Say there’s a coin that’s currently worthhundreds of U.S. dollars, but it’s not made of gold, or platinum, or any precious metal. In fact, it’s not the kind of coin you canhold in your hand or stick in a piggy bank. It’s a digital currency, which means itonly exists electronically.
I’m talking about bitcoin. Bitcoin doesn’t work like most money. It isn’t attached to a state or government,so it doesn’t have a central issuing authority or regulatory body. Basically, that means there’s no organizationdeciding when to make more bitcoins, figuring out how many to produce, keeping track ofwhere they are, or investigating fraud. So how does bitcoin work as a currency, orhave any value at all? Well, bitcoin wouldn’t exist without a wholenetwork of people and a little thing called cryptography.
In fact, it’s sometimes described as theworld’s first cryptocurrency. And here’s how it works. Bitcoin is a fully digital currency, and youcan exchange bitcoins between computers in a worldwide peer-to-peer network. The whole point of most peer-to-peer networksis sharing stuff, like letting people make copies of super legal music or movies to download. If bitcoin is a digital currency, what’sstopping you from making a bunch of counterfeit copies and becoming fabulously wealthy?
Well, unlike a mp3 or a video file, a bitcoinisn’t a string of data that can be duplicated. A bitcoin is actually an entry on a huge,global ledger called the blockchain, for reasons we’ll get to in a minute. The blockchain records every bitcoin transactionthat has ever happened. And, as of late 2016, the complete ledgeris about 107 gigabytes of data. So when you send someone bitcoins, it’snot like you’re sending them a bunch of files.
Instead, you’re basically writing the exchangedown on that big ledger – something like, “Michael sends Hank 5 bitcoins.” Now, maybe you’re thinking, “But, wait. You said bitcoin doesn’t have a centralauthority to keep track of everything!” Even though the blockchain is a central record,there’s no official group of people who update the ledger and keep track of everybody’smoney like a bank does – it’s decentralized.
In fact, anybody can volunteer to keep theblockchain up to date with all the new transactions. And a ton of people do. It all works because there are lots of peoplekeeping track of the same thing, to make sure all transactions are accurate. Like, imagine you’re playing a game of pokerwith some pals, but none of you have poker chips, and you left your cash at home. There’s no money on the table, so a fewof you get out some notebooks, and start writing down who bets how much, who wins, and wholoses.
You don’t completely trust anyone else,so everyone keeps their ledgers separately. And at the end of every hand, you all comparewhat you’ve written down. That way, if someone makes a mistake, or triesto cheat and snag some extra money for themselves, that discrepancy is caught. After a couple hands, you might fill up apage of your notebook with notes about the money movement. You can think of each page as a “block oftransactions.”
Eventually, your notebook will have pagesand pages of information – a chain of those blocks. Hence: blockchain. Now, if thousands of people are separatelymaintaining the bitcoin blockchain, how are all the ledgers kept in sync? To stick with our poker analogy: think ofthe entire bitcoin peer-to-peer network as a really huge poker table with millions ofpeople. Some are just exchanging money, but lots ofvolunteers are keeping ledgers.
So when you want to send or receive money,you have to announce it to everyone at the table, so the people keeping track can updatetheir ledgers. So for every transaction, you’re announcinga couple of things to the bitcoin network: your account number, the account number ofthe person you’re sending bitcoins to, and how many bitcoins you want to send. And all of the users who are keeping copiesof the blockchain will add your transaction to the current block.
Having a bunch of people keep track of transactionsseems like a pretty good security measure. But if all it takes to send bitcoins is acouple of account numbers, that seems like it might be a security problem. It’s a huge problem with regular money – justthink about all the ways criminals try to steal other people’s credit card information. And with bitcoin, there’s no central bankto notice anything weird going on to shut down fraud, like if it looked like suddenlyyou spent your entire life savings on beef jerky.
So what’s stopping Hank from pretendinghe’s me and just sending himself all of my bitcoins? Bitcoins are kept pretty safe thanks to cryptography,which is why it’s considered a cryptocurrency. Specifically, bitcoin stays secure becauseof keys, which are basically chunks of information that can be used to make mathematical guaranteesabout messages, like “hey, this is really from me!” When you create an account on the bitcoinnetwork, which you might have heard called a “wallet,” that account is linked totwo unique keys: a private key, and a public key.
In this case, the private key can take somedata and basically mark it, also known as signing it, so that other people can verifythose signatures later if they want. So let’s say I want to send a message tothe network that says, “Michael sends 3 bitcoins to Olivia.” I sign that message using my private key,which only I have access to, and nobody else can replicate. Then, I send that signed message out to thebitcoin network, and everyone can use my public key to make sure my signature checks out.
