Bitcoin White Paper for Dummies – Explained Like I’m Five

Before Bitcoin

The circuitous quest for a secure digital payment system began in 1994, when a bespeckled Dutch cryptographer named David Chaum conducted the first-ever electronic cash transaction. His company was called DigiCash and his goal was to create a digital currency. Although the transaction itself was a success, DigiCash never caught on – the world wasn’t ready. And in 1999, Chum’s vision of a digital currency faded. Whether by bad fortune or technological limitations, DigiCash was a failed experiment.

But the immense promise of online cash remained. In the years following DigiCash’s demise, PayPal came to dominate the world of online payments. As innovative as this new technology was, it fell short of true digital cash. First, PayPal requires transactions to be validated by third-parties. It is also unable to provide the level of anonymity afforded by cash. Those who wish to use the services often have to provide a social security number and their bank account information, and PayPal charges hefty fees – they recently announced yet another increase in their service fees.

Bitcoin. Would any sane VC invest in a project “lead by a single unknown founder, plans to quit in a year, has a 9-page document with mostly math symbols, no marketing plan/budget, and is projected to have $200,000,000,000+ USD market cap in 10 years”? The crowd did, and made it. ~CZ, Binance

Even after PayPal’s inception, there was no technology that could facilitate peer-to-peer payments online that bypassed the inherent problems of centralized financial institutions. Attempts to remedy these problems were unable to overcome the ‘Double Spending’ problem –  or the fraudulent reproduction of the digital currency.

A technological solution remained elusive – until October 31, 2008 when ‘Satoshi Nakamoto’ published a paper called Bitcoin: A Peer-to-Peer Electronic Cash System. To this day, the identity or identities of the author remain unknown. In the paper, Nakamoto proposed a peer-to-peer network that used cryptography and a Proof-of-Work consensus mechanism to generate trust between transactors. The internet-based money, called Bitcoin, enabled online payments without a centralized third party – it wasn’t issued by a government or corporate entity. The benefits of Nakamoto’s peer-to-peer network – privacy, protection from fraud, personal control over one’s assets – are nothing short of revolutionary.

At the time of its publication, Nakamoto’s paper was distributed to only a handful of cryptographers. In January of 2009, a computer scientist named Hal Finney received 10 Bitcoin – the first ever transaction on the decentralized network. From there, the idea spread like wildfire. Today, ten years after the paper was published, Bitcoin has become a living and breathing economy that shows no sign of slowing down.  The network is used by millions of people from every corner of the world, and the underlying ‘blockchain’ technology of Bitcoin has found application in hundreds of other ‘crypto’ projects, like Ripple and Ethereum.

As the blockchain ecosystem grows, it is important to remember where it all began: with a 9-page white-paper. To honor Nakamoto’s seminal work and gain a better understanding of the decentralized revolution, here is everything you have to know about Bitcoin.

So you’re ready to buy your first Bitcoin. Where to start? First, you got to set up your exchange account by creating an account and submitting your verification details. Once that is done, you’ll be able to send USD from your bank account into the exchange to purchase BTC. Read More…

White Paper Overview

This  section seeks to provide a cursory understanding of how Bitcoin works, including what it means to mine, own or send Bitcoins.

In simple terms, the Bitcoin network is a piece of software that keeps track of accounts and funds like a ledger. A copy of this ledger is stored on every computer within the network. The numbers on the ledger don’t correspond to anything in the material world. Instead their value is derived because people are willing to trade real world goods and services in exchange for a bigger number in their Bitcoin wallet. In other words, the numbers in the ledger do not have intrinsic value – like a precious metal or a car. Rather, like any fiat currency, they have value because other market participants assign them value.

To send Bitcoin, one broadcasts to all other computers in the network that the amount on their account should decrease, and the amount on the receiver’s account should go up. Other computers on the network, or nodes, incorporate that transaction into their copy of the ledger, and then direct other nodes to do the same. This – aside from a fancy cryptographic security system – is basically all Bitcoin is: a protocol that enables a group of computers to maintain a ledger.

This system might appear similar to the way a bank would keep track of their ledger. But because the Bitcoin ledger is kept by a group instead of a single entity, there are a number of crucial differences. The first is that, unlike for a bank account balance or transfer, everyone on the Bitcoin network can see everyone else’s transactions. Second is the issue of trust. While banks are usually perceived to be trustworthy, the Bitcoin network is made up of strangers whose identities are anonymous. Finding a way to facilitate trust between disparate network participants is what makes Nakamoto’s white paper so ingenious.

