Understand Bitcoin White Paper
We can say the beginning of Blockchain Technology
Original White Paper
1. Introduction
To implement a distributed timestamp server on a peer-to-peer basis, we will need to use a proof-of-work system similar to Adam Back’s Hashcash, rather than newspaper or Usenet posts. The proof-of-work involves scanning for a value thatwhen hashed, such as with SHA-256, the hash begins with a number of zero bits. The WTF average work required is exponential in
the number of zero bits required and can be verified by executing a single hash. For our timestamp network, we implement the proof-of-work by incrementing a nonce in the block until a value is found that gives
the block’s hash the required zero bits. Once the CPU effort has been expended to make it satisfy the proof-of-work, the block cannot
be changed without redoing the work.
That’s a real excerpt from the Bitcoin White Paper. In fact, it addresses one of the most important elements in Bitcoin.
As Satoshi puts it:
No mechanism exists to make payments over a communications channel without a trusted party. What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.
Why is this section important?
This section discusses the main problems with digital transactions today. It also briefly introduces Satoshi’s solution to solve this problem. You probably carry out online transactions all the time, but you may not have realized the central role intermediaries play in your transactions. After reading the introductory section, you should have a good idea about the nature of the double spending problem and the flow on issues it creates. You should also understand that it is the double spending problem which Satoshi
seeks to solve with the Bitcoin peer to peer system.
2. Transactions
This section introduces the technology that enables Bitcoin to operate — You may have heard about it.
It’s called Blockchain!
What is a blockchain?
A blockchain is a type of distributed ledger or decentralized database that keeps continuously updated records of digital transactions (who owns
what). The Bitcoin blockchain is designed as a write once read only database where records can only ever be added, not edited or deleted. Rather than having a central administrator like a traditional database, (think banks, governments), a blockchain has a network of replicated databases,
synchronized via the internet and visible to anyone within the network.
The relationship between Bitcoin and Blockchain is best summed up by Sally Davies, FT Technology.
How does this decentralized network made up of strangers spread across
the world (the Bitcoin blockchain) overcome the double spending prob-
lem?
It does this by publically announcing all transactions
to the network.
As Satoshi states:
The only way to confirm the absence of a transaction is to be aware of all transactions. In the mint based model, the mint was aware of all transactions and decided which arrived first. To accomplish this without a trusted party, transactions must be publicly announced.
What about privacy and security?
When people hear that all transactions are publically announced, a typical response is — that’s an abuse of my privacy and security! I don’t want my transaction history and identity presented to the world. Don’t worry. While it’s true that all transactions are publicly announced, transactions use cryptography instead of relying on centralized intermediaries to provide security and privacy.
What is cryptography?
Cryptography is just a form of encryption that involves the creation of codes to allow information to be kept secret. It is the cryptographic element of Bitcoin which turns a transaction message into a format that is unreadable to an unauthorized user. So even though Bitcoin transactions can be viewed by
anyone on the network, they are pseudonymous. When you send and receive bitcoins, it’s like writing under a screen name, pen name, alias or whatever you want to call it. This alias which comes in the form of a jumbled
bunch of characters is not linked to your identity.
Why is this section important?
Most of you will have heard about blockchain technology but wondered where it fits into the whole Bitcoin thing. Now you can understand the relationship between Bitcoin and Blockchain and see why they are so often confused or used as interchangeable terms.
First Bitcoin Transaction
In 2010, Laszlo Hanyecz spent 10,000 Bitcoins at a local pizza restaurant called Papa John’s to buy himself two pizzas. Back then his Bitcoins were worth only $40. But, since the cryptocurrency wasn’t yet a thing in the commercial world, Hanyecz reached out to the Bitcointalk community and openly traded his Bitcoins to anyone who would buy him these pizzas. Considering Bitcoin’s value today, which is over $46k currently, these two pizzas can be regarded as the costliest pizzas of all time.
Pizza Day
As this transaction heralded the commercialisation of cryptocurrency in the real world, crypto fans named May 22 as the Bitcoin Pizza Day. This Day completed 11 years this year.
