What is Bitcoin?

(This if from the MFA Critical Theory thesis I’m writing on Bitcoin)

What is Bitcoin?

On January 3, 2009 a stranger named Satoshi Nakomoto released a computer program on the internet. Its operation is simple: a peer-to-peer network. Except instead of trading music (like Napster) or file-sharing (like BitTorrent), the network trades virtual coins. That’s right, imaginary coins, half-cousin of the economic widget.

Today these virtual coins are better known as Bitcoin. It is a “currency” valued at $1-2 billion (though that value has fluctuated wildly in the Spring of 2013, 1 Bitcoin trading anywhere from $30 to $250) and can be used to purchase some goods and services over the internet. Bitcoin’s own in-house wiki[1] lists a surprisingly wide range of industries, including:

– Financial, telecommunications, and web services —most notable recent addition WordPress.

– Physical products such as housewares, electronics, books, music, films, artwork, crafts, car accessories, and beauty and fitness products.

– Professional services, such as consulting, legal services, counseling, insurance, and architecture and engineering services.

– Portals for commerce and community such as charities, web communities, information services, and political activism.

– Travel, tourism, leisure, hotel accommodations, tour guides, restaurants, and more[2].

 

Bitcoin operates as a currency without any formal government, public, or corporate oversight. Yet I wish to stress that Bitcoin did not start out as a form of money in its inception (or, to put it another way, it conceivably has other non-monetary uses that take advantage of the instant and relatively anonymous exchange of information, such as BitTorrent). Bitcoin is simply a computer code, designed to release a fixed quantity of virtual coins every 10 minutes into the Bitcoin network. It takes two to trade, and the brilliant code “Nakomoto” created would not even have a semblance of currency today if others didn’t see value in it. You have to imagine the madness of it in the beginning —hoarding virtual coins. Those coins didn’t have any value, but it didn’t really cost anything to store them either— a negligible amount of memory on a hard drive (as compared to the security and logistics of storing a vault of gold).

This research on Bitcoin comes from many sources, and many anecdotal, as there is little scholarly work as yet. In the wake of the spring 2013 Bitcoin bubble (roughly March through Mid-April), there has been a flurry of press, from NPR to the NY Times to the Colbert Report. No detail is too small and there are even shouts of Tulipmania. Yet few have delved into what scholarship there is, which includes the original whitepaper by Nakamoto, titled “Bitcoin: A Peer-to-Peer Electronic Cash System”, published in late 2008. It is short and technical (but not overbearing for someone unfamiliar with Bitcoin), proposing an online “electronic cash” that would circulate between users on a peer-to-peer network[3].

The following is a simplified explanation of the Bitcoin network. A user initiates a cryptographic transaction by using their “wallet”, a program that gives them access to multiple Bitcoin addresses. An address is a long string of letters and numbers, like JKOH4ho45lkhj34kljbnmm0. Each address has an amount of Bitcoins (an account balance) and a pair of keys to facilitate transactions. It’s easy to mistake addresses as bank accounts; actually, a user can make a new address for each transaction, and is encouraged to do so for privacy reasons. Each address is actually creating a cryptographic key pair; one key is private (that only the user knows) and one key is public (and is used to verify transactions).

Every ten minutes transactions are bundled into “blocks” that the users of the Bitcoin network collectively verify (known as “mining” in Bitcoin parlance). The incentive for staying in the network and verifying transactions is that whoever verifies (“mines”) a block is automatically awarded a fixed amount of Bitcoins into their address. Mining blocks is competitive. It used to be anyone with a standard desktop could do it, but now it is the domain of custom-built high-end machines that do nothing but mine coins (EXPAND), and guilds of computing power working together and splitting the profit. As the New Yorker explains, “This feature of the system, by design, resulted in a kind of computational arms race that strengthened the network by rewarding increased computing power. Four years into the Bitcoin project, only very powerful, purpose-built machines have enough muscle to keep pace with existing network nodes. In this way, bitcoins are mined like gold used to be, in quantities that are small relative to the total supply, so that the supply grows slowly.”[4]

The network is set to generate 6 blocks of transactions per hour. In order to keep this pace despite the varying computing power in the network (which is a consequence of the competitive mining), the difficulty of solving a block for “proof of work” is adjusted, based on “a moving average targeting an average number of blocks per hour” (Nakamoto,3). If they’re generated too quickly, the proof-of-work difficulty increases. The hourly quantity released is designed to reduce to half every four years, such that the total amount of 21 million Bitcoins will be released asymptotically, until the full amount exists in 2140[5]. Currently 25 BC is released per hour, but in 2012 it was 50/hour.

Releasing Bitcoins with each block created is also a convenient way to distribute the currency, since there is no central issuer. This incentive also deters what is known as a 51% attack, wherein an attacker[6] controls 51% of the computing power on the network. This would be a tremendous feat given the amount of Bitcoin users (a matter of speculation, but the New Yorker puts claims 20,000 nodes[7]) and the sophistication of the hardware they’re using to mine.

Nakamoto explains that a 51% attacker would still have an incentive to not wreck the network: “If a greedy attacker is able to assemble more CPU power than all the honest nodes[8], he would have to choose between using it to defraud people by stealing back his payments, or using it to generate new coins. He ought to find it more profitable to play by the rules, such rules that favour[9] him with more new coins than everyone else combined, than to undermine the system and the validity of his own wealth” (Nakamoto, 4).

