mrb's blog

Bitcoin: The Simplest Non-technical Explanation

By Marc Bevand

10 Jan 2012

Keywords: bitcoin finance

Bitcoin is diametrically opposed to all existing electronic currencies, a radically new concept that is quite difficult to explain, to a point that many articles on Bitcoin mistakenly compare it to Beenz, e-gold, Flooz, PayPal, Pecunix, etc, This is always a sign that the authors do not comprehend the main pillar of Bitcoin's design.

Bitcoin is the world's first invention of a decentralized electronic currency, with no central authority or trusted parties whatsoever, as its inventor originally describes. Not even the Bitcoin developers themselves have special control of Bitcoin. Compare this to other e-currencies that are operated by central authorities that are single points of failure: they have a history of regulating transactions (Paypal blocking donations to Wikileak, etc), or simply failing and shutting down (Beenz, etc).

If Bitcoin is confusing to you, that is normal. Bitcoin is best explained by this list of analogies. Read carefully:

  • Bitcoin is like digital gold.
  • By design, there is a known, immutable, fixed supply of bitcoins, similar to gold being available in limited quantity on Earth. There are 2.1 quadrillion indivisible units of value (0.00000001 bitcoins), and not one more will ever exist.
  • Bitcoins are digital, therefore you can instantly transfer them to anybody across the world.
  • Bitcoins are stored locally on your electronic device (cellphone, computer), contrary to being stored in an account managed by a financial institution. This is similar to how you can store cash or gold in a physical location of your choice. This means there is no "Bitcoin account" that can be frozen by someone in power (eg. your spouse making malicious claims to seize a bank account during a divorce).
  • Bitcoin transactions are technically irreversible. There is no mechanism to revert a transaction, other than convincing the recipient to send the bitcoins back. This solves the fraud problem for merchants, as all the payments they receive are final, whether fraudulent or not. (On the downside, like cash or gold, if bitcoins are stolen from you, the chance of recovering them is generally slim.)
  • Payments are sent directly from one party to another without going through a financial institution, similarly to how cash or gold can be handed directly to someone. You do so by sending them from your computer, to the recipient's computer, through the Bitcoin network (which is nothing more than other computers running Bitcoin). Since no one can realistically prevent a computer from getting Internet access one way or another, no one can regulate or block transactions (eg. oppressive governments financially repressing activists.)
  • Finally, there is no financial institution, or bank, or company, operating Bitcoin, just like there is no company in charge of "operating gold". There is no Internet server to shut down to terminate Bitcoin. It exists merely as an application running on your computer, which communicates with other Bitcoin users over the Internet. This "mesh" Bitcoin network is called a peer-to-peer network, and this design makes it effectively indestructible, as long as the medium of communication (Internet) exists.

You must be wondering:

  • How can Bitcoin offer all the above security guarantees? The entire system is secured by a novel and clever use of cryptographic algorithms. It was so difficult to get right that it had to be designed completely openly. So it was made open source, available for free for anybody to use. Its openness has allowed peer-review of its source code and has attracted a lot of attention from some world-class cryptographers and computer scientists (Jeff Garzik, Dan Kaminsky, Jacob Applebaum, etc). As experts, they are used to find weaknesses in applications, but to their suprise they found Bitcoin well designed, offering the guarantees it claims. If you are inclined to read technical documents, read the Bitcoin design paper, this LWN introductory article, or my first post on Bitcoin.
  • How are the coins created? With gold, miners have to perform a lot of work to discover gold deposits in the planet's crust. Bitcoin emulates gold here again: "Bitcoin miners" run specialized software on high-powered computers and solve complex mathematical puzzles. The difficulty of the puzzles ensures that coins are slowly introduced in the system over time, and are randomly distributed to its users. (Depending on your electrical costs, mining may be a profitable activity.) However the vast majority of Bitcoin users acquire them by simply purchasing them from other users or from exchange markets, or by trading goods or services with users owning bitcoins.
  • If the coins are stored on my device, what prevents me from making copies, counterfeiting them? The entire network uniquely identifies all coins and tracks all transfers. For example a transfer is recorded like this, coming from opaque addresses, going to other opaque addresses. (Note that this makes Bitcoin not fully anonymous, but at least pseudo anonymous, because it can be hard to figure out who owns which addresses as the Bitcoin software creates new addresses for every transfer and users are encouraged to not re-use them.) If you copy coins and attempt to spend them twice, the network will detect the "double-spend" and reject it.
  • Why do Bitcoins have value? What backs Bitcoin? Bitcoin is like gold: nothing backs it. The only reason a currency or commodity has value is because people are willing to trade goods or services for it. Initially, Bitcoin was perceived as having no value. Then early-adopters started to grasp its potential and invested in it. For example, one of the first transactions was two pizzas that famously sold for 10000 Bitcoins. This was a risky trade because Bitcoins were worth virtually nothing at the time. Nonetheless, this trade and subsequent ones helped "bootstrap" the currency, because people knew there would be at least one guy willing to trade pizzas for Bitcoins. Trade and value grew step by step over time. Fast-forward to the present and there is today a thriving community of merchants accepting Bitcoin. This community alone is what gives bitcoins value.

