The Loser’s Guide to Bitcoin
Everything you need to know about the digital currency, in 10 minutes or less
Bitcoin has been making headlines passing $100, $1,000, and then $10,000 in equivalent value. Its price has turned heads and gotten the attention of hobbyists and investors alike, but what exactly 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, for example. Some people — let me correct that, most people — pretend to know what these words mean. Meanwhile, honestly curious people mope around feeling like losers because they lack the vocabulary or foundational knowledge to participate in the discussion. This isn’t their fault. With Bitcoin having 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.
There Are Two Sides to a Bitcoin
The first hurdle we’ll tackle 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’ve just completed a transaction: you saw a product, recognized a price expressed in dollars, and paid for the product in physical U.S. currency.
Bitcoin, on the other hand, 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. The pro to this is that its value is independent of any one nation, the con is that it is not fully embraced and accepted by any one nation.
Double-Spending and Trust
Bitcoin was introduced by Satoshi Nakamoto to solve the problem of trust within the realm of digital payment. (Satoshi Nakamoto was the name used by the person, or persons, who invented Bitcoin, who still remains anonymous today.) With cash, trust isn’t a problem. You exchange cash for a product and 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, because digital spending uses digital files that can be copied or forged. Someone could pay for a product, receive said product, and then reverse the transaction before its completed in order to have both the product and their money. Someone could also claim to have and promise to pay money that isn’t his, or isn’t there. All of the above situations are variations of what’s called the double-spending problem, a problem where one person could spend a currency that’s meant to be finite twice, or more, 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 fees for the hassle. It’s both time and 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.
Part 1: Blocks
The terms “block” and “blockchain” are now 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, listing the amount of money transferred, noting from who and to whom. That’s what a bitcoin block is: one 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. You must consider it in the context of the entire book. For example, John Doe may appear wealthy if you see an incoming deposit of $15,000. However, if the previous page notes that he owes $2,500,000, a much different picture is painted. It’s only when all of Mr. Doe’s credits and debits are accumulated and shown that we get a full picture of his finances. To this end, his account must be assessed considering all the pertinent pages in the entire ledger. That comprehensive ledger is the blockchain.
So now we’re here: a bitcoin’s block is to a page, as 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 most recent to least recent. Likewise, if we scan the blockchain from the most recent to least recent block, we can see all bitcoin transactions by following the blocks before it. Each new block connects to its previous block creating a “chain” of blocks, hence the name blockchain. To summarize, if an accountant’s ledger represents all the transactions of an entity, this means the blockchain represents all the transactions of all bitcoins.
You might ask:“Isn’t it dangerous?” For all the records of all transactions to be held in one place — though it’s distributed, but still in one place — some ambitious, conniving person might look to profit from this type of setup, thinking, “Maybe I can sneak a transaction into the blocks. Maybe I can create a corrupt block. Maybe I can sneak a bitcoin or two into my own wallet.” Of course, they could try, but the odds are against them.
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 securely 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 acceptance of a new block is called mining.
Part 2: Mining and Miners
In the field of accounting, a junior accountant often bears the brunt of the work.
The junior accountant 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 day, he is still but a junior accountant. It is the responsibility of the senior accountant to vet and sign off on his subordinate’s work. The junior presents his findings, and the senior scrutinizes the work for inconsistencies.
If the junior’s ledger holds up, the senior, ideally, rewards the junior. The senior gives the document the stamp of the firm’s approval and all is well. However, if the ledger is inconsistent, it’s back to work for the junior to correct his mistakes. 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. So instead of choosing the central authority of an established institution like a bank, Bitcoin 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 that checks the calculations of workhorse computers called miners.
Part 3: Proof-of-Work
The security of the multi-billion dollar industry begins with email spam. The economics of computer time vs. human time means it takes an individual much longer to weed out and delete spam than it does for an automated program to produce the offending emails. In the late 90s, email service providers figured out how to use the same economics that email spam thrives 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 test without any shortcuts, that anyone, given enough time, can solve. For automated programs spamming a million emails a millisecond, this introduces a bottleneck. At this point, spamming programs have two options:
- Set a time limit on the proof-of-work, and time out the spam attack when it reaches the limit.
- Spend the time it takes to solve the proof-of-work to send the 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 a million emails per millisecond to maybe 10 per minute. One nullifies the desired action and the other nullifies the economics that spam thrives on. Blockchains use this same proof-of-work protocol 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 one year to solve a single instance of Bitcoin’s proof-of-work. You might still be worried. Maybe you’re thinking, “What if conniving entities got their hands on a supercomputer for the express purpose of corrupting the blockchain?” This is where economics comes in.
Part 4: Economy
Banking is a peculiar industry. It’s the only industry that’s paid in the same goods it manages. In case you’re in any way confused, we’re talking about money.
Bitcoin emulates this practice. Using a proof-of-work to validate transactions, miners compete with each other 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 with the express purpose of authenticating bitcoin transactions. However, it would be unwise to rule out the machinations of the nefariously minded.
It’s estimated that it would take a corruption of 30 to 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 Bitcoin grows stronger the more people use it.
With miners bearing 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 alarm bells should start ringing about now. The economics sounds too good to be true, and that’s because it is. The value of a bitcoin hinges on an if, a huge if; the if being if people adopt its use.
Like gold, Bitcoin has no value by itself. 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 bitcoin nor will there ever be physical tokens substantiating its existence. It started as, and will remain, a purely digital currency. However, Bitcoin was never meant to interact with the physical world. Satoshi Nakamoto created Bitcoin not for greed, nor fame, nor power. The spirit of the idea is, and always has been, an experiment to proliferate trust.
Bitcoin, and associated blockchain technology, has become a force to be reckoned 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 rule out the middle man. Proof-of-work systems replace the need for a central authority and, by emulating the self-interest of the finance industry, create a veritable army of miners fighting 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 other individuals as flawed as ourselves. The experiment may still be in progress, but if the recent and mounting attention paid to Bitcoin says anything, Nakamoto just might have been on to something.