Bitcoin borrows from nearly three decades of research by academics, cypherpunk practitioners, and hobbyists who tried to create similar payment protocols. Some of the most prominent projects that preceded Bitcoin include: Digicash, b-money, Hashcash, e-gold, and Bit Gold. Bitcoin is often associated with Austrian economic theories, anarcho-capitalist principles, and general libertarian politicking by virtue of the exclusive developer community to whom Nakamoto first released their white paper, certain protocol design characteristics, and the political affiliations of early Bitcoin investors.
Conception to Launch
On October 31, 2008, at the peak of the Global Financial Crisis, just six weeks after the infamous investment bank, Lehman Brothers, declared bankruptcy, the pseudonymous Satoshi Nakamoto released the Bitcoin whitepaper to the cryptography mailing list. Titled “Bitcoin: A Peer-to-Peer Electronic Cash System”, the whitepaper proposed a new electronic cash system that would allow fully peer-to-peer online payments without reliance on trusted third parties. Soon after the release of the whitepaper, Satoshi implemented the Bitcoin software as open-source code. On 3 January 2009, the Bitcoin network came into existence with Satoshi mining the genesis block of Bitcoin, which included a now-famous “The Times” headline in the coinbase both to prove the network’s fair launch and to make a political statement about the global financial system. The event marked the birth of the world’s first non-sovereign, decentralized, digital money.
Hal Finney, who invented the first reusable proof-of-work system (RPoW) in 2004, received the first Bitcoin transaction (10 bitcoins) on January 12, 2009. In 2010, the first known commercial transaction using bitcoin occurred when programmer Laszlo Hanyecz bought two Papa John’s pizzas for 10,000 bitcoins.
In August 2010, a major vulnerability in the Bitcoin protocol was spotted and exploited in the Bitcoin network, allowing users to create an infinite amount of bitcoins. The transactions exploiting the vulnerability were quickly spotted and erased for the Bitcoin blockchain, with the vulnerability being patched in a network upgrade of the Bitcoin protocol. This was the only major security flaw found and exploited in Bitcoin’s history.
In December 2010, amidst rising publicity from Bitcoin’s use in financing Wikileaks, Satoshi Nakamoto, disappeared from involvement with Bitcoin. It is unknown why Satoshi disappeared from the project, although some believe Satoshi, cognizant of past struggles to launch a digital currency, recognized that a leader of the Bitcoin project could be a central point of failure. It is estimated that Nakamoto had mined about one million bitcoins before disappearing in 2010 when he handed the network alert key and control of the code repository over to Gavin Andresen.
Silk Road & Mt. Gox
One of the most iconic early use cases for Bitcoin was the Silk Road. Launched in early 2011, the Silk Road was a darknet marketplace that allowed users to buy and sell a wide variety of goods including, most notably, illegal drugs. Underpinning the Silk Road was the Tor network, which allowed users to browse the Silk Road anonymously and securely without potential traffic monitoring, and Bitcoin which provided a censorship-resistant payment rail for pseudonymous transactions. Over the course of its life, it is estimated that the Silk Road facilitated more than $1.2 billion in transactions, collecting over $80 million in sales commissions, leveraging the Bitcoin network as its payment rail. The site was shut down in 2013 when the FBI took advantage of the Silk Road’s centralized infrastructure, arresting founder Ross Ulbricht, and shuttering the site.
Founded by Jed McCaleb in July 2010, and led by Mark Karpeles until it collapsed, Mt. Gox was one of the earliest Bitcoin exchanges in the world. Based in Tokyo, Japan, the exchange would go on to handle over 70% of all bitcoin (BTC) transactions worldwide at its peak. Known for its chronic security issues, Mt. Gox was infamously hacked in 2014, losing 850,000 bitcoins worth about $450 million at the time. The hack sent the price of Bitcoin, which was in the midst of one of its first major price bubbles, plummeting. Bitcoin would sink into a bear market with prices not recovering until the 2017 bull run.
2017 Bubble & Bitcoin Cash Hard Fork
The 2017 price bubble was a watershed moment for Bitcoin. The price of Bitcoin rose more than 1900% from just under $1,000 at the beginning of the year to near $20,000 at its peak in December. At its peak, Bitcoin’s market capitalization eclipsed $325 billion. Along with the proliferation of Initial Coin Offerings, powered by Ethereum, Bitcoin’s incredible 2017 run propelled cryptocurrency into mainstream consciousness, among the most discussed phenomena of 2017.
