. Banks and credit card companies could not “freeze” a person’s ability to use their assets.
Satoshi’s vision was realized when he/she/they mined the first Bitcoin block in January 2009. As if to highlight the cultural moment that inspired its creation, the first Bitcoin block contained the embedded text “The Times Jan/03/2009 Chancellor on brink of second bailout for banks.”
Bitcoin continues to serve as a foil to fiat currencies to this day, based on the self-same concepts laid out in its original whitepaper. It also spawned a new economy of digital assets that we call cryptocurrencies. Some use the Bitcoin network for payments (like cash), others use it for storing value (like gold), and still others use it for more creative outlets like the collection of non-fungible tokens (NFTs).
Bitcoin vs. fiat currency
Bitcoin and fiat currencies transactions have crucial differences, each with its own set of advantages and drawbacks:
- Bitcoin transactions are irreversible – Once you send your bitcoin to another address, the transaction is added to the blockchain and is finalized. It also means if you type a Bitcoin address incorrectly, your assets can be permanently lost. For this reason, users must be careful when sending bitcoin. With credit cards, if there's a mistake or fraud, transactions can under certain conditions be reversed, offering users more protection.
- Bitcoin is decentralized – When you make a credit card payment, the card issuer has complete authority over the transaction. The credit card company either confirms that you have enough credit available and sends funds to the other person or it cancels the transaction. The same company validates that the transaction took place, and it notifies all involved parties. Centralization offers organized payment processing, support, and help with disputes, but also comes with fees and rules set by these middlemen. With Bitcoin, the role of these authorities is distributed to a decentralized network of thousands of computers called nodes. The nodes constantly verify individual accounts and transactions across the network. This decentralization reduces reliance on banks and financial institutions but also means there’s less institutional support and oversight.
- Bitcoin is not bound by geography or borders – The Bitcoin network is global. There is no central framework that restricts it to a geographic location, so it can be sent anywhere in the world at the same speed and for the same fee. Conversely, sending fiat between countries or continents can be complicated, as it is governed by political rules and inter-institution agreements that make the process costly, slower, more opaque, and sometimes impossible. However, fiat transactions come with the security and regulation provided by the governing bodies of the countries involved.
Bitcoin: the first cryptocurrency?
Although Bitcoin is commonly called the “first” cryptocurrency, this is not necessarily true. Beginning in 1990, multiple other cryptography-based digital assets were proposed and developed. These include eCash (later called Digicash), b-money, and bit gold. However, Bitcoin was the only cryptocurrency to be fully operational and publicly accepted, possibly due to the impetus provided by the global financial crisis.
Regardless of its predecessors, Bitcoin is certainly the first modern cryptocurrency. Additionally—and maybe more importantly—it is the inspiration behind a crypto market that grew to $3 trillion less than 13 years since Bitcoin’s trailblazing beginnings.
Who is behind Bitcoin?
Satoshi Nakamoto is the pseudonymous person (or entity) who first described Bitcoin and mined its first block. Therefore, the creator of Bitcoin is known—in a way. In truth, the true identity of Satoshi is not known. Some have postulated that it is one of a few software engineers or digital currency experts including Nick Szabo, Dorian Prentice, and Hal Finney. However, many believe that Satoshi is a group of developers. Satoshi’s identity is still a mystery. In fact, it is a mystery that may never be solved, as their last public communication was in 2011.
Although Satoshi created Bitcoin, not one person owns it. More recently, the software that underlies the network (called Bitcoin Core) is maintained by a group of developers. Anyone can volunteer to develop Bitcoin, but their contributions are peer-reviewed before being applied to the code. Once implemented, Bitcoin nodes must begin running the new software to enact the changes.
How does Bitcoin work?
In order to operate a trustless digital currency, Bitcoin must: 1) ensure each public address has the correct balance; 2) broadcast, validate, and record the transactions through a network-wide consensus process; 3) prevent bad actors from “double-spending” their assets; and 4) incentivize participants to secure the network. It uses a combination of public/private key cryptography, blockchain technology, and a decentralized peer-to-peer network of nodes to accomplish these goals.
Public and private keys
Users of the Bitcoin network have alphanumeric addresses that hold their assets. Each address has a public key that identifies it to the network. It functions like a mailing address where anyone can send bitcoins (BTC).
Meanwhile, the private key is like the key to the house’s front door. Only the owner of an address knows their private key. It is used to confirm they want to send their BTC to other Bitcoin addresses. In other words, it is used to “sign” transactions.
Blockchain and nodes
Bitcoin brought the concept of blockchain technology to the public. A blockchain is a way of organizing, storing, and recording data—like cryptocurrency transactions. It comprises a series (or chain) of data organized into batches (or blocks) confirmed by network participants.
Each participant, called a node, stores a copy of the entire blockchain so every bitcoin can be tracked from its very beginning. The thousands of Bitcoin nodes can “compare notes” to ensure their copies match, assuring a decentralized, collective truth of the blockchain.
In addition to storing the blockchain’s data, nodes place transactions into a queue called the mempool. From here, transactions are picked up by certain nodes called miners. These computers collect transactions and add them to a block, then validate the transactions to add the block to Bitcoin’s ever-elongating chain. However, this is a competitive process. Miners race to solve mathematical puzzles called hash functions through a process called Proof of Work. The first to solve the hash function is granted both the ability to validate a block and the associated cryptocurrency reward (in the form of BTC).
Updates to Bitcoin
Over time, the Bitcoin code has been updated to account for increased use of the protocol and the need for more functionality. One major update occurred in 2017. Called SegWit (short for “segregated witness”), this update paved the way for the Lightning Network, a solution that allows for fast peer-to-peer payments. In short, it was designed to increase the speed and capabilities of the Bitcoin blockchain.
In 2021, the Taproot update further improved the Lightning Network, decreased network fees associated with some transactions, and added an element of privacy to Bitcoin transactions.
How many bitcoin (BTC) are there?
One of the draws of Bitcoin as a store-of-value is the fact that there is an unchanging, maximum supply. This differs significantly from fiat currencies which have variable supplies under centralized control, and it protects the digital currency against inflation. Though bitcoins are created through mining, there will only ever be 21 million BTC. At the same time, there are plenty of units for people to use, especially since each bitcoin can be divided into 100,000,000 tradable units called satoshis (or “sats”).
However, some bitcoins are believed to have been lost forever. This is because a portion of the total supply of BTC has been dormant (i.e., not moved) for such a long period of time that many assume their owners have lost the private keys to their wallets, inadvertently sent their BTC to incorrect (nonexistent) addresses or died. More than 1 million BTC have been dormant since 2009, and more than 4 million BTC have been dormant since 2016.
Bitcoin essentials
- As the first modern cryptocurrency, Bitcoin set the standards for blockchain technology and operating a decentralized digital asset network.
- Bitcoin was created just after the great financial crisis of 2007-2008 by a pseudonymous person (or group) called Satoshi Nakamoto who has since disappeared from the public eye.
- Transactions on Bitcoin’s network are secured by a decentralized network of computers called nodes, and unlike fiat currencies they are borderless and irreversible.
This webpage has been approved as a financial promotion by Bitstamp UK Limited which is registered with the UK’s Financial Conduct Authority. Please read the Risk Warning Statement before investing. Cryptoassets and cryptoasset services are not regulated by the Financial Conduct Authority. You are unlikely to be protected if something goes wrong. Your investment may go down as well as up. You may be liable to pay Capital Gains Tax on any profits you earn.