In my view, the unrestricted and decentralized aspect of Bitcoin has the potential to change our society the same way the unrestricted and decentralized flow of information on the World Wide Web changed it.

Comments

200Au wrote: Quite simply, Bitcoin isn't like "digital gold".

If 51% of real gold miners decide that they want real gold with 200 particles in the nucleus such gold will turn into mercury in a couple of hours.

If 51% of digital gold miners decide that they want twice the original amount of gold then they will get it. Moreover the gold of the remaining 49% will continue to exist, but the two types of digital gold wont mix.

The transmutation of "digital gold" can be done with simple editing of a few lines in a C++ program and few truckloads of AMD graphic cards. Your claim of immutability is simply a specious nonsense or devious propaganda. 11 Jan 2012 06:49 UTC

mrb wrote: Well, the analogy is of course not perfect. But it gets the point across.

As discussed in the community, an attacker owning more than 50 percent of the mining power should have little incentive to undermine the validity of his own Bitcoin wealth by performing a majority attack. Instead he would benefit more financially by simply using his power to mine legitimate coins. 11 Jan 2012 08:51 UTC

Meni wrote: 200Au, you are talking about creating an alternative Bitcoinesque currency (even if it is technically equivalent to Bitcoin with only a different genesis block), which is completely orthogonal to having 51% of the mining. The alt currency thus created is not Bitcoin, and the statement that you cannot exceed the Bitcoin limit remains true.

Your confusion might be in thinking that the majority mining sets the rules, which simply isn't true. If a miner majority tries to create invalid blocks they will just be rejected by all honest nodes. 11 Jan 2012 18:57 UTC

spj wrote: One thing that I think is important to mention is that Bitcoin has value because it offers a current viable solution (and sometimes the only existing solution) to several real world problems such as

1) How to instantly send money over the internet with low or non existent transaction fees

2) How to send money to people in countries where there are international restrictions and embargos otherwise preventing this action

3) How to guarantee an irrevocable transfer of value digitally without a separate escrow service.

4) How receive payment pseudo anonymously without a physical transaction

5) How to access a currency with fixed and permanently immutable inflation rate

In the strictest interpretation its true that "Bitcoin only has value because people will exchange goods and services for it", just like all other stores of value in this world. However, Bitcoin also derives its value from the problems that it solves and the size of the markets that those problems represent. 11 Jan 2012 19:35 UTC

beckspace wrote: > There are 21 trillion units of fundamental value (0.00000001 bitcoins)

Isn't 2.1 quadrillion atomic units? 11 Jan 2012 21:02 UTC

mrb wrote: beckspace: you are right; I corrected the post. 12 Jan 2012 03:04 UTC

beckspace wrote: Nevermind. Nice article.

