Mining is a record-keeping service done through the use of computer processing power.[d] Miners keep the blockchain consistent, complete, and unalterable by repeatedly verifying and collecting newly broadcast transactions into a new group of transactions called a block. Each block contains a cryptographic hash of the previous block, using the SHA-256 hashing algorithm,:ch. 7 which links it to the previous block, thus giving the blockchain its name.
To be accepted by the rest of the network, a new block must contain a so-called proof-of-work. The proof-of-work requires miners to find a number called a nonce, such that when the block content is hashed along with the nonce, the result is numerically smaller than the network’s difficulty target.:ch. 8 This proof is easy for any node in the network to verify, but extremely time-consuming to generate, as for a secure cryptographic hash, miners must try many different nonce values (usually the sequence of tested values is 0, 1, 2, 3, …:ch. 8) before meeting the difficulty target.
Every 2,016 blocks (approximately 14 days at roughly 10 min per block), the difficulty target is adjusted based on the network’s recent performance, with the aim of keeping the average time between new blocks at ten minutes. In this way the system automatically adapts to the total amount of mining power on the network.:ch. 8
Between 1 March 2014 and 1 March 2015, the average number of nonces miners had to try before creating a new block increased from 16.4 quintillion to 200.5 quintillion.
The proof-of-work system, alongside the chaining of blocks, makes modifications of the blockchain extremely hard, as an attacker must modify all subsequent blocks in order for the modifications of one block to be accepted. As new blocks are mined all the time, the difficulty of modifying a block increases as time passes and the number of subsequent blocks (also called confirmations of the given block) increases.
The successful miner finding the new block is rewarded with newly created bitcoins and transaction fees. As of 9 July 2016, the reward amounted to 12.5 newly created bitcoins per block added to the blockchain. To claim the reward, a special transaction called a coinbase is included with the processed payments.:ch. 8 All bitcoins in existence have been created in such coinbase transactions. The bitcoin protocol specifies that the reward for adding a block will be halved every 210,000 blocks (approximately every four years). Eventually, the reward will decrease to zero, and the limit of 21 million bitcoins[e] will be reached c. 2140; the record keeping will then be rewarded by transaction fees solely.
In other words, bitcoin’s inventor Nakamoto set a monetary policy based on artificial scarcity at bitcoin’s inception that there would only ever be 21 million bitcoins in total. Their numbers are being released roughly every ten minutes and the rate at which they are generated would drop by half every four years until all were in circulation.
A wallet stores the information necessary to transact bitcoins. While wallets are often described as a place to hold or store bitcoins, due to the nature of the system, bitcoins are inseparable from the blockchain transaction ledger. A better way to describe a wallet is something that “stores the digital credentials for your bitcoin holdings” and allows one to access (and spend) them. Bitcoin uses public-key cryptography, in which two cryptographic keys, one public and one private, are generated. At its most basic, a wallet is a collection of these keys.
There are several types of wallets. Software wallets connect to the network and allow spending bitcoins in addition to holding the credentials that prove ownership. Software wallets can be split further in two categories: full clients and lightweight clients.
- Full clients verify transactions directly on a local copy of the blockchain (over 136 GB as of October 2017), or a subset of the blockchain (around 2 GB).[better source needed] Because of its size and complexity, the entire blockchain is not suitable for all computing devices.
- Lightweight clients on the other hand consult a full client to send and receive transactions without requiring a local copy of the entire blockchain (see simplified payment verification – SPV). This makes lightweight clients much faster to set up and allows them to be used on low-power, low-bandwidth devices such as smartphones. When using a lightweight wallet however, the user must trust the server to a certain degree. When using a lightweight client, the server can not steal bitcoins, but it can report faulty values back to the user. With both types of software wallets, the users are responsible for keeping their private keys in a secure place.
Besides software wallets, Internet services called online wallets offer similar functionality but may be easier to use. In this case, credentials to access funds are stored with the online wallet provider rather than on the user’s hardware. As a result, the user must have complete trust in the wallet provider. A malicious provider or a breach in server security may cause entrusted bitcoins to be stolen. An example of such security breach occurred with Mt. Gox in 2011.
Physical wallets store the credentials necessary to spend bitcoins offline. Examples combine a novelty coin with these credentials printed on metal. Paper wallets are simply paper printouts. Another type of wallet called a hardware wallet keeps credentials offline while facilitating transactions.
The first wallet program – simply named “Bitcoin” – was released in 2009 by Satoshi Nakamoto as open-source code. Sometimes referred to as the “Satoshi client”, this is also known as the reference client because it serves to define the bitcoin protocol and acts as a standard for other implementations. In version 0.5 the client moved from the wxWidgets user interface toolkit to Qt, and the whole bundle was referred to as Bitcoin-Qt. After the release of version 0.9, the software bundle was renamed Bitcoin Core to distinguish itself from the underlying network. Today, other forks of Bitcoin Core exist such as Bitcoin XT, Bitcoin Classic, Bitcoin Unlimited, Parity Bitcoin, and BTC1.