What Happens When You Send Bitcoin

In simple terms, if Jane wants to send money to Frank, she simply broadcasts a message to the network with the amount and accounts in question. For instance, she would tell the network to “Send 0.3 Bitcoin from Jane to Frank.” Once this message is broadcast, every node that receives it will update their copy of the ledger, and then notify other nodes in the network to do the same. But how can the nodes be sure that the request to transfer the Bitcoin from Jane to Frank is genuine and that Jane owns the 0.3 Bitcoin she is attempting to send?

To access and spend funds, the Bitcoin network requires special authorization, which is similar to a password. You can think of this password as a ‘Digital Signature.’ In some ways, this digital signature is similar to a real signature on a check. Both are used to prove the validity of a request to send money. But because Bitcoin operates in the digital world, and not the physical world, it uses a mathematical protocol, instead of a pen and paper, to prevent forgery or copying.

Unlike the password you might use to sign into your email, a completely different Digital Signature is required to approve every transaction. Digital signatures work by using two different ‘keys’  that are mathematically linked to one another. One is the ‘private key,’ which creates the signature, and the other is the ‘public key,’ which others can use to verify the authenticity of the former.

Think of the private key as the real password, and the digital signature as  the middle man who proves you own the password without you having to actually reveal it. If you lose your private key, any funds linked to the corresponding public key will be unretrievable, so make sure you have lots of secure backups. Public keys are the addresses where you can send Bitcoin – when you send someone funds, you are sending it to their public key. The total number of Bitcoin was fixed by Nakamoto, somewhat arbitrarily, at 21 million and. Because, over time, people lose private keys due to misplacements or insufficient backups, the Bitcoin currency will eventually be deflationary.

In order to spend Bitcoin, you must verify that you are the real owner of a public key address where it was sent. To do so, the Bitcoin system generates a Digital Signature from your private key and from the transaction message. The other nodes in the network use this Digital Signature to confirm that it corresponds with your public key. It is important to note that, because the signature is linked to the message, it will be different for every transaction, and thus can’t be reused by someone in a different transaction.

Privacy

If you transact in Bitcoin through a TOR network – which hides your IP address – you can send and receive funds using only your public key and without revealing any personal information. To make sure no one can trace your string of transactions (remember, the Bitcoin ledger is public to everyone), you can generate a new public key for every new incoming transaction.

Even the act of generating a public key is anonymous, and can be completed without a connection to the broader network. Because there are so many different possible addresses – roughly 1.46 x 10⁴⁸ – there’s no need to even confirm that the address isn’t already in use. To comprehend just how large this number is, consider that there are about a hundred times more possible addresses than there are molecules of H₂O in all the oceans.

The anonymity of Bitcoin has made it a popular currency for online ‘dark web’ drug marketplaces. It is important to note that techniques for tracing users to their Bitcoin transactions are getting more advanced, so true privacy is increasingly difficult to attain.

The Double-Spending Problem

Other attempts to create a decentralized digital currency have been unable to overcome what is commonly referred to the ‘Double-Spending Problem,’ which is the risk that a digital currency can be spent twice. This problem is distinct to digital currencies because digital information can be duplicated with relative ease. Fiat currencies like the dollar do not have this problem because they cannot be easily replicated, although people still attempt this by printing counterfeit cash.

To understand how Nakamoto tackled this problem, it is helpful to review what we have learned so far about Bitcoin security.

First, the Bitcoin software authenticates a transaction message by verifying that the true owner holds the Digital Signature.

Second, to confirm that the sender actually owns the Bitcoin they are trying to send, the system verifies that the funds in question are unspent.

This leaves only one key flaw in Bitcoin security: determining the order in which the transactions occur.

As transactions are spread node-by-node through the network, it isn’t certain that the order in which they are received is true to the order in which they were created. Trusting a ‘timestamp’ – the date and time a transaction was requested – is not possible because a malicious user could manipulate the digital information to lie about the time a transaction was created. This is not a problem for centralized systems – like PayPal – where a central record can keep track of the order of all transactions.

Because of its decentralized system, it is complicated for the nodes in the network to come to a consensus about whether one transaction preceded another. A malign user, Jane, could create a transaction message that sends Bitcoin to Frank, wait until Frank has provided the requested good or service, and then create another transaction message to effectively cancel out the first payment by confusing the nodes in the network. This would have the undesirable result of cheating Frank out of his payment.

Disparities in the time when the nodes in the network receive these two requests, means that some nodes might receive a fraudulent, “double-spending” transaction before the genuine one. This opens the possibility that the nodes would invalidate Frank’s ownership of the payment because it would be perceived to be trying to re-use coins that were already spent. In other words, there would be disagreement in the network about whether Frank or Jane should own the funds because there would be no way of knowing which transaction message was created first.

