Bitcoin, also known as BTC, is a digital currency which is used for making online financial transactions. The financial transactions are performed for trading goods and services by various traders who accept bitcoin as mode of payment. The financial transactions are totally de-centralized, i.e., not controlled by any central authorities or governments. Unlike hard currencies (such as dollars, yens or rupees) which are created and printed by respective governments, bitcoins are generated by programming and secured by a technology called cryptography.
Cryptography is a technology that is used to secure any digital data against possible tampering during online transmission. It employs a mechanism by which the data is combined with a mathematical function called private key which generates a new encrypted data which is difficult to recognize and hence modify or misuse. This process of modifying original data with the help of a private key is known as encryption. The encrypted data is then transmitted through online media to the designated receiver. The receiver performs a reverse process called decryption with the help of another function called public key in order to generate the original data. In this manner the original data remains protected from any type of modification during transmission. This process of using a pair of encryption keys, namely private key (for encryption) & public key (for decryption) is known as public key encryption. Bitcoin employs cryptography for securing the transaction and is also known as cryptocurrency.
Bitcoin was first invented by an unidentified person named Satoshi Nakamoto in 2009. It was generated by a mathematical process called mining and was since then used for trading of a wide range of goods and services by numerous customers and companies. Many big corporations such as Microsoft, Amazon, Expedia, CVS Pharmacy, Kmart, WordPress, HomeDepot etc., accept bitcoin for selling operations. Although in some countries, bitcoin is not considered legal tender for performing government or banking transactions, in countries like United States, Japan, Russia, India, Singapore, Germany, Canada, Holland etc., bitcoin is considered as legal tender.
Bitcoin can be exchanged for any valid currency (such as US dollar ($), Japanese yen (¥), Indian Rupees (₹)) through online transaction. The value of bitcoin is volatile and varies according to the market demand and amount of trading at any instant. As of January, 2021, 1 Bitcoin = 39,364 USD. Several small amounts of bitcoin are available for making transactions, such as mBTC (milliBitcoin = .001 Bitcoin), Sat (Satoshi = .00000001 Bitcoin) etc. People can buy Bitcoin after paying by US dollar, Indian Rupee etc., and make financial transactions using Bitcoin.
A bitcoin is a string of data consisting of 34 alphanumeric characters. It is called Bitcoin address. It comes with a private key/public key pair each of which is a 256-bit data. The private key is combined with Bitcoin address to generate an encrypted Bitcoin address which is secured against tampering. The private key is kept secret by the owner of the Bitcoin. If the private key is lost the bitcoin will be lost forever as it is impossible to make any bitcoin transaction without the private key. The encrypted bitcoin address is transmitted to the designated receiver of the payment along with the public key through online mode. The receiver (payee), on receiving the encrypted bitcoin address, will apply the public key, to decrypt it and get back the original bitcoin address. The receiver, in turn can reuse the bitcoin address for making another payment transaction to other vendors, using another set of private/public key pairs. Thus bitcoin transaction is secured with the help of cryptography.
The bitcoin address is generated by a mathematical process called mining. The mining is done by professionals called miners who solve a mathematical algorithm to find out a valid 34-character bitcoin address that will satisfy all criteria for performing bitcoin transactions. There are in total 21 billion valid bitcoin addresses and the job of a miner is to guess a unique & unused bitcoin address which could be used for making bitcoin transactions. The miner who generates a new bitcoin address gets a reward of 12.5 unused bitcoin addresses but the reward amount varies with time and get reduced by every 4 years. Apart from creating new bitcoin addresses, miners also create bitcoin transaction blocks which records bitcoin transactions. After a bitcoin transaction is made, corresponding bitcoin transaction block is created by the miner and added to a public network called the blockchain which contains numerous bitcoin transaction blocks recording all bitcoin transactions ever made.
The blockchain is a public network consisting of a number of software blocks that record details of bitcoin transactions. All the blocks are connected with each other like a chain and hence the name. It is also called digital ledger as it stores financial transaction records just like an accounting ledger. The blockchain software is open source and can be downloaded free of cost from internet. Anyone with an internet connectivity can download the entire blockchain containing thousands of blocks. Approximately a new block is added to the blockchain at every 10 minutes. Anyone can edit the blocks in a blockchain using blockchain software just like Wikipedia. However, as all blocks are interconnected, any attempt to illegally changing any block gets immediate attention and immediately gets corrected by others. The hash function (of previous block) present in each block automatically detects if the previous block is tampered by any fraudster and appropriate actions are taken.
