Bitcoinomics, Chapter 3: What is Bitcoin?
[heading]3. What is Bitcoin?[/heading]
“Yes, [we will not find a solution to political problems in cryptography,] but we can win a major battle in the arms race and gain a new territory of freedom for several years. Governments are good at cutting off the heads of a centrally controlled networks like Napster, but pure P2P networks like Gnutella and Tor seem to be holding their own.” – Satoshi Nakamoto
This section gets a bit technical. Few truly understand how Bitcoin functions, but by coming into contact, if even briefly, with the degrees of technology that go into powering a p2p network like Bitcoin, one can have their mind expanded and appreciation for Bitcoin raised. To paraphrase Karl Marx, “the masses must live through the revolution in order to understand the revolution.”
First of all, there are many misconceptions about Bitcoin. Such as that they are backed by nothing. Therefore, Bitcoin is not a virtual gold. But, the value of gold is largely reflected in the amount of energy consumed in mining and refining the metal, which contributes just as much to gold’s value as does its suitability as money. As one individual once put it, “A gold coin represents a large amount of land, highly refined, with the input of a great deal of energy, labor and capital.”
In a similar manner, bitcoins represent the computing power, energy and capital required to create them. It takes specialized technology running for sometimes many days to create a Bitcoin.
This was even true many years ago. Like mining for precious metals, it is not easy to mine bitcoins profitably. Bitcoin mining is extremely competitive, as we will detail later, and it’s rarely a profitable venture unless higher future prices in Bitcoin are assumed.
A main advantage of Bitcoin is its peer-to-peer nature. This means there is no “issuing authority” for Bitcoin, no central depository or true, centralized managing group.
Several cryptographic technologies form to create Bitcoin, first being public key cryptography. Each Bitcoin is tied to its current controller’s public ECDSA key. When you send bitcoins to another address, you create a message (transaction), which attaches the new owner’s public key to the right amount of coins, and the transaction is signed off with your private key.
This transaction gets broadcast to the bitcoin network, informing all nodes (users) who the new controller of these coins are. The entire history of transactions is kept by all users, and so anyone can verify wallets and how many coins they control.
The record of transaction is called the block chain, a sequence of record-keeping called blocks. All computers participating in Bitcoin (that download to their own computer their own wallet client, at least) have a copy of this block chain, which constantly updates as new blocks get confirmed.
Each block shows a group of transactions that have been sent since the prior block. The block chain is preserved as each block in the chain confirms the integrity of the prior block, a process that goes all the way back to the first block, “the genesis block.”
The generation of new bitcoins is made difficult by the Hashcash cost-function. Hashcash represents the first secure, efficient and verifiable cost-function or proof-of-work function, and it is non-interactive so it has no secret keys that must be managed centrally or by any party.
Hashcash is fully distributed and infinitely scalable. Hashcash uses symmetric key cryptogaphy, namely a one-way hashcash function – typically either SHA1 or SHA-256. In Bitcoin, integrity, block-chaining, and the hashcash cost-function all use SHA256 as the base cryptographic hash function. A cryptographic hash function takes input data of essentially any size, and transforms it, in an essentially irreversible and/or unpredictable manner, into a more compact string. (in the case of SHA-256 the hash is 32 bytes)
And so, with a compact hash, you can confirm that it matches a certain input datum, and since Bitcoin’s input data is a block-chain, and much larger than the SHA-256 hash, Bitcoin blocks don’t have to contain serial numbers, because blocks can be identified by their hash.
The hash serves two purposes: identification and integrity verification. An identification string is called a self-certifying identifier. These functions and others enable verifiable ownership of bitcoins, and a distributed database of all transactions so as to prevent double spending.
The block chain represents Bitcoin’s common ledger. It details the controller of each bitcoin, or fraction thereof. The ledger of transactions is stored by broadcasting minute pieces (known as “blocks”), each stating in its code that it continues the prior block. The block chain could split into a new branch – that is, two blocks can both point to the same parent block and contain some of the same transactions – and when this transpires each computer in the network must then decide which branch is “correct” and should be accepted by the network.
When there is a fork in the block chain, the rule says to accept the “longest” valid branch. Bitcoin discovers the sequences of blocks assumed to have required the most work (CPU or GPU time) to generate. Bitcoin will see this as the true sequence of events, and will take this into account when calculating the balance to show users.
To be certain, the concept of Bitcoin is actually quite simple: adapt the p2p platform to money. But, Bitcoin’s execution is what separates it from past digital currency experiments. Since Bitcoin arises out of the Internet, there is certain to be not only generation gaps in understanding, but also skeptics the world over who make good points about the Bitcoin’s legitimacy and viability. But, Bitcoin is a protocol that helps route traffic and is at a layer of the Internet “below” the http (for example, http://goldsilverbitcoin.com) layer.
The Bitcoin protocol, at its heart, has solved the double-spend issue. Federal Reserve’s quantitative easing is an example of double-spend. What if there were a computer code that disallowed double-spending? Open-source code as government, essentially. Remember, Bitcoin, being open-sourced, is available to peer review.
The advancement in accounting Bitcoin uses is referred to as triple-entry accounting. In order to compromise the code, Trace Mayer estimates $30 billion worth of computing power would be needed, for currently Bitcoin is secured by processing power of approximately 250 pedaflops. The Department of Energy built a supercomputer for $1.2 billion that has 15 pedaflops. This gives you an idea of how big Bitcoin is.
And so, each individual will find his or her own comfort level with using digital currencies, and so they should only do so within their own perceived comfort levels. But, what they might not already realize, is that the US Dollar and all other fiat currencies are basically totally digital. Bitcoin is a novel monetary system. It functions as not only a currency, but also a payment network for that currency.
Dialysis for society, by using Bitcoin, can be a dangerous exercise in bravado, naivete and courage. By using alternative means of doing business, one then begins the process of changing their perspective on doing business.
Bitcoin is many things, one of which is an intriguing technical and scientific feat. It is a digital currency unit and it is a global payment network through which one can send and receive the Bitcoin currency units. It frees humanity up in ways more meaningful than other p2p revolutions, such as media file-sharing, torrents and telecommunication, for the p2p nature of Bitcoin makes it available to all the aforementioned services. It is there to be used by them.
When viewing Bitcoin as a currency unit, feel free to compare it to other currencies. We are all familiar with euros, dollars, yen, gold and silver ounces. Just add Bitcoin to that list of potential currencies for you to use.