Bitcoin – A new world currency? (Pt.1) ToT#002

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A lot of people have heard the word bitcoin, but what is it? We tackle this question in this Pt.1 episode of a two part series on bitcoin. Pt.1 covers all of the technical, and mostly behind the scenes information on bitcoin. Pt.2 will cover using and trading bitcoin, government scandals, big news in the world of bitcoin, and some speculation on the future of bitcoin.

  1. What is digital currency (cryptocurrency)?
    1. Bitcoin is a decentralized and ungoverned method of sending funds to anywhere in the world for extremely cheap. (As opposed to something centralized, such as Paypal.)
  2. Who created Bitcoin
    1. A person or group of people that went by the alias of Satoshi Nakamoto – In an attempt to create a decentralized way of sending money around the world so that everything is governed by math and cryptology rather than trust.
    2. After introducing bitcoin to the world on January 8, 2009, Satoshi Nakamoto went anonymous. The last words from Satoshi Nakamoto were in April of 2011 in an email that stated “I’ve moved on to other things”
    3. Satoshi possesses an estimated 1-1.5mil bitcoins. Which, at the time of this writing, is worth upwards of 7 billion dollars. This is a cause for concern because if that many coins were to be unloaded on the market at one time, would most likely crash the market.
  3. How is currency stored?
    1. Via a digital account called a bitcoin wallet. It is very similar to a bank account.
    2. A wallet is manipulated by.
      1. Public key – Compare to an account number that is printed on the bottom of checks. It is a 34 character hex code comprised of random digits, uppercase letters, and lowercase letters. The public key is derived from the private key. (See below)The public key is the address that is given to people so that they may send you bitcoin.
      2. Private key – Compare to the password that protects your bank account. Only the account owner knows the private key.The private key is what you would use to send bitcoins from an account. The public key is a hashed version of the private key. The public key can be recovered if you have the private key, but not the other way around. If you lose the private key, the bitcoins are locked on the account forever. It would take the world’s most powerful supercomputer several trillion years to crack.
  4. How do you get a wallet?
    1. Least secure, but easiest – Digital Wallet
      1. The easiest method is to use a bitcoin wallet provider such as Coinbase. Although less secure due to the fact that the wallets are managed online by a company, they provide methods of linking bank accounts and purchasing bitcoins directly through the wallet provider. They also keep track of your wallet balance public and private keys for you.
    2. More secure, but a bit more work – Paper Wallet
      1. A wallet may also be created using a hex generator such as bitaddress.org. And then printed or written on a piece of paper. Keep in mind that if you lose these addresses, they cannot be recovered.
    3. Most secure, but a lot of work. – Un-networked paper wallet.
      1. Follow the method described in point 2, but adding these extra security measures to prevent malware and spyware from gathering your information. Start with a fresh operating system. Best (most secure) method would be to load an OS onto a flash drive or CD, disconnect the hard drive and then boot from the flash drive or CD. Go to bitaddress.org and then disconnect the internet. Once loaded, the website should still be able to function after the connection is removed. Generate your wallet codes, and then write them down or print from an un-networked printer. These accounts are generally used as a one time use wallet to store bitcoin for a longer period of time. Once the private key is used to send coins, the security of the wallet is compromised and will not be as secure.
    4. Side note:
      1. Never store large amounts of bitcoin on a bitcoin exchange. They can, and have been hacked by thieves or shut down for various offenses in the past. Mt Gox and BTC-E are examples of this.
  5. How do transactions work?
    1. What is blockchain?
      1. Blockchain is a ledger of every transaction ever completed on within the bitcoin network. Every computer on the network has their own copy of the blockchain ledger. These ledgers are compared with each other and if any one copy of this ledger has a discrepancy, that transaction is considered invalid. A block is a pool of transactions that occurred during a specific time frame. These blocks are all linked together to show the entire history of bitcoin transactions and where every coin has gone. Any bitcoin may be traced back through blockchain to find out every location that it has been since it’s creation.
    2. Who controls validation of transactions if there is no central authority?
      1. People/computers called Miners are in charge of confirming transactions. Anyone on the network may “mine” for Bitcoin. This is where computers are in charge of validating transactions through a complicated mathematical process and updating the blockchain to reflect these changes. Miners are compensated for their efforts with a few Bitcoin every time a new block is added to the chain. (More on this in section F)