I like to remember myself that 1 Bitcoin can be divisible into 1 million units plus cents (,00) from day one. Or 100.000.000 atomic parts, as you prefer. 12 Jan 2012 04:13 UTC

mrb wrote: And I like to remember that when adding the total number of bitcoins to the smallest indivisible unit, there are as many decimal places before and after the decimal mark (eight): 21000000.00000001 12 Jan 2012 06:05 UTC

Tim wrote: Here is the simplest explanation of bitcoin I could find:

1. There is a giant accounting book in which every entry is cryptographically signed by the sender. Anyone can download the accounting book via a p2p network in which nodes are found by connecting to an IRC channel.
2. In order to determine the "official" accounting book from a fake one, there is a cryptographic puzzle attached to the accounting book. If there are two or more accounting books floating out there (presumably, one of them fake) the accounting book that has the most work done on the cryptographic puzzle is deemed the "official" one.
3. Miners are simply clients that work on solving the puzzle on the "official" book. Since a black hat probably won't have enough computing power to do more work on a fake book than the miners, the "official" book stays official, and any fake one will be recognized as fake.
4. Miners make money by being allowed by the rules of the accounting book to put their own entries in giving them free bitcoins. The rules allow this to go on for a certain number of entries, before it halves the reward, again and again until it's practically nothing.

That's about it. 12 Jan 2012 09:10 UTC

Bitcoin FAQ wrote: "There is no mechanism to revert a transaction, other than convincing the recipient to send the bitcoins back."

I might also add something like the following to that statement:

"...by initiating a completely new transaction back to you for the same amount." 12 Jan 2012 23:15 UTC

200au wrote: Meni, no I'm not talking about alternative Bitcoinesque currency. Bitcoin is defined by a C++ program and a simple majority of the miners. If the simple majority of the miners decides to change the rules then the Bitcoin will change. There is no concept of "honest miner" in the Bitcoin protocol, everything is decided by a simple majority. "Honest miner" tends to be defined purely in the dialectical terms as somebody with "economic incentive in maintaining the Bitcoin integrity". All those analyses have the same flaw: they assume that Bitcoin is the only available means of exchange. 14 Jan 2012 01:09 UTC

Meni wrote: 200au, this is simply not true. The miners do not set the rules, they only set which transaction history is valid among potential histories which follow the rules. If 90% of the miners will try inventing their own rules, their blocks will be rejected (by my node, mtgox's node, and everybody else's), and thus, not part of Bitcoin at all.

The working definition of an "honest miner" is a miner who always works on the longest branch he knows, and releases every block he finds.

More fundamentally, Bitcoin isn't defined by a C++ program and a majority of miners, it is defined by a protocol and by people who vote on protocol changes by choosing which program to run. In case of a conflict either the group with the higher economic power wins, or there will be a split to two different currencies. 01 Feb 2012 15:54 UTC

darul75 wrote: Very nice bitcoin overview. 28 Aug 2012 12:12 UTC

adamantic wrote: Bitcoins and Assassinations: http://adamantic.wordpress.com/2013/04/11/anarchy-and-bubblecrap/ 11 Apr 2013 07:26 UTC

docweasel wrote: "you are enclined"
You mean "inclined". 28 Aug 2013 18:14 UTC

mrb wrote: docweasel: fixed, thanks. 29 Aug 2013 04:48 UTC

Tony wrote: Bitcoins aren't like gold for more than the reasons above. Gold has more than an intrinsic value. Its real. Meaning it has real uses. Even if the entire worlds supply was suddenly tripled, the value may decrease, but its value to electronics as a material would mean it would never be worth nothing. Where as the bitcoin can be worth nothing as soon as the majority of people stop believing in it. The threat to bitcoin is perception, which we all know is not logical. Say a mathematician solves all remaining bitcoin all at once with the discovery of a super algorithm or computing power suddenly quadruples every 2 years? Bitcoins are a great idea, but I feel they are two volatile and risky to hold a future for too long. 27 Oct 2013 21:25 UTC

mrb wrote: Tony: 90+ percent of gold's value is due to people thinking it has value (financial speculation + jewelry), not its intrinsic industrial value. In other words, if people stopped wanting gold just because it is precious, leaving only industrial demand untouched, it would loose 90+ percent of it's value overnight.

