Tales from the crypto

Crypto whatshisface?

In this age of reckless de-information, if you want to feel current and retain an ounce of cool, you need to cave into social pressure and stamp the word blockchain somewhere in your CV. Better still, you need to be working on your own ICO, or you lack all societal value.

For all the crypto-virgins out there (update Dec 2019: are there any left?), I thought I’d attempt to explain in relatively layman terms just what the hell Bitcoin, Blockchain and the emerging Cryptoeconomics are, and what it means for the future of this troubled world. Even though everyone seems to be loosing it over what very much looks like a repeat of the 2000 .com bubble, there are some arguments that validate the “it’s different this time” point of view.

You remember the 2008 world financial slump, right? Increasingly sophisticated financial instruments (packaged crap) were concocted by greedy investment bankers, overlooked by regulators who probably didn’t even understand what was happening, and justified by a self-reinforced sense of economic invulnerability that would give everyone a chance to make an easy return on their investment and get that home they deserved, even if they could hardly afford it. We all know how that ended.

So, at about the same time, a brilliant, handsome and charismatic argentinian born in Mar del Plata named Satoshi Nakamoto (he might as well be) published the Bitcoin paper, which improved on previous work on digital cash and proposed the first workable alternative to central bank controlled “fiat” currency. On that sublime paper he made not one, but three crucial inventions: 1) the Bitcoin currency, 2) the Blockchain distributed consensus protocol and 3) the governing Crytpo-economics.

Let me explain.

Invention #1. The Bitcoin currency

In the beginning, people coveted gold. It was shiny and precious. You could woo a lover with it. For centuries it would be used, as other scarce substances, as a means to exchange goods. Mining it was hard work, so that effort was translated into its value.

The world has changed. Would you carry gold around today, to buy a banana? We use a proxy nowadays, central bank issued paper and metal representations of gold, which is lighter so our pants don’t fall down. Though technically we stopped equating currency to it’s gold weight equivalent in the 70’s when we demised the gold standard, because Nixon, still “money” is a transactable unit of value backed by a government, and everyone just choses to adhere to that convention. That’s why, when a government screws up, its currency goes down in the same proportion as people’s trust in that country’s ability to function and support that currency, relative to other currencies. I’m not an economist, so comment below if you wish to complement.

Satoshi et al got fed up with central banks setting the rules, owning the system, so they circumvented it. And Bitcoin was born as a new type of currency that does not require a central authority. It’s digital, not physical. It lives in the world of Tron. Your wallet is not made of leather, but of an alphanumeric address you better not misplace, or else your coins go poof. You can use it to buy a banana. That is, if the banana place accepts Bitcoin. More and more physical stores accept Bitcoin, you can even find them on a map. You can buy or sell Bitcoin online using traditional currencies via exchanges like Bittrex or Poloniex.

More importantly, it’s a digital cryptocurrency, where “crypto” here means it’s risen from the dead. Kidding. Actually it means every supported transaction (creation, exchange, payments, transfers) follows a protocol controlled by cryptographic algorithms that will ensure it’s both secure and anonymous, even though the transactions are posted publicly and can be accessed (though not read) by anyone. It also means the system operates under a pre-defined set of rules which are common knowledge and open to the community, therefore subject to high levels of scrutiny. One of those rules is: There is no inflation. By design. There is a max number of coins to be generated, ever.

Invention #2. The Blockchain distributed consensus protocol

There are a number of technological innovations that make Bitcoin possible, some of them fascinating when you get deep into the details. Once again, proof that nerds sometimes are the most gifted artists, and that coding is a sublime expression of human endeavour.

Perhaps the most captivating innovation is the distributed consensus model, commonly simplified as the Blockchain.

Bitcoin has no central authority. It’s a peer to peer public network, where every node operates to support the platform and contributes to run and enforce the rules. The blockchain is distributed, so it does not reside in one place. Every node has a copy of it. The size grows exponentially and is at about 46 gigs, last time I checked.

