What is Bitcoin

What Is Bitcoin

What is Bitcoin

Bitcoin means different things to different people. For some, it is a future of freely moving currency untied to any central bank. To others, it is a purely digital entity of questionable value and dubious origin. But what is Bitcoin, in the most basic sense?

In most casual conversations, you can get away with knowing that bitcoin is, basically, a digital currency. But of course, it’s much more complicated than that. In fact, it is two much more complicated things.

Bitcoin has been with us since 2009, when a person (or group) under the pseudonym Satoshi Nakamoto introduced a platform (Bitcoin, uppercase) that hosts a digital currency (bitcoin, lowercase).

Bitcoin the platform is built on the concept of “proof of work” data that is expensive and time-intensive to produce but can be easily verified. In Bitcoin’s case, proof of work is created through the process of “mining.” To mine a bitcoin, a computer must complete a complicated algorithm, essentially going through the work of an extensive calculation in exchange for some newly minted currency. That piece of digital currency is worth whatever the market decides through supply and demand.

Transactions are connected to a user’s Bitcoin address, which is stored on its general ledger, called the blockchain. If that address is linked to a real identity, transactions can be traced back to the user; if it isn’t, they can’t. This relative anonymity makes the platform appealing for things like incognito purchases over the internet.

A key component of Bitcoin’s blockchain is the fact that it is an open, distributed ledger. Through the distributed nature of this ledger, the transactions on the blockchain are verified by the consensus of every member, offering security and trust without a third-party overseer.

One of the most important things to keep in mind when thinking about what Bitcoin (or bitcoin) is: there is no single answer. Bitcoin is a platform that hosts a digital ledger on which people can mine, store and trade bitcoins, a digital form of currency earned through a computer algorithm and tied to no central authority.

 

What Is a Blockchain?

Bitcoin depends on a distributed ledger system known as the blockchain. The blockchain is possibly the most powerful innovation associated with Bitcoin, as countless industries from financial services to healthcare have begun contemplating how to leverage the technology for their own uses. So it’s worth asking: What is a blockchain?

The essential power of blockchain technology is its ability to distribute information. Because it is distributed across all of the nodes, or individual computers, that make up the system, the term “blockchain technology” is often swapped with “distributed ledger technology.” A blockchain’s database isn’t held in a single location, which could be infiltrated or controlled by a single party, but rather it is hosted by numerous (in the case of Bitcoin, tens of thousands of) computers all at once. 

The blockchain network automatically verifies itself at certain intervals, creating a self-auditing system that guarantees the accuracy of the data it holds. Groups of this data are known as “blocks,” and as these blocks are cryptographically chained together, the pieces of data get buried and harder to manipulate. Altering any piece of data on the blockchain would require a huge amount of computing power.

One significant disadvantage of a blockchain, compared with other types of databases, is that this distributed setup requires constant computing power from several different sources to keep up.

Like Bitcoin, the invention of the blockchain as we understand it now is usually credited to the person or group that goes by the name of Satoshi Nakamoto. But actually, the idea of a mutual distributed ledger can be traced back to a 1976 research paper called “New Directions in Cryptography.” For many years the concept was seen as insecure and overly complicated, but when it was finally paired with Bitcoin, the technology’s security and distribution benefits became clear.

Now, new uses for the blockchain are being developed by companies like Microsoft and Deloitte, which believe that its decentralized and verifiable nature give it huge potential beyond digital currencies.

Only time will tell how far blockchain technology can go. If the present is any indication, it will be utilized far and wide.

 

What Is an Altcoin?

Using our handy guide, you may have already familiarized yourself with the ins and outs of Bitcoin. But aside from bitcoin, there are hundreds of other digital currencies out there. These are known as “altcoins,” or alternatives to bitcoin; for example, ether, ripple, zcash, monero and dash, to name just a few.

 

Altcoins can differ from Bitcoin in a range of ways. Some have a different economic model or a different coin-distribution method, like altcoins that were given away to all citizens of a country. Others employ different proof-of-work mining algorithms, perhaps to resist specialized mining hardware — or maybe they don’t even rely on proof of work at all. Several altcoins offer a more versatile programming language to build applications on top of, while yet others offer more privacy compared to Bitcoin. And there are also altcoins that serve very specific, non-monetary use cases, like domain name registry or data storage pointers.

 

However, there are also many altcoins that don’t do much interesting at all. The vast majority of altcoins simply tweak some parameters that don’t matter much, or offer something that may sound useful but isn’t. If, for example, an altcoin has a greater total amount of coins, it just means each individual coin is worth less. If an altcoin finds blocks faster, it only means that a transaction requires more confirmations for a similar level of security.

