Darlotech Ltd

I don’t have any Bitcoins but I thought it useful to understand them.

Cryptocurrencies are digital tokens, not physical coins or notes, which can be used to make online payments directly without the need for banks. The worth of cryptocurrencies is set purely by what people are willing to pay for them in the market.

Bitcoin was launched in 2009 and was designed to electronically copy features of a cash transaction. It was designed to allow person to person transactions, without the need to know or trust the other party in the transaction and without the need of a bank. The Bitcoin system uses blockchain technology to record transactions and ownership. This is basically technology that connects blocks of transactions together in a chain. Each time a new transaction occurs, it forms part of a new block that is added to the chain. As a result, the blockchain provides a record of every Bitcoin transaction that has ever happened, and it is available for anyone to see online.

Blockchain sits on a network of computers which all have the same history of transactions. So instead of one company or a database holding all the information, the information is spread across a network. Whenever a valid transaction occurs, it is put ahead in that history of transactions. All the transactions are encoded using cryptography for security.

Suppose you want to send Bitcoins to someone else., you first send an instruction to the network which is visible to all users. The transaction sits in a queue waiting to be compiled into a block with other transactions. A compiled block has a signature made up of the signature of the previous block, a list of transactions and a random number called a ‘nonce’. From these numbers a mathematical function called a hash function is used to produce a number, a ‘Hash‘.

The Hash function is designed so that you can’t take the Hash and work out what the original signature was, you can only guess it, and running your guess through the Hash function, see if you get the Hash. For Bitcoin the Hash function is SHA-256 (SHA-256 stands for Secure Hash Algorithm 256-bit. Published in 2001, this was a joint effort between the National Security Agency (NSA) and the National Institute of Standards and Technology (NIST), both of the USA.

The compiled block is now ready to be checked.

As cryptocurrency systems don’t have a bank to check transactions as would happen normally, the job is left to ‘miners’. Mining in cryptocurrency is the process whereby transactions are checked and confirmed as valid. ‘Miners’ (‘normal’ computer literate people) use computers to look at a block and try to work out the nonce. They must try many different nonce values to be successful which needs a very powerful computer to do this in a reasonable time. To make the job quicker multiple miners can get together to form a pool and hence multiply up the computing power. Their answer is checked by other miners and if it’s agreed the be correct, then they get rewarded with Bitcoins and the new block is added to the end of the blockchain.

The supply of Bitcoins are limited to 21 million. This keeps the currency scarce which in theory ensures it maintains its value. It’s for this reason that Bitcoin is often called “digital gold”; like gold, there’s only a certain amount in existence.

Bitcoin mining uses a huge number of computers and this consumes a lot of energy which leads some to be concerned on its environmental impact, especially if the energy supply is from fossil fuels not renewables.