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Bitcoin made headlines passing $100, $1000, and now $10,000 in equivalent value. Its price has turned heads and has gotten the attention of hobbyists and investors alike, but what is it and why all the hype?It’s difficult to discuss Bitcoin when most laypeople get stuck on the vocabulary of mining, proof-of-work, or Blockchain. Some people — let me correct that, most people — pretend to know what these words mean. Meanwhile, honest, curious people mope around looking like losers because they lack the vocabulary or understanding to participate in the discussion. This isn’t their fault. With roots in economics, mathematics, and cybersecurity, it would be surprising for experts in any one field to fully comprehend Bitcoin, much less the layperson. This piece aims to change that.
What: Two Sides to A BitcoinThe first hurdle to get over is the difference between how a Bitcoin is represented and how it operates. Picture yourself shopping in Manhattan one day. You go to a café to purchase a cup of coffee, pay with cash, and take a seat.You completed a transaction. It’s obvious; you saw a product, recognized a price in USD, and paid for the product in physical US currency. However, Bitcoin has no physical form. Because it isn’t palpable nor backed by any government, despite its BTC currency ticker Bitcoin operates like gold: it’s volatile, openly-traded, and treated like a commodity. There are some pros and cons. The pro is that its value is independent of any one nation, the con is that it is not accepted by any one nation.
Why: Double-Spending and Trust.Bitcoins were introduced by Satoshi Nakamoto to solve the problem of trust. With cash, this isn’t a problem. You exchange cash for a product, the transaction is irreversible. You have your coffee and the vendor has your cash. The problem with digital transactions is in its impermanence. Someone could copy-paste more money. Someone could pay for a product, receive said product, reverse the transaction and have both the product and the money. Someone could also claim to have money that isn’t his. All of the above situations are variations of the eponymous double-spending problem, a problem where one person could spend a currency meant to be finite twice or more times in duplicitous transactions.To avoid this, we trust institutions such as banks and credit agencies to regulate, authenticate and standardize the process. They confirm the increase and decrease of credit on behalf of both parties and charge you a fee for the hassle. It’s time-intensive, resource-intensive and relies on a central authority. Without national backing, digital currencies were too unstable and insecure for practical use; that is until Bitcoin came along.
How Part 1: Blocks
The terms Block and Blockchain are invariably tied to Bitcoin. The highest level of abstraction of a Bitcoin is the Block. This is, however, a bit of misnomer; think of the Block more so as a page.
Imagine an old-school accountant’s ledger. Each brittle, ink-stained page is filled with line items, each listing the amount of money transferred, from who, and to whom. That’s what a Bitcoin Block is: a page of a ledger.
However, a single page of an accountant’s ledger is useless. A short-term view of added credits or subtracted debits means nothing by itself. For example, John Doe may seem a bit wealthy with an incoming deposit of $15,000. However, an amount due of $2,500,000 on the previous page, paints a much different picture. It is only when all of the credits and debits of Mr. Doe are accumulated that we get a full picture of his finances. To this end, his account throughout all the pages in the entire ledger must be reviewed. That is the Blockchain.
As a Bitcoin’s Block is to a page, the Blockchain is to the accountant’s ledger. When a reader scans the pages of a ledger from right-to-left, he sees every transaction from the most recent to least recent. Likewise, if we scan the Blockchain from the most recent to least recent Block, we can see all the transactions of Bitcoin by following the Blocks before it. Each new Block “chains” to its previous Block creating a chain of Blocks, hence the name Blockchain. However, if an accountant’s ledger represents all the transactions of an entity, that must mean the Blockchain represents all the transactions of Bitcoin. That’s exactly the case.
“Isn’t it dangerous?” you might ask. For all record of transactions to be held in one place, distributed, but in one place, someone ambitious and conniving might look to profit from the setup thinking, “Maybe I can sneak a transaction into the Blocks. Maybe I could create a corrupt Block. Maybe sneak a Bitcoin or two into my own wallet”. You could try, but the odds are against you.
Once authenticated and accepted by the Blockchain, a Block can never be altered. If a Block can never be altered, then the Blockchain itself can also never be changed. It is in this manner, that the Blockchain holds the recorded history of all Bitcoin transactions. The only part of the Blockchain that can be modified is the tail end of the chain: where the next Block is accepted. The acceptation process of a new Block is called mining.
How Part 2: Mining and Miners
In the discipline of accounting, a junior accountant often bears the brunt of the work.
The junior examines, analyzes, and crunches the numbers to the best of his abilities. He is the backbone of the industry. However, at the end of the end of the day, he is still but a junior accountant. It is the responsibility of the senior to vet and sign-off the junior’s work. The junior presents his findings, and the senior scrutinizes the junior’s work for inconsistencies.
If the ledger holds up, the senior, ideally, rewards the junior. The senior gives the documents the stamp of the firm’s approval and everyone is better off. However, if the ledger remains inconsistent, it’s back to work for the junior. In the same manner that a Senior accountant scrutinizes, judges, and rewards a junior accountant, the Blockchain scrutinizes, judges, and rewards its workhorses through an approval process called Mining.
