A short explanation by the Bitonic.nl founders
Please note: this page is outdated. You can find an improved version in Dutch on bitcoin.nl
What is Bitcoin?
To be completely honest: Bitcoin is a complicated concept and it took us a while before we really understood what it is. And we still learn new things every day. In this article we will try, despite its complexity, to explain what Bitcoin is.
First, it is important to make a clear distinction between two things: the Bitcoin network with its underlying technology, i.e. the Bitcoin protocol: (Bitcoin) and the currency: (bitcoins). We will tell you more about the Bitcoin protocol later. Let’s discuss (paying with) bitcoins: these are digital units that are sent through a network and represent a certain value.
You can use Bitcoins to make digital payments without the use of a bank or other central institution. You can regard it, in a way, as digital cash. However, it is not yet officially recognized as a currency.
The clip below will give you a clear understanding of the basic principles:
Paying with bitcoins
Sending and receiving payments is just as easy as sending an email, but with the use of a bitcoin address (a sequence of numbers and letters) via the Bitcoin network. This is a decentralized (peer-to-peer) network, similar to the technology used in Bittorrent, run by nodes spread across the world (everyone can help maintain it). Payments are stored in the Bitcoin network in a large, publicly available, distributed ledger. The balances to each address are recorded in this ledger, this means the entire network agrees on how many bitcoins belong to each bitcoin address. The "key" you use to spend your bitcoins, is stored locally on your device. This enables you, and only you, to control your bitcoins. You are your own bank.
To transfer bitcoins you need a unique key (called a private key) for every bitcoin address (public key), which you use to make a digital signature to prove that you are the owner. Usually, your Bitcoin wallet does this for you. The wallet is a website or program / app that manages your private keys which will let you spend your bitcoins safely and easily.
Where do bitcoins come from?
Since its inception, bitcoins have been ‘created’ by users who can earn them by contributing to the network with computing power, storing and confirming bitcoin transactions. This is called ‘mining’. Anyone can start mining bitcoins, although nowadays you will need to invest a lot of money in hardware if you want to make a profit.
Because of its decentralized nature, the proven mathematical and cryptographic principles it uses and the huge amount of computing power in the network, Bitcoin is a highly reliable currency suited for fast payments of any amount. The software it runs on is open source, so everyone can review it. Other advantages are:
- Anonymity (Public transactions, but you can control whether or not a transaction / address is traceable to you.)
- Low or no transaction fees
- Payments are worldwide and almost immediate *
- Payments are irreversible
* More often than not you will have to wait for one or more confirmations before the bitcoins are definitively yours. These are new blocks at the end of the blockchain that are usually discovered every 10 minutes. Every block gives you more certainty that the transaction is definitive. It is generally accepted that after 6 confirmations (which takes an hour on average) you are completely sure that the bitcoins are yours, but in practice, without any confirmation, you can be sure that the bitcoins are yours too.
More about the technology
We think it’s practically impossible to explain the Bitcoin protocol comprehensibly and understandably, while being 100% correct in our explanation. But how many people really understand the technology behind the internet? The most important thing is that you know how to use it: you don’t need to be an expert to safely store or send bitcoins. Are you still curious about the workings of bitcoin, the explanation below will give you an idea about how it works. Should you give up halfway – you won’t be the only one.
The Bitcoin network
As we mentioned before, the Bitcoin network is decentralized: there is no central institution or server that holds all the power. Anyone can join in. Every computer that joins the network makes a connection with a few other computers. Transactions are verified by every computer, and if the transaction meets the requirements, it is sent to the other computers in the network. Transactions spread across the globe in merely a few seconds. Every computer keeps a copy of the transaction in a transaction logbook: the blockchain.
The Blockchain & Mining
Bitcoin transactions are digitally stored in smaller pieces of data or ‘blocks’ that are linked together as a chain (each new block references the previous block). Hence the name ‘blockchain’ for the transaction logbook. These blocks must meet strict cryptographic requirements, which can only be met by making many mathematical calculations. Finding a block becomes increasingly difficult when more and more computers are working towards finding the next block. The speed at which these blocks are discovered is therefore more or less constant. View it as looking for a needle in a haystack, and you can find that needle in about 10 minutes. If more people join you in looking, the haystack will be made bigger over time.
The miner who discovers the block (finds the needle) determines which transaction it includes, and is allowed to create new bitcoins that are sent to his bitcoin address(es) (the “block reward” - a reward for the effort of securing the blockchain). In the beginning a miner was rewarded 50 bitcoins, now it’s down to 12,5. It will decrease even further over time, until a total of 21 million have been created. In addition to the reward, the miner also receives the fees of all the bitcoin transactions that he places in the block. In the long term, when the block reward is negligible, these transaction fees will replace the block reward altogether.
Apart from creating bitcoins, mining is essential for network security. The appearance of a block (confirmation) means that a huge amount of computing power has been invested towards confirming transactions (also called ‘Proof of Work’). This prevents bitcoins from being spent twice and it serves as a significant roadblock to malicious parties because they will have to spend a lot of money to have more computing power than the rest of the network.
The security of Bitcoin (transactions) is based on the cryptographic principle of public and private keys (public-key cryptography). The private key is linked to the public key but is undiscoverable by someone who has the public key. The private key is proof that the public key is yours. Secured internet traffic like on bitonic.nl (recognizable by the lock and https in the address) uses a similar principle. Bitcoin does not have encryption or decryption, the encryption only goes in one direction: there is nothing to decrypt, only to check.
Bitcoin addresses are derived from the public key, which in turn is dervied from the private key. They exist out of a combination of usually 34 numbers and letters, starting with a 1 or 3. With a private key you can ‘sign’ a transaction to prove that you are the owner of the bitcoins that are being sent. A bitcoin address is randomly generated. This is possible because there are so many possible bitcoin addresses that it is extremely unlikely that two similar bitcoin addresses will ever be generated. To give you an idea: the possible number of bitcoin addresses is comparable to the number of atoms on earth (one grain of sand already has more than a million billion atoms!).
Bitcoin transaction are puzzles
Bitcoin contains its own scripting language which allows for many more possible applications than simple bitcoin transactions. If you delve deeper into the technology, you will find that bitcoin addresses in the blockchain do not exist. A bitcoin transaction consists out of inputs and outputs which are linked together. The amount of bitcoins included in outputs point towards a bicoin address is the balance to that address. You do not need to transfer one whole or even multiple bitcoins: you can split them into smaller units to eight decimal places.
You can consider an input/output a stack of digital bills / coins in a digital safe for which you need a ‘puzzle’ (calculation) to open it. A normal bitcoin transaction has a fairly simple puzzle: you need the private key to open the safe, and the bitcoin address (public key) to put money in the safe and lock it with the accompanying puzzle. When you use an input in a transaction (you open the safe), you need to empty it completely. You can then split the total of inputs to as many outputs (new safes) as you like. Usually you return a part of the bitcoins to one of your own safes because you only want to transfer so much to someone else.
It is also possible to create completely different puzzles. For example, a safe for which you need two private keys, or two out of three (this is already being used, we call it “multisignature transactions”). Theoretically you can also put your coins in a safe that anyone can open, in a safe that has an extra password, or even a safe with a time lock. The possibilities are endless.
It is definitely a complex story, but you don’t need to be an expert to safely store or send your bitcoins. Through Bitcoin you can generate a bitcoin address, print out the private key and put it in a (physical) safe, have 10 bitcoins transferred to your address and in ten years time, with your printed out private key, spend your bitcoins anonymously. And there are even more possibilities!