That way, everyone keeping track of all thebitcoin trading knows to add my transaction to their copy of the blockchain. In other words, if the public key works, that’sproof that the message was signed by my private key and is something I wanted to send. Unlike a handwritten signature, or a creditcard number, this proof of identity isn’t something that can be faked by a scam artist. The “who” part of each transaction isobviously important, to make sure the right people are swapping bitcoins.
But the “when” matters, as well. If you had a thousand dollars in your bankaccount, for example, and tried to buy two things for a thousand dollars each, the bankwould honor the first purchase and deny the second one. If the bank didn’t do that, you’d be ableto spend the same money multiple times. Which … might sound awesome, but it’salso terrible. A financial system can’t work like that,because no one would get paid.
So if I only have enough money to pay Oliviaor Hank, but I try to pay them both, there’s a check built into the bitcoin system. Both the bitcoin network and your wallet automaticallycheck your previous transactions to make sure you have enough bitcoins to send in the firstplace. But there’s another problem that might happenwith timing: Because lots of people are keeping copiesof the blockchain all over the world, network delays mean that you won’t always receivethe transaction requests in the same order.
So now you’ve got a bunch of people witha bunch of slightly different blocks to pick from, but none of them are necessarily wrong. Okay, bitcoin. How do you solve that problem? Turns out, it’s by actually solving problems. Math problems. To add a block of transactions to the chain,each person maintaining a ledger has to solve a special kind of math problem created bya cryptographic hash function. A hash function is an algorithm that takesan input of any size, and turns it into an output with a fixed size.
For example, let’s say you had this stringof numbers as your input And our example hash function says to addall of the numbers together. So, in this case, the output would be 10. What makes hash functions really good forcryptography is that when you’re given an input, it’s really easy to find the output. But it’s really hard to take an output andfigure out the original input. Even in this super simple example, there arelots of strings of numbers that add up to 10.
The only way to figure out that the inputwas ‘1-2-3-4’ is to just guess until you get it right. Now, the hash function that bitcoin uses iscalled SHA256, which stands for Secure Hash Algorithm 256-bit. And it was originally developed by the UnitedStates National Security Agency. Computers that were specifically designedto solve SHA256 hash problems take, on average, about ten minutes to guess the solution toeach one.
That means they’re churning through billionsand billions of guesses before they get it right. Whoever solves the hash first gets to addthe next block of transactions to the blockchain, which then generates a new math problem thatneeds to be solved. If multiple people make blocks at roughlythe same time, then the network picks one to keep building upon, which becomes the longest,and most trusted chain. And any transactions in those alternate branchesof the chain get put back into a pool to be added onto later blocks.
These volunteers spend thousands of dollarson special computers built to solve SHA256 problems, and run their electricity billsup sky high to keep those machines running. But why? What do they get out of maintaining the blockchain? Is it just community service? Well, bitcoin actually has a built-in systemto reward them. Today, every time you win the race to adda block to the blockchain, 12 and a half new bitcoins are created out of thin air, andawarded to your account.
In fact, you might know the bitcoin ledger-keepersby another name: miners. That’s because keeping the blockchain updatedis like swinging a proverbial pickaxe at those hash problems, hoping to strike it rich. When bitcoins were first created in 2009,they didn’t really have any perceived value. Tens of bitcoins would have been worth thesame as a bunch of pennies. As of November 10th, 2016, though, one bitcoinis worth 708 US dollars.
So 12 and a half bitcoins are worth 8,850dollars. That’s a nice chunk of change! Every single bitcoin that exists was createdto reward a bitcoin miner. Besides the big payout when they add a newblock of transactions, miners are also essentially tipped a very small amount for each transactionthey add to the ledger. It’s also worth noting that every 210,000blocks, the number of coins generated when a new block is added goes down by half. So what started as a reward of 50 bitcoinsdecreased to 25, then 12 and a half.
It’ll only be around 6 bitcoins in a couplemore years, and keep decreasing. Eventually, there will be so many transactionsin a block, that it’ll still be worthwhile for miners to mostly be paid in tips. According to current projections, the lastbitcoin – probably around the 21 millionth coin – will be mined in the year 2140. This decreasing number of bitcoins is actuallymodelled off the rate at which things like gold are dug out of the earth.
And the idea is that keeping the supply ofbitcoins limited will raise their value over time. So, is investing in bitcoin a good idea? Now that’s… not really a SciShow kindof question. Bitcoin is still volatile, and experimental. A lot of people love it, and a lot of peoplethink it’s doomed to fail.
We just think it’s an interesting idea,and it makes us wonder what cryptography might do for us next. Thanks for watching this episode of SciShow,brought to you by our patrons on Patreon. If you want to help support this show, justgo to patreon.com/scishow. And don’t forget to go to youtube.com/scishowand subscribe!