Without a central authority, such as a bank, in place to regulate transactions, Bitcoin faced a security threat. Bitcoin, instead of choosing the central authority of a bank, chose to rely on the universal authority of mathematics. In place of a senior accountant checking the work of a junior, Bitcoin has the law of mathematics checking the calculations of workhorse computers called Miners.
How Part 3: Proof-of-Work
The security of the multi-billion-dollar currency begins with email spam. Spam is annoying. The economics of computer time vs. human time means it takes a living person much longer to weed out and delete spam than it does for an automated program to produce spam. In the late 90s, email service providers figured out how to use the same economics that email spam thrived on against them. They required every incoming email request to pass a Proof-of-Work.
The Proof-of-Work is an annoying math problem that takes up a large amount of computational power to solve. It’s a brute force math problem without any shortcuts that anyone, given enough time, can solve. For automated programs spamming 1,000,000 emails a millisecond, this introduces a bottleneck. At this point, spamming programs have one of two options:
1. Set a time limit on the Proof-of-Work, and time-out the spam attack when it takes too long.2. Spend the time it takes to solve the Proof-of-Work to send their spam.
For the spamming programs, either choice forces a losing hand. The first choice prevents spam from entering the inbox, and the second choice demolishes the throughput of 1,000,000 emails per millisecond to maybe 10 per minute. One nullifies the desired action and the other nullifies the economics spam thrives on. Blockchains use this same Proof-of-Work to authenticate new blocks.
You might ask, “What if some deviant miner tried to alter Bitcoin values in a Block, authenticate it through solving a Proof-of-work, and have the Blockchain accept it?” Sure, a maladjusted miner could try, but the last estimation was that it took a standard computer about 1 year to solve a single instance of Bitcoin’s Proof-of-Work. You might still be worried, “What if conniving entities got their hands on a supercomputer for the express purpose of corrupting the Blockchain?” Ah, but you see, that’s where economics comes in.
How Part 4: Economy
Banking is a peculiar industry. It’s the only industry that is paid in the same goods it manages. In case you’re in any way confused, we’re talking about money.
Bitcoins emulates this practice. Using a Proof-of-Work to validate transactions, miners compete with each to come up with a solution before anyone else. The first miner to solve the current proof-of-work is rewarded with the same currency it authenticates: Bitcoins.
With the incentive of the very currency that the miners authenticate, miners form a distributed network in competition with each other to solve the next Proof-of-Work. If a supercomputer is nothing more than a distributed network of computers, then the collective mining of self-interested miners is a supercomputer aimed with the express purpose of authenticating Bitcoin transactions. However, it would be unwise to rule out the machinations of the nefariously minded.
It is estimated that it would take a corruption of 30%-50% of the miner population to have a significant chance of authenticating a corrupt Block. Block corruption is a real threat, however, as the popularity of Bitcoins and mining grows, the more and more unlikely this becomes. That is one of the reasons why people say that Bitcoin grows stronger the more people use it.
With miners taking the brunt of the back-office work, the currency grows more secure as more miners compete against each other. The more miners compete, the more currency is allotted. The more currency is allotted, the greater the number of transactions. The greater the number of transactions, the more miners are needed to authenticate transactions and the more secure the currency becomes. It’s a self-sustaining loop.
However, if you’re an economist, your alarms should start ringing about now. The economics sounds too good to be true, and that’s because it is. The value of Bitcoin hinges on an if, a huge if; the if being if people adopt its use.
Like gold, Bitcoin, by itself, has no value. As a self-contained economy, Bitcoin has no utility in-and-of itself. Without the possibility of national backing, storefronts will never display prices in Bitcoins nor will there ever be physical tokens of its existence. It started and will remain a purely digital currency. However, Bitcoin was never meant to interact with the physical world. Satoshi Nakamoto published his ideas on Bitcoin not for greed, nor fame, nor power. The spirit of his idea is, and always has been, an experiment to proliferate trust.
Conclusion:
Bitcoin, and associated Blockchain technology, has become a force to reckon with. Updating the accountant’s ledger for the 21st century, Blockchain has built a system of checks and balances founded on mathematical proofs and economics to rules out the middle-man. Proof-of-Works replaces the need for a central authority and by emulating the self-interest of the finance industry, a veritable army of miners fight to reinforce the security of the Proof-of-Work. However, despite its success as a currency, Bitcoin still remains an experiment of trust. It is an experiment against central authority, that of banks, credit agencies, and of other individuals as flawed as ourselves. The experiment may still be in progress, but if Bitcoin’s recent attention says anything, Nakamoto just might be on to something.
Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not reflect the views of Bitcoin Insider. Every investment and trading move involves risk - this is especially true for cryptocurrencies given their volatility. We strongly advise our readers to conduct their own research when making a decision.