What Backs Bitcoin?

Why does Bitcoin have value? Why does the Bitcoin's price keep on fluctuating? Is Bitcoin just a fad? I am sure you have come across these questions tens (if not hundreds) of times. I know I have. These are some of the most asked questions regarding Bitcoin and other digital currencies.

To completely understand how bitcoin works and to help you answer these questions you need to start from the beginning. Let’s start by defining what Bitcoin is and how it works.

What is Bitcoin?

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Bitcoin is a digital currency made possible by a type of technology known as cryptography. It is decentralized in the sense that it has no form of central authority. Bitcoin can be used to buy or sell commodities just like any other form of currency.

What makes a Bitcoin transaction unique is that it works in a peer-to-peer manner. This simply means that there are no intermediaries whatsoever when a transaction is taking place. Traditionally, transactions were either validated by an intermediary (third-party) or trust between a seller and a buyer.

In the case of Bitcoin or cryptocurrencies in general, transactions are verified using cryptography. So, what is cryptography? The word crypto means to conceal or secret, literally. Instead of using tech jargon to explain what cryptography is, let’s use a simple analogy.

Imagine you wanted to send a secret message to your friend, but there is the possibility that the message might fall into the wrong hands. So, you and your friend come up with a secret code that only the two of you know. When sending messages to each other you conceal them in the code you both created. This way you are sure that only your friend, the intended recipient, can interpret the code.

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This is exactly what cryptography is, just that in the case of Bitcoin computers create the code using two keys. A public key, which is usually the recipient's address, and a private key that is only known to the recipient. The public key authenticates the transaction while the private key guarantees the security of the transaction.

How Bitcoin Works

A technology known as Blockchain technology powers bitcoin. Simply put, a blockchain is an open-source public ledger that stores data in blocks. As the name suggests, these blocks are chained (connected) to each other. Data is stored/recorded in these blocks.

Data stored on the blockchain is referred to as immutable data (unchangeable). Once data is stored in the blockchain, it cannot be changed or deleted. This is because in a blockchain each new block depends on the underlying blocks to exist. Therefore, we can only add data onto a blockchain but cannot change or delete data that already exists on the blockchain.

In the case of Bitcoin, this is made possible through hashing. A hash is a cryptographic function that takes input, performs a mathematical operation, and converts it to a hash code or hash value. This hash value is what is used to create new blocks through the process of bitcoin mining.

It is important to note that hashing is a one-way operation. There is no way to work out the hash value in a bid to figure out the input, hence the immutability of the blockchain.

Bitcoin Mining

Bitcoin mining is the process by which specialized computers (miners) create new bitcoin as a reward for solving mathematical equations. In the abstract, new bitcoins are offered as a reward for confirming transactions on the Bitcoin network.

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A transaction is confirmed when the computer can work out the correct hash value for a new block. Transactions waiting to be confirmed are then stored on this newly mined block. This operation requires a lot of electricity, time, and even human resources to be successful. Transactions are confirmed in a few minutes. This is referred to as proof-of-work and contributes to bitcoin value.

The mining operations requires a lot of computing power hence the term "work". Understanding the proof-of-work mechanism is essential and will help us answer the question of why bitcoin has value.

Now that you have the basics of what Bitcoins are and how they work, let us talk about Bitcoin and what exactly backs Bitcoin. Any argument about what backs Bitcoin and why it is valuable must involve fiat currency. This is because it has been in use for more than a decade.

About the Author

I am a 23 year old Kenya blockchain enthusiast. I am a firm believer in the technology and what it can do especially in Africa as a whole. To give back to my community, I write educational content on blockchain technology, cryptocurrencies and the broader “Web 3.0” in a bid to get as many people as possible invested in the space.