The Bitcoin whitepaper explained with visuals
We explain one of the papers that have revolutionised finance and technology in our time.
A few weeks ago it was the anniversary of the Bitcoin whitepaper, considered by many to be the “most influential in history”. No wonder: it laid the foundations for Blockchain technology and has led to the emergence of a vast market of cryptocurrencies and other digital assets that mobilise huge amounts of wealth every day.
It is a short but elegant text that, with only 9 pages and 8 references, is capable of laying the foundations for a new digital economy. As for its author, the only thing we know is that he signs under the pseudonym of Satoshi Nakamoto, who may be one or several people who, for the moment, have preferred to remain anonymous. Join me throughout this post to go deeper into this disruptive and enigmatic paper!
Let’s start at the beginning…
“Internet commerce has come to rely almost exclusively on financial institutions acting as trusted third parties to process electronic payments”.
In its introduction, Nakamoto references to the current financial model, in which money exchanges are entrusted to third parties (banks). The fact that trust is the cornerstone of the system is its greatest weakness. Nakamoto proposes the creation of a financial system where cryptography is the link between the parties, eliminating intermediaries. Said and done!
Transactions and blocks
In the conventional system, what do we do to transfer money? It’s simple: we log into our bank’s application, select an amount and the recipient, and confirm the transaction by entering some kind of PIN that confirms our identity.
“We define an electronic coin as a chain of digital signatures. Each owner transfers the coin to the next by digitally signing a hash of the previous transaction and the public key of the next owner and adding them to the end of the coin”.
Something very similar happens with Bitcoin, but with a strong cryptographic component. Let’s say that a user’s public key is their account number, which anyone can find out in order to make a deposit. Meanwhile, their private key is their “password”, which is used to confirm transactions and prove their identity.
But what is a hash? It is nothing more than a kind of unique transaction identifier. When we transfer money, we indicate the hash of the previous transaction, thus ensuring that transactions are in order and that the same money is not spent twice. This forms the cryptographic glue of transactions and blocks, allowing anyone to check the integrity of the blockchain.
Proof-of-Work and consensus
“The proof of work also solves the problem of determining representation in majority decision making”.
What is the proof of work? How do you get the nodes of a network to agree on the ordering of blocks of monetary transactions without intermediaries? Mathematics, and more specifically the aforementioned hash functions, have the answer. These functions are also called one-way functions, in other words, it is very easy to calculate the hash of a piece of data, but it is very complicated to calculate the data from its hash. With this premise, a “mathematical challenge” is created for each new block, the complexity of which increases with the number of blocks in the chain. When one participant in the network solves it, the rest can easily check that the solution is correct. This process is called “block mining”, although Nakamoto does not mention the term (nor does he explicitly mention “blockchain”).
Incentives
Why mine? In other words, why do thousands of people and organisations spend hardware and energy resources on the complex calculations required by the network? According to Nakamoto:
By convention, the first transaction in a block is a special transaction that initiates a new coin owned by the creator of the block.”
It’s as easy as that: if you manage to mine a block, you get a Bitcoin, which is not insignificant at the latest currency prices. In addition, nodes also earn commissions for transactions processing. These incentives also help to discourage malicious nodes: what’s more profitable, defrauding the network or earning $20,000?
All this, in a network
We already know how transactions and blocks on the chain are linked, how consensus is reached in the network through proof of work (mining) and what incentives there are for this.
At this point, Nakamoto explains how the network is coordinated, the distributed component that makes the Blockchain so robust. The algorithm is simple and illustrative:
- New transactions are broadcast to all nodes.
- Each node collects the new transactions in a block.
- Each node works to solve the proof of work for its block.
- When a node finds a proof of work, it broadcasts the block to all nodes.
- The nodes accept the block only if all the transactions it contains are valid and have not already been spent.
After these simple steps, all the nodes add the accepted block to their blockchain and start working on the next block.
Privacy
OK, I get it, but… How come my transactions are sent to all nodes? Will everyone be able to see every single payment I make? Not only that, but these records will remain written there “forever”. Wait, don’t panic. You still have to read the fine print:
“The need to announce all transactions publicly precludes this method, but privacy can still be maintained by breaking the flow of information elsewhere: by keeping the public keys anonymous.”
It is true that any participant in the network can see all transactions: how much was sent and the accounts (public keys) of sender and recipient. The catch is that these accounts are freely created and have no personal data assigned to them. In other words, we will know which accounts are involved in the transactions, but not who is behind them (unless they disclose it, of course). In this way, privacy is achieved through anonymity.
Final thoughts
As we have seen through the previous points, Nakamoto did nothing more than use everyday concepts and existing technologies to, with great creativity and elegance, revolutionise the monetary and technological paradigm.
If you have reached this point, I can only congratulate you on your perseverance and thank you for reading. It is not easy to understand scientific publications with such a load of technicalities as the Bitcoin whitepaper.
I hope I have helped you understand Bitcoin and the underlying technology a little better!
