Understanding Bitcoin
This is a writedown of the talk I gave at Web à Québec in 2018. Since Bitcoin just crossed $100,000, I decided to transcribe & publish it. Enjoy.
We’ve all heard the crazy Bitcoin stories.
Some guy trashed his USB key and lost $500 million. Another guy bought 2 pizzas for 10,000 Bitcoins and missed out on $1 billion.
These stories made it so that today, everyone has heard of Bitcoin. But somehow, it remains controversial. Some say it’s a bubble and a scam, and some other, like myself, say it’s a revolution.
In this article, I will explain to you what Bitcoin is, and why I believe it’s one of the most important inventions since the Internet.
History
To understand Bitcoin, we first need to go back to the 2008 financial crisis.
Back then, the bank’s greediness caused a housing bubble. When it popped, we got the worst market crash since 1929.
$5,000 billion in pension funds were lost. Millions of people lost either their jobs or their homes. The US government spent nearly $700 billion to save banks that were too big to fail. And somehow, nobody went to jail.
Disgusted by the situation, an anonymous programmer known as Satoshi Nakamoto came up with a system that would allow people to transact money without banks.
In 2008, he published the Bitcoin’s White Paper, establishing the basis of today’s crypto revolution.
The First Digital Currencies
Before Bitcoin, there had been many failed attempts at creating digital currencies. For instances: Hashcash, E-Gold, and B-Money. All of these were killed before they even stood a chance.
For instance, E-Gold, the most popular of these, was immediately prosecuted by the US government and forced to shut down.
So, why did Bitcoin survive while every other attempt was killed? Because it was the first digital currency to do something fundamentally different, thanks to a few technological breakthroughs.
The Bitcoin Breakthrough
If you remember one thing from this article, make it this:
The Bitcoin revolution is that it allows us to create unique digital objects.
What do I mean by this?
One of the most valuable features of computers is their ability to effortlessly duplicate information.
When I send you an email, I don’t really send the email itself. I send a copy of it. In the end, both computers have a version of it. I duplicated the email.
This is completely different from the physical world. Back in the days, if I sent you a paper letter, the letter was gone. I didn’t have it anymore. There could only ever be a single version of that letter in the world.
Duplicating information is what computers do best.
In the digital world, can duplicate anything. This makes it incredibly easy to freely duplicate, share and consume media and documents. One person can make a video, and millions can freely enjoy it on TikTok. This is the information revolution.
But, when it comes to money, this sucks. Because money that can be freely duplicated has no value.
This is the paradox of digital money: for something to have value, it must be unique and scarce. But computers make everything that is digital infinitely available to everyone.
In finance, duplication is known as the double-spend problem. To prevent it, we rely on third-party institutions like banks or PayPal.
When I send you money, the bank’s job is to make sure there is no double-spend. The money is deducted from my account and then added to yours.
This control over digital money gave banks incredible power.
Today, 97% of all the money in the world is digital. Banks have complete control over it. They decide who gets to send and receive our money.
This great power comes with great responsibilities. But, as we’ve seen in 2008, the banks did not live up to these responsibilities.
Bitcoin allows us to go towards a world where institutions aren’t needed to send money over the Internet.
With Bitcoin, sending money is now as easy as sending an email.
But, unlike emails, when I send a Bitcoin to a friend, that Bitcoin has left my possession. It’s now only in my friend’s possession.
There can only ever be a single version of this digital Bitcoin in the world.
This is a bit paradoxical because we’re essentially taking away a core feature of computers: their ability to duplicate digital things. By doing so, we revolutionize technology and finance.
How Bitcoin Works
Buckle up, now we’re going to see how things work under the hood.
There are four fundamental technologies that power Bitcoin:
- The Blockchain
- Cryptography
- Peer-to-Peer Networking
- Consensus Algorithm
I often hear people say “Bitcoin is great but the Blockchain is the real revolution.” This is false, and a misunderstanding of how Bitcoin works.
