Video - Bitcoin Overview - Khan Academy

What are some general advantages to using Bitcoins in a transaction vs. using Dollars, Euros, Pesos, etc.-- i.e., what is the point of their existence? As if the concept of paper money isn't hard enough to comprehend; now, digital money.


Bitcoin is a new virtual currency system that's been gathering a lot of attention recently. And I thought I would do a series of videos where I really dive into the innards of Bitcoin and explain how it works in detail. And my plan for this first video in this series is to describe some of those mechanics at a high level. And then what I'll do in subsequent videos is dive a bit deeper into all of the underlying aspects that I touched upon within this first video. And my hope is that by the end of this video series you'll know not only what a Bitcoin is but you'll also understand the mechanics of how transactions are initiated. You'll see how verification occurs to those transactions. And you'll also learn what it means for someone to really engage in a process known as Bitcoin mining. That may be a term that you've heard if you have had any interest in Bitcoin recently.

I do want to point out also that the Bitcoin scheme is fairly involved. It requires some time to really cover all of the relevant details and to me the best way to really wrap your head around the scheme like Bitcoin is to -- to really suspend belief for a bit and get exposed to all of these relevant details. Now, you'll undoubtedly, you'll have a lot of questions along the way. But my hope is that by the end of this video series all of the relevant stones will have been overturned and your questions will have been appropriately answered. But it might take some time to get there, okay. And in part that's because I'll try to describe things in a way that's sensible and that might involve leaving some details out until I can explain enough pieces of the scheme and then adding those details in as I go along. So, that you're not inundated with too many miner's points and new ones is along the way. But you get to feel for the overall system as I go through things. So, with that let me go ahead and just dive right in.

First of all, I do want to point out that Bitcoin has been described really as a decentralized currency because there's no real central bank or entity that's involved in generating or transacting Bitcoins. And in fact, what happens in the context of a Bitcoin is that all of the transactions really require what's known as a peer to peer network. A network of just individual hosts that essentially collectively agree on different aspects of how the protocol is implemented in and used, okay. And then Bitcoin itself is also referred to sometimes as a cryptocurrency. And by cryptocurrency I mean that we use a lot of cryptographic techniques in order to facilitate or to really enable Bitcoin transactions to take place. And I'll do separate videos and some of these techniques. But just take it at face value right now that it's decentralized and it is type of cryptocurrency.

I also want to point out that the term Bitcoin itself can in fact be a bit confusing. And in many ways Bitcoin transactions don't really resemble traditional coin transactions so much as they represent a really entries in some type of a global ledger. And by that, I mean that let's say you have a transaction taking place. And let's say the transaction is taking place within or among two parties. And we'll call them Alice and Bob which are traditional names that are used in many cryptographic protocols to describe the parties involved. And imagine that Alice wants to transfer or really wants to assign a certain number of Bitcoins that she possesses over to Bob, okay. And you can think of this transaction really as an entry in a ledger of some sort, okay. And I also want to point out before proceeding that even though I have used terms like Alice and Bob what I really mean in the context of Bitcoin is not the actual identities and in their physical sense but really that Alice and Bob are identities in the Bitcoin system. And these identities are just an actual implementation or just collections of numbers. They do not have to be tied with Alice and Bob's real-world identities. So, in that capacity you can think of Bitcoin and really is effectively being, of being pseudonyms, okay, rather than real names. And the idea is that Bitcoin then becomes more of us is pseudonymous protocol where people are addressed by their pseudonyms and that provides some level of privacy to users who want to transact using the Bitcoin system, okay.

Now in a transaction between Alice and Bob. What Alice will basically do is specify a few different numbers. She has to specify how many Bitcoins she wants to allocate to Bob. So let's say Alice started off with 50 bitcoins of her own. She might decide that she wants to give let's say 30 of these Bitcoins over to Bob. And let's say she wants to have some number of Bitcoins return it back to her. So, you have to specify or Alice has to specify rather, how much change she's going to get. In this case, let's say her change is going to be 18 bitcoins for herself. And then the remaining 2 Bitcoins are going to be a transaction fee. And we'll talk about what a transaction fee means a little later and I think I'll also dive into it in future videos. But it's basically an incentive for other nodes in the Bitcoin network to help Alice in essentially validating some of the details of this transaction for Bob, okay.

