Bitcoin has no backing

What Is Bitcoin Backed By?

Hint: The correct answer is not ‘nothing’

One of the most common comments made by people when I am presenting or writing about Bitcoin is the ‘but-it’s-backed-by-nothing’ position.

On the face of it, it seems like a fair comment. After all, there’s nothing physical about Bitcoin that we can point to and nothing that it is obviously linked or pegged to.

And, if I’m completely honest, I remember having the same thought myself when I began my own voyage of discovery into this new weird alternative money some years ago. It’s actually the part of Bitcoin that took me the longest to really understand.

But if Bitcoin is not backed by anything, what it is backed by?

Before we answer that question, there is an elephant in the room we must address first.

The myth of fiat currency

If you ask anyone in a roomful of people in the UK if they would accept a five-pound note in settlement of a debt that existed between you to the same value, the chances are that everyone would accept it without hesitation or suspicion. This is, of course, exactly what we do every day when we go to the shop or pay someone to do something.

But who says this five-pound note is worth five pounds? Most of us never really think about this because the system has worked this way for hundreds of years, especially in the UK which is currently enjoying the status of having the oldest currency in the world being established some 1,200 years ago.

Put simply, there isn’t anyone alive who can remember anything different.

If you examine carefully your five-pound note, you will find, in extremely small letters, the following words:

I promise to pay the bearer on demand the sum of five Pounds

Why is this there and what does this actually mean?

These days it simply means that if you take it to the central bank, in this case, the Bank Of England, they will happily exchange it for … another five-pound note. Or a combination of change that comes to the same total.

However, prior to 1931, a time when this message was considerably more prominent on the front of all currency notes, it was actually possible to exchange your five-pound note for the equivalent in gold. Yes, real, actual gold in the form of minted gold sovereigns that you could physically walk away with and take home. It’s difficult to imagine for those of us who walk the earth today.

Later on, our currency was still backed by gold, albeit slightly more indirectly, under the Bretton Woods agreement which pegged our currency to the US dollar beginning in 1944. In turn, the US guaranteed a gold standard for all forty-four members of the scheme by keeping physical gold reserves to the same level as dollars issued.

However, by 1971 this became unsustainable and in that year President Nixon closed the gold window, effectively converting all currencies on the planet to a form of fiat currency at a stroke.

The difference is subtle on the face of it, but actually important economically speaking.

A fiat currency has no psychical backing at all and is not pegged to any commodity except, basically, the confidence of the people. This means you can produce as much as you like of it without worrying about reserves as long as you maintain enough confidence in the people concerned.

That confidence, in turn, is essential to the system working and is directly affected by the actions of governments, banks and even, on occasion, individuals who have far too much power. It uses the trust of the people in those same bodies to manage and maintain our spending power, something that has, historically, been fraught with problems.

On the whole, however, the system works. We will happily accept that five-pound note in settlement of debt even though we know it’s only a piece of a paper with no inherent value whatsoever.

We will accept it knowing that we have no real way of knowing what it’s value will be tomorrow, except an idea, backed by experience, that it will only be slightly less than today as long as our elected official maintains the current inflation levels.

We accept it even though we know that unsustainable debt mountains are piling up around the world and we know, in our heart of hearts, that at some point we’re going to have to go through a lot of pain to fix these. Hopefully, we all think, not in our lifetimes.

The reality is that we accept it mainly because we have absolute confidence that someone else will accept it from us.

Of course, if you lived in Argentina in the 1980s, Zimbabwe in the 2010s or Venezuela today, you might disagree. Such is the disadvantage of the fiat system — when the curtain is pulled back, it simply won’t function.

But up until now, there has never really been a better alternative.

So what is Bitcoin actually backed by?

I took a few minutes to reiterate how our fiat currencies work to make it clear that even if it were the case that Bitcoin was backed by nothing, it wouldn’t actually matter anyway so long as certain conditions are met.

As we have seen (and experience every day), a global system can still work based only on confidence, albeit with the odd hiccup in the form of hyperinflation or a devaluation from time to time.

But if I were to go to that same room of people I offered the five-pound note to earlier and instead offered the equivalent amount of Bitcoin, how many would accept it this time? It’s likely to be a much lower number. Those who did accept it would no doubt be familiar with it, many would-be asking “what is Bitcoin?” and a few may even decline even though they know what it is.

So whilst confidence in Bitcoin is much lower than fiat for the time being (and is likely to remain this way for some time) Bitcoin has several advantages over fiat which are not immediately obvious. One, in particular, is quite relevant. It’s the fact that Bitcoin IS actually backed by something other than just confidence.