3. Timestamp Server
In section three, Satoshi goes into more detail about how the decentralized Bitcoin network overcomes the double spending problem. He proposes a
specific software that is used to digitally timestamp data called a timestamp server.
What you need to know
Even though the majority of the network agree to run on a single timeline, for a decentralized system like Bitcoin to operate without any central intermediary, there needs to be a way for the network to agree about which order transactions are generated in. That means each transaction needs to get stamped with a precise time on it. Think about it. Without the network running on a single timeline and each transaction getting timestamped, how does a new recipient of bitcoins know and trust that the previous owner did not sign any earlier transactions? In the Bitcoin network there is no central intermediary to confirm if a transaction or previous transactions have been
double spent.
The solution
The timestamp server is a piece of software that timestamps transactions when they occur. It takes a small section of the transaction data and digitally
timestamps it to create a hash.
What’s a hash?
A cryptographic hash is an algorithm that takes an input and turns it into an output of a fixed size. It looks like a line of jumbled up numbers and letters.
There are many types of cryptographic hashes.
Bitcoin, for example, uses a hashing algorithm called
SHA-256.
Here’s an example:
INPUT: Hello
OUTPUT: 2cf24dba5fb0a30e26e83b2ac5b9e29e1b161e5c1fa7425e73043362938b9824
What happens after the hash is created ?
• The timestamped hash is made publicly available for everyone in the network to view.
• The Bitcoin network processes each transaction in order of their respective timestamped hash.
• The hash serves as a complex computer problem that needs to be solved by miners before a transaction can be added to the blockchain for eternity.
• Each time stamp includes the previous transaction timestamp thus forming a chain of transactions aka a blockchain.
An important note
If the same coin is sent to multiple recipients only the first recorded transaction will be accepted. The transactions with later timestamps are rejected. Because the entire Bitcoin network agrees to the same transaction timeline, there are no discrepancies.
Why is this section important?
If you ever wondered how members of the Bitcoin
network agree on a single history of the order in which
transactions were received and overcome the double
spending problem, this section has the answers.
4. Proof-of-Work
Section four is SUPER important. It focuses on how the Bitcoin network deters denial of service attacks and other service abuses.
What you need to know
For a decentralized system like Bitcoin to operate without any central intermediary, there needs to be a way for the network to agree about which
transaction records are valid and deter any abuse of service attacks like spamming.
Although we have already learned how the Bitcoin network agrees to the order of transactions, it will help your understanding of Proof of Work if quickly go over it again.
When transactions are publically broadcast on the Bitcoin network, they do not come in the order in which they get generated. Transactions get passed
from node to node in the network, but there is no guarantee that the order in which they are received at each node is the same order in which the
transactions were generated.
To agree to the order of transactions, decentralized networks like Bitcoin use Blockchain technology which places transactions in timestamped blocks
(groups).
All transactions in a specific block are deemed to have occurred at the same time, and each block gets linked to a chain of other timestamped blocks in
chronological order.
But a big problem still remains.
If multiple blocks can be created at the same time, and blocks travel through the network arriving at different points in the network at different times, how does the network agree which additions to the ledger are valid? Any member of the network can still collect unconfirmed transactions, create a block and send it out to the network in an attempt to add it to the validated chain of blocks (the Bitcoin blockchain).
If an ill-intentioned member of the network sends out a bunch of unconfirmed or illegitimate transactions to add to the blockchain, it could clog up the entire system by monopolizing the network’s computing power, preventing the validation of real transactions from occurring.
Introducing Proof of Work (PoW)
Proof of Work aka mining is performed to facilitate transactions on the blockchain and discourage bad actors from spamming the network by sending out fraudulent or illegitimate transactions. It involves miners (members in the network with high levels of computing power) to prove that a specified amount work has been completed.
These miners must solve complex mathematical puzzles that are difficult to solve yet easy to verify.
