Bitcoin is a decentralized digital currency that is exchanged between two parties without involving intermediaries like banks or other financial institutions.
As defined in a whitepaper released by the hidden inventor of Bitcoin, Satoshi Nakamoto, Bitcoin is “a purely peer-to-peer version of electronic cash that would allow online payments to be sent directly from one party to another without going through a financial institution”.
How Does Bitcoin Work?
Bitcoin achieves elimination of intermediaries with the help of its underlying technology, blockchain.
Currently if you have to transfer funds to someone, one of the possible ways is by giving cash or alternatively use a trusted intermediary (example, a bank). Both the mechanisms, whether it be physical cash (with the central bank of the country as the guarantor) or electronic transfer, involve an intermediary (in the later case, a bank or another financial institution). When intermediaries are involved, there are transaction costs.
How the blockchain technology helps achieve elimination of intermediaries is by replacing trust that intermediaries bring to the table with cryptographic proof by the use of CPU computing power.
This cryptographic trust is built into Bitcoin through a wallet, a public key and a private key in the program.
Anyone can create a Bitcoin wallet for free by downloading the Bitcoin program. Each wallet contains a public key and a private key.
The public key is like an address or an account number via which any person can receive Bitcoins.
A private key is like a digital signature via which a person can send Bitcoins. The name suggests that private keys should be only held and known by the owner and public keys can be shared with anyone for receiving Bitcoins. That is where you would have heard in the news about Bitcoins being lost either due to a private key not being accessible or stolen by hackers.
Owners of Bitcoin addresses are not explicitly identified, but all transactions on the blockchain are public.
Since the inception of Bitcoin in 2009, each and every transaction that has occurred is stored in a ledger, which is considered immutable, non-tamperable and irreversible.
Bitcoin transactions are verified via telecommunication network nodes through cryptography and are then recorded in a decentralized distributed ledger called blockchain. This is one of the distinguishing aspects of Bitcoin from some other crypto assets, where there is centralized exchange (like the stock exchange) through which all transactions need to be routed or validated.
How Does Bitcoin Mining Work?
In the Bitcoin ecosystem, there is a network of miners who use their CPUs to process transactions.
- Once a user who intends to send Bitcoin enters the public address, number of Bitcoins to be sent and affixes the private key to generate signature, the encrypted information is then sent to the network of miners who are given the task to verify whether there is sufficient balance to transfer and authenticate the transaction.
- The faster the CPU of the miner, the greater are the chances that they will verify and that miner gets rewarded in Bitcoins for facilitating the transfer.
- Here the miner’s job is only to provide CPU power, which automatically runs the Bitcoin program to validate Bitcoin transfers. There is no manual intervention by the Bitcoin miner.
- Once the transaction is processed by a Bitcoin miner, this number of transactions is then broadcasted to the network of miners who get the copy or download of the same block.
- These blocks through a timestamp mechanism are stored in a sequential or chronological order forming a blockchain. Each miner in the network is supposed to have the updated and complete copy of the ledger or the blockchain if they want to facilitate transfer and earn Bitcoins.
The program is built in such a way that the ledger or the blockchain is automatically updated.
As per the original whitepaper on Bitcoin, the probability of hackers tampering the blockchain is next to zero due to the copy of updated ledger each miner carries. If someone is trying to tamper or hack the ledger by any means to gain unfair advantage, then immediately the miner is considered invalid and fails to process transactions until they have a copy of the untampered ledger.
Can Bitcoin be Considered a Real Currency?
It is debatable whether Bitcoin is a currency at all and why any country would want to replace it with their existing currency as Bitcoin does not have any intrinsic value of its own.
By definition, a currency is “a system of money in general use in a particular country,” or “the fact or quality of being generally accepted or in use.” Currently, there is some traction in the number of companies using Bitcoin as a mode of payment, however, no major country or economy has accepted it as money in general use. An exception is El Salvador, which adopted Bitcoin as a legal tender in September 2021 and became the first country to do so.
Regulation of Bitcoin in India
On the regulatory front, India saw two major developments this year:
In February 2022, in India, the Indian government proposed to introduce taxation on virtual digital assets, which would imply a taxation system for cryptocurrencies, but there is no clarity on whether the Indian government finds cryptocurrencies legal either as “asset” or “currency”.
India’s Finance Minister has categorically stated since then that “taxing cryptocurrencies doesn’t mean legalizing them.” This indicates the government is still evaluating all the factors associated with cryptocurrencies and it would be early to make any assumptions on their legality.
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