The unknown persons or person, Satoshi Nakamoto registered the “bitcoin.org” domain name on August 18, 2008 and on October 31, 2008, published, “Bitcoin: A Peer-to-Peer Electronic Cash System” on a cryptography mailing list. On January 3, 2009 the first open source code for the bitcoin client was released and Satoshi Nakamoto mined the first ever block of the first ever blockchain earning himself 50 BTC or bitcoins. Satoshi Nakamoto’s first transaction was 10 BTC transfer to a programmer friend and collaborator. Embedded in the data of the first block is the headline: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” Satoshi Nakamoto has mined over 1 Million BTC and is suspected of paying 10 000 BTC for a pizza. In April 2011 the last public post of Satoshi Nakamoto read “I’ve moved on to other things…” Satoshi Nakamoto has not been heard of since.
According to coindesk.com bitcoin reached its highest ever trade of $19,783.21 USD on Dec 16, 2017 (as of today Jan 19, 2018). As of January 7, 2018 the original open source code has spawned 1384 different cryptocurrencies many having major or minor variations on the original source code.
The paper begins by lamenting the need for trust in third parties for commercial transactions. “Commerce on the internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments….[commerce] still suffers from the inherent weaknesses of the trust based model.” We necessarily have to trust the third parties because there does not exist a common accepted system of verification: the trusted third parties are obliged to mediate disputes which increase the costs of the current system as there will always be disputes with the third party and there will always be some fraud. These costs limit the minimum practical transaction size as can be seen in the reluctance of merchants to accept credit cards for very small purchases and in the requirement for banks and credit card companies to have security and fraud investigation divisions. “These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.”
The internet makes the copying of information very easy: I can take a picture and send a thousand emails with that picture in them. Money, if it is to retain its value remain scarce. No one can be allowed to spend the same dollar twice. The way the current electronic system based on trust overcomes this double-spend problem is that every transaction has to be cleared and verified by a central trusted authority, like a bank or credit card company, that makes official the source and destination of every dollar. The major problem that this system is meant to overcome, the double spending problem, is overcome by the central authority legitimizing each transaction that it judges as valid and not any other. This system is labour intensive with transactions often requiring days to clear. We need to trust that the trusted central authority will do three things: 1) be aware of every transaction and their order, 2) be ready to receive every digital coin (which can only validly be paid to the trusted third party) and 3) be able to deliver every digital coin to a new owner (because money can only be validly received from the trusted central authority third party). Naturally these centralized trusted third parties will need lots of expensive regulation and oversight and they represent a fat juicy centralized target for fraudsters.
“What is needed is an electronic payment system based on cryptographic proof instead of trust….we propose a solution to the double-spending problem using a peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions….To accomplish this without a trusted party, transactions must be publicly announced, and we need a system for participants to agree on a single history of the order in which they were received.”
Think of an electronic coin on a blockchain as 1) a unique ID (such as a serial number) plus 2) a chain of digital signatures of every owner and the timestamp of every transaction hashed after a block of time. The “block” has a double meaning as a block of time and a block of data in that time (in the Bitcoin network a block is all the transactions in each 10 minute interval). A hash is a function that takes any amount of data and returns a unique but fixed length number (usually 32 place values in base 16). Every electronic coin therefore has its entire history hashed on every block that it was exchanged. Each block on the blockchain represents a final state of the world of every change of bitcoin ownership at the end time of each block.
The network follows a six step process for every block: “1) New transactions are broadcast to all nodes [computers connected to the network].” This means that every computer on the network hears about every transaction. “2) Each node collects new transactions into a block.” The information is arranged and hashed. “3) Each node works on finding a difficult proof-of-work for its block.” The proof-of-work involves finding a random number that when added to the original data and hashed produces a new hash below a number such that it takes ten minutes or so to solve. It is during this work that the node is also collecting all transactions for the next block. “4) When a node finds a proof-of-work, it broadcasts the block to all nodes.” Since all nodes are working from the same data the answer is hard to find but easy to verify. “5) Nodes accept the block only if all transactions in it are valid and not already spent.” To illegally change a transaction at this point would require that an attacker control 51% of all the nodes in the network and find the proof-of-work first. “6) Nodes express their acceptance of the block by working on creating the next block in the chain, using the hash of the accepted block as the previous hash.” Using the previous hash means that all block are linked together in each new hash. If an attacker wanted to change the history he would have to control enough computing power to find each proof-of-work for every ten minutes block in line to the present and pass all the other computers in the network that are working on the current proof-of-work.
The Bitcoin network comes with a set of incentives and disincentives that make it in participant’s best interest to support and not attack the network. For example 1) the nodes (miners) that do the proof-of-work are rewarded with new bitcoin and tiny amounts of transaction costs when they solve the puzzles. 2) Each bitcoin can be divided to 8 decimal places and the bitcoin reward gets halved every four years meaning that these rewards will get smaller and smaller until all the predetermined 21 Million BTC will be minted by the year 2140. A preset amount was determined in advance to prevent bitcoin from suffering inflation – like gold with its limited supply and small increased supply bitcoin’s value should continue to increase over time. 3) The distributed nature of the network means that it is very expensive to attack or destroy the network. According to GoBitcoin.io, today, the estimated cost to get 51% of the current size of the Bitcoin network would require $5,544,333,865 USD in hardware costs that would consume 198,182,898 kWh per day in electricity. And finally 4) undermining the network undermines your investment in the network. If the Bitcoin network is damaged or destroyed then any value of bitcoin dies with it. The incentive is therefore to support the network.
Next time we will look at the next generation of blockchain, cryptoeconomics, smart contracts, Vitalik Buterin and the Ethereum blockchain.