Solving these problems demands lots of expensive computational effort (lots of hardware equipment and electricity usage), so fraudulent transactions
become infeasible. They are just not worth it! Miners that successfully solve the PoW puzzle and update the blockchain get a reward of bitcoins. (This
is how new bitcoins get made) The network picks the longest valid chain with the highest amount of work as the correct chain. Consensus is reached!
Think about PoW as a system that adds a penalty or cost to members who try to present an alternate history of transactions to the network.
What does Proof of Work actually involve?
A Proof of Work problem is based on something called a cryptographic hash function. In Bitcoin,miners put new blocks of transactions through an
algorithm that turns a large amount of transaction data into a fixed length aka a hash. (Remember we looked at hashing in the previous section.)
The Bitcoin network demands that a block’s hash has to look a certain way. If the hash doesn’t fit the required format, then the puzzle remains unsolved. It usually takes many attempts to find the solution, and as stated before, it takes a lot of computing power. Every time a miner successfully creates a hash that fits the required format, they get a reward of bitcoins, and the blockchain is updated.
Why is this section important?
Proof of Work aka mining is used to facilitate transactions on the Bitcoin blockchain and prevent attacks from dishonest members. Although Proof
of Work is not a new idea, the way Satoshi used it in combination with digital signatures, and P2P networks is groundbreaking. It is Satoshi’s combination of these existing concepts that provide the main innovation in the Bitcoin white paper.
5. Network
Section five of the Bitcoin white paper addresses the steps involved in running the network
What you need to know
The steps involved are as follows :
• New transactions are broadcast to all computers (nodes) in the network.
• Each node collects new transactions into a block of transactions.
• Each node works on finding a difficult proof-of- work for its block.
• When a node solves the mathematical problem (proof-of-work), it broadcasts the block to all nodes.
• The network nodes only accept the new block if all transactions in it are valid and not already spent.
• Nodes then move on and start creating the next block in the chain.
• Repeat above steps.
If two nodes broadcast different versions of the next block simultaneously, the network nodes consider the longest chain to be correct and will keep working
on extending it. Any nodes that are switched off and fail to receive a new block will be updated when they connect back to the network.
Why is this section important?
Bitcoin is reliant on a network of nodes and a consensus mechanism (PoW) to keep members of the network (nodes) honest and incentivized. By understanding the steps involved in running the network, you can get a better overall picture of how Bitcoin works. As you can see, the process of running the network is relatively simple
6. Incentive
In section six of the Bitcoin white paper, Satoshi looks at how to incentivize members/nodes to support the network and carry out the expensive and time-consuming task of PoW, aka mining.
What you need to know
Bitcoin mining is an expensive and time-consuming task. To incentivize members to support the network a reward is given in the form of bitcoins.
The first transaction in a block creates a new coin which is owned by the person (node/miner) who solved the puzzle and subsequently created that
particular block.
This adds an incentive for nodes to support the network, and provides a way to initially distribute coins into circulation, since there is no central authority to issue them.
Unlike traditional currencies like the US dollar, Bitcoin doesn’t have a central bank to ‘print’ or produce more currency. To introduce more bitcoins into the network and motivate people to keep the system honest, miners are rewarded with new bitcoins.
Transaction fees which are additional charges added to transactions are also used to incentivize miners to keep the network operating smoothly. Once a predetermined number of coins (21 million to be precise) have entered circulation, the incentive will then transition entirely to transaction fees.
Why is this section important?
Ever heard the term crypto-economics? The term refers to the study of economic interactions in adversarial environments. It’s all about incentives
and disincentives. In adversarial P2P environments like Bitcoin,
where there are no central intermediaries to keep bad things from happening, there needs to be a set of incentives and penalties to keep things running smoothly. Without a way to incentivize members, the Bitcoin network would not be able to operate.
7. Reclaiming Disk Space
This section is all about saving space!
What you need to know
Think about the history of transactions that have ever occurred on the Bitcoin blockchain since its inception in 2009. That’s a lot of transaction data! Think about what happens when your computer gets low on disk space. Standard processes begin to slow down, and your computer runs painfully slow,
right?