Bitcoin runs on a highly secure network, one that grows in security every day, which, in turn, is based on unbreakable, unchangeable, incorruptible mathematics. Even better, this system operates without our imperfect, entirely corruptible human selves involved. It is an entirely closed, self-checking system.

It cannot be influenced, changed or affected by any one individual, official, government or country at any time. It deals only in absolutes and is designed, at its very core, to be a very long term, deflationary store-of-value system. It’s complex and I don’t propose to go into it here, although this article covers it in detail if you want to find out more information about how this works.

Put simply, your transactions are backed by solid, immutable data on a scale of security that is hard to demonstrate in simple terms. That backing is also the reason why Bitcoin has never been hacked at any point in its entire history and, as each day goes by, the likelihood of it ever is diminishing steadily.

Compare that to fiat which is literally printed out of thin air and ascribed value based on traditional confidence and our central organizations assuring us that it does. Most of the time they are right, of course, and the system works pretty well, but Bitcoin is always right in that sense.

These are bold and almost unbelievable statements when you first hear them, but the fact is that Bitcoin will always work and will always be a solid basis of currency or transaction as long as the rules of mathematics continue to apply. In basic terms, as long as two plus two continues to equal four.

This is still not so easy for us humans to get our brains around. We can easily imagine ‘two’ or ‘three’ for example, but we can’t picture ‘eight million’ or ‘sixty thousand’ — our brains just don’t seem to be capable of doing that. Yet all these numbers are ‘real’ and form the basis of much of what we do.

To use a simplified analogy, when you buy a four-pack of tuna in the supermarket, that ‘four’ is a real, solid representation of something physical that is absolute. You don’t get three or five, you always get four. You have total confidence in what you’re getting and, of course, you can visually check it anyway. You have the same with Bitcoin both in terms of that mathematical confidence and the fact you can check the blockchain if you want to. After all, it’s a public ledger.

But this is still not easy for us to grasp because we’re so used to seeing something physical at the end of it. Even things we intrinsically know are backed by maths, such as architectural projects, aircraft, any form of engineering or, actually, most things that we’re familiar with in our day to day lives, still have some sort of psychical presence that make them ‘real.’

Bitcoin’s output, of mathematically perfect blocks of immaculately encrypted information that forms the basis of all our transactions, is always virtual and, like trying to imagine that eight million, that’s the step that seems to push our brains too far into the realms of incredulity.

Somehow we still have to check it out for ourselves, like insisting on touching something when the sign says ‘wet paint’ just to make sure. How do you that when it’s virtual?

Bitcoin’s greatest strength is also its greatest weakness — understanding the complexity that underlies it and why any of us should have any confidence in it at all. Bitcoin is non-proprietary and entirely open for public scrutiny by anyone at any time and that, at least, makes that task a little easier. Reading, investigating and learning is the answer.

But at the same time, I always use this analogy: You can get in a car and drive it safely and with complete confidence, regardless of whether you actually know how that complex machine works. And if you want to learn, there’s nothing stopping you from taking the engine apart and finding out.

The takeaway

Our current currency system still works pretty well despite its obvious limitations in an increasingly digital world and the detachment of fiat from any sort of backing at all. Confidence remains high for now and you can always spend your pounds and dollars pretty much anywhere with no issue.

Bitcoin moves us to the next natural step in financial evolution AND provides a solid backing to do it, but for the time being it is no more than a niche project in terms of the global financial behemoth that surrounds it. Naturally, that means, for now, confidence is lower.

But in any case, as more and more of us drive that metaphorical car and security in the system continues to grow day by day, it’s entirely possible that sheer confidence alone will be enough to drive the transactions forward in future in any case, just like fiat.

And whilst that’s a wonderful place to be that’s already proven to work, I still personally find it reassuring that there’s a solid form of mathematical backing behind it AND a way of checking it for myself on a public, incorruptible ledger should I ever feel inclined to do so.

Y’know, like checking that paint is still wet, regardless of what the sign says.

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Bitcoin

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Bitcoin is a decentralized digital currency created by an unknown person or group of people under the name Satoshi Nakamoto and released as open-source software in 2009. It does not rely on a central server to process transactions or store funds.
There are a maximum of 2,099,999,997,690,000 Bitcoin elements (called Satoshis, the unit has been named in collective homage to the original creator), which are currently most commonly measured in units of 100,000,000 known as BTC. There will only ever be 21 million Bitcoin (BTC) to ever be created.

As of January 2018, it is the most widely used alternative currency, now with the total market cap around 250 billion US dollars.