For this reason, there needs to be a mechanism that establishes consensus in the network about the chronology of the transactions – a daunting problem in a decentralized system.

To solve this, Nakamoto designed  a process called ‘Proof-of-Work,’ or PoW for short. This process works to both ascertain and safeguard ordering, by verifying transactions through a kind of mathematical race.

What is the ‘Blockchain?’

The Bitcoin system orders transactions by grouping them in ‘blocks.’ These blocks are connected to form a ‘blockchain.’ It is important to note that the blockchain is different from the transaction chain described earlier – the blockchain is used to order the transactions, while the transaction chain monitors how ownership changes.

Each new block references the previous block, which is what, over time, forms the structure of a chain. This means that someone could go all the way back to see the very first group of transactions ever made. All transactions that are made in the same block are considered to have occured at the same time. Transactions that have not yet been placed in a block are considered “unconfirmed.”

Any node in the network can compile a group of unconfirmed transactions into a block and send it to the rest of the network as a recommendation for what the next block in the chain should look like. But, because multiple nodes can propose blocks simultaneously, there could be several possible blocks to choose from. So how does the network determine which proposed block should be next on the chain? It can’t depend on the order that blocks arrive, because they may be broadcast in different orders in different parts of the network.

Part of Nakamoto’s solution to this problem is that each valid block must also provide an answer to a very difficult mathematical problem. Nodes on the network must propose a new block and a random guess – called a cryptographic hash. Because of the way the hash function works, the output is impossible to predict – the only way to find the right value is to make millions of random guesses. The process is not unlike trying to guess the combination to a bike lock. You might get lucky and unlock it on your first try – but it usually takes many attempts.

Amazingly, it would take a typical computer many years of guessing to find the solution to one of these puzzles. This would mean that transactions between parties could take years to confirm. Fortunately, the Bitcoin system can harness the combined computing power of all the nodes in the network, which reduces the ‘block time’ down to about 10 minutes. The first person, or ‘miner,’ to solve the problem, broadcasts their block to the network and their proposed group of transactions is placed on the chain.

Compared to credit card transactions – which can be verified in just seconds – waiting 10 minutes or longer for a block to clear seems slow. But remember that credit card users can claim their card was stolen months after the transaction and have the old charges reversed, referred to as a ‘chargeback.’ Once a transaction is cleared on the blockchain it is irreversible, so from a merchants perspective, receiving an irreversible, guaranteed payment is actually much faster with Bitcoin.

Why does it take 10 minutes to confirm a block? Nakamoto’s choice of 10 minutes was a compromise between shorter times – risking network instability – and longer times – which mean transactions would take longer to be confirmed.

As the network accumulates more computing power and specialized hardware is designed to maximize the efficiency of the mining process, the block solution time invariably decreases.

To compensate for this, the Bitcoin software readjusts the the difficulty of the math problem to always hit the 10 minute target.

Mining Bitcoin

We’ve covered how funds are transferred using Digital Signatures and transaction chains, and how the order of those transactions is established on the Blockchain. But we haven’t addressed where Bitcoins come from – how do coins first enter the ownership chain?

A ‘reward’ of 12.5 Bitcoin is allotted to whichever computer successfully solves a block. Miners compete with one another for this reward, but the real purpose of what they are doing is to safeguard the integrity of the blockchain and verify new transactions.

The first mechanism of ownership distribution is through the process of mining. A ‘reward’ of 12.5 Bitcoin is allotted to whichever computer successfully solves a block.

Miners compete with one another for this reward, but the real purpose of what they are doing is to safeguard the integrity of the blockchain and verify new transactions.

However, Satoshi designed the Bitcoin software so that only 21 million coins will ever be created, and 17 million of these have already been mined.

Once there are no more coins to mine, how will miners be incentivized to process transactions?

In addition to the ‘block reward,’ miners in the network are also awarded small fees that are attached to each transaction. This means that, as long as transactions are being made on the network, miners will have an incentive to process transactions – even if all 21 million bitcoins have already been distributed.

Conclusion

Bitcoin has the potential to revolutionize money.

Bitcoin is about tearing down old and obsolete ideas about money and building new ones for our own monetary independence.

Nations today are inept at managing the smooth operations of a global economy flowing on the internet.

There are still 2.5 Billion people in the world unbanked. Read How Bitcoin is Combating this Vs. PayPal…

A decentralized network like Bitcoin empowers any user, even those living in impoverished areas and communities to trade on the internet like never before.

They cannot be censored by the almighty government.

They cannot be stopped by trade wars.

Their savings cannot be diminished by inflation.