A Crash Course of Bitcoin - "The Internet of Money"

Sun Mar 02, 2014 18:14:35PM | Categories: Bitcoin

Here is my attempt at explaining Bitcoin. I'll start with some history, move on to breaking down the basics of the technology, and then talk about some of the pros and cons of this new and exciting virtual money system; a type of money known as cryptocurrency.

History:

Satoshi Nakamoto created an ingenious cryptocurrency model back in 2008; a virtual currency system known as Bitcoin. No one knows exactly who Satoshi Nakamoto is, to be clear. This could be one man, a woman, a group of people under one psuedonyme.. no one knows for sure because Satoshi Nakamoto has decided to remain anonymous. What we do know is a person(s) under the name of Satoshi Nakamoto published a paper on The Cryptography Mailing list at metzdowd.com, describing the Bitcoin digital currency in a 9-page outline. And In 2009, Nakamoto released the first Bitcoin software that launched the network and the first units of the Bitcoin currency.

Nakamoto continued to contribute to the initial Bitcoin software release with other developers until contact with his team and the community gradually began to fade in mid-2010. Near this time, Nakamoto handed over control of the source code repository and alert key functions of the software to Gavin Andresen. Also around this same time, Nakamoto handed over control of the Bitcoin.org domain and several other domains to various prominent members of the Bitcoin community.

Nakamoto is believed to be in possession of roughly one million Bitcoin. At one point in December 2013, this was the equivalent of 1.1 billion US dollars.


The Bitcoin Paper

When the internet got a hold of Nakamoto's Bitcoin Paper, 'Bitcoin: A Peer-to-Peer Electronic Cash System', independent organizations almost immediately began coming out with software (working in conjunction with Bitcoin.org and its prominent leaders) to make Nakamoto's vision and outline a reality. The open sourced Bitcoin code has spawned numerous Bitcoin Wallets (an electronic app to send an receive Bitcoin) and numerous Bitcoin Mining applications (software that computates mathematical equations, allowing Bitcoins to be "unearthed" from the digital framework, until all the currency is eventually mined). The Bitcoin network has displayed impressive and exponential progress since its inception just 6 short years ago.

So, what exactly is Bitcoin? What is cryptocurrency? And why do we need another currency anyways? Isn't the US dollar good enough? Where's the real world value in a virtual currency platform? Isn't a currency that's not backed by a governmental body of some kind fundamentally unstable? Why would anyone feel the need to use this on a global scale, like for real?

These are the inevitable questions everyone asks when they first hear about Bitcoin. (At least those where my first questions. Maybe you are more versed on the subject of currency and wondered initially about its portfolio and investment opportunities in an emerging marketplace, or whatever.) However you approach it, its new to almost everyone. To tackle the initial question, 'What is Bitcoin?', I heard it described best by Andreas Antonpoulos on the 'Joe Rogan Experience' podcast: "Bitcoin is the internet of money." Simple answer, right? Maybe. To me, its not unlike E=mc2. It's an elegant and simple explanation to a complicated idea; the more you research Bitcoin, the more I believe Antonpoulos really nailed Bitcoin down in one sentence.

For now though, let's stick with Nakamoto's explanation. Here's the first bit of Nakamoto's paper, explaining what Bitcoin is with a quick introduction:

[Bitcoin is] a purely peer-to-peer version of electronic cash [that] would allow online
payments to be sent directly from one party to another without going through a
financial institution. Digital signatures provide part of the solution, but the main
benefits are lost if a trusted third party is still required to prevent double-spending.
We propose a solution to the double-spending problem using a peer-to-peer network.
The network timestamps transactions by hashing them into an ongoing chain of
hash-based proof-of-work, forming a record that cannot be changed without redoing
the proof-of-work. The longest chain not only serves as proof of the sequence of
events witnessed, but proof that it came from the largest pool of CPU power. As
long as a majority of CPU power is controlled by nodes that are not cooperating to
attack the network, they'll generate the longest chain and outpace attackers. The
network itself requires minimal structure. Messages are broadcast on a best effort
basis, and nodes can leave and rejoin the network at will, accepting the longest
proof-of-work chain as proof of what happened while they were gone.


Let's break that intro down. For starters, the first line of Nakamoto's paragraph:

A purely peer-to-peer version of electronic cash [that] would allow online payments to be sent directly from one party to another without going through a financial institution.

The democratization of money. A libertarian's dream currency. A money for the people, by the people. Awesome idea. Nakamoto is suggesting that the Bitcoin system can be a trusted, electronic currency system that eliminates the need for a middle man (a trusted third party), i.e. a governmental body, a regulatory system like the FDIC, or a Federal Reserve system, thought to be backed by a gold standard, etc. Go on...

Let's look at the second chunk of Nakamoto's intro:

Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending. We propose a solution to the double-spending problem using a peer-to-peer network. The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work. The longest chain not only serves as proof of the sequence of events witnessed, but proof that it came from the largest pool of CPU power.