Bitcoin has no central issuer; instead, the peer-to-peer network regulates Bitcoins, transactions and issuance according to consensus in network software. These transactions are verified by network nodes through the use of cryptography and recorded in a public distributed ledger called a blockchain.

Bitcoins are issued to various nodes that verify transactions through computing power. It is established that there will be a limited and scheduled release of no more than 21 million BTC worth of coins, which will be fully issued by the year 2140.

Bitcoins are created as a reward for a process known as mining. They can be exchanged for other currencies, products, and services. As of February 2015, CoinJolt provided over 100,000 merchants and vendors accepted Bitcoin as payment. Research produced by the University of Cambridge estimates that in 2017, there were 2.9 to 5.8 million unique users using a cryptocurrency wallet, most of them using Bitcoin.

Internationally, Bitcoins can be exchanged and managed through various websites and software along with physical banknotes and coins.

Contents

Basic Concepts [ edit ]

Currency [ edit ]

Alice wants to buy alpaca socks which Bob has for sale. In return, she must provide something of equal value to Bob. The most efficient way to do this is by using a medium of exchange that Bob accepts which would be classified as currency. Currency makes trade easier by eliminating the need for coincidence of wants required in other systems of trade such as barter. Currency adoption and acceptance can be global, national, or in some cases local or community-based.

Banks [ edit ]

Alice doesn’t necessarily need to be in direct contact with bob in order for the funds to be transferred. She may instead transfer this value by first entrusting her currency to a bank who promises to store and protect Alice’s currency notes. The bank gives Alice a written promise (called a «bank statement») that entitles her to withdraw the same number of currency bills that she deposited. Since the money is still Alice’s, she is entitled to do with it whatever she pleases, and the bank (like most banks), for a small fee, will do Alice the service of passing on the currency bills to Bob on her behalf. This is done by Alice’s bank by giving the dollar bills to Bob’s bank and informing them that the money is for Bob, who will then see the amount the next time he checks his balance or receives his bank statement.

Since banks have many customers, and bank employees require money for doing the job of talking to people and signing documents, banks in recent times have been using machines such as ATMs and web servers that do the job of interacting with customers instead of paid bank employees. The task of these machines is to learn what each customer wants to do with their money and, to the extent that it is possible, act on what the customer wants (for example, ATMs can hand out cash). Customers can always know how much money they have in their accounts, and they are confident that the numbers they see in their bank statements and on their computer screens accurately reflect the number of dollars that they can get from the bank on demand. They can be so sure of this that they can accept those numbers in the same way they accept paper banknotes (this is similar to the way people started accepting paper dollars when they had been accepting gold or silver).

Such a system has several disadvantages:

• It is costly. EFTs in Europe it can cost up to 25 euros. Credit transactions may cost a significant proportion of the transaction in place.
• It is slow. Checking and low-cost wire services take days to complete.
• In most cases, it cannot be anonymous.
• Accounts can be frozen, or their balance partially or wholly confiscated.
• Banks and other payment processors like PayPal, Visa, and Mastercard may refuse to process payments for certain legal entities.

Bitcoin is a system of owning and voluntarily transferring amounts of so-called bitcoins, in a manner similar to online banking, but pseudonymously and without reliance on a central authority to maintain account balances. If bitcoins are valuable, it is because they are useful and limited in supply.

Bitcoin Basics [ edit ]

Buying Bitcoin [ edit ]

How to buy Bitcoin? There are many ways to buy Bitcoin cryptocurrency, with debit or credit card, PayPal, online on cryptocurrency exchange, with bank transfers and etc. It’s difficult to say what is the best way to buy Bitcoin. After the opening Bitcoin address-account you can start buying coins.

Buying and selling coins to individuals is carried on specialized sites, such as LocalBitcoins. User should select the country and the city in the special window, fill in the information on the number of coins and select the purchase payment method.

Seller should be chosen according to the grade level on the site. Purchasing Bitcoins at the unaccredited sites or from individuals is not recommended due to the high fraud risk.

Creation of coins [ edit ]

The creation of coins must be limited for the currency to have any value.

New coins are slowly mined into existence by following a mutually agreed-upon set of rules. A user mining bitcoins is running a software program that searches tirelessly for a solution to a very difficult math problem whose difficulty is precisely known. The difficulty is automatically adjusted regularly so that the number of solutions found globally, by everyone, for a given unit of time is constant: an average of 6 per hour. When a solution is found, the user may tell everyone of the existence of this newly found solution, along with other information, packaged together in what is called a «block».

