Understanding Bitcoin (1 of 5)
It’s more than half year since I began my study on Bitcoin and its relevant topic like Blockchain. I always have an idea to write a series of articles introducing what Bitcoin is and how it works. Recently I got a chance discussing Bitcoin with two of my friends, and tried to take a more systematic way. The result is quite good, at least from their response. Therefore I am writing them down in this five-part series, covering several areas about Bitcoin. Before you dive into this new area, or plan to criticize it, let’s get familiarized with some basic concepts.
The topics I am covering are,
- Bitcoin as transaction medium: what is the difference with other payment system?
- Bitcoin as a virtual currency
- What’s behind a transaction
- Ledger: everything is kept in record
- Mining: let the ledger keep running
Bitcoin as transaction medium: what is the difference with other payment system?
Despite the negative words today describing Bitcoin, such as “speculation”, “ponzi scheme”, “money laundering”, the original idea of Bitcoin is for transaction, which is something like how we spend the cash. The very first white paper of Bitcoin is titled with the term “Electronic Cash System”, and we can see what purpose it is at the very beginning.
Let’s imagine a scenario. I’m going to a convenience shop and buy a magazine. I notice that this shop accepts Bitcoin as payment method. I take out my Bitcoin wallet, input the shop’s Bitcoin address (usually it is QR code shown publicly) and the amount needed (of course, in Bitcoin), the transaction is done.
Hold on, we do have many this type of service today like XX-Pay (you can add whatever XX is), and it is linked to bank accounts or credit cards. Why do we need a new one? There are some areas quite unique in Bitcoin system.
One unique point is anonymity. There is much difference when using cash (banknotes or coins) versus other payment systems today, and anonymity is a very important one. That is to say, no one can trace the usage history of a banknote or a coin: who has been using this banknote or coin for what purpose and to whom it is passed. Only police may be able to trace the the banknotes in criminal investigation, and this would be a rare case. On the contrary, other payment systems have some ways to keep track transaction history for someone (well, they are eager to do so).
The use of Bitcoin is considered anonymous. To be accurate, Bitcoin is only “close to” anonymous. Each Bitcoin wallet holds the Bitcoin addresses I own. Bitcoin is not anonymous per each of these addresses: anyone can track the flow of this amount of Bitcoin based on this address. However, Bitcoin wallet allows generation of these addresses randomly and without limit, and there is no mechanism to bind my identity to these addresses. That is to say, anyone can trace the flow based on a Bitcoin address, but no one can confirm that this Bitcoin address belongs to “me”.
Here we touch on two concepts: Bitcoin address and Bitcoin wallet. We have more on them later.
Side track a bit: in Hong Kong, we have a payment system Octopus. It comes with several versions. Among them, the Standard version of “On-Loan Octopus” is of anonymity. The serial number of this Octopus has no relation with the owner. This version keeps the anonymity like how we use cash today.
Anonymity is something we enjoy for long time since using cash. Today many new payment systems come with great convenience. To certain extent we are giving up the anonymity. Whether they are good or not will be debatable continuously, and there is no harm to bring them in. However, whether we can keep certain level of anonymity would be the big challenge.
Here the term “independency” comes with two levels. Bitcoin does not require being bound with any bank accounts or credit cards. As far as I can deposit some money into the wallet, I can use that amount of bitcoin.
A more deep level of being independent is the term “decentralization”. Bitcoin is powered by Bitcoin network, which is built between nodes. There is no central institution, not a Datacenter, not a single server who can claim the ownership of this network. You and I can join the network, or leave it at any time we wish. We will touch on the actual operation on upcoming articles.
This decentralization, in addition to the special way of ledger operation (again, we will cover this later), makes Bitcoin operation robust. No single organization or government can shut it down completely. The bitcoin network can also withstand DoS attacks (i.e. attacking the single point or several points to disable the whole operation). I heard one saying like this: as long as one node remains, the whole bitcoin network can be rebuilt from that node.
Transaction without Boundary
The convenience shop scenario mentioned above shows that, as far as I have the address of recipient, the transaction has no geographic boundary. It is equivalent to money transfer.
Think of money transfer today: the process requires one or more intermediaries (banks, wiring service providers, wiring networks, etc.). They are responsible for interfacing customers, currency exchange, executing the legally required procedure, etc., before handing money to the recipient. The service is always costly.
Imagine if both sides accept Bitcoin, there is no need on these intermediaries. The paying side simply use the recipient’s address and the required amount of bitcoins, the transaction is done. Without those intermediaries, the transaction fee can be largely reduced (it won’t go to zero, as we talk on the transaction detail more in depth). Money transfer is considered a use case for Bitcoin, especially when it is across region.
In the next article we will talk about virtual currency.