If you are familiar with the way that torrent files are sent and shared online, this should be fairly clear to you, at least in theory. If not, let me try and break it down. As far as transactions of Bitcoin go, the need for a trusted third party is eliminated and replaced with its own version of proof that any given transaction is valid. This is accomplished by an open source record of all transactions, written and stored into a history database to be shared openly and freely with everyone that uses the system. Basically, an ongoing, electronically viewable ledger that automatically attaches itself to every single Bitcoin transaction; a mandatory and ongoing software driven accounting system.

For example: the first person to buy something with Bitcoin (no matter what software or app used) as long as they are using the Bitcoin system, gets an electronic hash code encrypted onto that transaction. A "hash" is marked and time stamped, allowing any member at any given time the ability to verify that the transaction did in fact take place. All one has to do is look at the on-going chain mail-like ledger. Then a second transaction, and a third and fourth and fifth take place.. all that info is saved and time stamped into the ongoing chain mail-like ledger that records every single individual transaction, again being open for any and all to view at any time they wish.

This stops the issue of what Nakamoto refers to as "double spending". That's why we currently need third party trusted systems with today's hard currency. You need someone to give you confidence that if someone writes you a check or processes a transaction online, that "promise to pay" means something. People need assurance that digital transactions are legit, that's why we back them with the FDIC or PayPal or whatever supposed, trusted institution. Currently, the only way around this is if you buy something from someone with psychical money. But, in a growing global marketplace that offers more and more of it's services and materials online, its becoming increasingly rare that people use hard money.

Imagine if you could use a virtual system of money to buy an item or pay for a service electronically that had an ironclad way to insure its validity, without having to worry about a bounced check, or having to rely on the backing institution's reputation and reliability? Bitcoin's elegant online ledger system that time stamps and hashes every single transaction (for all members to see) is a true way to make this happen. Best part is, you wouldn't have to worry about converting your currency into other global money. Bitcoin is universial by nature, and not dependent upon any given nation's form of currency (or unstable inflation/deflation levels either).

The main caviot with the Bitcoin ledger system is that the majority of its users need to be honest. It's a system banking on the fact that a majority of its users will be wanting the system to actually work. That is expressed in the final part of Nakamoto's intro:

As long as a majority of CPU power is controlled by nodes that are not cooperating to attack the network, they'll generate the longest chain and outpace attackers. The network itself requires minimal structure. Messages are broadcast on a best effort basis, and nodes can leave and rejoin the network at will, accepting the longest proof-of-work chain as proof of what happened while they were gone.

So, as long as this electronic chain mail ledger system that time stamps and hashes every transaction is in the hands of an honest majority, success! You have a money system in place that allows people to spend and accept Bitcoin currency without a fear of getting screwed over. Well, ideally anyways. Like most, I still have my doubts. Even Andreas Antonpoulos admits that fraud can occur. A completely digital currency comes with its own weak points of entry and would-be criminals, mainly hackers. I'm no hacker and I won't pretend to understand how they operate. But I would imagine no matter the elegance of Bitcoin, or any other cryptocurrency, hacking and fraud are always a possibility.

The rest of the 9 pages of Nakamoto's paper goes into further explanation of the Bitcoin tech and implementation techniques, with short but detailed chapters on: Transactions, Time-stamp Server, Proof-of-work, Network, Incentive, Reclaiming Disk-space, Simplified Payment Verification, Combining And Splitting Value, Privacy, and Calculations. But for this column's sake, its in depth (and complicated) enough to cover the basic idea of Bitcoin. I do encourage anyone interested in the nitty gritty to give the short paper a thorough read through. In my experience, it takes several reads to start to process the idea in its entirety.


Andreas Antonpoulous, "The Internet of Money"

Here's a little bio of Andres Antonpoulous, showing why I value his opinion on Bitcoin:

As a bitcoin entrepreneur, Andreas has founded three Bitcoin businesses and launched several community open-source projects. He often writes articles and blog posts on bitcoin, is a permanent host on Let’s Talk Bitcoin and prolific public speaker at technology events. Andreas is also writing a bitcoin book for developers, for O’Reilly Media.

Andreas serves on the advisory boards of several bitcoin startups and serves as the Chief Security Officer of Blockchain. He is available for limited-scope strategic consulting projects.


Andreas Antonpoulos outlines a future for Bitcoin that honestly sounds like this new currency could actually change the world. Andreas compares this time in Bitcoin's history to that of the early days of the internet: it's complicated and difficult and ripe with flaws and controversy and even illegality, but the framework is genious and will revoluntionize the world! (I'm paraphrasing)

Early on, I proposed a handful of questions many have about Bitcoin. Why do we need another currency anyways? Isn't the US dollar good enough? Where's the real world value in a virtual currency platform? Isn't a currency that's not backed by a governmental body of some kind fundamentally unstable? Why would anyone feel the need to use this on a global scale, like for real?

