It all began with a dramatic vision. That of a digital currency that would replace fiat currency, a currency of the people, not controlled by central banks, with no intermediaries, driven by the power of the network. The author of this vision was someone who went by the name of Satoshi Nakamoto (who remains anonymous to this day). Out of this vision was born Bitcoin. A currency consisting of digital coins where a coin is a transaction or perhaps it might be more correct to say that a transaction is comprised of one or more coins being transferred (For example: Alice pays Bob x bitcoins). Transactions have inputs (coins coming in) and outputs (coins going out). Each transaction is identified by a hash of its contents as well as the digital signature of the sender, and is defined via a scripting language.
To make sure everything is hunky-dory, transactions need to be validated. For that, they are announced to the network where the validators or miners vet them and add them to a block of pending transactions. However, for the block to make it into the blockchain, miners need to compete by solving a proof of work puzzle using a so-called nonce value and the hash function. Something that requires significant computing power. The first miner to solve the puzzle gets the privilege of adding the new block to the chain. And a reward in terms of a set number of bitcoins, which is currently 12.5 coins, the coinbase transaction. This is the only way that new bitcoins can enter the system. Others are left with no option but to fall in line. They quickly verify the solution, which is to say they confirm that the nonce satisfies the proof of work rule, add the new block to their copy of the chain, and start trying to form the next block. Blocks are strung together by including a hash of the previous block in each new block.
Occasionally there are forks in the blockchain when two or more miners solve the puzzle at the same time. However, one of the forks eventually becomes longer and becomes the working chain. Blocks in the shorter chain are returned to the network as pending transactions to be picked up by miners and the cycle repeats. Nodes are the folks who participate in the Blockchain, buying and selling coins, they could be individual wallets or coin exchanges. No bank or intermediary in this process, just the network of nodes and miners. The total number of bitcoins that can be issued is capped at 21 million. No more. No quantitative easing possible!
Aptly named the Genesis block, this very first block from Satoshi injected all of 50 bitcoins into the system. Bitcoin took off. From the thousands in 2009 (when the currency was launched), the number of transactions per month grew to the several millions per month in 2017. In the beginning, each coin had zero value, thereafter Bitcoin grew steadily in value, and hit parity with the USD in 2011. Since then, Bitcoin has grown erratically in a series of ups and downs, reached an all-time high of $3,000 on June 12th, 2017, and stayed around the $2,500 level since then. Nothing less than phenomenal in its overall growth.
Success of course breeds imitation. Many imitation bitcoins followed. Enter the altcoins. Per Wikipedia, there were more than 710 cryptocurrencies available for trade in online markets as of July 11, 2016. Of which, 667 were based on Bitcoin’s code, which is 94%. The top 10 coins are Ethereum, Ripple, Litecoin, Dash, NEM, Ethereum Classic, Monero, Zcash, Decred, and PIVX. Ethereum is the top contender backed by big powerhouses: J.P Morgan Chase, Microsoft and Intel. Interestingly, Ethereum had a split (hard fork): resulting in an eponymous Ethereum and Ethereum Classic.
But Bitcoin is the leader. It has yet to experience a hard fork. While competing altcoins have, Ethereum is a case in point. When Bitcoin drops, others tend to swoon. Ethereum crashed to 10c this week (on June 21st) though that doesn’t seem to have had anything to do with Bitcoin. Many altcoins have been getting launched through initial coin offerings ICOs. Some scams in the mix too.
Not to say that Bitcoin has been perfect. With millions of users, daily transactions have grown to the hundreds of thousands. In 2010, a block size limit of 1 MB was introduced to prevent potential DoS attacks from large blocks crippling the network, limiting the throughput to seven transactions per second. Waiting times on transactions have gone up to hours and even days. Getting miners to process transactions faster has required paying them more fees to attract their attention.
Initial solutions revolved around increasing block sizes, a hard fork, which would make older versions of Bitcoin software incompatible. Today, there are two competing solutions. Bitcoin Unlimited (BU), a hard fork, and SegWit, a soft fork. BU turns over power to the miners and mining pools by allowing them to set block sizes. SegWit instead proposes detaching the signature from the rest of the transaction data and moving it to a separate structure at the end of the transaction. This also prevents users from modifying the transaction id to get more coins from the sender as that would nullify the signature (transaction malleability).
A solution that takes Bitcoin throughput to an entirely new level is the Lightning Network. Essentially two parties create a ledger entry in the blockchain and then transfer funds at the “speed of lightning” by opening an off-block payment channel between them. These lightning transactions are seen only by the counter-parties. When the transfers are over, the final state is then confirmed on the blockchain through the regular consensus method. Reminded me about how a mobile app continues to function offline and syncs up with its server when connected to the network. The result is near-instant transactions, thousands to millions per second, that are free or cost just a fraction of a cent. Clearly, a huge, huge game changer. Lightning Network and Segwit go hand in hand as Lightning needs the malleability fix that SegWit provides.
SegWit clearly appears to be a better fix for Bitcoin scalability. Unlike BU that puts power in the hands of miners and mining pools. The very centralization that was anathema to the Bitcoin founders.
To be clear, Bitcoin presents a threat to the current monetary system based on fiat currencies. With SegWit and Lightning Network, Bitcoin could likely become a mainstream currency itself. Not an outcome that would make the stakeholders in the current monetary/financial system happy. That probably explains why there is this recurring drumbeat that Bitcoin is not what matters, it is the underlying Blockchain technology that does. There should be a few powerful people who would probably like to see Bitcoin’s slow but inevitable demise. A BU driven hard fork seems to lean in that very direction. Raises questions about who is behind BU. The battle lines are drawn.