Bitcoin for Beginners

This article covers the basics of Bitcoin and what you need to know to get started. It assumes zero prior knowledge from the reader and covers the basics in an informal language and uses practical examples.

Table of Content

Introduction

So you've heard about Bitcoin and this thing called cryptocurrency but you are not sure of what it is or where to start? You keep seeing it mentioned on the news, hearing about it from some of your friends in an almost prophetic manner (which puts you even more in doubt about whether it is really legit) and even some dodgy Facebook ads show up on your feed about it. But what is it, really?

If I were to invest into this "internet money" I would like to know what am I really investing in. How does it work, which advantages and drawbacks does this new alternative bring amongst other dozens of questions that you may have on your mind right now. Sounding familiar?

Bitcoin Principles

What is Money?

We use it every day, but we don’t question its meaning or value, we take it for granted. Well, we can agree that it lies deep within our society and the way in which it operates. Furthermore, the value is not in the money itself, but in the things/objects that you exchange for your money. Money is simply the way of expressing that value and we, as a society, have agreed to do so.

Bitcoin challenges the prerequisites we tend to assume for the attributes of money:

• Physical presence - you have your euros/dollars/yens in your bank however you can retrieve them anytime for a physical note. This is not possible with Bitcoin (or any cryptocurrency for that matter).
• Issuing authority - currency is usually created by a nation or government, a third party which symbolizes trust.

On the other hand, Bitcoin does not possess these properties which we have grown accustomed to have in our day-to-day currency.

How does Bitcoin actually work then?

The first concept that you need to get your head around is Hashing, more precisely the idea of a cryptographic hash function. This can be tricky at first but hang in there, it is one of the core principles of cryptocurrency. This is the reason why it is called that way!

When sending cryptocurrency, every person has access to a public key and an associated private key that allow us to send a transaction. When sending it, the system requires the amount you want to send (think of it as a message), the receiver’s public key (his/her address destination) and your private key which only you know. This is where the concept of the cryptographic hash function comes in: it takes your message together with the address destination address and your private key and “hashes” it, producing a message which is completely different from your private key, receiver’s public address and initial message, resulting in a Signed transaction.

Is it Safe?

Perhaps you are not entirely convinced about this Hashing thing and its ability to keep your information safe or it is the first time you hear about this concept. Let me tell you that the same principle is used to secure our passwords on platforms such as Google, Facebook or Twitter which all apply hashing algorithms. There is a variety of them, but the underlying principle is the same: they are a one-way function – you can only get the output from the input, but you can’t get the input from the output. So in our case above, we can only get the Signed transaction after performing the Bitcoin transaction, but it does not work the other way around.

The hashing function transforms what you put in and if you make it complex enough, you will be able to ensure that your initial information is stored safely.

Similarly to the platforms such as Google and Facebook, Bitcoin uses a certain hashing algorithm called SHA-256. Because we are in the cryptocurrency space, we can refer to it as a cryptographic hash function. This Link will give you more detail on how hashing works.

So, if we go back to what we need for our Bitcoin transaction, now that you have a better understanding what makes this system safe, we can look at what happens during the Bitcoin transaction and Signed transaction stages. Remember that our input requires the amount you want to send (the message), the receiver’s public key (address destination) and your private key which only you now. The entire process looks something like this:

On the other end of the hash function, lies your Signed transaction that went through the SHA-256 cryptographic hash function. The collection of random alphanumerical characters that you get after applying the hash function is called a Signed transaction, commonly referred to as signature and it contains your message, the destination address and your private key (believe it or not).

The random aspect in the end of it all is exactly one of the main goals of the hash function. I mean, you don’t want your private key to be revealed and “hashing” successfully enables to hide that information. Also, remember that only you know your private key that is also directly linked to your public key.

Always store your private keys in a safe place but make sure you don’t lose them. Otherwise you will not be able to access your funds.

Now that you have sent your transaction, all we need is someone to confirm that transaction and ensure that it was sent by you.

