Where do we start? There are so many cryptocurrencies, each working
differently with different rules and mechanisms, that is it not particularly
easy to make accurate generalisations: however you describe
cryptocurrencies, there are bound to be exceptions. For example, Bitcoin
uses a mechanism called ‘proof-of-work’ to ensure that anyone (in theory,
at least) can add blocks to the blockchain at a certain cadence without a
central actor coordinating access or providing permission. Proof-of-work
creates a fair competition between block adders who compete to add
blocks. This competition consumes electricity—a lot of it75—which is one
reason some people describe Bitcoin as wasteful. However not all
cryptocurrencies, and certainly not all blockchain technologies, work this
way. So it is inaccurate and therefore unhelpful to generalise and say
‘cryptocurrencies’ or ‘blockchains’ are energy intensive. Just because
Bitcoin works in a certain way, it doesn’t mean everything else does.
Bearing this in mind, we will nevertheless start by getting a good
grounding in how Bitcoin works, and then later describe some of the
differences between Bitcoin and other cryptocurrencies and their
respective blockchain protocols (all to be explained—do not fear!).
People refer to Bitcoin as a digital currency, virtual currency, or
cryptocurrency, but it may be easier to think of it as an electronic asset.
The word currency often side-tracks people when they are trying to
understand Bitcoin. They get caught up trying to understand aspects of
conventional currencies which do not apply to Bitcoin, for example, what
backs it (nothing) and who sets the interest rate (there is none). Bitcoin is
also sometimes described as a digital token, and in some respects that is
accurate; but, alas, the term token is now also used to mean something
more specific, which we will cover later, so the ambiguity of this term too
is best avoided.
What Are Bitcoins?
Bitcoins are digital assets (‘coins’) whose ownership is recorded on an
electronic ledger that is updated (almost) simultaneously on about
10,000 independently operated computers around the world that connect
and gossip with each other76. This ledger is called Bitcoin’s blockchain.
Transactions that record transfer of ownership of those coins are created
and validated according to a protocol—a list of rules that define how
things work and which therefore govern updates to the ledger. The
protocol is implemented by software—an app—that participants run on
their computers. The machines running the apps are called ‘nodes’ of the
network. Each node independently validates all pending transactions
wherever they arise, and updates its own record of the ledger with
validated blocks of confirmed transactions. Specialist nodes, called
miners, bundle together valid transactions into blocks and distribute
those blocks to nodes across the network.
Anyone can buy bitcoins, own them, and send them to other people.
Every Bitcoin transaction is recorded and shared publicly in plain text on
Bitcoin’s blockchain. Contrary to many media articles, Bitcoin’s
blockchain is not encrypted. By design, everyone sees all details of all
transactions. Anyone can, in theory, create bitcoins for themselves too.
This is part of the block creation process, called mining, and is described
What Is the Point of Bitcoin?
The purpose of Bitcoin is described in its whitepaper—a short document
written by a pseudonymous Satoshi Nakamoto, published in October
2008. It describes why Bitcoin exists and how it should work. It is worth
reading the whitepaper in full. It is only nine pages long and available
online77. The abstract says:
A purely peer-to-peer version of electronic cash would allow online payments to be sent
directly from one party to another without going through a financial institution. Digital
signatures provide part of the solution, but the main benefits are lost if a trusted third party
is still required to prevent double spending. We propose a solution to the double spending
problem using a peer-to-peer network. The network timestamps transactions by hashing
them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be
changed without redoing the proof-of-work. The longest chain not only serves as proof of
the sequence of events witnessed, but proof that it came from the largest pool of CPU power.
As long as a majority of CPU power is controlled by nodes that are not cooperating to attack
the network, they’ll generate the longest chain and outpace attackers. The network itself
requires minimal structure. Messages are broadcast on a best effort basis, and nodes can
leave and rejoin the network at will, accepting the longest proof-of-work chain as proof of
what happened while they were gone.
That first sentence says it all. It sets out the purpose of Bitcoin, and how
Bitcoin derives both value and utility. For the first time in history, we
have a system that can send value from A to B, without the physical
movement of items or using specific third-party intermediaries. It is
difficult to overstate how important a milestone this is in the evolution of
payments. I get shivers down my spine every time I think of Bitcoin like
this78. As popularised by cryptocurrency industry commentator Tim
Swanson79, Bitcoin is designed as censorship resistant digital cash.
There is no mention of a blockchain or ‘block chain’ at all in the original
Bitcoin whitepaper, even though we are constantly reminded by the
media that Bitcoin is built on blockchain or that blockchain is the
underlying technology of Bitcoin. A chain of blocks was not the purpose
of Bitcoin, it is just the design that was developed to achieve the objective
—the solution to the business problem.