Blocks create 12.5 new bitcoins at present. This amount, known as the block reward, is an incentive for people to perform the computation work required for generating blocks. Every 210,000 new blocks generated (roughly every 4 years), the number of bitcoins that can be «mined» in a block reduces by 50%. Originally the block reward was 50 bitcoins; it halved in November 2012 and then once more in July 2016. Any block that is created by a malicious user that does not follow this rule (or any other rules) will be rejected by everyone else. In the end, no more than 21 million bitcoins will ever exist.

Because the block reward will decrease over the long term, miners will some day instead pay for their hardware and electricity costs by collecting transaction fees. The sender of money may voluntarily pay a small transaction fee which will be kept by whoever finds the next block. Paying this fee will encourage miners to include the transaction in a block more quickly.

Bitcoin Mining [ edit ]

Bitcoin Mining is the process of adding transaction records to Bitcoin’s public ledger of past transactions (and a mining rig is a colloquial metaphor for a single computer system that performs the necessary computations for mining). This ledger of past transactions is called the block chain as it is a chain of blocks. The block chain serves to confirm transactions to the rest of the network as having taken place. Bitcoin nodes use the block chain to distinguish legitimate Bitcoin transactions from attempts to re-spend coins that have already been spent elsewhere.

Bitcoin mining’ is intentionally designed to be resource-intensive and difficult so that the number of blocks found each day by miners remains steady. Individual blocks must contain a proof of work to be considered valid. This proof of work is verified by other Bitcoin nodes each time they receive a block. Bitcoin uses the hashcash proof-of-work function.

The primary purpose of mining is to allow Bitcoin nodes to reach a secure, tamper-resistant consensus. Bitcoin Mining is also the mechanism used to introduce Bitcoins into the system: Miners are paid any transaction fees as well as a subsidy of newly created coins. This both serves the purpose of disseminating new coins in a decentralized manner as well as motivating people to provide security for the system.

Bitcoin mining is so called because it resembles the mining of other commodities: it requires exertion and it slowly makes new currency available at a rate that resembles the rate at which commodities like gold are mined from the ground.

Sending payments [ edit ]

To guarantee that a third-party, let’s call her Eve, cannot spend other people’s bitcoins by creating transactions in their names, Bitcoin uses public key cryptography to make and verify digital signatures. In this system, each person, such as Alice or Bob, has one or more addresses each with an associated pair of public and private keys that they may hold in a wallet. Only the user with the private key can sign a transaction to give some of their bitcoins to somebody else, but anyone can validate the signature using that user’s public key.

Suppose Alice wants to send a bitcoin to Bob.

• Bob sends his address to Alice.
• Alice adds Bob’s address and the amount of bitcoins to transfer to a message: a ‘transaction’ message.
• Alice signs the transaction with her private key, and announces her public key for signature verification.
• Alice broadcasts the transaction on the Bitcoin network for all to see.

(Only the first two steps require human action. The rest is done by the Bitcoin client software.)

Looking at this transaction from the outside, anyone who knows that these addresses belong to Alice and Bobcan see that Alice has agreed to transfer the amount to Bob, because nobody else has Alice’s private key. Alice would be foolish to give her private key to other people, as this would allow them to sign transactions in her name, removing funds from her control.

Later on, when Bob wishes to transfer the same bitcoins to Charlie, he will do the same thing:

• Charlie sends Bob his address.
• Bob adds Charlie’s address and the amount of bitcoins to transfer to a message: a ‘transaction’ message.
• Bob signs the transaction with his private key, and announces his public key for signature verification.
• Bob broadcasts the transaction on the Bitcoin network for all to see.

Only Bob can do this because only he has the private key that can create a valid signature for the transaction.

Eve cannot change whose coins these are by replacing Bob’s address with her address, because Alice signed the transfer to Bob using her own private key, which is kept secret from Eve, and instructing that the coins which were hers now belong to Bob. So if Charlie accepts that the original coin was in the hands of Alice, he will also accept the fact that this coin was later passed to Bob, and now Bob is passing this same coin to him.

Preventing double-spending [ edit ]

The process described above does not prevent Alice from using the same bitcoins in more than one transaction. The following process does; this is the primary innovation behind Bitcoin.

• Details about the transaction are sent and forwarded to all or as many other computers as possible.
• A constantly growing chain of blocks that contains a record of all transactions is collectively maintained by all computers (each has a full copy).
• To be accepted in the chain, transaction blocks must be valid and must include proof-of-work (one block generated by the network every 10 minutes).
• Blocks are chained in a way so that, if any one is modified, all following blocks will have to be recomputed.
• When multiple valid continuations to this chain appear, only the longest such branch is accepted and it is then extended further.

