Bitcoin — How I explained it to my friend Barry.
16th April 2019
With all the hype and price movement in the Bitcoin market, I’m regularly getting asked by non-technical folks how it works. I’m by no means an expert on the topic, there are countless others out there that can explain in more detail and that I do. However, I’ve wrapped up my conversations into a chat thread with a friend Barry below. I hope in some way it helps and please understand it’s meant as a simplistic rather than 100% accurate thread.
Barry — I’ve heard a lot about Bitcoin in the press, what is it?
Me — Bitcoin is an electronic-only currency known as a cryptocurrency that is
Barry — I’m confused, if it’s not issued by a bank or country where is it our Bitcoin held?
Me — That’s a great question, one that comes up a lot. Bitcoin is based upon an electronic ledger that is distributed thousands of times on user’s computers. Every time a transaction takes place a copy is distributed into the ledger on all the computers in the Blockchain.
Barry — OK, there’s another new term, what’s Blockchain and isn’t that Bitcoin?
Me — Blockchain is the underlying technology that underlies not just Bitcoin but other cryptocurrencies and is also used by other services such as document protection, contract storage etc. A Blockchain is a record of transactions that are blocked together into groups based on their date and time. Those groups are known as blocks. Those blocks are joined together into a chain, hence the blockchain name.
Barry — So, if there’s a chain of data stored in blocks on my computer can’t I simply change that data and cheat the system?
Me — Each of the blocks of transactions is distributed many times around the system so if it is wrong on one computer, it will differ from all the other copies elsewhere. Each Block also has a unique value calculated based on the content of each of the transactions stored within it. Think of this value as a checksum, that is, the total value of all the transactions. If you change the value of a transaction then the checksum no longer adds up. It’s like a double layer of security.
Barry — So if I change the content of a transaction or block on my computer it won’t match the other copies distributed around the world?
Me — Exactly, and that’s the concept behind Blockchain. Bitcoin transactions use this electronic ledger system as its security protocol.
Barry — Why not simply use a bank, a regular currency and its services?
Me — The appeal of Bitcoin customers is twofold. The first is that your data is not held by a single bank. If that bank was hacked and account information was stolen, you’d lose everything. With Blockchain the concept is that you’d have to hack everyone at once for it to work.
Barry — And what’s the second reason?
Me — Banks act as a middleman in the transfer of money from one place to another and for this they charge a fee. Bitcoin and other cryptocurrencies work on the basis that there is no middleman and therefore there are no fees like the ones you get on the high street.
Barry — So if I open up a Bitcoin account how does it work?
Me — You download the software and create an electronic wallet that has a unique ID much like an account number. You can then use whatever currency you want to buy into Bitcoin and the transaction is made in the ledger to show you have a credit. If you later buy or transfer Bitcoin to another wallet such as when you buy goods or services then there’s a ledger transaction that debits your wallet and a second that credits the new wallet.
Barry — Is my Bitcoin balance held in my wallet?
Me — Not quite. Every time a transaction takes place the ledger is queried and every credit and debit are calculated to define your balance. If the balance is correct then the new credit and debit take place. The downside is that because your wallet balance has to first be calculated before the new transaction can take place, the payments are not completed right away, they take around 10 minutes to complete. That can vary as the higher the number of transactions taking place in the system, the greater the demand and the longer it can take. As an extreme case, it can take up to 16 hours. Remember, as the blocks are distributed around the system for security reasons, multiple checks will be made to confirm things.
Barry — So a bank transaction can be quicker?
Me — Yes, there are payment systems for traditional cash transactions that are done in minutes such as Western Union.
Barry — OK, so why would we use Bitcoin if it can be slower?
Me — It’s in part back to the lack of middleman in that there are no traditional middlemen charging commission but it also provides secure, anonymous transactions between parties.
Barry — Isn’t that anonymity used by criminals to launder cash and transfer drug money as the owner isn’t disclosed?
Me — The reality is that undoubtedly cryptocurrencies are used for illicit reasons as well as for the well-intentioned. That’s why there’s a lot of talk about regulating cryptocurrencies such as Bitcoin.
Barry — If anyone can set up a wallet and buy Bitcoin how would you regulate it?
Me — For a cryptocurrency to be of material value as it’s not really that usable on the high-street you need traditional cash. To get cash, you need to go to an exchange who will swap Bitcoin to Dollars for example. The same applies to someone who has Dollars and want’s Bitcoin, they also need an exchange. The idea is to regulate the exchanges or the gateways into and out of Bitcoin.
Barry — OK got it. There’s been a lot of activity with the value of Bitcoin rising and falling at crazy levels. Why is that?
Me — It’s like a gold rush. When gold is found in a new location, speculators rush in and start to spend so that they don’t miss out. That rush causes a spike in activity and demands as with any currency, causes the prices to rise. Eventually, the price will settle down as the speculators calm down. Where that level will be, is still a guess today.
Barry — Thanks, I think I’ve got it.
Me — No problem.
You can, of course, dive into the subject in a lot more depth, especially if you’re from an IT background as the cryptography alone is fascinating however for the layman who has no need or interest, a basic summary is all that is needed. If you’re a layman I hope you’ve found this article interesting in some way.