I like to look at Bitcoin the same way as I look at gold. Here’s a quick explanation as to why.
Remember the gold rush of the 19th century? Being in California at that time was very fruitful. With a little bit of luck you could run into gold nuggets, pick them up and increase your wealth. It was like free money, if you were lucky enough. With time passing by, the word spread out, more people started searching for the gold hoping to hit it big. Some did, for sure, but most of the folk ended up losing money or even go bankrupt. Let’s not get carried away in this history lesson. What does this have to do with Bitcoin?
Well. it’s path is supposed to be somewhat similar to what gold had in the beginning. Of course, gold has been known to man for millenia. In the early days (pre gold rush, and even ancient times) gold was not that rare (it was rare, when compared to other metals, though). But as time went by, more and more gold has been found, excavated and processed, and less and less of new gold could be found in Earth’s core. This effectively makes gold a deflationary asset (if you consider gold an asset).
A characteristic of deflationary asset is its rarity. There is only so much of it in the world, and that’s it. New gold can’t be produced (well, not in any measurable quantities). What happens when the demand for gold increases? We can’t print more of it, so it’s value must go up, ie. its price becomes higher. Simple supply and demand law.
Umm, Bitcoin? Wow, I totally forgot about it… sorry..
Bitcoin is a lot like gold. It’s logo is a golden coin, with a B sign, so this has to count for something right? Bitcoin is also envisioned as a deflationary asset (a currency if you like). There is only a finite number of Bitcoin that will be in circulation at some time (a maximum number), and that is 21 million. Why 21 million? We don’t know, and honestly, it doesn’t really matter. Who made it 21 million? Well, it was coded in Bitcoins source code by its creator - Satoshi Nakamoto.
Is he issuing these “coins”, and how can we be sure that someone won’t issue more than this number? Bitcoin is actually issued every ~10 minutes as a reward to a certain individual for helping to secure Bitcoin network, and process other peoples transactions.
How? Here is a simplified version of what is happening - you make a transaction (send a bitcoin to certain someone), and also a thousand other people make transactions at the same time (buying stuff, sending money, gambling etc.). All those transactions are sent to the Bitcoin network - an internet if you will - of computers connected for a single purpose - to process the transactions people are creating, and making sure they’re valid. There are thousands of computers in the Bitcoin network, and they all work on processing transactions and securing the network. To continue, all of these transactions are distributed across the network, and anyone can see them and process them. One computer gets a hold on your transaction (as well as many others), and bundles it up in a nice container called a block. He then does some dark magic called mining (actually it’s quite simple, and I’ll explain it in another article), and announces to the Bitcoin network that the block he has created is next link in a chain of blocks called - surprise, surprise - the Blockchain.
All other miners agree with him, and accept all transactions in this new block as valid. And that’s how you buy your coffee. Everyone agrees on the fact that you have made a transaction in which you’ve sent some of your Bitcoins to your local coffee shop.
What’s the incentive for these people to work on transaction processing? Of course, they aren’t doing it for free (at least not anymore). Their incentive is the block reward (remember? new Bitcoin every 10 minutes? new Bitcoin - new Block? - bingo!). Every block in it holds a prize for the person who created it, and when the block is accepted, so is the prize. Network is accepting the fact that this computer earned Bitcoin while creating the block.
When you think of it, that’s what money is all about - trust. We all now agree on the past, and what is more important, we have a proof that it happened - Blockchain, remember?
Also, we can be sure there won’t be new Bitcoin once 21 million is reached by a simple fact - since all computers in the network run the same program they all agree on the fact that 21 million is maximum. So, when certain someone comes and mines a block, giving himself a prize when all Bitcoin have been “mined”, no one is going to validate this. We’ll all say - nah man, you’re full of crap, I’m not going to validate this... And that is how it all works, in a nutshell.
This is a simple introduction to a world of Bitcoin. In future articles I’ll try to demistify it some more (wallets, addresses, mining and pools, transaction types etc.)
Cheers.