    3. What is a signature?
      1. Every time a transaction is executed, a unique digital signature is created and sent along with the transaction to prove that it is a valid transaction. Think of this compared to your handwritten signature. When you write a check to somebody, you have to sign the check at the bottom to prove that you, the account owner, are the one that wrote the check. Banks are then able to compare the signature on the check to the signature that they have on file to verify that they are the same and that you did in fact write the check.
    4. How is a transaction validated? Consider an example where person A wants to send some bitcoin to person B (this is all done behind the scenes):
      1. -Person A will generate a new input script that references an output script from the previous transaction where it received those bitcoin. This is proven by comparing the public key of the wallet and the transaction signature to what is recorded in the blockchain. In summary, person A is proving where those bitcoin came from and that they actually have them to spend by referencing the spot in the blockchain ledger where they received them.
      2. -Person A will then create a new output script that stores the hash (public key) of Person B’s wallet address and the amount of bitcoin sent. This is what will be added to the blockchain ledger once confirmed. It will be what is referenced when Person B needs to verify that they actually own the bitcoin just as Person A did.
    5. What are confirmations?
      1. Once a transaction is enacted as explained in section 3, person B will see that they have received the bitcoin. BUT…at this point, the transaction is unconfirmed and can be reversed. That transaction is sent to a list of unconfirmed transactions that the miners will review. This list is a pool of all transactions that occurred within the last few minutes. This pool of transactions will be what are grouped together to form the next block in the blockchain. All of the miners on the network will compare the output script containing the proof of ownership, the hash of person B’s address, and the transaction signature generated by person A to the blockchain ledger to verify that they actually have those bitcoin to spends. Compare this to a store checking your bank account balance when confirming a card transaction, but in this case, the balance is checked by looking at every transaction that person A has ever made and comparing the incoming bitcoin amounts to the outgoing amounts. If you have a positive account balance, the transaction may be confirmed. Once all of the transactions in the pool are confirmed, the block is added to the chain.
    6. What makes it secure?
      1. Since every computer on the network contains their own copy of the blockchain ledger, it is impossible to modify. Once a block is added to the chain, it is there forever. Minus one exception:
      2. Every time a node (computer) on the network verifies a transaction, it also verifies every other transaction ever completed in the blockchain. Since all of these transactions are being verified at the same time, it takes longer for them to be confirmed on some computers than others, depending on when each computer receives the transaction request. Think of this as a group of people gossiping: One person will tell a story to a few people they know, and those people will then go back to the source (blockchain in our case) to verify that the story is true. Those people will then spread the story to a few people that they know each and it starts a chain reaction with every person going back to the source to verify that the story is true. If one person gets a negative response from the source, the whole chain falls apart and the story (transaction) gets sent back to it original unconfirmed state and the chain starts over.
      3. Depending on when these confirmations take place, two blocks composed of different transactions may be confirmed at the same time. This will cause the blockchain to fork into two chains for a little while where different computers have different versions of blockchain (See section F to understand the likelihood of this happening). If this happens, computers will continue to build on their chain until one fork of the chain becomes longer than the other. The longest chain in the fork is then accepted as the legitimate chain and all computers adopt this chain as the valid chain and the blockchain becomes one again. The shorter chain of transactions are then discarded and any transactions that were confirmed in the shorter chain that were NOT ALSO confirmed in the longer chain will be bumped back to an unconfirmed state. This is the only way the chain could potentially be modified.
      4. Consider this example:
        A scammer/thief wants to try to steal from someone. They would send a legitimate transaction to somebody, it shows on the recipients end that the bitcoin was sent and the transaction was confirmed one time when the block was added to the chain, so the recipient sends the goods purchased. The thief would then send another transaction request trying to spend the same bitcoin at another location (Most likely another wallet that they own). At this point, the coins are effectively spent twice; one for the legitimate transaction with one confirmation, one for the bogus transaction with zero confirmations. A race then ensues. The thief would have to race to build the most blocks in a chain containing the bogus transaction before the rest of the world is able to add on to the legitimate chain. This puts the thief’s computer vs. the rest of the computers on the network. It is extremely difficult for one computer to build two blocks back to back (explained in section F). The thief would have to build the longest chain out of every computer on the network for the bogus transaction to be considered valid. If this were to actually happen, the legitimate transaction would then be discarded and sent back to an unconfirmed state. When the computers try to verify the legitimate transaction with the blockchain, they would see that the bitcoin have already been spent on the bogus transaction and the legitimate transaction would be invalidated.
      5. Every time a block is added to the chain, that block of transactions, and every other block of transactions in the chain is reconfirmed. This means for every confirmation that is received on a specific block, the less likely it is to be reversed. Because of this, it is recommended that the recipient wait for at least six confirmations (six new blocks added to the chain) before sending goods of extremely high value. This is when odds mathematically determine that it is (almost) impossible to reverse a transaction. This should take approximately 1 hour.
  6. How are new Bitcoins produced/minted?
    1. What is mining?
      1. Mining is the process of validating transactions and adding new blocks to the blockchain. A miner will take a group of unconfirmed transactions and verify that all of the transactions within that group are valid by comparing the output script generated by the client that initiated the transaction to the blockchain ledger. Once these transactions are confirmed, the miner has a block prepared to be added to the chain.
      2. Before they are able to do this though, the mining computer must solve a very complex math problem. This math problem is designed to delay the amount of time that computers take to add new blocks to a chain. Ideally a new block will be solved approximately every 10 minutes. The system is designed to automatically adjust the difficulty of the problem depending on how often blocks are added to the chain to meet that average. The more efficient computers become at solving these problems, the harder they will get. This process consists of randomly guessing a hash code until it is guessed correctly. Once a computer guesses the code, it may add the new block to the chain and will be rewarded with some newly minted bitcoin!
    2. How much is the reward?
      1. The amount awarded will slowly decrease over time. For now, 12.5 bitcoins are awarded per block (approx every ten mins) until mid year 2020. After that, 6.25 bitcoins per block will be awarded for the next 4 years. Halving will continue every 4 years ending roughly in year 2140 @ 21mil bitcoins. After that, no more will be produced. By then, the currency should be stable enough to maintain itself via transaction fees to create incentive for people to continue confirming transactions.
    3. What are mining pools?
      1. Some people join groups called “mining pools” so that they have a better chance of solving the problem first. With this process, people combine their computing power together to solve the problem. The reward is then divided among all of the computers based on the amount that they contributed to the process.
    4. Is it worth it?
      1. Mining can be profitable, but one must consider the price of bitcoin and amount of bitcoin awarded vs. the amount of expenses that go into it to determine if it is worth it such as initial costs/maintenance for the computer, electricity fees, etc. There are various calculators available online that will aid in these calculations.
  7. What is backing the currency?
    1. Absolutely nothing is backing the currency. Similarly to how the price of precious metals is determined, the value is determined by what people are willing to pay per bitcoin. This makes the bitcoin value very volatile as it can be driven by emotion. If big news is released, often you will notice the price reflects this depending on whether the news is good or bad. As of the time of this writing, the value trades at around $4500 per coin.
  8. How are bitcoins traded?
    1. There are various bitcoin exchange platforms online that people use to trade bitcoin. These platforms allow a person to trade between a fiat currency, bitcoin, and other various cryptocurrencies similarly to the way you would trade stocks online. A lot of exchanges support most of the traditional trade options such buying, selling, shorting, trading on margin, setting buy and sell limits and other options. At the time of this writing, bitfinex.com is probably the most used bitcoin exchange.

For an awesome Facebook page about bitcoin visit: https://www.facebook.com/bitcoinchart/

The post Bitcoin – A new world currency? (Pt.1) ToT#002 appeared first on Think On This.

12 episodes available. A new episode about every 6 days averaging 73 mins duration .