The topic of Bitcoin is as deep as you want to make it. Simply put, Bitcoin is a peer-to-peer electronic cash system using a public ledger, a ‘Proof-of-Work’ consensus algorithm, and private key cryptography. If that’s enough for you and the gears are moving, then you can stop reading and start using it. If not, we will delve deeper into why it exists and how it changed the financial landscape of the world forever. Would you like to know more?
There is no official creator of Bitcoin but a pseudonym. Though the whitepaper was authored by someone calling themselves Satoshi Nakamoto, there is no official confirmation as to who this pseudonym represents. There is only speculation, is it Adam Back? Hal Finney? Craig Wright?
Since we cannot truly say who made it, we can at least try to understand it. In order to understand how Bitcoin as a technology came to be and how it changed the way finance operates, it is important to briefly acquaint yourself with the progression of solutions to computing problems from various mathematicians and computer scientists.
The Byzantine Generals problem is an abstraction for distributive computing problem in which information needs to travel through hostile environments unmolested in order to function properly.
The metaphor has loyal generals surrounding an enemy city where they must come to a consensus on whether to attack or retreat; a consensus is needed, or the siege will surely fail. The problem is that there are traitorous Generals attempting to disseminate malicious information to honest Generals with the purpose dividing consensus and thwarting the attack. So, it goes with a network of computers.
Regarding Bitcoin, this problem is used to find a method to ensure that honest nodes will reach agreement on the public ledger of transactions in an environment of hostile nodes. One of the more practical solutions was to send encrypted messages using cryptography.
Though the problem can be solved using many forms of encryption, the use of a public/private key pair would be the catalyst to changing the financial landscape forever.
The basic idea is to generate a pair of keys, one private and a public key derived from the private key. The private key would be, you guessed it, kept private while the public key is broadcast publicly to be used by anyone. There are many ways to use the public key to verify ownership or legitimacy of a message, but there is no way to find the private key from the public key.
Regarding cryptocurrencies, the private key is used to sign (create a hash of) a transaction where the public key used to verify the signature as being linked to the private key without revealing the public key.
In 1997 Adam Back announced his Hashcash package to the Cypherpunks message group as a countermeasure to email spam and later to Denial-of-Service attacks. The idea was to create a protocol in which an email sender must create a hash of their email that required a certain amount of computing power expenditure.
This hash needed to be relatively difficult to create but easy to decrypt to provide a proof-of-sender or proof-of-work from the sender. To the everyday user this would mean the email is delayed by a negligible amount of time, but to the email spammer whose business model requires sending ten thousand emails a minute this would be expensive.
These are incredibly brief explanations of complex problems, and I suggest you embark on further reading understand the importance of these milestones. But for now, these concepts are important to know when learning about cryptography as a financial tool.
Though the market rate for access to a single bitcoin currently seems daunting, (bitcoin is currently ~24K USD) you can rest assured that business can be done using denominations of a bitcoin known as ‘satoshis’. There are one hundred million satoshis in a bitcoin, like one hundred cents in a dollar. But the currency is merely a unit of account in the Bitcoin Network. The heavy lifting of the network is done under the hood and kept away from the general users.
The Bitcoin network relies on the rules that join cryptographic techniques to safely communicate between wallets and blocks to hold data (UTXOs), and nodes to incentivize the honesty of miners. This overview will not provide a complete technical explanation, but we can begin with a brief overview of two key concepts.
It is crucial to have a cursory understanding of the Unspent Transaction Output (UTXO) model Bitcoin uses as opposed to the account model other networks use.
For our educational purposes, UTXO’s can generally be described as a cash/change system similar to spending fiat cash:
These steps are collected and stored in a block, created by miners, on the blockchain. This is a simple explanation but will help you better contextualize the functions and limitations of the Bitcoin network.
The core concept of a peer-to-peer cash system is trust, or lack thereof. Effective monetary systems employ a third-party (a trust or bank) to ensure accurate accounting of transactions as well as detection of fraud.
Satoshi posited that this new network must use cryptographic proof instead of trust for the peer-to-peer transaction to work. Peers also needed a single source of truth to agree upon and a blockchain was used to solve for these variables. Every node on the network would own a copy of the record of account and this would serve as the point of truth for the network and the miners that mine the blocks for it.
Blockchain is not a new concept and is simply an immutable digital ledger made of blocks containing transactions (data). Immutability refers the property of blockchain in which blocks may only be added, not removed or changed. Each new block would use a hash of the previous block to enforce the immutable properties of the ledger making it easy for the network to verify each hash but incredibly difficult to recreate each hash.
Any changes detected in the chain shall render the data invalid as it does not match the record distributed throughout the network. But how does the network know which hashes to record as truth?
There are two ways to attain bitcoin: You can buy bitcoin from an exchange like AscendEX with fiat or you can provide a service in exchange for bitcoin. To answer the question of where it comes from, you will have to employ method number two, but instead of providing a service to a customer, your customer would be the network.
We briefly went over some of the key mechanics of the Bitcoin software like UTXOs, blockchain, and public key cryptography. Now we can safely explain block mining and the purpose of proof-of-work.
Bitcoin miners are nodes that expend energy and computing power to find the next hash of a block on the blockchain. These computers perform calculations thousands of times per second until they find a matching hash. The miner then collects the ‘coinbase’ transaction as its reward and moves on to finding the next block. The rest of the network then updates their copy of the ledger and broadcasts it to the rest of the network.
Note: Simply mining a block doesn’t guarantee success of a miner, the hash needs to coincide with the next block found in the chain. Honest nodes will only refer to the longest copy of the blockchain.
Proof-of-work as a concept hasn’t changed much since it was created for use with Hashcash. The idea is to require an expenditure of energy in the form of computing power to show that an amount of time has passed, and work has been done. It is one of the few ways to represent linear time on a network as it takes time for a computer to calculate the algorithm needed to solve the hash used (SHA-256) in Bitcoin.
The math/design works out so that a miner will find a hash every ~10 minutes depending on difficulty set by the network in response to amount of mining is happening. The more miners on the network, the higher the difficulty.
One of the major selling points you’ll come across is Bitcoin’s steady inflation schedule. There will only be 21 million bitcoins in circulation by the time the schedule is complete in around the year 2140. During that time bitcoin miners will continue to collect their block creation reward transaction where the reward will be cut in half roughly every four years or ~210,000 blocks.
The obvious question is: Why wouldn’t someone just make their own blockchain to trick the network? This is what is referred to as an ‘attack’ on the network. It requires a significant amount of energy, 51% of the computing power of the network, to mine a legitimate block and it requires a significant amount more to mine an illegitimate block and then match up the blockchain hashes to fit this fake block. It is more profitable to behave honestly on this network than it is to try to subvert it.
The idea is still to make it incredibly difficult to create the hash than it is to verify the hash.
User interactions of the Bitcoin network aren’t all that complex, it’s just that the average user has never had to employ cryptography in their everyday transactions. The layer of complexity comes from the extra steps added to obfuscate the unsecured aspects of a financial transaction.
Understanding the key concepts above is not meant to give you a mastery of the subject, but simply meant to give you the tools to dig deeper into a complex topic like Bitcoin. There’s the Economics, the Philosophy, Proof-of-Work’s energy usage debate, Hard-forks, Seed phrase security and so on and so forth. More on those to come!