Also notable in 2017, Bitcoin experienced its most contentious fork to date. Amidst rising transaction fees on Bitcoin and increasingly divergent views on scaling Bitcoin, an agreement was reached amongst prominent Bitcoin stakeholders in what is now known as the “New York Agreement”. The agreement was to support a set of network upgrades called SegWit2x. The proposal was backed by over 80% of Bitcoin’s hash rate. However, despite the desires of miners, users wanted to activate SegWit without the 2MB block size increase, the philosophy underpinning this decision being that the users controlled the network, not miners and Bitcoin businesses. Subsequently, they set a date (August 1, 2017) where Bitcoin would soft fork to support SegWit and keep the 1MB block size. Enough nodes signaled support for it that they forced miners to accept or have their blocks rejected by the network. A faction of the bigger blocks camp, rejected SegWit altogether, citing frustrations with the prioritization of SegWit over bigger blocks, and on August 1, 2017, they launched a hard fork of Bitcoin called Bitcoin Cash, with 8MB block limits. These events marked, one end, a landmark demonstration of power by the users of the Bitcoin network, and on the other end, the first great schism within the Bitcoin community.
2018 – Present
After peaking in December 2017, Bitcoin, along with the rest of the cryptocurrency market in January 2018, crashed, sending the cryptocurrency market into its latest bear market. Since then Bitcoin has dropped as low as $3,200, more than 80% below its ATH. However, while prices have yet to recover to 2017 highs, the institutionalization of Bitcoin has picked up significantly. Traditional Wall Street institutions including Chicago Mercantile Exchange, Intercontinental Exchange, and Fidelity have all launched cryptocurrency offerings, opening up the market to institutional investors. There are now several regulated exchanges and custodians. Furthermore, regulatory clarity around Bitcoin has improved dramatically with SEC Chairman, Jay Clayton, revealing at a Congressional hearing in February 2018, that the SEC does not consider Bitcoin to be a security.
Since it reached its cycle low in February 2019, Bitcoin’s price has recovered considerably, rising as high as $13,000 in June. With the recent announcements of Facebook’s Libra project and China’s Central Bank digital currency, governments and multinational corporations around the world have begun to look at cryptocurrencies more seriously. American officials are debating a digital dollar and lawmakers around the world are considering the central bank digital currency (CBDC) options. Furthermore, there have been numerous cryptocurrency-related hearings since Libra was announced. China has recently announced blockchain was a revolutionary technology and that it would make blockchain technology a strategic imperative for the country. Bitcoin’s price rose more than 40% after the announcement, its highest intraday movement since 2011.
BTC is used as a native currency within the Bitcoin network. BTC can be used for peer-to-peer payments and value storage within the Bitcoin network. Bitcoin is also used to pay fees for transactions. In efforts to keep Bitcoin decentralized, with its small, limited block sizes and low on-chain throughput, Bitcoin leverages off-chain payment channels for increased scalability. It is in this respect that Bitcoin acts as a payments settlement network.
Throughout its life, Bitcoin has most notably served as a digital currency for online marketplaces, a settlement layer for transferring value between Bitcoin exchanges, a capital-raising mechanism for novel cryptocurrency projects, a collateral asset for lending products, and a speculative store of value.
Bitcoin pioneered and currently uses Nakamoto Consensus whereby the valid chain is the longest chain with the most accumulated proof-of-work. Consensus in Bitcoin, and other systems using Nakamoto Conensus, is probabilistic because there is always a chance that a new, longer competing chain could emerge with more accumulated proof-of-work, that would invalidate the current chain.
How Does Distributed Consensus Work Anyways?
Miners solve computational puzzles to generate new blocks using a SHA-256 algorithm. In this process, miners compete to generate a hash less than the target number set by Bitcoin’s difficulty adjustment algorithm. The target difficulty level is adjusted every 2016 blocks.
Although open to anyone with a CPU, Bitcoin mining is now dominated by ASICs situated in enterprise-scale data centers. In order to smooth individual miner revenue as mining has become more competitive, mining is now done in pools where participants contribute hash power to the pool and receive a proportional share of the profits if the pool finds a valid block.
State of Cryptocurrency Mining
“Bitcoin” is a label used for a protocol and a currency.