This an exert of Andreas Antonpoulos from his appearance on the "Joe Rogan Experience" podpast. This is his response to the question of what is the real value of Bitcoin, is it a fade or not? (I translated all of this from audio, that's why it reads like a conversational rant.) To hear the audio instead, here's the YouTube link - Bitcoin is the Internet of Money. Audio text italicized below, broken down into easier to read paragraphs:


Here's the thing. Bitcoin is not just money. Bitcoin is an invention. And what that invention allows people to do is move value across the internet. And that invention means you can do Bitcoin. But, it also means you can do a lot of other things. And, Bitcoin is an incredible invention because it, for the first time it completely democratizes money. It separates money from a function of power of the state to an individual exchange between people, like it used to be when it was shells and feathers, right? Or, ya know, barter exchange.

But, the beauty of it, is that it can at the moment, if you think about it, there's let's say a billion people in the western world who have, not just banking facilities, but like turbo charged, power banking.. They have international transactions. They can buy stocks on any stock market. They can do wire transfers, some of them are accredited investors, etc: The power user of banking. There's another maybe 2 billion people who have a basic bank account. And then there's the rest of them, right? The giant majority of the population on this planet has very limited access to banking. Very limited access to international finance, to lending, to capital, to the ability to even change their money into another currency. And so Bitcoin is so much more important for them.

I call this "the other 6 billion". Just keep the focus on the other 6 billion, because for the billion, it might be a fade. But, for the other 6 billion, this is an opportunity to change the way we deal with poverty, and to change the way we unite the economic system of the planet, which is a whole other level of conversation. We look at Bitcoin and think of it as just money, but its not just money for the internet. Money for the internet is what it does, and it does it very well. But its the internet of money, and it allows people at the edge, by downloading just a simple application, to join an economy. And then to hold their own money without any state or corporation being able to steal it from them, or inflate it out of value and destroy their children's future. It allows them to hold and control that money and send it to anyone in the world they want to, instantly, for very little money. I mean, that's never happened before.

And the implications it has for poverty, for the developing world, for the way that non-governmental organizations work is staggering. Just take one example: International remittances. At the moment, 500 or so billion dollars are sent every year from the first world to countries in the developing world. And, out of that money, $74 Billion gets spent in fees, fees as high as 30 or 40%. In fact, the poorer the country, the higher the percentage of fee you have to pay. So a Somolian migrant in the U.S. who's sending $100 dollars home, only $70 gets to the wife, or brother back home, or the husband back home, and the rests gets chewed up by the money transfer companies. Now, we give the developed world a $150 or so Billion and then we transfer that to the richest, and hope it trickles down. And, then we take $74 Billion from the poorest. What if we could change that? What if we could enable Bitcoin remittances and international payments and re-deliver that $74 Billion of their money and allow them to send that money directly home without paying that fee? That changes the lives of a billion people.



Conclusion

Bitcoin is new, interesting, scary, exciting, weird... all things that the world wide web was to the world a few decades ago. Now, we can't envision a world without it (or at least not without thinking of that world as taking a huge step backwards). Many consider the internet to be the single greatest invention and tool ever created; a democratization of communication and information. And many, like Andreas, see Bitcoin as the currency equivalent, a way to democratize and liberate the exchange of money and value from the supressive confines of any given nation-state.

Of course Bitcoin has many hurdles ahead. For one, how much is it worth? The value of a Bitcoin varies almost daily. It's value comes down to how much the Bitcoin community is willing to value it at. For example: if someone takes X amount of bitcoin for a laptop, then that's a value marker to go off of. A lot of little value markers set the overall value of Bitcoin. The community then compares that in ratio to, say the US Dollar to present to the world its current "value". That is a problem. Its not exactly self-sustaining until a very large group of people start using it more exclusively. That has yet to happen. But, there is time. And, least we forget that something even as seemingly stable as the US Dollar falls prey to similar inflation standards; the US Dollar has not been backed by any "gold standard" for almost 60 years! Did you know that? The global currencies of today are just as subject to inflation as Bitcoin. The only difference is where people put their trust. If Bitcoin all of the sudden was used by a majority of the world and the US Dollar was used to the extent of Bitcoin today, the US dollars' value would most certainly suffer.

Inflation and deflation spikes, value, bitcoin mining, controveries like Mt. Gox and Silk Road.. all bumps along the pothole-filled road for Bitcoin to become a true global currency. But, Nakamoto has paved the way. It's up to the rest of us to make it work. The "Internet of Money" can change the world. I hope it happens in my lifetime.


Since there is so much more to read about when it comes to Bitcoin, I figured I'd throw out a few additional reference links:

Bitcoin: The Cryptoanarchists’ Answer to Cash
Bitcoin Survival Guide: Everything You Need to Know About the Future of Money
B
itcoin, Explained
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