Let’s describe, in a simplified way, how this works:

• Every node has a copy of the full history of transactions, all the way back to the original Satoshi transaction, bundled into blocks and linked into a chain. Each valid block of transactions points to the next block, therefore it’s a chain, not a tree.
• Every Bitcoin transaction (when A wants to pay B for a banana) is pushed from the originating node that captures it, to all others nodes.
• Every node checks all these pending transactions are valid, by making sure they’re properly signed with the right encryption key and that there is no double-spend.
• Every node bundles the valid transactions into a block, and then proposes this block to every other node, so they can add it to their local chain.
• Every node will receive the proposed block, check if it’s valid (including all the contained transactions) and if it is, it will add it to it’s local chain of blocks.
• Once a reasonable number of nodes in the network have also added this block to their local chain (this is called a confirmation) then it is safe to assume that the block and it’s containing transactions are included in the chain irreversibly. 6 confirmations is good enough. New blocks are accepted every 10 minutes.

Wait, what? We have to wait a full hour until our transaction is confirmed?!

In perhaps one of the few trade offs in the protocol, this is required to prevent adversaries taking advantage. It might happen that a malicious node generates a double-spend transaction and quickly pushes it to the network before the real valid transaction is inserted into the block. How can we prevent this?

Here’s the beauty of the Bitcoin protocol. For every node to propose a block, they must solve a cryptographic exercise which requires high computational power. This is called “proof of work” and guarantees that 1) every node is operating following the protocol rules and 2) there aren’t any fishy or fake nodes added to the chain. Since solving the block riddle is so costly and time consuming (currently an adjustable average of 10 minutes), there is no way to “run-ahead” on your local chain and create blocks full of double-spend transactions. The probability of a single adversary node actually solving multiple consecutive block riddles and in turn adding malicious transactions into the system decreases very rapidly. These irregularities will be soon picked up by other nodes that will ignore the dubious branch and fork out of the longest valid chain.

But why would nodes even go through this trouble, spending so much electricity on computing hashes and validating blocks? Money, silly. Everytime a node “mines” a block they earn 25 Bitcoins. Today, that’s about $165.000. Not bad, huh? That reward is the main incentive to run the network. The number of reward coins halves every 4 years, by design. In the future, running a node for the reward won’t be enough, and the transaction fees, also supported by the protocol, will kick in.

So, the blockchain is beautiful because it does not rely on one party defining what is true or false. It relies on the network effect of multiple nodes agreeing on the veracity of the block contents and reaching distributed consensus. The mining effort is the crucial component that makes it impossible for nodes to continually subvert the process, mine spurious blocks and corrupt the system. The only way this can happen, is if a malicous entity controls 51% of the nodes, which would irreversibly destroy confidence in the currency. Let’s hope this doesn’t happen.

Invention #3. The governing Crypto-economics

Who gives Bitcoin, or any other alt-coin, its value? It’s easy to say that speculative market dynamics are the main reason for the hockey stick rise of Bitcoin value this year. There certainly is a crypto FOMO effect at play. But increasingly governments and financial institutions are becoming interested in attaching Bitcoin to their portfolios and accepting it as a legal payment method, which captures attention and opens minds.

In reality, YOU give Bitcoin it’s value. If you’re a believer, you believe. If you are convinced that…

• the world is moving from central silos of control towards decentralised, distributed world-wide computing and decisioning engines, where anyone can participate, collaborate, create value, and contribute to the economy,
• there’s a revolution in the making towards a new paradigm for how to operate and make decisions, where makers and consumers can be directly connected without middlemen,
• technology can enable trust-minimal databases and applications that have embedded security, fraud control, and scalabilty, by design,

…then you're valuating Bitcoin. You support this “world government” and this distributed truth engine. And you’re not alone.

So, is it a bubble? Joseph Lubin, cofounder of Ethereum, believes it is, but a good one. One that fuels the discovery and engineering of the underlying technology and principles. I’ll cover Ethereum and the token economy in a future post, and expand on cryptoeconomics and ICOs.

I deeply recommend everyone to explore beyond the buzzword and truly understands the mechanics of Bitcoin and what blockchain-based applications really mean to society. You’ll be surprised there’s paradigm-shifting content.

Update 2023: Yep, it was a bubble. Of horse manure gas. Popped in thunderous silence. But GPT is the future. Believe you me. This time it’s different™.