Bitcoin creator Satoshi Nakamoto designed bitcoin not to need a central authority. According to the academic Mercatus Center, US Treasury, IEEE Communications, Surveys & Tutorials, The Washington Post, The Daily Herald, The New Yorker, and others, bitcoin is decentralized.
Bitcoin is pseudonymous, meaning that funds are not tied to real-world entities but rather bitcoin addresses. Owners of bitcoin addresses are not explicitly identified, but all transactions on the blockchain are public. In addition, transactions can be linked to individuals and companies through “idioms of use” (e.g., transactions that spend coins from multiple inputs indicate that the inputs may have a common owner) and corroborating public transaction data with known information on owners of certain addresses. Additionally, bitcoin exchanges, where bitcoins are traded for traditional currencies, may be required by law to collect personal information.
To heighten financial privacy, a new bitcoin address can be generated for each transaction. For example, hierarchical deterministic wallets generate pseudorandom “rolling addresses” for every transaction from a single seed, while only requiring a single passphrase to be remembered to recover all corresponding private keys. Additionally, “mixing” and CoinJoin services aggregate multiple users’ coins and output them to fresh addresses to increase privacy. Researchers at Stanford University and Concordia University have also shown that bitcoin exchanges and other entities can prove assets, liabilities, and solvency without revealing their addresses using zero-knowledge proofs.
According to Dan Blystone, “Ultimately, bitcoin resembles cash as much as it does credit cards.”
Wallets and similar software technically handle all bitcoins as equivalent, establishing the basic level of fungibility. Researchers have pointed out that the history of each bitcoin is registered and publicly available in the blockchain ledger, and that some users may refuse to accept bitcoins coming from controversial transactions, which would harm bitcoin’s fungibility. Projects such as CryptoNote, Zerocoin, and Dark Wallet aim to address these privacy and fungibility issues.
Bitcoin was initially led by Satoshi Nakamoto. Nakamoto stepped back in 2010 and handed the network alert key to Gavin Andresen.Andresen stated he subsequently sought to decentralize control stating: “As soon as Satoshi stepped back and threw the project onto my shoulders, one of the first things I did was try to decentralize that. So, if I get hit by a bus, it would be clear that the project would go on.” This left opportunity for controversy to develop over the future development path of bitcoin.
The blocks in the blockchain are limited to one megabyte in size, which has created problems for bitcoin transaction processing, such as increasing transaction fees and delayed processing of transactions that cannot be fit into a block. On 24 August 2017 (at block 481,824), Segregated Witness went live, increasing maximum block capacity and making transaction IDs immutable.[better source needed] SegWit also allows the implementation of the Lightning Network, a second-layer proposal for scalability with instantaneous transactions.[better source needed]
Bitcoin is a digital asset designed by its inventor, Satoshi Nakamoto, to work as a currency. It is commonly referred to with terms like digital currency,:1 digital cash, virtual currency, electronic currency, or cryptocurrency.
The question whether bitcoin is a currency or not is still disputed. Bitcoins have three useful qualities in a currency, according to The Economist in January 2015: they are “hard to earn, limited in supply and easy to verify”. Economists define money as a store of value, a medium of exchange, and a unit of account and agree that bitcoin has some way to go to meet all these criteria. It does best as a medium of exchange; as of February 2015 the number of merchants accepting bitcoin had passed 100,000. As of March 2014, the bitcoin market suffered from volatility, limiting the ability of bitcoin to act as a stable store of value, and retailers accepting bitcoin use other currencies as their principal unit of account.
According to research produced by Cambridge University, there were between 2.9 million and 5.8 million unique users using a cryptocurrency wallet, as of 2017, most of them using bitcoin. The number of users has grown significantly since 2013, when there were 300,000 to 1.3 million users.
Acceptance by merchants
In 2015, the number of merchants accepting bitcoin exceeded 100,000. Instead of 2–3% typically imposed by credit card processors, merchants accepting bitcoins often pay fees under 2%, down to 0%. Firms that accepted payments in bitcoin as of December 2014 included PayPal, Microsoft,Dell, and Newegg.
Payment service providers
Merchants accepting bitcoin ordinarily use the services of bitcoin payment service providers such as BitPay or Coinbase. When a customer pays in bitcoin, the payment service provider accepts the bitcoin on behalf of the merchant, converts it to the local currency, and sends the obtained amount to merchant’s bank account, charging a fee for the service.
Bitcoin companies have had difficulty opening traditional bank accounts because lenders have been leery of bitcoin’s links to illicit activity. According to Antonio Gallippi, a co-founder of BitPay, “banks are scared to deal with bitcoin companies, even if they really want to”. In 2014, the National Australia Bank closed accounts of businesses with ties to bitcoin, and HSBC refused to serve a hedge fund with links to bitcoin. Australian banks in general have been reported as closing down bank accounts of operators of businesses involving the currency; this has become the subject of an investigation by the Australian Competition and Consumer Commission. Nonetheless, Australian banks have keenly adopted the blockchain technology on which bitcoin is based.
In a 2013 report, Bank of America Merrill Lynch stated that “we believe bitcoin can become a major means of payment for e-commerce and may emerge as a serious competitor to traditional money-transfer providers.” In June 2014, the first bank that converts deposits in currencies instantly to bitcoin without any fees was opened in Boston.