Bitcoin’s power comes in the elegant merging of these four technologies. This is what makes it such a profound invention.
1. The Blockchain
What is this innovation that everyone is talking about?
Essentially, it’s just a spreadsheet, like an Excel or Google Sheets file.
Right now, you can find Bitcoin’s blockchain online and take a look at it. You’d see something like this:
The blockchain’s role is to keep track of every transaction. When Andy sends John a Bitcoin, that transaction is recorded on the blockchain, in a new line.
However, the blockchain is particular because it is built sequentially. Every 10 minutes or so, we add in a new block containing all the transaction since the last block.
2. Cryptography
This is where cryptography comes in. The blockchain is encrypted end-to-end. If you look at a Bitcoin block, you will see all transactions from the past 10 minutes. But you will also see a cryptographic hash — a signature that is unique to this block, which also contains the signature of the previous block.
In other words, when you add a new block of transactions, you forever lock in all the previous blocks.
This makes the blockchain incredibly secure. If someone tries to commit fraud by changing a block, in an attempt to give himself more money. The fraud will be evident to anyone looking at the blockchain, because every block that comes afterward will be corrupted.
3. Peer-to-Peer
Peer-to-peer technology has been around for a long time.
If you ever used software such as BitTorrent or uTorrent to download, say, the entire Game of Thrones series, you used peer-to-peer.
When downloading your T.V. shows, you probably noticed that a bunch of peers are all sending you the same file.
This is the same with Bitcoin. The same Bitcoin blockchain is shared among tens of thousands of peers around the world.
When you send a Bitcoin, you broadcast the transaction to all of them.
Then, all of these people will update their chain accordingly.
This is why we say that Bitcoin is decentralized. This means the system doesn’t have a single point of failure.
This is different from centralized systems like banks, which can be more easily attacked.
If you want to hack a bank, you just need to hack their central computer. If you want to hack Bitcoin, you’d need to hack millions of computers around the world at the same time. This is practically impossible.
4. Consensus Algorithm
This is the most complicated part.
There are many consensus algorithms. The one used by Bitcoin is called Proof of Work.
People who run a copy of the Bitcoin blockchain are called “Miners.”
However, not everyone can add blocks to the blockchain. Because otherwise, it would be too easy to spam the system with hundreds of fake blocks. To prevent this, the blockchain requires miners to show they have done some “work”.
In this case, the work is to solve an extremely complex mathematical puzzle. The only way to solve them is to spend a bunch of electricity.
Once the puzzle is solved, the block is added, and the miner is rewarded with 6.25 Bitcoins, plus the fees from the transactions in the block.
Every 10 minutes, a new block of transactions is added to the chain, and 6.25 new Bitcoins are created.
This will go on until the year 2140, when a total of 21 million Bitcoins have been created, and not a single more.
Why 21 million? It’s an arbitrary number chosen by Bitcoin’s creator. The goal is to emulate natural properties of currencies like gold.
There is a maximum amount of gold on Earth, and there is a maximum amount of Bitcoins on the blockchain.
Mining Makes Bitcoin Harder to Mine
As more people mine Bitcoin, the Proof of Work algorithm automatically increases its difficulty to make sure a block is only found every 10 minutes. This prevents someone from coming in with a supercomputer that could mine faster and overtake the entire system by brute force.
This system currently consumes a LOT of electricity. This is a real problem, and a valid criticism of Bitcoin. However, there are solutions, and I will talk about them in the conclusion.
But remember: this energy consumption is a feature, not a bug. It is one of the many ways the system secures itself to prevent abuses.
To Sum it Up
Bitcoin is a transactional system that is encrypted end-to-end, distributed on millions of computers around the world, and requires a ton of energy to modify.
This brings 3 revolutions:
- We can now create what are essentially unique digital objects.
- It allows us to do trusted transactions without needing a third party.
- It is an immutable public archive.
This last one isn’t well known but it’s extremely valuable. It’s so hard to write on the blockchain and when it’s done, it is encrypted and distributed worldwide.