When Bob sees that his transaction has been included in a block, which has been made part of the single longest and fastest-growing blockchain (extended with significant computational effort), he can be confident that the transaction by Alice has been accepted by the computers in the network and is permanently recorded, preventing Alice from creating a second transaction with the same coin. In order for Alice to thwart this system and double-spend her coins, she would need to muster more computing power than all other Bitcoin users combined.

Anonymity [ edit ]

When it comes to the Bitcoin network itself, there are no «accounts» to set up, and no e-mail addresses, user-names or passwords are required to hold or spend bitcoins. Each balance is simply associated with an address and its public-private key pair. The money «belongs» to anyone who has the private key and can sign transactions with it. Moreover, those keys do not have to be registered anywhere in advance, as they are only used when required for a transaction. Transacting parties do not need to know each other’s identity in the same way that a store owner does not know a cash-paying customer’s name.

A Bitcoin address mathematically corresponds to a public key and looks like this:

Each person can have many such addresses, each with its own balance, which makes it very difficult to know which person owns what amount. In order to protect his privacy, Bob can generate a new public-private key pair for each individual receiving transaction and the Bitcoin software encourages this behavior by default. Continuing the example from above, when Charlie receives the bitcoins from Bob, Charlie will not be able to identify who owned the bitcoins before Bob.

Capitalization / Nomenclature [ edit ]

Since Bitcoin is both a currency and a protocol, capitalization can be confusing. Accepted practice is to use Bitcoin (singular with an upper case letter B) to label the protocol, software, and community, and bitcoins (with a lower case b) to label units of the currency.

Bitcoin Halving [ edit ]

Bitcoin halving — is a process when every 210 000 blocks (approximately every four years) Bitcoin’s extraction complexity is increased (new coins begin to appear two times slower), and the reward for miners is reduced [1] .

Bitcoin price [ edit ]

The price of BTC token or Bitcoin is always chaining, however, BitcoinWiki gives you a chance to see the prices online on Coin360 widget.

Where to see and explore [ edit ]

You can directly explore the system in action by visiting Biteasy.com, Blockchain.info, Blokr.io Bitcoin Block Explorer or Bitcoin Block Explorer. This last site will show the latest blocks in the blockchain. The blockchain contains the agreed history of all transactions that took place in the system. Note how many blocks were generated in the last hour, which on average will be 6. Also notice the number of transactions; in just one hour there are between 6000 to 7000 transactions. This indicates how active the system currently is.

Next, navigate to one of these blocks. The block’s hash begins with a run of zeros. This is what made creating the block so difficult; a hash that begins with many zeros is much more difficult to find than a hash with few or no zeros. The computer that generated this block had to try many Nonce values (also listed on the block’s page) until it found one that generated this run of zeros. Next, see the line titled Previous block. Each block contains the hash of the block that came before it. This is what forms the chain of blocks. Now take a look at all the transactions the block contains. The first transaction is the income earned by the computer that generated this block. It includes a fixed amount of coins created out of «thin air» and possibly a fee collected from other transactions in the same block.

Drill down into any of the transactions and you will see how it is made up of one or more amounts coming in and out. Having more than one incoming and outgoing amount in a transaction enables the system to join and break amounts in any possible way, allowing for any fractional amount needed. Each incoming amount is a past transaction (which you can also view) from someone’s address, and each outgoing amount is addressed to someone and will be part of a future transaction (which you can also navigate down into if it has already taken place.)

Finally you can follow any of the addresses links and see what public information is available for them.

To get an impression of the amount of activity on the Bitcoin network, you might like to visit the monitoring websites Bitcoin Monitor and Bitcoin Watch. The first shows a real-time visualization of events on the Bitcoin network, and the second lists general statistics on the amount and size of recent transactions.

How many people use Bitcoin? [ edit ]

This is quite a difficult question to answer accurately. One approach is to count how many bitcoin clients connected to the network in the last 24 hours. We can do this because some clients transmit their addresses to the other members of the network periodically. In September 2011 this method suggested that there were about 60,000 users.

White Paper [ edit ]

Bitcoin WhitePaper (WP) is a document that helps your prospective customer make an informed decision in favor of your company or a specific product. If the document does not facilitate a decision, it may be anything but not WP. Speaking in the most understandable language, white paper is something between an article and an advertising brochure. The document contains quite useful information and at the same time leads to the fact that the best solution is to purchase a certain product or service.

You can read English (Original) Bitcoin White Paper here.

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