Bitcoin for Beginners

Introduction

The Web2 Institutions

In today’s society, the money system resolves around the central bank and they store all transaction on their ledger. This creates a centralized system and when this happens, the institution that is printing the money holds a enormous amount of power. The system has served its purpose, but there are inherent flaws in the design with the biggest one being the lack of a trust based model. Due to the fact that banks have to serve as the middle man, they have to mediate disputes and as such, cannot provide a mechanism for truly transparent and irreversible transactions.

The Web3 Model

In Web3, blockchain technology provides an ecosystem where there is a peer-to-peer network to form transactions without the middle man (banks and other platform institutions). However, one of the problems that previous digital currencies could not solve for the double-spending issues. Enter Bitcoin

Transactional Key Concepts

1. Digital signatures on the blockchain create what is defined as digital coin
2. When a transactions takes place, the transferor signs a hash of the previous block and the public key of the next block
3. Elimination of double-spending

• Current solution: Create a middle-man like banks to verify the transactions on their ledger
• Web3 solution: Timestamp server

4. Timestamp Server

4. Timestamp Server

1. By taking the has of a block of items and timestamping them publicly
2. By taking a timestamp of transactions, they are broadcasted to all the notes in the Bitcoin network
3. Each timestamp is built on top of the previous timestamp, forming a chain

Consensus Mechanism: Proof of Work

What is Proof of Work (POW)?

Launched back in 2009, POW was launched with the aim to solve double spending, which could’ve been a major issue for crypto projects. Being a decentralized ledger, the blocks that are formed have to be verified to create the blockchain. In layman’s terms, each block consists of a list of transactions.

Now miners within the ecosystem execute POW each time that a new block is added (about 10 mins per block). There are essentially a ton of computers around the world computing a random sequence until it reaches the correct code. Now, this randomly guessing task is actually a hash function which is very important to proof of work. When the miner finally completes this guess and check sequence to arrive at the correct password for the block, they will be rewarded as a proof that they put in a significant amount of work hence, proof of work.

Key benefits of POW include:

• Security: Reliable, safe, permanent, fair and transparent
• Consensus: Miners broadcast what they are doing on the transactions and the nodes validate them

Conclusion

Bitcoin creates a blockchain ecosystem that solves the double spending problem that previous digital coins tried to solve but could not. With a decentralized ledger, nodes work all together with little coordination creating a trust based system.

Risks

1. Environmental impact: POW requires the use of CPU energy, and therefore with the increase in usage, the more energy is required
2. Scalability: With the slow transaction time, peak times will pose issues for everyday transactions to take place for a typical user
3. Lack of penalties: Besides increased cost and preventing miners from adding blocks, there are no real severe punishments for miners with malicious intent, which could pose room for further misconduct