Digital money is one of the hottest trends of the 21st century. Google trends show growing interest in cryptocurrencies and blockchain, the underlying technology behind Bitcoin. Everyone knows that Bitcoin is hot, but very few people understand how it works.
In this article, we will show you that Bitcoin technology isn’t nearly as complicated as you may think. We won’t be using complex math formulas and geek language. Bitcoin really can be simple.
Why do we need digital signatures
We are living in a digital world where everyone may create a digital “name” and a digital “signature”. (Public and private keys accordingly). The “name” is known to everyone, while the “signature” must remain hidden. It allows to:
1. Write messages, sign them with personal signature and publish online.
2. Show everyone that the message was written by a certain person.
3. Ensure safety, as the message cannot be faked.
4. Create several digital alias for different purposes.
The basic principles of hash
For example, I want to say hello to a friend. But how do I know that they will receive the correct message? Of course, I could always ask the receiver to send it back so I can compare. But what if something happens to the message on its way back? Or, what if the message is too big and contains gigabytes of video? Such way of verifying messages doesn’t seem to be very effective.
Instead of requesting a return message, I could always use a different strategy. This is where hash comes into play.
1. Let’s try to encrypt our “hello” message using english alphabet, replacing each letter with the corresponding position number. The result will look like this: 8 5 12 12 15.
2. If we multiply the numbers, our hash will be 86,400. This is an example of the most simple hash.
3. When sending my message to a friend, I will simply send the hash along with it. Now they can easily check if the message is correct.
4. If something happened to my message and it looks like “hallo” now, the hash for such message will look like this: 8*1*12*12*5=17,280. As you can see, it no longer matches the original one.
5. If my friend is expecting 86,400, but receives a different number, he will instantly know that something went wrong.
It is important to understand that hash doesn’t guarantee that the message will remain unchanged. Furthermore, the hash itself can be faked too. It is simply a quick way to verify a message.
If you change the positions of the letters in a message, hash will remain the same, which once again would make it ineffective. This is why in real life people use more complex encryption methods, that allow hash to change even when the only thing that has changed is the order of letters.
Enough with the techie stuff, let’s see how these technologies are being applied in the digital world.
Let’s imagine a class of 30 students. Within this mini economic system, they agreed to have its own virtual money. The students record the amount of money they have on the class board. Whenever they want to pass money to somebody else, they also write it on the class board and verify with a personal signature so nobody can mess with the data.
The system works just fine and the children are perfectly happy with it. Until a strict teacher walks in and washes everything away. The teacher claims to hold all the authority. He wants to control the cash flow and make sure there’s no illegal sale of sweets.
However, the children love their sweets too much and they just don’t give up so easily. Each one of them now owns a ledger where they can record all transitions. Whenever someone makes a payment, they write a note and pass it to everyone in the class. Every student copies the note to their own ledger.
Now we have 30 notes being shared with everyone in the class. It becomes very easy to get confused. Can Tom accept a payment from Harry? Or has the money been already transfered to somebody else, and Tom is yet to receive the corresponding note?
Our students decide to change the algorithm. Now there’s only one person at a time writing down the transactions. After that, the page is shared with everyone so they can copy it to their ledgers. Each page contains a number of transactions and hash pointers to the previous page. Each student can check and make sure that they really do have the amount of money listed on the page. If the numbers don’t match, such page simply gets thrown away.
As you might have guessed, the ledger represents blockchain, where each page is a block of recorded transactions.
Say no to graphomania
If we don’t add rules, every child will try to write their own page and everyone will end up confused once again. This is why everyone agreed that a new page will be released every 10 minutes, and will only be written by one random person at a time.
For Bitcoin, rules are pretty much the same. All “students” work on solving a complex math problem. Whoever was first to solve it gets to write the page.
It’s not a big deal if only the best students get to do it. After all, everyone gets access to the page. However, if there’s always only one student writing all the pages, then there might be a problem. Should one person gain all the power, they would be able to deny transactions if they feel like it.
Good news is, in order to do so they would need to own over 50% of all hash power in the class. In real world, that’s millions of computers. People that are able to invest that much money in hardware wouldn’t be interested in such fraudulent practices.
The perks of using digital money
1. It isn’t dependent on the number of participants.
2. Every member is able to verify the “pages”.
3. There is no centralized institution hogging all the power.
4. Bitcoin is pseudo anonymous, which means it is nearly impossible to tie the digital “name” to the real one.
5. Low fees.
6. The data cannot be tampered with, as it will no longer match the previous block. In order to make changes, you would need to rewrite all the previous blocks since day one.
Where does the money come from?
It wouldn’t be fair to just split all the coins between the lucky students on page one. In order to keep it sportsmanlike, the students are able to send a little bit of coins to themselves when writing the page. It serves as the reward for solving a complex math problem. Every few years, the rewards get cut in half.
A total of 21 million Bitcoins can be “found” by the students. As of now, the number of coins available has reached 15 million. As a result, more and more children want in on solving the math problems. They know that the reward will only keep decreasing as the time goes. Plus it’s being split among more and more children as the new generation learns to solve them too.
Some of the students have been working harder than the others and they already own a fair amount of coins. Now, they are able to trade them, just like stocks. Not all children want to spend a fair amount of time in math class and try their luck. Some prefer to simply exchange their money for coins. Retailers are also trying to keep up with the new generation, allowing them to use virtual money to buy sweets.
Within a “normal” economy, financial institutions control the cash flow and regulate the money supply with certain rules and policies. When it comes to Bitcoin, the lack of control leads to high volatility and drastic price increase. It is one of the main reasons why governments are looking to develop policies for Bitcoin regulation.
We are hoping that this article helped you understand the basic principles of Bitcoin technologies. You’ve got every reason to be proud of yourself now, as you know more about Bitcoin than most people on earth!