Perhaps you have heard of miners when talking about Bitcoin but you’re not sure about what they do. If you have not heard about them, there is nothing you have missed. Miners are simply people who verify whether your transaction was performed by you. They want to ensure and provide a degree of trust in the ecosystem.

To do so, they take your Signed transaction and your public key (which anyone can see) and perform computational work (the so called mining) to do this verification process. For the effort that the miner puts in, he/she gets a reward in the form of newly created cryptocurrency (in our case, in the form of Bitcoin). An incentive built within the system to keep it working by continuously verifying all the transactions sent by the users.

But wait, money created out of thin air? Not quite. The thing is that this reward will get smaller over time and mining will become increasingly harder. This ensures only a set number of Bitcoins in the end: around 21 million.

One last thing before we are done with all this new knowledge, I want you to understand where the blockchain concept comes from. You see, one of the characteristics of the system is that at any point in time, you can go back and see the entire history of performed transactions. This place is the blockchain (some people call it public ledger). Every cryptocurrency has one and this is the place miners store the transaction they have successfully verified.

If you feel a bit lost, this example may help. Let’s imagine that you are attending a class that has mandatory attendance and you have to write your full name and signature on an attendance sheet that guarantees the teacher you were present during this lecture. The only way the teacher has to confirm whether you were present is by checking the attendance sheet after the lecture has finished. If he/she sees that your name and signature are there, it directly implies that you were there. It provides a degree of trust to the teacher that you were present in the lecture.

Similarly to how your public and private keys are used by miners to verify that the transaction was sent by you, the teacher uses your full name and signature to prove your presence in the class. Because anyone can write your full name but only you should be able to re-create your private signature (like only you should know your private key), the teacher knows that you were there.

Also, like the miners who receive newly created currency, this teacher gets payed to do his/her job; that’s his/her incentive to check the attendance sheet after the class. Lastly, you can think of the blockchain (the public ledger) as the entire attendance sheet that contains all the full names and signatures from your colleagues. The teacher checks these one-by-one to guarantee that everyone was present in the class.

Is Bitcoin controlled by anyone?

Coming back to the question of "what is money?", the currencies we have grown accustomed usually possess an issuing authority, but not in the case of Bitcoin. As we found out, the miners (verifiers) are the ones that get rewarded for performing the computational work (mining).

Very obviously, Bitcoin miners on the Bitcoin blockchain will be rewarded in Bitcoin. This is the only way new currency will be created in this ecosystem but remember, this won’t happen forever, this value is finite.

Despite this, there are no prerequisites to becoming a miner. Anyone, from anywhere in the world can join the Bitcoin network and become part of the verification process.

This brings into play a very important aspect of Bitcoin: decentralization. In the picture below, we see A which represents a centralized system and B which is a decentralized system. In case something happens to the central entity in A, the entire system would be shut down because it is directly dependent on what happens in the center. On the other hand, there is no central entity in B so if part of the system is shut down, it would still live on.

So even if a decentralized system like Bitcoin became illegal in one country and as a result, part of the system would have to be shut down, somewhere else in the world that would be seen as an opportunity. Miners would either move there or new people would decide to join the network thus ensuring that it lives on. This makes hard, nearly impossible to kill Bitcoin.

At the same time, this idea of decentralization is also present when considering the Bitcoin protocol and its code. You can easily check out the Bitcoin source code which is constantly being upgraded by many people around the planet: Link

So as we have seen, there are four major players in the space: miners, programmers, the user and the Exchanges

The Exchanges

These, contrary to Bitcoin, are fully centralized meaning that they can be easily shut down or perhaps even hacked. Most of the big exchanges are based in the U.S. which puts them at mercy of the government that has the power to cease the operation of the exchange at any time.

Currently, decentralized exchanges are starting to appear which would mean that we would not depend on any trusted third party to operate these new exchanges. However, these are far from being commonly used these days and will take some time to improve.

So, there you have it. And remember, you as a user also have a responsibility on the network: you are responsible for your coins. You should not keep your coins on exchanges if you’re planning on investing for the long-term.