Now, Alice will take these transaction details and apply what's known as a digital signature to these transaction details. And a digital signature is basically the mathematical analogue of a traditional signature, really binds Alice's identity to the details of this transaction. And by Alice's identity again I mean her identity within the Bitcoin system. And this binding is really done in a cryptographically strong way, okay? Now, the details of this transaction once it takes place are going to be broadcast out. So, Alice is going to take these transaction details and effectively just broadcast them out to all the nodes in the peer to peer network that represent Bitcoin nodes, okay?

Now, Bob when he receives information about this transaction. He receives it over the peer to peer network. He'll probably send the check some part of the transaction. For example, he might check that the numbers were got correctly that Alice, let's say started off with 50 Bitcoins and is not trying to transfer more than 50 Bitcoins to him and so on and so forth. Then he's going to have some mathematical assurance because of some of the cryptography involved that some of these claims are accurate that Alice, let's say has the Bitcoins that she's claimed to possess. And that she's expressed an interest to assign those Bitcoins to him. But what he won't know yet is whether Alice has really tried to transfer those same Bitcoins to anyone else over the course of time or maybe just prior to that point.

And the way that we handle that situation. And by the way I should point out that this concept of Alice trying to let's say spend coins twice in the context of digital cash. And electronic currency systems this concept is known as double spending and it's something you have to worry about when you have virtual currencies because it's very easy for someone to just copy the numbers that represent this transaction and try to use them elsewhere, okay. And the way we basically handle and reduce the risk of double spending is through a specific set of nodes in this peer to peer network who are known as Bitcoin miners, okay. So, you might have heard this term Bitcoin miners. And the Bitcoin miners are basically specific individuals, specific nodes with this peer to peer network. And what they basically do is they take all of the transaction that they see. And remember the listing to all of these transactions not just Alice's and Bob's but other transactions that are taking place. And they'll take those transactions and ultimately, they will take those transactions and compile them into what's known as a transaction block, okay.

So, it's basically a recording of all of the previously unrecorded transactions. So, if you think of a single transaction. Let's say as a ledger item you could think of a transaction block as representing let's say an entire page in a ledger book, okay. And these Bitcoin miners will also include in this block. In addition to all these unrecorded transactions they will also include in this block a special transaction, it's meant just for themselves to basically reward themselves for the effort of doing this mining, okay.

Now, transaction block will also contain an encoding of the previous transaction block. So, there's going to be some level of continuity. And then Bitcoin miners will also include a specially crafted sequence of numbers associated with these transactions. And this sequence of numbers is known as a proof of work. Okay, and it's called the proof of work because it's something that's really hard to generate. Something that requires a lot of effort to do and that kind of makes it hard for just anybody to get involve with Bitcoin Mining willy-nilly but it requires that they really exhibit or exert some computational effort. Basically, in exchange for getting this this extra reward of a payment. And also in exchange for getting this transaction fee that they're going to be promised by Alice to engage in this sort of work, okay. And I'll talk about a proof of work protocols are in a separate video in more detail.

Now, because each transaction block contains information about previous transaction. Really, what you end up having is not just a single block. You ultimately have what you can think of as a chain of transactions and you can call this a transaction blockchain, okay. And the idea is that as soon as a Bitcoin miner is able to construct a transaction Blockchain containing all these unrecorded transactions and this proof of work. It will broadcast the details of that chain out to all of the nodes, all the peers on that peer to peer network for Bitcoin, okay. And then once the newly broadcast chain gets kind of verified and meets the right properties and nodes on the network are just going to go ahead and start using it and there are sort of pending new transaction blocks to that chain, okay. They're going to take anything that hasn't yet been processed and start incorporating it into the transaction chain that was broadcast out by the node who came up with the proof of work correctly, okay.

Now, this transaction blockchain really what we're going to be doing in the context of Bitcoin is the nodes are only going to consider the transaction Blockchain that reflects the greatest amount of work to generate its contents. And again, there is this proof of work that I mention that is used to kind of determine or identify what the what work was involved in coming up with a transaction Blockchain, okay. And the one that's the long list is going to be considered sacrosanct within the Bitcoin system. And future miners are supposed to only work off of the chain that is the most work put into it. Now, what's remarkable here is that this whole process is decentralized. There is no bank or no centrally trusted entity that was actually involved in the transaction. So, hopefully this first video gave you a bit of a description a flavor if you will for the high-level mechanics of the Bitcoins system. There are a lot of stones I have left unturned. And what I'll do in subsequent videos is start covering those details. And I'm sure you have a lot of questions and hopefully the future videos will help answer some of those questions for you.

Written by Zulfikar Ramzan on May 1, 2013.