As such, most altcoins offer no benefit over Bitcoin at all. Plus, they have less hash power securing them, involve fewer developers improving them and are usually less useful due to smaller network effects. And while many altcoins promise useful features, upon closer inspection many of these promises are just that: promises.

 

This also means that altcoins are typically riskier than Bitcoin. Their exchange rates are often more volatile, and over the years virtually no altcoins have maintained their value against bitcoin; most have come and gone. On top of that, many altcoins can be considered outright scams, mainly created to enrich its inventors and early adopters.

 

While some altcoins out there can and do perform useful tasks (for example acting in a testnet capacity or offering greater anonymity than bitcoin) and may have a future, many others are exclusively driven by speculation or worse. So make sure to do your research, and buyer beware!

 

What Is an ICO?

An Initial Coin Offering, also commonly referred to as an ICO, is a fundraising mechanism in which new projects sell their underlying crypto tokens in exchange for bitcoin and ether. It’s somewhat similar to an Initial Public Offering (IPO) in which investors purchase shares of a company.

ICOs are a relatively new phenomenon but have quickly become a dominant topic of discussion within the blockchain community. Many view ICO projects as unregulated securities that allow founders to raise an unjustified amount of capital, while others argue it is an innovation in the traditional venture-funding model. The U.S. Securities and Exchange Commission (SEC) has recently reached a decision regarding the status of tokens issued in the infamous DAO ICO which has forced many projects and investors to re-examine the funding models of many ICOs. The most important criteria to consider is whether or not the token passes the Howey test. If it does, it must be treated as a security and is subject to certain restrictions imposed by the SEC.

 

ICOs are easy to structure because of technologies like the ERC20 Token Standard, which abstracts a lot of the development process necessary to create a new cryptographic asset. Most ICOs work by having investors send funds (usually bitcoin or ether) to a smart contract that stores the funds and distributes an equivalent value in the new token at a later point in time.

 

There are few, if any, restrictions on who can participate in an ICO, assuming that the token is not, in fact, a security. And since you’re taking money from a global pool of investors, the sums raised in ICOs can be astronomical. A fundamental issue with ICOs is the fact that most of them raise money pre-product. This makes the investment extremely speculative and risky. The counter argument is that this fundraising style is particularly useful (even necessary) in order to incentivize protocol development.

 

Before we get into a discussion over the merits of ICOs, it is important to have some historical context for how the trend started.

 

History of ICOs

Several projects used a crowdsale model to try and fund their development work in 2013. Ripple pre-mined 1 billion XRP tokens and sold them to willing investors in exchange for fiat currencies or bitcoin. Ethereum raised a little over $18 million in early 2014 — the largest ICO ever completed at that time.

The DAO was the first attempt at fundraising for a new token on Ethereum. It promised to create a decentralized organization that would fund other blockchain projects, but it was unique in that governance decisions would be made by the token holders themselves. While the DAO was successful in terms of raising money — over $150 million — an unknown attacker was able to drain millions from the organization because of technical vulnerabilities. The Ethereum Foundation decided the best course of action was to move forward with a hard fork, allowing them to claw back the stolen funds.

 

Although the first attempt to fund a token safely on the Ethereum platform failed, blockchain developers realized that using Ethereum to launch a token was still much easier than pursuing seed rounds through the usual venture capital model. Specifically, the ERC20 standard makes it easy for developers to create their own cryptographic tokens on the Ethereum blockchain.

 

Some argue that crowdfunding projects might be Ethereum’s “killer application” given the sheer size and frequency of ICOs. Never before have pre-product startups been able to raise this much money and in this little time. Aragon raised around $25 million in just 15 minutes, Basic Attention Token raised $35 million in only 30 seconds, and Status.im raised $270 million in a few hours. With few regulations and such ease of use, this ICO climate has come under scrutiny from many in the community as well as various regulatory bodies around the world.

Are ICOs Legal?

The short answer is maybe. Legally, ICOs have existed in an extremely gray area because arguments can be made both for and against the fact that they’re just new, unregulated financial assets. The SEC’s recent decision, however, has since managed to clear up some of that gray area. In some cases, the token is simply a utility token, meaning it gives the owner access to a specific protocol or network; thus it may not be classified as a financial security. On the other hand, if the token is an equity token, meaning that it’s only purpose is to appreciate in value, then it looks a lot more like a security.

