Bitcoin

Main technical concepts

What is blockchain?

Blockchain is the underlying technology that powers Bitcoin and other cryptocurrencies. The Bitcoin network is a digital public ledger that everyone can see, which keeps a record of all Bitcoin transactions ever made. Each block contains a list of transactions and is linked to the previous block, forming a chain—hence “blockchain.” This chain keeps growing as more transactions are added.

The Bitcoin blockchain is structured as a peer-to-peer (P2P) network architecture on top of the Internet, which means that the computers that participate in the network are peers to each other, that they are all equal, that there are no “special” nodes (devices participating in the network) and that all nodes share the burden of providing network services. There is no “server”, no centralized service, and no hierarchy within the network.

Each node has a copy of the public ledger. Thanks to cryptographic technology, it is impossible to change a block in the blockchain without changing all the previous blocks across all the copies stored in a large network of nodes. The large number of participating nodes in the network contributes to the highly decentralized nature of Bitcoin, making it secure and tamper-proof even without a centralized figure exerting control.

Mining and Proof-of-work

Mining is the process by which new bitcoin is added to the money supply. Miners provide processing power to the bitcoin network to validate transactions and secure Bitcoin against fraud in exchange for the opportunity to be rewarded in Bitcoin. Miners receive two types of reward for mining: new coins created with each new block and transaction fees from all the transactions included in the block. When miners record transactions on the global ledger. A new block containing transactions is “mined” every 10 minutes. Transactions that become part of a block and added to the blockchain are considered “confirmed”.

Mining is the main process of the de-centralized clearinghouse, by which transactions are validated and cleared. Mining secures the bitcoin system and enables the emergence of network-wide consensus without a central authority. Miners in the network compete for the right to record transactions on the blockchain to earn the reward by solving a difficult mathematical problem based on a cryptographic hash algorithm. The solution to the problem, called the Proof-of-Work, is included in the new block. This process is the basis for bitcoin’s security model.

How are transactions processed?

All traditional payment systems depend on a trust model that has a central authority providing a clearinghouse service, basically verifying and clearing all transactions. Bitcoin doesn’t need one, because of the economic incentive design and independent validation across a large networks of nodes. When you send Bitcoin to someone, a series of steps ensures the transaction is valid and added to the blockchain.

When you create a Bitcoin transaction which includes details like the amount of Bitcoin you’re sending and the recipient’s Bitcoin address, your transaction is sent (broadcast) to the Bitcoin network. All the nodes (computers) in the network receive and see this transaction. Miners collect these transactions and put them into a new block. They then start solving the Proof-of-Work puzzle for this block. Every node validates blocks according to the same rules. If a miner cheats and propose an invalid transaction, that would make the entire block invalid, which would result in the block being rejected and therefore that transaction would never become part of the ledger. The miner’s incentive is thus to construct a valid block based on the shared rules that all nodes follow and mine it with a correct solution to the Proof-of-Work to earn the block reward. To do so they expend a lot of electricity in mining and if they cheat all the electricity and effort is wasted.

Once the block is confirmed and added to the chain, your transaction is part of the blockchain, and the nodes in the network confirm this by updating their copies of the blockchain to include the newly created block.

Tokenomics

Fixed supply

Bitcoin has a capped supply of 21 million coins, ensuring scarcity. This fixed limit is fundamental to its value proposition, akin to precious metals like gold. The controlled supply is managed through the Bitcoin protocol, preventing inflation that could devalue the currency over time.

Halving events

Approximately every four years, the reward that miners receive for adding a block to the blockchain is halved. These events, known as “halvings,” reduce the rate at which new bitcoins are created. Starting with a reward of 50 BTC per block in 2009, the reward has decreased to 6.25 BTC per block as of the 2020 halving. This mechanism ensures a gradual reduction in the issuance of new bitcoins until the maximum supply is reached.

In addition to block rewards, miners earn transaction fees paid by users. These fees can vary depending on network congestion and the priority of the transaction. As the block reward decreases over time, transaction fees are expected to play a more significant role in incentivizing miners.

Distribution

Bitcoin’s decentralized nature means no central authority controls its issuance or supply. New bitcoins are distributed through mining, with the rewards decreasing over time. Early adopters and miners acquired a significant portion of the supply, but the distribution has become more widespread as the network has grown.

Bitcoin’s inflation rate is designed to decrease over time, approaching zero as the maximum supply is reached. After each halving event, the reduction in block rewards lowers the rate at which new bitcoins enter circulation. This declining inflation rate contrasts with traditional fiat currencies, which can be subject to inflationary pressures due to monetary policy decisions.

Infrastructure projects

Bitcoin’s most well-known scaling solution is the Lightning Network, a layer-2 scaling solution designed to facilitate faster and cheaper Bitcoin transactions by creating off-chain payment channels.

Nascent layer 2 solutions like Stacks, BEVM, Rootstock, and BOB extend Bitcoin’s capabilities through smart contracts, enabling a myriad of decentralized applications and financial instruments that settle on the Bitcoin network.