Blockchain - Other Use Cases

How about all the other 1400 cryptocurrencies (at the time of writing) listed on Coinmarketcap.com ? If you don’t know what I am talking about, you can check out all the existing coins over there: Link

How do those differ from Bitcoin? Well, that is a very hard question to answer because all of them represent a different project. Each one of these possesses a different team of people behind it who have a certain idea of how this new blockchain concept could be explored.

There are projects that aim to be a better currency than Bitcoin, introducing features such as faster transactions, others enable you to hide your transactions so well that no one will ever know where your money went or what you received (the so-called privacy coins)

But it doesn’t stop there. You may have heard of Ethereum and the word smart contract. A smart contract is a piece of code that executes itself on platforms such as Ethereum. This platform thus represents another different use case of blockchain technology. This is where decentralized applications start coming together.

Decentralized applications, or dApps, are a collection of smart contracts that when running, execute a pre-written code. This code cannot be changed and is fully transparent because all of these smart contracts are stored on the blockchain of Ethereum, so anyone can check them out.

But what is the advantage of these dApps anyway? Today we have platforms such as Facebook or the Google Play Store (or the Apple’s App Store, nothing personal) which are the centralized entity between the users. We as users, are forced to trust these platforms and provide them with information and in return, we get to connect with each other, or you get the chance to download an app.

The idea of decentralized applications is to remove this middle-man completely so users can directly connect with each other. If you don’t really see how this could work.

An interesting thing to note is that not every project has its own blockchain: several projects are built on top of smart contract platforms such as Ethereum, so they don’t have to go through the hassle of establishing a new blockchain, they can just take advantage of the existing infrastructure.

A lot of the tokens use Ethereum as their platform which means that the smart contracts that run these projects are found on the Ethereum blockchain. These are so called ERC20 tokens. Once again, a visual representation might help:

Also, similarly to Bitcoin, Ethereum contains a great number of verifiers on its network which guarantee that the smart contracts are correctly executed. Anyone can join this network and become part of its ecosystem.

Besides executing these projects, Ethereum has been widely used for Crowdfunding because you can easily write a smart contract that will run automatically. You can include in the total amount you need to kickstart your idea, note who sent you the money and is even able return it to the sender if you have not reached your total amount you needed to kickstart your project.

This is one of the reasons why ICO’s (Initial Coin Offerings) exploded in 2017. It is so easy to write one of these smart contracts that a lot of people saw an opportunity to create their own and ride the ICO craze. This is the reason why you used to get those dodgy looking ads on Facebook promising you to be the next Bitcoin. Let’s be real, most likely they won’t.

So, is Ethereum only used as a platform to run other projects and fuel these ICO’s and crowdfunding events?

Mostly, these days. Not too crazy I know, but it’s a start. Perhaps you’re a bit disappointed as I was for a cryptocurrency that, some say, aims to rival Bitcoin (something rather untrue).

Ultimately, Ethereum aims to be used for “applications such as online voting and decentralized governance”. One of the ways it aims to enable this, is through the concept of a DAO: a Decentralized Autonomous Organization.

Think about a major decision that has to be made by several people who all have different views and are likely to trick each other. Once again, the issue of trust could be solved by using a smart contract which executes without any bias. Taking this idea one step forward, it is possible to say that we could use platforms such as Ethereum for voting and organizing our society at some point in the future.

Let’s not get too ahead of ourselves though. We need to remember that these projects are relatively new and experimental. If you are going to impact the world in a meaningful manner, there will be several failures along the way. That is to say that the great majority of those 1400 cryptocurrencies you see on Coinmarketcap.com today, are very likely to not be around in a few years’ time.

However, it is safe to say that Bitcoin and Ethereum represent the first of their kind and this fact, creates a lot of confidence in these platforms (that’s why their total market cap is so large). Bitcoin is a currency and represents the idea of money without a bank and Ethereum is a contract, ultimately attempting to enable organizational governance

Lastly, I would like to touch on Ripple, also one of the top coins. This project aims to make bank-to-bank transfer payments much faster and cheaper than those you have today.

