Bitcoin Explained Through Examples
The fundamentals of Bitcoin are confusing. Especially if you don’t have a background in computers, the pieces and steps don’t make sense. This confusion can make investing in and using Bitcoin seem risky or overwhelming.
To break down the complexity of Bitcoin, we’ve written a short story and then translated the tale into cryptocurrency processes.
A Bitcoin example: Trading in a Small Town on Mars
Picture an idyllic town on Mars like the Wild West of the United States from the movies. It’s a place entirely separate from the world order anywhere else in the Universe. Here, it’s every person for themselves – trying to survive and trusting no one.
To protect their possessions, this town has created a centralized system for keeping track of what everyone has. A book in Town Hall holds a list of every member of the city and their belongings.
If someone reports a robbery, everyone’s property is checked against the town records. With this system, it’s easy to check that someone else hasn’t taken an object that doesn’t belong to them.
When the time comes for individuals to trade, everything is documented in the book. For this story, let’s say that Bob wants to exchange a pear for one of Alice’s apples.
Alice and Bob go to Town Hall together. Two records in the master book are modified. Alice’s entry says “-1 apple, +1 pear.” Bob’s new entry says “-1 pear, +1 apple.” If there’s ever any confusion, citizens can go back and check the record book.
Here, people have time to record the transaction together. They ensure that the records are current and correct.
Most banks on Earth follow a similar system to our hypothetical Martian town record book. Instead of trading individual items, on Earth, we use money to facilitate the exchanges of goods or services. The bank tracks what you have because it keeps a record of how your money comes and goes.
The challenge to the system is that banks are expensive to maintain. They have buildings, security personnel, bankers, accountants, online systems, computers, and so on. None of this is cheap! So, banks charge a transaction fee for using their services.
Bitcoin, like banks, follows this same system of resource transfers. Instead of a centralized, private, internal process of record-keeping, Bitcoin acts more like the town on Mars. Everyone’s Bitcoin transactions are visible to anyone else.
This virtual town record book stays updated and safe from becoming lost or damaged by having working copies all over the world at any given time. The technical process of tracking all of these transfer transactions is called Blockchain.
Blockchain architecture works exactly like the journal entries on Mars. Every time an item is sold, the resource list of both the sender and receiver is updated. A note is made on their files (called seeds) and, in the case of Bitcoin, on the object itself.
Unlike Mars, on Earth, we need a third-party to take care of the record-keeping for us. Most people on Earth have a lot going on. Plus, digital transactions are much faster and harder to keep up with than trading an apple for a pear. That’s why we use computers to keep everyone’s records updated and to track transfers.
With Bitcoin, miners maintain the record books. Miners use their computers to keep the record books secured and updated. Spreading this responsibility among multiple people makes it safer and more efficient. Because it takes time and tools to manage all of the transactions and assets, miners charge for their services in the form of Bitcoin transaction fees.
Bitcoin record books are protected using a form of encryption called hashing. Hashing combines all of the transaction information in a way that cannot be guessed easily. It turns information like “Susie traded four gold to Greg on March 1 who then bought two pears from Steven who turned around and bought 15 carrots from Margaret” into a combination of seemingly random, computer-generated letters and numbers. Hashing also keeps all of the book entries safe from prying eyes or those trying to hack the system.