While many individuals purchase tokens to access the underlying platform at some future point in time, it’s difficult to refute the idea that most token purchases are for speculative investment purposes. This is easy to ascertain given the valuation figures for many projects that have yet to release a commercial product.

The SEC decision may have provided some clarity to the status of utility vs security tokens; however, there are still plenty of room for testing the boundaries of legalities. For now, and until further regulatory limits are imposed, entrepreneurs will continue to take advantage of this new phenomenon.

What is Ethereum?

Before you can understand ethereum, it helps to first understand the internet.

Today, our personal data, passwords and financial information are all largely stored on other people’s computers – in clouds and servers owned by companies like Amazon, Facebook or Google. Even this CoinDesk article is stored on a server controlled by a company that charges to hold this data should it be called upon.

This setup has a number of conveniences, as these companies deploy teams of specialists to help store and secure this data, and remove the costs that come with hosting and uptime.

 

But with this convenience, there is also vulnerability. As we’ve learned, a hacker or a government can gain unwelcome access to your files without your knowledge, by influencing or attacking a third-party service – meaning they can steal, leak or change important information.

Brian Behlendorf, creator of the Apache Web Server, has gone so far as to label this centralized design the “original sin” of the Internet. Some like Behlendorf argue the Internet was always meant to be decentralized, and a splintered movement has sprung up around using new tools, including blockchain technology, to help achieve this goal.

Ethereum is one of the newest technologies to join this movement.

While bitcoin aims to disrupt PayPal and online banking, ethereum has the goal of using a blockchain to replace internet third parties — those that store data, transfer mortgages and keep track of complex financial instruments.

 

The ‘World Computer’

In short, ethereum wants to be a ‘World Computer’ that would decentralize – and some would argue, democratize – the existing client-server model.

With ethereum, servers and clouds are replaced by thousands of so-called “nodes” run by volunteers from across the globe (thus forming a “world computer”).

The vision is that ethereum would enable this same functionality to people anywhere around the world, enabling them to compete to offer services on top of this infrastructure.

 

Scrolling through a typical app store, for example, you’ll see a variety of colorful squares representing everything from banking to fitness to messaging apps. These apps rely on the company (or another third-party service) to store your credit card information, purchasing history and other personal data – somewhere, generally in servers controlled by third-parties.

 

Your choice of apps is of course also governed by third parties, as Apple and Google maintain and curate (or in some cases, censor) the specific apps you’re able to download.

 

Take the example of an online document service like Evernote or Google Docs.

 

Ethereum, if all goes according to plan, would return control of the data in these types of services to its owner and the creative rights to its author.

The idea is that one entity will no longer have control over your notes and that no one could suddenly ban the app itself, temporarily taking all of your notebooks offline. Only the user can make changes, not any other entity.

In theory, it combines the control that people had over their information in the past with the easy-to-access information that we’re used to in the digital age. Each time you save edits, or add or delete notes, every node on the network makes the change.

It’s worth noting that the idea has been met with skepticism.

Although the apps appear to be possible, it’s unclear which blockchain applications will actually prove useful, secure, or scalable, and if they will ever be as convenient to use as the apps we use today.

What is Ripple?

Originally released in 2012 as a subsequent iteration of Ripplepay, Ripple is a real-time gross settlement system (RTGS), currency exchange and remittance network. Using a common ledger that is managed by a network of independently validating servers that constantly compare transaction records, Ripple doesn't rely on the energy and computing intensive proof-of-work used by Bitcoin. Ripple is based on a shared public database that makes use of a consensus process between those validating servers to ensure integrity. Those validating servers can belong to anyone, from individuals to banks.

The Ripple protocol (token represented as XRP) is meant to enable the near instant and direct transfer of money between two parties. Any type of currency can be exchanged, from fiat currency to gold to even airline miles. They claim to avoid the fees and wait times of traditional banking and even cryptocurrency transactions through exchanges.

How Is It Fundamentally Different From Bitcoin?

It is the validating servers and consensus mechanism that tends to lead people to just assume that Ripple is a blockchain-based technology. While it is consensus oriented, Ripple is not a blockchain. Ripple uses a HashTree to summarize the data into a single value that is compared across its validating servers to provide consensus.

 

Banks seem to like Ripple, and payment providers are coming on board more and more. It is built for enterprise and, while it can be used person to person, that really isn't its primary focus. The main purpose of the Ripple platform is to move lots of money around the world as rapidly as possible.

 

Thus far, Ripple has been stable since its release with over 35 million transactions processed without issue. It is able to handle 1,500 transactions per second (tps) and has been updated to be able to scale to Visa levels of 50,000 transactions per second. By comparison, Bitcoin can handle 3-6 tps (not including scaling layers) and Ethereum 15 tps.