Well, to save disk space and keep Bitcoin usable, Satoshi proposes old transactions get discarded after a set amount of time. But, Satoshi isn’t proposing to delete past transactions altogether. To maximize disk space and keep the entire history of the Bitcoin blockchain intact, Satoshi recommends keeping a trace or root of a transaction so that the blockchain can remain
unbroken but at the same time have more space. It’s kind of like data compression where all the number of bits needed to represent data is reduced
to save storage space and speed things up. To facilitate this without breaking a block’s hash, transactions are hashed in a Merkle Tree. A Merkle tree is just a hash based data structure that allows the efficient and secure verification of large amounts of data.
Why is this section important?
Bitcoin may appear all-powerful, but it has constraints just like any other network or system. Memory allocation is a critical factor in determining
the Bitcoin network’s storage capacity and speed of transactions.
While it’s not critical for you to understand this section in depth, the main takeaway is that storage capacity is an issue in the Bitcoin network. To save space, a particular method of structuring data is used called Merkle Trees.
8. Simplified Payment Verification
Section eight is all about payment verification.
What you need to know
You don’t have to be a miner that helps verify transactions to make Bitcoin transactions. It’s also possible to just send and receive bitcoins with a simple Bitcoin wallet. Most members of the Bitcoin network around the
world do not operate full payment verification nodes and don’t have massive supercomputing power at their fingertips. Most people just own a simple light
wallet aka a simplified payment verification node.
What’s the difference?
Whereas Full Payment Verification wallets, also called thick or heavyweight wallets, require a complete copy of the blockchain and can verify
transactions, Simplified Payment Verification wallets, also called thin or lightweight wallets, do not have a full copy of the blockchain and cannot check whether transactions are valid. They can however securely determine whether or not a user has received transactions.
Why is this section important?
Nothing is stopping you from going online right now, buying some bitcoins and beginning to send and receive bitcoins to and from your wallet. Well nothing except maybe regulations, but that is a whole different discussion.
Bottom line. You don’t need to be a computer geek with thousands of dollars of equipment to get involved in the Bitcoin revolution. It’s pretty easy!
9. Combining and Splitting Value
Don’t be scared of the title. This is one of the easier sections to understand.
What you need to know
Have you ever wondered how varying amounts of bitcoins get handled when they are transacted?
As you may know, bitcoins can be split up, so it’s not only possible to transact in full Bitcoin denominations. Think about it like dollars and cents. When you go to the local store, it’s possible to pay for an item in a variety of ways right? 10 or 20 cent coins for example. You don’t just have one dollar
coins or notes in your wallet.Just like traditional currencies such as the US dollar, bitcoins can be split into ‘cents.’ Whatsmore, they can also be combined to form larger transactions.
An example
You walk into a store and want to purchase something for $50. It would be inefficient for you to hand over $1 coins/notes to the shop attendant. It would also be inefficient for the store owner to individually process each of these $1 transactions independently 50 times!
It’s much easier to just hand over a $50 note in one quick and easy transaction. In bitcoin, a coin can be both split into multiple parts before being passed on and combined to make a larger amount, thus ensuring practicality and efficiency in the network.
Why this section is important?
The way bitcoins get processed impacts the efficiency of the bitcoin network. By enabling the value of coins to be split and combined, the network can remain relatively efficient
10. Privacy
Yes, you guessed it!
This section is all about privacy.
What you need to know
In the traditional banking model, privacy is achieved by limiting access to transaction information to the parties involved and the trusted third party.
In Bitcoin, however, there is no central intermediary like a bank. Instead, new transactions are broadcast to the network so all members can check that no
fraudulent activities like double spending are taking place.
But what about the privacy of people making transactions?
This is where public key cryptography comes to the rescue. Transaction information is encrypted so members of the network only see a random bunch
of letters and numbers.
No party that intercepts a transaction message will be able to read it. Only the holder of the private key can make sense of the message contents.
Why is this section important?