This means once something is written into the blockchain, it’s nearly impossible to change or erase it.
Maybe in the future, rather than say that something is “written in stone” we’ll say it’s “written in the blockchain.”
How do I use it?
To use Bitcoin, you first need to create a Bitcoin address. When you do so, you get two pieces of information:
- A public address
- A private key.
Your Bitcoin address is like an email address. You can give it to anyone. Anyone who knows your address can send you money, the same way anyone who knows your email address can send you an email.
The private key is your password. Keep it to yourself! While anyone can send money to your address, but to send money from your address, you need the password.
However, using Bitcoin isn’t as easy as using email. Bitcoin addresses and private keys are long series of letters and numbers. These are very hard to memorize, and even to type down.
This causes a few problems which we’ll talk about in the conclusion. Often, people will use QR codes to show their addresses.
For instance, a college kid printed his Bitcoin address on a large banner and showed it to television during a football game. People thought it was funny and sent him money. He received about $24,000 worth of Bitcoin!
Anonymous vs Pseudo-Anonymous
People think Bitcoin is anonymous. This is false.
As I mentioned, Bitcoin is public. Anyone can download Bitcoin’s blockchain. You can look up this student’s address on the blockchain.info website. And you can see every transaction that was received to and sent from his address. As you can see below, he received 23.04300457 BTC. Which is worth about $2.3 million dollars today!
I bring your attention to these numbers because there’s another misconception about Bitcoin, which is that most people think don’t have enough money to buy one.
In truth, Bitcoin can be divided into the 8th decimal.
So if you have $0.00001, you have enough money to buy Bitcoin.
Benefits of Bitcoin
Now, let’s talk about use cases that make Bitcoin exciting.
Bitcoin Gives Us Control Over Our Money
In 2017, I discovered that the Wall Street Journal had been charging me for months for their subscription, which I didn’t even use.
I called my credit card company to get the transactions removed. I even changed my credit card number several times.
But every month, without fault, the Wall Street Journal kept charging me nevertheless. I later learned they were paying my credit card company to automatically get my new card numbers. This was incredibly frustrating.
How is this possible?
This is because the design of our financial system is fundamentally flawed.
When I use a credit card, I literally give the merchant the password to all my money.
The merchant can then freely re-use that information to charge me over and over without my authorization.
Furthermore, nothing prevents them from selling my credit card information to fraudulent people or organizations.
On the other hand, when I use Bitcoin, all the critical information stays with me. The only thing that the merchant gets is a cryptographic signature. This signature is only valid for this transaction. So it’s impossible for the merchant to charge me again in the future.
In other words, credit cards are a “Pull” technology, and Bitcoin is a “Push” technology.
With credit cards, anyone can pull money from you. With Bitcoin, you get to push money to other people.
This simple change could solve most of the credit card fraud problems save billions of dollars every year.
Open-Source
Bitcoin is open-source. Until now, banks have had a monopoly over innovation in finance. Because Bitcoin is open-source anyone in this room could develop new innovations and submit them to be approved. This enables incredible innovations.
Comparing Bitcoin with banks is like comparing Wikipedia to Encyclopedia Britannica.
Wikipedia is this crazy idea that should never have worked.
It is an open source encyclopedia. You can go on Wikipedia today and edit a bunch of things. You’d think this would make it unusable or untrustworthy. But somehow, it just works. In fact, Wikipedia completely outmatches any other encyclopedia on the planet.
People believe the same thing will happen with Bitcoin vs the banks. Because Bitcoin is open source, and anyone can contribute to it, it has the potential to become the Wikipedia of financial institutions.
In fact, one of the most interesting innovations coming from an open source contributor is the mnemonic phrase. A mnemonic phrase converts your private key into a series of 12 words from the English vocabulary.
This makes it incredibly easier to remember. Even if you lose all of your paperwork or any proof of who you are. As long as you remember this phrase, you are essentially carrying your bank account in your brain.
