Varsity explains: How does Bitcoin work?
This one’s for all you corporate Cantabs
Bitcoin, blockchain: both are buzzwords, often peddled as heralds of a new finance. Their impact is great, but not total – the pound, dollar and euro no doubt shall continue circulating for decades.
Nevertheless, the problem that Bitcoin was intended to solve began with the growing disenchantment with conventional banks. The traditional financial system relies to a great extent on all users trusting some third party to mediate the exchange, both to confirm that the payment was made as intended and to confirm that both participants have the money they purport to. For many years, cryptographers had been looking for a way in which this middleman could be removed from the transaction, in part to reduce this reliance on trust. However, there was a central issue, known as the ‘double-spending problem’ – essentially, when digital currencies are used in a system without a central authority, how can one ensure that the same digital token isn’t used twice?
It proved rather difficult to solve; the first practical solution was published in late 2008 in a paper on a cryptography messageboard, credited only to a shadowy, pseudonymous figure under the name of Satoshi Nakamoto. (They left their project around 2010; their actual identity is still completely unknown, despite inordinate amounts of speculation.) Two months later, Nakamoto launched Bitcoin as a practical currency.
The protocol behind Bitcoin is centred on the ‘blockchain’, a public record of transactions made using the currency. Each time an exchange takes place, a message – say, “Alice sends Bob one bitcoin” – is broadcast, and checked through the network against the records to avoid the possibility of double-spending. Every ten minutes or so, the transactions are grouped together into a single ‘block’, which is then added to the blockchain.
However, it is clearly important that the creation of the block is correct, and there are no central authorities to do this. Nakamoto’s ingenious idea was to open up the block creation process to public competition, with accuracy being ensured through a ‘proof-of-work’ system. In a broad sense, the bitcoin ‘miners’ race to solve a certain mathematical problem, whose answer is then included in the block. The problem is set up such that the answer can be almost immediately checked, but the actual determination of the answer takes a relatively large amount of time. This is taken as proof that the process has been carried out correctly, and the block is then incorporated into the overall chain. For their troubles, the user who created the block receives a payment in Bitcoin. There is hence a double-function to the process: both the maintenance of the public transaction record, and the introduction of new Bitcoins into the economy (up to a long-term limit of 21 million).
These factors combined means that the system is extremely secure – its public nature makes it almost impossible to successfully carry out meaningful fraud. There are certainly other concerns, however – the possibility of easy anonymity has arguably made it easier for people to carry out illegal business over the internet. There’s also the remarkable statistic that, due to the extraordinary amount of hardware being used worldwide in the mining process, the electricity usage for such a virtual-seeming currency is approaching a remarkable 1% of the world total. Whilst ingenious, there are certainly still a lot of questions to be asked.
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