As an investment
Some Argentinians have bought bitcoins to protect their savings against high inflation or the possibility that governments could confiscate savings accounts. During the 2012–2013 Cypriot financial crisis, bitcoin purchases in Cyprus rose due to fears that savings accounts would be confiscated or taxed.
Other methods of investment are bitcoin funds. The first regulated bitcoin fund was established in Jersey in July 2014 and approved by the Jersey Financial Services Commission. Forbes started publishing arguments in favor of investing in December 2015.
In 2013 and 2014, the European Banking Authority and the Financial Industry Regulatory Authority (FINRA), a United States self-regulatory organization, warned that investing in bitcoins carries significant risks. Forbes named bitcoin the best investment of 2013. In 2014, Bloomberg named bitcoin one of its worst investments of the year. In 2015, bitcoin topped Bloomberg’s currency tables.
According to bitinfocharts.com, in 2017 there are 9,272 bitcoin wallets with more than $1 million worth of bitcoins. The exact number of bitcoin millionaires is uncertain as a single person can have more than one bitcoin wallet.
Venture capitalists, such as Peter Thiel‘s Founders Fund, which invested US$3 million in BitPay, do not purchase bitcoins themselves, instead funding bitcoin infrastructure like companies that provide payment systems to merchants, exchanges, wallet services, etc. In 2012, an incubator for bitcoin-focused start-ups was founded by Adam Draper, with financing help from his father, venture capitalist Tim Draper, one of the largest bitcoin holders after winning an auction of 30,000 bitcoins, at the time called ‘mystery buyer’. The company’s goal is to fund 100 bitcoin businesses within 2–3 years with $10,000 to $20,000 for a 6% stake. Investors also invest in bitcoin mining. According to a 2015 study by Paolo Tasca, bitcoin startups raised almost $1 billion in three years (Q1 2012 – Q1 2015).
Price and volatility
According to Mark T. Williams, as of 2014, bitcoin has volatility seven times greater than gold, eight times greater than the S&P 500, and 18 times greater than the US dollar. According to Forbes, there are uses where volatility does not matter, such as online gambling, tipping, and international remittances.
The price of bitcoins has gone through various cycles of appreciation and depreciation referred to by some as bubbles and busts. In 2011, the value of one bitcoin rapidly rose from about US$0.30 to US$32 before returning to US$2. In the latter half of 2012 and during the 2012–13 Cypriot financial crisis, the bitcoin price began to rise, reaching a high of US$266 on 10 April 2013, before crashing to around US$50. On 29 November 2013, the cost of one bitcoin rose to a peak of US$1,242. In 2014, the price fell sharply, and as of April remained depressed at little more than half 2013 prices. As of August 2014 it was under US$600.
In January 2015, noting that the bitcoin price had dropped to its lowest level since spring 2013 – around US$224 – The New York Timessuggested that “[w]ith no signs of a rally in the offing, the industry is bracing for the effects of a prolonged decline in prices. In particular, bitcoin mining companies, which are essential to the currency’s underlying technology, are flashing warning signs.” Also in January 2015, Business Insider reported that deep web drug dealers were “freaking out” as they lost profits through being unable to convert bitcoin revenue to cash quickly enough as the price declined – and that there was a danger that dealers selling reserves to stay in business might force the bitcoin price down further.
According to an article in The Wall Street Journal, as of 19 April 2016, bitcoin had been more stable than gold for the preceding 24 days, and it was suggested that its value might be more stable in the future. On 3 March 2017, the price of a bitcoin surpassed the market value of an ounce of gold for the first time as its price surged to an all-time high of $1,268. A study in Electronic Commerce Research and Applications, going back through the network’s historical data, showed the value of the bitcoin network as measured by the price of bitcoins, to be roughly proportional to the square of the number of daily unique users participating on the network. This is a form of Metcalfe’s law and suggests that the network was demonstrating network effects proportional to its level of user adoption.
Ponzi scheme concerns
Various journalists, economists, and the central bank of Estonia have voiced concerns that bitcoin is a Ponzi scheme. In 2013, Eric Posner, a law professor at the University of Chicago, stated that “a real Ponzi scheme takes fraud; bitcoin, by contrast, seems more like a collective delusion.” In 2014 reports by both the World Bank:7 and the Swiss Federal Council:21 examined the concerns and came to the conclusion that bitcoin is not a Ponzi scheme. In July 2017, billionaire Howard Marks referred to bitcoin as a pyramid scheme.
On 12 September 2017, Jamie Dimon, CEO of JP Morgan Chase, called bitcoin a “fraud” and said he would fire anyone in his firm caught trading it. Zero Hedge claimed that the same day Dimon made his statement, JP Morgan also purchased a large amount of bitcoins for its clients. On 13 September 2017, Dimon followed up and compared bitcoin to a bubble, saying it was only useful for drug dealers and countries like North Korea. On 22 September 2017, hedge fund Blockswater subsequently accused JP Morgan of market manipulation and filed a market abuse complaint with Swedish Financial Supervisory Authority.