As the world digitizes at a rapid speed, data privacy has become a significant concern. Data breaches have impacted companies & government agencies
around the world. From Yahoo, Sony and Target to the NSA and US Department of Defense, sophisticated hackers are stealing highly sensitive
data on an unprecedented scale.
If a breach of the Bitcoin network occurs, your address and transaction information cannot be easily linked to your identity.
11. Calculations
What you need to know
This section is getting well into the weeds. Understanding it is not only unnecessary, but it could also be detrimental to your mental health.
Jokes aside, it will only serve to confuse you so we will skip right over it and head to the conclusion.
Take a look at this excerpt and you will see what we’re talking about.
=z q p To get the probability the attacker could still catch up now, we multiply the Poisson density for each amount of progress he could have made by the probability he could catch up from that point:
12. Conclusion
Congratulations! If you have lasted all the way to the end, you should now have a fundamental understanding of Bitcoin and Blockchain, the underlying technology that enables it to operate. In the final section, Satoshi summarizes the key points addressed throughout the white paper.
Here are the key takeaways :
• To overcome the double spending problem which results in reliance on intermediaries and a whole new set of problems (inability to
make non-reversible transactions, increased costs, etc.) Satoshi proposes a new electronic payment system that relies on complex computer encryption (cryptography) instead of the trust generated by intermediaries.
• A blockchain is a type of distributed ledger or decentralized database that keeps continuously updated records of digital transactions (who
owns what). It is the underlying technology that enables Bitcoin to operate.
• Instead of relying on centralized intermediaries to provide security and privacy, Bitcoin transactions use cryptography. Transaction information can’t
be linked to any identify because it is encrypted. Members of the network only see a random bunch of letters and numbers.
• For a decentralized system like Bitcoin to operate without any central intermediary, there needs to be a way for the network to agree about which order transactions are generated in (to prevent double spending) and which transaction records are valid (to deter any abuse of service like denial of service attacks and spamming).
• Proof of Work aka mining is performed to facilitate transactions on the blockchain and prevent abuse of service attacks. It involves miners (members in the network with high levels of computing power) to prove that a specified
amount work has been completed.
• To incentivize members to support the network and carry out the expensive and time- consuming task aka mining, a reward is given in the form of
bitcoins.
• To maximize disk space and keep the entire history of the Bitcoin blockchain intact, the Bitcoin network keeps a trace or root of
transaction data.
• You don’t have to be a miner that helps verify transactions to be involved in the Bitcoin network. It’s also possible to send and receive
bitcoins with a simple Bitcoin wallet.
• A bitcoin can be both split into multiple parts before being passed on and combined to make a larger amount, thus ensuring practicality and
efficiency.
13. Oficial Repositories & Site
Bitcoin Core integration/staging tree
Bitcoin Github
Bitcoin BIPS — Bitcoin Improvement Proposals
References
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W. Dai, “b-money,” http://www.weidai.com/bmoney.txt, 1998.
[2]
H. Massias, X.S. Avila, and J.-J. Quisquater, “Design of a secure timestamping service with minimal
trust requirements,” In 20th Symposium on Information Theory in the Benelux, May 1999.
[3]
S. Haber, W.S. Stornetta, “How to time-stamp a digital document,” In Journal of Cryptology, vol 3, no
2, pages 99–111, 1991.
[4]
D. Bayer, S. Haber, W.S. Stornetta, “Improving the efficiency and reliability of digital time-stamping,”
In Sequences II: Methods in Communication, Security and Computer Science, pages 329–334, 1993.
[5]
S. Haber, W.S. Stornetta, “Secure names for bit-strings,” In Proceedings of the 4th ACM Conference
on Computer and Communications Security, pages 28–35, April 1997.
[6]
A. Back, “Hashcash — a denial of service counter-measure,”
http://www.hashcash.org/papers/hashcash.pdf, 2002.
[7]
R.C. Merkle, “Protocols for public key cryptosystems,” In Proc. 1980 Symposium on Security and
Privacy, IEEE Computer Society, pages 122–133, April 1980.
[8]
W. Feller, “An introduction to probability theory and its applications,” 1957.
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