Think of how useful this is for people like political refugees.
Imagine a family who worked super hard all their life to save money. They put it in the bank. Then, there’s a war; the terrorists blow up the bank and steal all the gold. Then, the refugees find themselves in a new country without any papers. They’ve lost everything.
Had they used Bitcoin and a mnemonic phrase, even if they lost everything as long as they remember these 12 words, they would still have their money, no matter what country they end up in.
Because Bitcoin is global, you can’t blow up the “Bitcoin” bank. It’s a powerful way to protect yourself financially.
In the end, Bitcoin is a powerful check against corrupt and fiscally irresponsible governments.
Thanks to Bitcoin, governments can never have full control over their population’s money. Because they can always use Bitcoin.
Read more about Bitcoin & political freedom in this other article from me:
Ethereum
Ethereum is the second most popular cryptocurrency.
While Bitcoin was created in 2008, Ethereum was created in 2015. It was created by a Canadian named Vitalik Buterin at the age of 19 years old. Vitalik is a genius.
Pretty much everything that I just said about Bitcoin also applies to Ethereum. Except Ethereum adds one more innovation.
Ethereum is Turing Complete
This means that Ethereum can run any program or app on its blockchain.
If you were to compare them:
- Bitcoin is an old calculator, it can only do additions and subtractions.
- While Ethereum is a computer, it can run apps.
This brings the 4th crypto revolution: smart contracts.
A good metaphor for a smart contract is a gum machine.
Say I walk into a shopping mall and I see a gum machine. By observing its shape, I understand how it functions. I see that if I put $0.25 in, and turn the handle, I will get a gum in return.
Smart contracts are the same way, but in code. Rather than metallic gears, the gum machine is built with codes.
Anyone can create a smart contract and drop it on Ethereum’s public blockchain, just like anyone can build a gum machine and drop it in a mall.
Here’s a simple use case. Imagine your teenager asks you $20 to go to the movie theater. What you could do is take 0.0052ETH (which is $20 worth of Ethereum), send it to a smart contract that will redirect it to your teenager, but with the condition that the money can only be used to buy a movie ticket. It cannot be used to buy something else, like a beer.
Programmable Money
Smart contracts mean you can program money. This is revolutionary.
In order to do the example I just mentioned, you would need to program a DApp, which is short for decentralized application.
Today, there are thousands of DApps on the Ethereum network.
Eventually, you could imagine an entire business built on the blockchain.
For example, think of Kickstarter. It’s essentially a series of rules to move money around. People send money to a project, and if it reaches its goal before a time limit, the money is automatically redistributed to the maker of the project. Otherwise, it is sent back to the givers.
All of this could be easily built into the Ethereum blockchain, in a fully decentralized way, and with no single corporation taking a huge cut of the profits.
In this case, the software itself holds the money. When it does, nobody can touch it, not even the people who programmed that software.
This brings us to another huge innovation: cryptocurrency doesn’t care if you’re a human or a computer.
With crypto, computers can now have their bank account for the first time in history. This is also revolutionary.
Decentralized Autonomous Applications
This can lead to some crazy ideas such as the DAO which stands for Decentralized Autonomous Organisation, which are entire companies with nobody in control, and who can manage their own money and operations.
Now, let’s push things even further and see what happens if we merge three of the most exciting upcoming technologies:
- Cryptocurrency
- Artificial Intelligence
- Self-Driving Cars
The Self-Owning car
Consider an AI car that manages its own Ethereum address.
The car drives around on its own and offers a service like Uber. People get in the car, go to their destination, and pay for the service with ETH.
The car works 24/7. It saves its own money and spends it on gas or electricity, maintenance, and repair costs.
We could put a bunch of these cars on the road and for the first time, we would have empowered AI to proactively participate and compete in the global economy. Wouldn’t that be incredible?
