In order to understand bitcoin, we must first determine the type of financial
instrument it represents. Bitcoin is a peer-to-peer digital payment system. As
Satoshi Nakamoto, the creator of bitcoin puts it – “an electronic cash system”. Not
simply a currency or asset, it is an electronic way of exchanging value across a new
economy, one which operates entirely independent of human intervention and 20th
century financial infrastructure. For the sake of explanation, we must establish the
fact that the way bitcoin works and the way the payment system operate, are one in
the same. We are dealing with one payment system known as the bitcoin blockchain,
and one unit of account for said system known as a bitcoin.
Bitcoin is a digital, cryptographic form of money. By this, we mean the
cryptocurrency exists as a computer software solution supported by techniques of
cryptography to ensure the integrity of the peer-to-peer network structure.
Cryptography describes a form of data transmission which serves the needs of
information security and confidentiality. Many applications of online
communication, banking, and ATMs already use an array of cryptographic
techniques to ensure user information is not tampered with or intercepted by a third
party.
Credit cards, which were conceived in a time when internet technology was
nonexistent, do not have the ability to perform the functions bitcoin is designed to
carry out. The use of credit cards originated in the United States during the year
1958, when firms such as the Bank of America began issuing them to customers who
made purchases based on credit at partnered institutions. In 1983, long after the advent of credit cards, the TCP/IP protocol was standardized into ARPANET and is
still the primary technology we use today for the internet. (Computer Hope, 2014)
Bitcoin was designed for the internet, although it has far reaching implications for
the physical realm, it will come to dominate our online lives because it was
specifically made to capitalize on payment functionality only internet technology
makes possible. We will discuss these functionalities later in this book. Combined
with the reality that our lives are becoming progressively intertwined with the
internet and computers, bitcoin will increasingly be seen as the standard way to
make transactions worldwide.
As a digital form of money, bitcoin is not physical in any sense and exists solely as
recorded information on the shared bitcoin blockchain. Because this form of money
is entirely digital, it has the innovative attribute of being native to the online realm.
When we talk about existing as recorded information on a shared ledger, we mean
residing on a network supported by an interconnected linkage of computing power.
These computers which agree to the information recorded in the blockchain ledger,
are known as miners, a concept of supporting the network as a node, something we
will discuss later.
This network of interconnected computing power is created when computers running
software (the bitcoin client) link up to record and handle transactions. Every time a
transaction is made, the amount is recorded in the network payment system, adding
to the public ledger (the blockchain) and making available for anyone to view. For
this reason, it is said that the bitcoin payment system is a fully transparent network -
anyone can view any payment and the time it was made since the inception of
bitcoin. When a payment occurs, ownership of the amount that was transacted is
now passed onto a new party.
Because the blockchain ledger is completely transparent, as in completely visible and
accessible, it creates a situation where the user can remain anonymous or have their
identity tied to their bitcoin holdings depending on how they handle the transaction.
In order to control a set amount of bitcoin, a user must first create a wallet (a bitcoin
bank account) which will serve as the point from which funds are sent and received
by other wallets in the bitcoin ecosystem. A typical wallet is identified by a string of
characters called a public address which is generated by the network. If you do not tie your real-world identity to this string of numbers and letters, it is possible to remain
anonymous and have full privacy with your payments.
Thanks for reading