As all the blocks are connected, the entire blockchain history is available for cross-checking. Whenever a new block is created by a bitcoin miner, the miner broadcast the information to all blocks and checks if the particular bitcoin mentioned in the new block is actually unused or not. If it is found that the same bitcoin address in already spent by the same owner, the later transaction will be cancelled. Similarly, if it is found that the bitcoin owner is not the valid owner of the bitcoin as per the blockchain records, it will be concluded that the later user has illegally copied/stolen the bitcoin address from the valid owner and hence the later transaction will be cancelled. Thus blockchain prevents copy/duplication of bitcoin addresses and stops double spending of the same bitcoin. If it is found that the bitcoin address is unspent and is owned by a legitimate owner, then the transaction block is added to the blockchain, the bitcoin transaction will be completed and the miner gets a transaction fee in terms of bitcoin.
Thus in one hand the blockchain prevents any attempt to tamper any bitcoin transaction block with the help of hash function. On the other hand mining technology prevents any attempt of double spending of same bitcoin by two users. Because of these two security reasons, bitcoin is considered as most secured way of making financial transactions. More and more people are purchasing bitcoin by spending hard currencies such as US dollar etc., and perform financial transactions using bitcoin for purchasing various goods and services. As bitcoin is completely de-centralized with no central authorities to control the currencies as well as the transactions, it is easy to make overseas and cross-border transactions without paying any extra foreign exchequer and licensing fees. Thus bitcoin offers an extremely secured and hassle-free mode of online financial transactions.
How to Get Bitcoin
A user can purchase bitcoin from a Bitcoin Exchange by paying in dollar (or any other valid currency). Popular bitcoin exchanges include Coinbase, Binance, Bitstamp or BitQuick. The user gets bitcoin address along with private key/public key pair using which he/she can make financial transaction using the bitcoin. Bitcoin can be exchanged for various goods and services from traders who accept bitcoin for payment transactions. Any time, the user can sell the bitcoin in the exchange and get back the normal currency, such as dollar.
Bitcoin once purchased must be stored in a bitcoin wallet. A bitcoin wallet is a software that stores bitcoin addresses and private/public key pairs, all of which are digital numbers. Whenever a user purchases bitcoin from an exchange, a bitcoin wallet is generated. A single bitcoin wallet can store multiple bitcoin addresses and private/public key pairs. Depending on the usage, there are four different types of wallets:
Software Wallet: This is a software that stores bitcoin address as well as private key/public key pairs and is capable of performing bitcoin transactions using block chain. At the time of making bitcoin transactions, software wallets login to blockchain through internet and perform the transaction. Software wallets are not very safe as they are connected to internet and suffer from various online threats such as stealing and hacking as a result of which the private keys are compromised.
Hardware Wallet: These are digital devices that store Bitcoin address and private/public keys in offline mode. This is the safest among all wallets as they are not connected to internet and hence free of any security threats such as stealing or hacking. However, if the device itself gets lost, the user will lose the bitcoin address & private/public key forever as there is no way to recover a bitcoin address by any means. Hardware wallets are also known as cold storage as they are not connected to internet. At the time of making bitcoin transaction, the bitcoin address and the keys need to be transferred in any software wallet so that transactions could be made through blockchain.
Paper Wallet: These are hard copy (paper copy) of the bitcoin address and private/public key pairs. These are nothing but printouts displaying the bitcoin address (a number) and kprivate/public keys (some other numbers). User can store these papers in any secured place such as bank vaults or lockers so that in case the hardware wallet gets lost, it can recover the bitcoin using any software wallet.
Bitcoin ATM: These are special ATM machines that receive hard currency (such as dollars or rupees) and returns bitcoin address and private/public keys to user bitcoin wallets.
Challenges of Bitcoin
The bitcoin offers an extremely safe and secure way of making financial transaction and is adopted by numerous users and companies across the globe as a means for making transactions. However, bitcoin is not free of challenges. As it offers a hassle free and cheaper option to make overseas transactions across the international borders, it is often used by illegal drug peddlers and terrorists for making transactions without being caught. As there is no central regulating authority, it is very easy for criminals to bypass lawmakers and government agencies and make unlawful transactions. For these reasons, some governments and banks do not allow bitcoin transactions for their official use. In spite of these, more and more people are resorting to bitcoin transactions to avoid frequent hacker and other security attacks and resulting financial and other losses.
Written by: Prof. Karabi Bandyopadhyay Faculty, IT & Systems, ISB&M, Kolkata