However, this coin does differ from Bitcoin and Ethereum because neither you or me can participate in the coin’s ecosystem as miners (verifiers). There are no miners (there is no verification procedure) for this coin. Ripple is fully centralized, meaning that when you use Ripple’s services, you are forced to trust the company and not the decentralized number of people spread across the globe.

Despite using the blockchain concept, it does not possess the decentralized aspect of it which stands at the core of cryptocurrencies like Bitcoin and Ethereum: if one part of the system were to be shut down, there will be others who will still be performing the verification process and the entire ecosystem would live on. In case of Ripple, it would suffer total fatality from something like that.

Is Crypto a Bubble?

Here is the true question on everyone's mind. In case you jumped straight into this section I welcome you and understand your concern regarding this topic. Over the years, there has been quite an extensive debate about this question. Arguably the best way of assessing something like this is to look at the past, namely the not so distant Dot-com bubble.

In the beginning of any new industry that promises extraordinary potential and returns, it is human nature to storm in, in hopes to get rich quick. This is what led to ridiculous valuations for a great number of companies in the end of the 90’s. The fact is, that most of these are not around anymore.

One of the most famous: Pets.com - where someone had the brilliant idea of attempting to sell pet food and other supplies online. The company ended up going bust despite receiving $82mn when going public. Why? The idea was ahead of the available technology.

As the adoption of the internet was occurring in the late 90’s, the hype surrounding the space was so great that everyone wanted a piece of it. However, the adoption became so great, that it overshot the actual tech available at the time, as the result of human greed which became completely illogical. Below you can find the attempt of depicting what a bubble looks like and all the emotions commonly experienced in such a cycle:

Despite these negative connotations, amongst all those that went bust, there were companies such Google, Amazon and Cisco. We use these in our everyday lives without thinking twice about it. If we look back, at the end of the day, the Dot-com bubble was about the internet and how it changed our banking, shopping, leisure and other experiences and activities.

Very similarly, the cryptocurrency space does seem to contain a great number of echoing ideas. As we have previously seen, it is rather clear that the 1400 cryptocurrencies that exist today will not make it, in their great majority.

This is part of the natural life cycle of a new industry: the mania surrounding the space and the nature of human psychology lead to extreme over valuations. And as happened in the Dot-com bubble, we are likely to overshoot adoption once again. There are still a number of issues that have to be solved in order for cryptocurrencies to go mainstream.

Despite this fact, platforms such as Bitcoin and Ethereum represent a new alternative to the current system that we have put in place. Banking as well as the whole idea of trade which needs rules and regulations, could automatically occur without any third-party involvement as full trust is put in the blockchain ecosystem.

Crypto is extremely volatile, and should not be considered a get-rich-quick scheme. You should only invest what you can afford to lose (so please don’t sell your most valuable items or borrow any money). There is great risk in this space and a great number of wealthier individuals, whose primary concern is to preserve their money, are averse to it.

Security

If you buy cryptocurrency, you are part of the ecosystem where you the one responsible for your own coins. There is no official entity you can address if you lose them or suffer from any kind of unforeseen event (such as getting hacked for example). As a result of this fact, your online and pc security should be aspects to consider when starting.

A fundamental starting point is whenever you are setting a new account on the exchange platforms covered above, you should always add a 2 Factor Authentication (2FA) procedure where you need access to your smartphone to login (together with your password).

Once bought on the exchange, you can send your newly acquired cryptocurrency to a wallet where you store it safely. If you do not plan to actively trade it, it is usually advised not to leave your cryptocurrency on an exchange.

The wallets that we have used ourselves without any issues are:

• Atomic Wallet
• Exodus Wallet
• Daedalus Wallet (for Cardano token ADA only)

Disclaimer

This article does not constitute investment advise. You should always do you own research before buy, selling, or otherwise trading in Crypto.

Authors

This article was written by Vladimir of the Be Independent Tribe and edited by Dmitry Shihaev of Dynamic Strategies