Bitcoin, the currency, is bits of data usable outside the limitations of the protocol using second-layer solutions like Lightning Network payment channels.
Bitcoin, the protocol, is a distributed, time-stamped ledger of unspent transaction output (UTXO) transfers stored in an append-only chain of 1MB data blocks. A network of mining and economic nodes maintains this ledger by validating, propagating, and fighting to include mempool transactions in new blocks. Economic nodes (aka “full nodes”) receive transactions from other network participants, validate them against network consensus rules and double-spend vectors, and propagate the transactions to other full nodes that also validate and propagate. Valid transactions are sent to the network’s mempool waiting for mining nodes to confirm them via inclusion in the next block.
Mining nodes work to empty the mempool usually in a highest-to-lowest fee order by picking transactions to include in the next block and racing against each other to generate a hash less than the target number set by Bitcoin’s difficulty adjustment algorithm. Bitcoin uses a Proof-of-Work (PoW) consensus mechanism to establish the chain of blocks with the most accumulated “work” (a.k.a., energy spent on solved hashes) as the valid chain. Other network peers can cheaply verify the chain’s work.
Mining difficulty regularly adjusts to maintain Bitcoin’s average ten-minute block schedule. Mining nodes add new blocks to whatever chain has the largest accumulated proof of work maintained by a network of economic nodes with downloaded copies of the same chain.
Bitcoin Developer’s Guide
Bitcoin governance is the process by which protocol rules are decided upon, implemented, and enforced. Users (full nodes) adopt new rules according to their subjective views on what Bitcoin is and should be. If two or more individuals adopt the same set of rules, they form an inter-subjective social consensus of what “Bitcoin” is. It is in this respect that many conceptualize Bitcoin as being set by a social contract. Every time rule changes are contemplated, the rules of the contract are decided and renegotiated continuously between stakeholders. Protocol changes are legitimized when users agree to adopt the new changes. Once adopted, the Bitcoin protocol automates the enforcement of the social contract.
Protocol development is governed by a proposal process whereby anyone in the open-source Bitcoin community can submit Bitcoin Improvement Proposals (“BIPs”). After debate by the community, when consensus has emerged, the Bitcoin Core maintainers merge code changes into Bitcoin Core’s GitHub Repository. Once new code has been implemented into the Bitcoin Core client, users of the network (full nodes) must be persuaded to adopt the new changes. Protocol changes are “ratified” on-chain when the majority of the network adopts the upgrade and doesn’t break consensus.
Once rules are adopted on-chain, all new transactions and block proposals are subject to the agreed-upon rules. Full nodes only accept new transactions and block proposals that are valid according to the rules of the Bitcoin protocol. Anything that is not valid will be rejected. Thus, miners must implement the prevailing rules of the network in order to participate in the block creation process.
User Activated Hard Fork
2017’s User Activated Soft Fork Event provided an illustrative case study on Bitcoin governance in practice.
As early as 2010, shortly after Satoshi implemented a block limit into Bitcoin, discussions around block size began. These discussions largely stayed in the background until 2017 when tensions within the Bitcoin community rose over rising transaction fees and increasingly divergent opinions on scaling Bitcoin. In May 2017, a meeting between miners, businesses, investors, and core developers took place at the Consensus conference in New York, in what is now referred to as the “New York Agreement”. The product of this meeting was an agreement to support SegWit (a soft fork) and a 2MB block size (hard fork).
Known as SegWit2x, this proposal was backed by over 80% of the network’s hash rate. However, despite the desires of miners, users wanted to activate SegWit without the block size increase. This plan was proposed as BIP 148, a Bitcoin Improvement Proposal, from a pseudonymous developer named Shaolinfry. Soon after, users set a date (August 1, 2017) where Bitcoin would soft fork to support SegWit and keep the 1MB block size. Eventually, enough nodes signaled support for it, forcing miners to accept or have their blocks rejected by the network.
Many see this user-activated soft fork (UASF) as a pivotal moment in Bitcoin’s history. The philosophy underpinning the event was that users controlled the network, not miners. The event not only illustrated the balance of power within Bitcoin’s network, but also calmed suspicions that parties such as miners, businesses, or Bitcoin Core developers, controlled Bitcoin.
Unpacking Bitcoin’s Social Contract
Who Controls Bitcoin Core?
Bitcoin Miners Beware: Invalid Blocks Need Not Apply