Say a car doesn’t do too well and goes bankrupt. We bring it back to the factory, tweak its AI, and send it back on the road. We could even take the AI that does the best job, and duplicate it in every other car.
In the end, cryptocurrency is the key innovation that enables AI to take part in the global economy, just like humans do today.
Problems
While all of these innovations are cool, there are still a lot of problems with crypto right now.
Under Construction
It’s important to understand that this is the early days of cryptocurrencies. Just like the Internet was in the early 90s.
Bitcoin and Ethereum are still under construction, and this leads to some crazy stories.
For example, a random programmer was playing around with Ethereum and accidentally killed a smart contract holding over 150 million dollars. He just destroyed that money forever.
This is what can happen when there is so much speculation and value around technologies that are in such an early stage of development.
Distribution
Only 4% of the Bitcoin addresses own over 96% of all Bitcoins.
In other words, if Bitcoin was a country. It would be one of the worst country regarding wealth inequality. We missed the mark with the idea of democratizing money with Bitcoin. It’s going to be important when we come up with future coins to think about ways of distributing them that would lead to a more balanced economy.
Speed
Lots of people are making fun of cryptocurrencies saying they are essentially very slow spreadsheets. These people have a point.
Because everything that goes into making crypto distributed and permissionless also makes them really slow. While Visa can process about 24,000 transactions per second, Bitcoin and Ethereum can only process about 20 on average.
Electricity Consumption
As I mentioned earlier, the environment is another issue. It’s estimated that the Bitcoin network consumes more energy than most countries. This is because of the proof of work algorithm, which requires a lot of electricity. But there are solutions in development as we speak.
For instance, in 2022, Ethereum successfully transitioned to the proof of stake algorithm, essentially reducing its energy consumption by 99.9% while still maintaining security.
User-Experience
As you might have heard, crypto is unforgiving.
For instance, if you forget your private key, or if someone else finds it or if you send your coins to the wrong address (and we have seen earlier how complicated these addresses are), your money is lost forever.
On the blockchain, there’s no I forgot my password buttons. There’s no undo, and there’s no customer support either.
The blockchain is built that way because it is the foundational layer of the infrastructure. It has to be ruthlessly unforgiving to guarantee that every transaction will absolutely go through, regardless of whether it is meant to be, or an error. No one can ever be able to interfere with the foundation.
On the other hand, it’s unfortunate because I have seen so many friends get into crypto, and then lose their money.
If you want to avoid losing your money, please read this article I wrote.
In Conclusion
As we have seen, crypto brings many revolutions:
- Create unique digital objects.
- Send money without financial institutions.
- Prevent government overreach.
- Program money.
- Create decentralized apps that anyone can freely use.
- Allow AI to use money.
Bitcoin isn’t just a weird new PayPal. It’s so much more.
This isn’t about an investment opportunity or making millions. It’s about a new, absolutely world-changing technology.
Bitcoin itself could disappear tomorrow, and it wouldn’t matter. The technology is there to stay. Bitcoin gave us a paradigm shift. It opened everyone’s eyes to new possibilities. A new way in which we can now transact value through the Internet.
It brings us to the Internet of value.
You see, the first version of the Internet revolutionized the free flow of information. Today we can instantly communicate with anyone, anywhere on the planet, for free.
Crypto will bring the same revolution but for the exchange of value. Whether it’s money, stocks, or commodities. We’ll be able to exchange anything that has value, as easily as we can send an email today.
Think of the early days of the Internet. Back when the only use case was sending emails. Nobody could have imagined all the incredible businesses and services that have been built on this new technology: Google, YouTube, Amazon, Netflix.
Cryptocurrencies bring upon us the same type of opportunity but with the economy of value, instead of information. Today, we learned about Bitcoin and Ethereum. But this is just the tip of the iceberg…
If you want to know more about the Internet of Value, read this other article from my talk back in 2019:
Thank you!
Did you enjoy this? Here’s even more articles I wrote about crypto
Understanding NFTs
How Governement Could Get Complete Control Over Our Money
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