 

Ripple’s token, XRP, isn't mined like Bitcoin, Ethereum, Litecoin and many other cryptocurrencies. Instead, it was issued at its inception, similar in fashion to the way a company issues stocks when it incorporates: It essentially just picked a number (100 billion) and issued that many XRP coins.

 

What is XRP and What’s It Used For?

As a technology, the Ripple platform may have real value and real history that validate the claims they make for its efficacy. The XRP token itself, however, seems to have negligible use cases. In fact, Ripple had planned to phase it out — at least, until fevered interest in cryptocurrencies began to take off in 2016. Nevertheless, as CNBC noted today, if Ripple hits $6.57, its market capitalization will be bigger than Bitcoin’s.

 

There are 100 billion XRP tokens that were issued by the Ripple company. At the moment, the company promises that this is the total number of XRP that there will ever be (though, technically, there is nothing to stop them from issuing more tokens in the future). Ripple’s hub-and-spoke design positions XRP in the middle as a tool that is fungible with any currency or digital asset, such as frequent flyer miles. Ripple can settle a payment in 3.5 seconds through XRP and have it available and spendable. The use of XRP is totally independent of the Ripple network in general; that is, banks don't actually need XRP to transfer dollars, euros, etcetera which is what many small investors might be missing when they are buying the token.

 

What Is Ripple’s Value Proposition?

The value here is the Ripple network itself and its ability to move assets around the world quickly, rather than in the XRP token.

Banks are able to use the Ripple software to shift money between different foreign currencies. Currently, this is typically accomplished using SWIFT, a system that is cumbersome and relies on the banks having separate accounts in every country they work in. Ripple says it has signed up more than 100 banks (compared to SWIFTs 11,000 financial institutions) including American Express.

 

So Why All the Hype?

While Bitcoin has seen a dramatic rise in price over the course of 2017, the end of the year saw the cryptocurrency almost breaking $20,000. As the price drove higher, we saw a massive increase in price for a large number of altcoins, with Litecoin jumping from $50 to nearly $400, Ethereum doubling, NEM and EOS going up by a factor of five, and the list goes on and on. The fear of missing out has driven many investors wild and “lower-priced” currencies are attractive to new investors who mistakenly think that the high price of an entire BTC puts the currency out of their reach.

 

Add to all the hype the rumors that had been swirling on social media through December 2017, that Coinbase was going to list Ripple, which caused the price to surge, which in turn prompted Coinbase to address the rumors in a more generic fashion in this blog post on January 4, 2018:

 

“As of the date of this statement, we have made no decision to add additional assets to either GDAX or Coinbase. Any statement to the contrary is untrue and not authorized by the company.”

The Coinbase announcement caused a big drop in Ripple, back to around the same levels as before the rumors began. SInce then, Ripple has both dipped dramatically and recovered, as have many other volatile cryptocurrencies. While Coinbase doesn’t support Ripple, there are a number of ways for people to acquire Ripple, should they still want to.

 

Words of Caution

There has been a lot of ink used on criticizing Ripple as well. The complaint from Bitcoin and other blockchain enthusiasts is that Ripple’s centralized control is in direct contrast to the ideals and advantages of decentralized blockchains like Bitcoin.

 

Ripple also maintains a trusted Unique Node List (UNL) that is meant to protect against potentially malicious or insecure validating servers. It is the UNL that controls the network rules, presenting a conundrum: On the one hand, it protects against problematic validators, but, in theory, a regulating body or government could come in and force a change that isn't necessarily desirable or is downright invasive. Furthermore, because of a FinCEN violation and fine in 2013, Ripple has updated its policies and will only recognize and recommend gateways that are in compliance with financial regulations.

 

New York Times reporter Nathaniel Popper commented on Twitter that he has yet to find a bank that anticipates using the XRP token in any meaningful way. Ripple’s CEO, Brad Garlinghouse, has denied Popper’s claims stating, “Over the last few months I’ve spoken with ACTUAL banks and payment providers. They are indeed planning to use xRapid (our XRP liquidity product) in a serious way.” However, as Popper points out, even the banks that he contacted at Ripple’s suggestion were non-committal in their plans to implement Ripple anytime soon.

 

According to the Financial Times, of the 18 banks and financial services companies publicly linked to Ripple, most of them stated that they “had not yet gone beyond testing” while a few had moved on to using Ripple’s systems “for moving real money.” However,  not one of the 16 companies that responded had used the XRP token.