Industrial demand represented only 9.3% of total gold demand in 2012 (407.5 out of 4382.7 tons): http://www.gold.org/investment/statistics/demand_and_supply_statistics/

So gold isn’t that much different from Bitcoin. 28 Oct 2013 03:19 UTC

Christopher Franko wrote: Bitcoins are not stored locally on your machine they are stored in the block chain once they are initially released by the network to a user who has confirmed a block of transactions. 23 Dec 2013 22:21 UTC

mrb wrote: Christopher: I am writing for a non-technical audience. Saying "the coins are stored on your machine" is the non-technical version of "the ECDSA private key is stored on your machine and the coins on the blockchain". 24 Dec 2013 18:19 UTC

Tim Courrejou wrote: Bitcoins are infinitely divisible. It's only that the software only currently supports finite divisibility at the moment. This means that if all but one bitcoin were to be lost, the system would still work. 01 Mar 2014 05:18 UTC

THEPULP wrote: Here is a video..might help the readers..thanks !
http://www.thepulp.co.in/content/digital-payment-system-bitcoin-explained 08 Mar 2014 21:22 UTC

BigD wrote: Hello
I am totally new to the bitcoin concept. What I cannot get my head round is who benefits from the creation of this virtual currency. It seems to me similar to the Federal Reserve printing money out of thin air. If there are potentially 21 million bitcoins, and say each was worth $1000, that is 21 billion dollars of value which some persons (the miners?) have received or will receive for nothing.
Or am I missing something? 22 Mar 2014 20:38 UTC

mrb wrote: BigD: by "benefit" I assume you mean "benefit financially". Well those who hold bitcoins benefit from its increase in value. For example those who either mine coins with GPUs or specialized devices, or those who just straight up buy bitcoins as an investment. 28 Mar 2014 06:27 UTC

Fizzy Pooch wrote: What happens if someone is mining them and harvesting them for themselves? 24 Mar 2015 18:35 UTC

mrb wrote: Fizzy Pooch: nothing special. In fact a lot of people do this.

As of April 2015, the network is at 350 Phash/sec, 1 Ghash/sec costs about $0.50, and 1 Ghash/sec consumes 0.5 watt, approximately. So if you wanted to mine and harvest 90% of the bitcoins starting today, you would have to spend $1.5 billion on mining gear alone, and build 1.6 gigawatt of data centers (equivalent to 16 world-class 100 megawatt facilities), which would probably cost another $1 to $10 billion dollars and take at least 2-3 years to plan. 24 Apr 2015 07:21 UTC

Nick Ricketts wrote: Still makes no sense. A load of tosh I think. Just one big joke or scam. If it is profitable this "make believe money" then only the hyper rich have them, it, whatever the hell it is. 28 Apr 2015 15:01 UTC

mrb wrote: Nick: at first I too thought Bitcoin was a scam (see my reaction in http://blog.zorinaq.com/?e=49). I guess the simplest thing I could say to convince you otherwise is that Bitcoin is praised by a few high-profile people: Eric Schmidt (CEO of Google), David Marcus (CEO of Paypal), Richard Branson, Ron Paul, etc (see http://bitcoinquotations.com/). Surely all these persons wouldn't fall for a "scam", would they? 03 May 2015 20:42 UTC

jim green wrote: Sure sounds like investing in 1920's German marc's, or 1866 Confederate paper bills to the uninitiated..... 02 May 2016 20:10 UTC

idara Israel. wrote: This is just a wonderful, how do i purchase bitcoin immediately?? 15 Oct 2016 17:01 UTC

Claudio wrote: "Bitcoins are stored locally on your electronic device (cellphone, computer)"
Actually bitcoins can be stored only on their own blockchain. The electronic device manages the keys that are necessary to sign transactions in order to spend them. 13 Sep 2018 20:23 UTC

Lyon_kvalid wrote: Do each public address on a blockchain has its separate ledger . 06 May 2020 03:44 UTC