Investment Analyst @ SenseTime. Founder of Worthyt. MIT Sloan 2020.
What do coal mines, peers, A-6, and lightning storms have to do with Bitcoin? Well, nothing. But if that’s what you were wondering, then you really need to start with this guide. Also, it’s spelled ASICs, not A-6.
If you’re already familiar enough with Bitcoin and want to get into the world of trading, take a look at my article 0 to Pro Crypto Trader.
This article goes through the concepts of decentralization, mining, and blockchain on a high level to give fledgling cryptocurrency enthusiasts a down-to-earth understanding of what Bitcoin is, and why the technology and concepts are considered highly impactful to the global economy.
To start to understand Bitcoin, you have to first understand decentralization, because that’s one of the primary value propositions of Bitcoin. Traditionally, when you spend money, the receipt of your transaction has to be recorded somewhere. In this way, banks and credit card companies can keep track of what, where, when and why you spend. The place that it’s recorded is referred to as the ledger. But just as important as recording onto the ledger is maintaining the legitimacy of the ledger. To clarify that, let’s take an analogy.
Bill and Rebecca are finalists in a spelling bee. There is one judge. There are 999 audience members. Each contestant earns a point every time he or she spells correctly. That information is recorded on the judge’s ledger. Currently, the score is tied at 26 to 26. Here are a few scenarios that could happen to make the contest unfair:
In an ideal world, the audience members and the contestants trust the judge, and the judge never does anything malicious. But even if he intends to preserve the full integrity of the contest, Malicious Scenario 1 can still happen and is outside of his control. Enter Decentralization with its flowing superhero cape.
With decentralization, anyone can get a copy of the ledger. And anyone can be responsible for updating the ledger. It is no longer a single entity or group that controls it.
In a decentralized spelling bee, instead of the judge recording every time Rebecca gets a point, the entire audience races to write down the point scored, what word it was scored on, and what time it was. There are some extra rules involved in Bitcoin’s decentralization world that we’ll touch on, but for the sake of simplicity in this analogy, we’ll ignore those rules for now. Now, looking back at the three scenarios, we can see how decentralization can counter them.
For scenario 1, if one person decides to make some changes, he would have a much harder time doing so because he has to update most of the audiences’ ledgers; if he only updates his own or a few, the other audience members can quickly call bullsh*t, as only 3 of the 1,000 records (999 audience members and 1 judge) of the spelling bee scores show Bill with an extra 3 points.
Scenario 2 follows a similar logic in that the judge himself has no more power than the audience members, and changing his own score would mean that he has 999 audience members with a different score record; i.e., the judge himself would become an audience member.
With Scenario 3, as the judge is now an audience member, he can’t just make up arbitrary rules to tip the scales of the contest. The rules would be the fair rules unless the majority of audience members agree that certain aspects of the contest need changing.
With Bitcoin, the audience members from the Spelling Bee scenario would be referred to as miners.
There is a total of 21 million Bitcoin that can possibly be in existence. Out of that 21 million, there are 16.8 million in circulating supply at the time of writing. This means 4.2 million are still not available; in order to make those remaining bitcoin available, miners must successfully mine blocks. Every time a block is successfully mined, the miner who mined it gets 12.5 Bitcoin. But what is mining?
Forget what people describe mining as. They’ll say things like “ASICs, Graphics Cards, Complex Algorithms, Hashrate” and other terms to obfuscate the fact that they’re just as confused as you.
Mining is just writing a chunk (i.e., a block) of transactions and then broadcasting that block of transactions to all of the other miners as quickly as possible (don’t worry, if you don’t know what that means, we’ll revisit the spelling bee analogy again to paint this picture). This is important because new transactions are happening all the time, and we all want transactions to complete as quickly as possible (who wants to wait 5 hours at a cash register just for their VISA card swipe to return APPROVED? This leads to another problem with Bitcoin’s blockchain that is solved by the Lightning Network but I won’t get into it in this explanation as it is a whole other story in itself).
Miners are able to broadcast this information to other miners because they have software installed on their computers that lets them to talk with one another in a network (i.e., a chain). Hence, it’s called a Blockchain.
If your computer is the first the broadcast the updated block of transactions, a verification process begins — other miners would look at their own ledger, compare it with yours, and if it looks the same, then nothing sneaky is going on and they will agree to use your most-updated ledger moving forward. If something is off with your ledger, then it won’t be verified and the entire blockchain network will wait for the next miner to present an updated block. Once verification is over, everyone’s ledger is updated with the new block included in it, and the whole process starts over again.
Looking back at the spelling bee analogy, the transactions would be the score points, and a block could be a set of 10 scores. One block could say “okay this round, Bill got 4 points and Rebecca got 6, and here are the individual receipts for each point: blah blah blah”, then another block would read “okay this round, Bill got 7 points and Rebecca got 3, and here are the individual receipts for each point: blah blah blah.”
Every time the first audience member writes down the complete new block, he would stand up and shout to the rest of the audience, “Take a look at my ledger!” Other members come by and take a look, and cross-reference their own ledgers. Once everyone agrees that the first audience member is right, they’ll all copy down his or her updated block into their ledger and then continue the game’s next ten rounds. You can probably imagine why updates occur in blocks — you don’t have to stop the game and get in agreement every round, which slows the entire game down. There are other reasons, too, that I won’t get into.
Just as easy as it is to be an audience member, it’s easy to become a miner. It’s made simple to allow anyone to participate and view the ledger, although the race to be the fastest miner is much more challenging. Miners want to be the fastest and the ones to update the ledger because it comes with rewards: a successful mine (aka, being the first to push out the new block and get verified) currently gives the miner 12.5 Bitcoins (this number will change in time). Mining is where the remaining 4.2 million Bitcoins will come from.
The incentive for speed means that miners are buying out very high-performance computers to do all the transaction recording. So while you can still get in on the Bitcoin Blockchain, view the ledger and take a crack at mining, chances are even your Macbook Pro is no match against professional miners’ machines when it comes to making it to the finish line first. ASICs are expensive, specialized computers designed for specific tasks such as mining Bitcoin. Eventually, once all Bitcoins are mined, miners will theoretically continue to be incentivized to mine because transaction fees will still be rewarded (transaction fees are the fees that users pay when they conduct a bitcoin transaction, similar to credit card fees that places like restaurants must pay to accept credit cards).
Well, the reality is, the majority of governments have not made indications that they hate it; instead, they are trying to regulate it. News tends to exaggerate, and once it hits the eyes and ears of readers/viewers, it’s just a game of telephone, and by the time you’re hearing it, what started off as “South Korea wants to tax cryptocurrency gains” becomes “North Korea is going to launch a bitcoin-powered missile at Hawaii.”
Although regulation sounds terrible, it’s a much-needed step in the right direction for cryptocurrency. While altruistic, letting people run free with this new economy is not the best idea, because everyone brings in habits of the old world such as capitalism (not saying capitalism is bad as a whole, just saying that it comes with its own set of values including greed), and try to find ways to game the ecosystem in order to make a quick buck at the expense of others.
This article isn’t intended to make you an expert on Blockchain, but I hope it gives you enough information to at least wrap your head around a concept that’s still arguably quite obfuscated. Bitcoin is not a super complex beast that only the most technical quantum computer scientists can possibly get a grasp on. If you’ve understood the concepts presented in this article, then you’re on the right track to becoming an informed (potential) investor.
So now you know what decentralization, mining, and blockchain are, and are probably thinking about the potential possibilities and how it’s a potential paradigm to the financial system. If you’re excited to actually start buying Bitcoin, take a look at my write up on 0 to Pro Crypto Trader.
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