Users conducting transactions are pseudo-anonymous. Nakamoto’s paper addresses this, stating “…privacy can still be maintained by breaking the flow of information… by keeping public keys anonymous. The public can see that someone is sending an amount to someone else, but without information linking the transaction to anyone” (Nakamoto, 6). The anonymity of Bitcoin has been more thoroughly tested by one of the only other scholarly papers on Bitcoin, titled “An Analysis of Anonymity in the Bitcoin System.”[10] One impetus for the work was Wikileaks’ public appeal in June of 2010 for donations in Bitcoins after they had been blocked by services like PayPal. Wikileaks claimed Bitcoin was secure and relatively anonymous, and for donators to use a fresh public key to maximize privacy (Reid, 2). Again, this is something Nakamoto recommended —   creating a new address (key pair) for each transaction to maximize privacy, but he concedes “Some linking is still unavoidable with multi-input transactions, which necessarily reveal that their inputs were owned by the same owner. The risk is that if the owner of a key is revealed, linking could reveal other transactions the belonged to the same owner” (Nakamoto, 6). The system is not foolproof to the statistical analyses used by law enforcement.

Reid and Harrigan conclude “Bitcoin is an electronic analog of cash in the online world” (Reid and Harrigan, 26). Just like regular cash, Bitcoin is easy to exchange and relatively anonymous. Of course, the authors are talking about the utility of Bitcoin; Bitcoin of course is not backed by a government, considered legal tender, and not government or corporate regulated. The authors conclude that there are varying degrees by which a Bitcoin user could be tracked:

“Using an appropriate network representation, it is possible to associate many public-keys with each other, and with external identifying information. With appropriate tools, the activity of known users can be observed in detail. This can be performed using a passive analysis only. Active analyses, where an interested party can potentially deploy ‘marked’ Bitcoins and collaborate with other users can discover even more information. We also believe that large centralized services such as the exchanges and wallet services are capable of identifying and tracking considerable portions of user activity.”

(Reid and Harrigan, 26).

I have read from several anecdotal sources online that it is not the priority of the developers to make Bitcoin entirely anonymous. This is also cited in Reid and Harrigan’s analysis of Bitcoin’s anonymity: “There is an understanding amongst Bitcoin’s more technical users that anonymity is not a prominent design goal of the system; however, opinions vary widely as to how anonymous the system is, in practice” (Reid, 2). An article from The New Yorker indicates that the most anonymous coins are ones that a person has mined themselves. This was revealed in a New Yorker interview with Mike Caldwell, who used to mine coins himself but lately is known for created physical bitcoins, called Casacius coins. He states, “ Mining produces bitcoins that are extremely anonymous. The most anonymous bitcoins you can get, system-wide, are ones you mined yourself. The mined coins have no origin, no history, no nothing. They just appear out of thin air.”[11]

To return to Nakamoto’s paper, he more specifically proposes the Bitcoin network as a solution to the problem of needing a trusted third party. This is the case with normal transactions, not only to verify them, but more importantly to prevent the “double-spending problem”. That is, how to prevent a user in the network from duplicating the cash, either by counterfeiting it, or taking advantage of a lag in the network to spend the 1 electronic coin in 2 places. The solution is “a peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions” (Nakamoto, 1). In other words, the ENTIRE transactions history between any users transacting any Bitcoin is publicly available in the “Blockchain” —the public archive of all of Bitcoin’s transaction history.

This public information lets the “nodes” of the network recognize and organize legitimate blocks and reject counterfeit ones. As aforementioned, these miners (nodes) get “paid” in Bitcoins by verifying blocks. This system is robust against attackers[12] to the system, as transactions pile on one another in the blockchain, and an attacker would have to undo the “proof of work” of the previous blocks before manipulating new ones. (Nakamoto 7). In other words the probability diminishes exponentially as the number of blocks the attacker has to compute increases.

With the entire history of transactions attached to every new transaction, on top of the dense cryptographic hash that must be verified within each transaction, you would think that the Blockchain would overwhelm the network over time. However, Nakamoto explains that the design of the system is such that Moore’s Law[13] outpaces predicted memory usage. Nakamoto explains that “A block header with no transactions would be about 80 bytes. If we suppose blocks are generated every 10 minutes, 80 bytes*6 [where 6 blocks are generated per hour]*24*365= 4.2MB per year. With computer systems typically selling with 2GB of RAM as of 2008, and Moore’s Law predicting current growth of 1.2GB per year, storage should not be a problem even if the block headers must be kept in memory” (Nakamoto, 4).


[2] There are also companies like Bitspend (https://bitspend.net/) that brokers online purchases with Bitcoins; if a merchant like Amazon doesn’t accept Bitcoins, the broker will make the exchange for a small fee.

[3] For a diagram of the following explanation please see the infographic “How a Bitcoin Transaction Works” http://visual.ly/bitcoin-infographic

[4] *From the New Yorker 4/2/2013 “The Bitcoin Boom” (Maria Bustillos)

 

[5] While the theoretical amount will have been released, charting the Bitcoin money supply over time will still resemble an asymptote, as some negligible owners lose their Bitcoins; the full amount will never be in circulation. In any case this notion of amounts is misleading, as Bitcoin is infinitely divisible (though is currently only divided to the eighth decimal place).

[6] to use the terminology of Nakamoto’s paper.

[7] From the New Yorker 4/2/2013 “The Bitcoin Boom” (Maria Butsillos)

[8] A node is simply anyone mining Bitcoins on the network; the mining program on each computer acts as a server verifying the blockchain’s transactions and history.

[9] Note the British spelling. There is some speculation that Nakamoto is Irish (EXPAND).

[10] Fergal Reid, Martin Harrigan. May 7 2012. http://arxiv.org/abs/1107.4524

[11] From the New Yorker 4/2/2013 “The Bitcoin Boom” (Maria Butsillos)

 

[13] The contemporary exponential improvement in computer memory and processing speed first observed by Gordon E. Moore in 1965.

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