Bitcoin and Cryptocurrencies from dummies to computer scientists
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The document explains the fundamentals of Bitcoin and cryptocurrency, highlighting its decentralized nature, the mechanics of transactions, and the roles of miners and wallets. Bitcoin, created by the pseudonymous Satoshi Nakamoto, serves as digital money that facilitates peer-to-peer transactions without the need for trusted intermediaries. It operates on a blockchain system where each transaction is recorded, ensuring security and transparency through cryptographic methods.
Bitcoin and Cryptocurrencies from dummies to computer scientists
- 1. Bitcoin And Cryptocurrency From dummies to computer scientists Baris Simsek simsek@gmx.us Nov 19, 2017 @bsimsekb
- 2. Opening • This topic is really hard to explain but I’ll keep it as simple as possible. • Ordinary people, non-technical investors, tech bloggers or journalists, engineers, computer scientists… no matter who you are. • I don’t expect everyone to understand everything. But I assure you, you just need this presentation to learn it.
- 3. Some Literature Sorry for my bare and poor presentation :)
- 4. What is Bitcoin • Let’s start with bitcoin. What is Bitcoin literally? • Simply Bitcoin is a digital money. You can buy goods, transfer your digital money to anyone in the network. • So it’s money. Nothing else. Just not tangible. It’s something digital lives on the internet. • I use Bitcoin as name of the system and bitcoin as money/currency.
- 5. Satoshi Nakamoto • Bitcoin was invented by an unknown person under the name Satoshi Nakamoto as open source in 2009. • He published a paper on bitcoin.org which titled Bitcoin: A Peer-to-Peer Electronic Cash System
- 6. The Paper • What he claims in the paper? Those words are from his paper: • Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes. • The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for non-reversible services.
- 7. The Problem • Because it’s useless for small amount of transactions Satoshi wanted to get rid of disputes and mediation. • Imagine you want to transfer 50¢ to someone else. No one does that over the banking system. And imagine the receiving party disputes it with the bank 1 week later. The cost of transferring 50¢ is not cheap for a bank. • And it’s not efficient. It’s just 50¢, you even don’t wanna talk about it. That’s what Satoshi means by saying non- reversible. We need efficiency not justice while we are dealing with small amount of transactions.
- 8. Difference • What are the differences between bitcoin and other online payment systems such as PayPal? Or physical banks? • Bitcoin is Decentralized, it means there is no trusted mediation party between peers. It’s peer to peer. • Bitcoin is Pseudonymous, it means that the money is not tied to real world people or e-mail addresses. Be careful! It’s not 100% anonymous!!!
- 9. Features • There is no government behind bitcoin that supply money to the market. States cannot interfere the value of the money directly. • Transactions happen peer to peer and irreversible. You can’t dispute a bitcoin transaction like a bank transfer. • There is no ‘trust’ in the network. Everything works based on the cryptographic proof. You don’t need trusted 3rd parties. Trust math.
- 10. Others • Bitcoin is not the only cryptocurrency. There are vast amount of cryptographic currencies available. • Their networks are completely different and independent. But the underlying protocol is similar. Some of them are bitcoin clones. Bitcoin, Ethereum, Litecoin, Bitcoin cash, Ripple, Dash… • Cryptocurrency is broader name. Bitcoin is a brand name of a certain cryptocurrency.
- 11. Let’s Design It From scratch We are Nakamoto and trying to design Bitcoin as Nakamoto described. This picture comes with the template. It’s not about Bitcoin. I just liked it.
- 12. IDs • First of all we need to verify IDs on the network. How we can trust people we don’t know? Of course no trust.There should be a way to prove the authenticity of a message. • Bitcoin uses public key/private key (asymmetric encryption) for this purpose. It’s explained in next slides. • Only I can make a transaction with my private key and others can verify the transaction by using my public key.
- 13. Money • Ok, we’re ready, we have our IDs. But where is the money? We don’t have money in the system yet. What is the source of money? • Don’t tell me “we can buy bitcoin online”. Where they get the money from? Or let’s imagine we are first users in the system.
- 14. Miners • Bitcoin protocol uses chain of blocks to keep record of transactions. You can imagine blocks like pages of a big ledger book. Multiple transactions on each page. • Block building is computationally costly. Miners compete to build next block. Whichever first builds the next block, the system rewards it with coins. • So, miners get coins from the system in return. That’s the source of money.
- 15. Transactions • Ok, now we have money in the system but not in our hands since we are not miners. How is the money being distributed across the network? • Miners, like normal users, sell their coins to other users. That’s how others get the money. And users exchange coins.
- 16. Hierarchy • Bitcoin network is flat and peer-to-peer. There is no super users or small users. It’s democratic and open to everyone. You just need an ID to join network. You can generate your ID freely. (Believe me, fraud is almost impossible) • So who are miners? Actually everyone can mine as everyone is equal. But when someone joins the race to build next block he wears ‘miner’ hat. It’s a choice not superiority.
- 17. Account Number • There is no account and balance management in Bitcoin. It’s because it’s decentralized and doesn’t want to maintain a database like PayPal. • To receive money, you should send your Bitcoin address to the sender. • Bitcoin addresses are calculated from public keys. There is no sending address. While you are sending bitcoin you need the receiving address. • Addresses are used only once.
- 18. Signatures • While sending money you must sign the transaction order. You can sign your transaction with your private key. It’s simply like signing a physical cheque. • Others can verify it belongs to you because only you can use your private, others cannot. • And you can’t claim you didn’t sign the transaction. • Well, there is no any authority to dispute. We all trust math.
- 19. Balance • We only have block chains that keep records of transactions. So how Bitcoin protocol decides whether a user has a sufficient balance or not? • User should provide the source of money -as a transaction- for each transaction. It’s called UTXO. • When you are sending bitcoin, you should refer to transactions that you received coins. And that coins should not be spent. • Let’s imagine below real world example:
- 20. Balance • You don’t have a bank account that you can collect money into. You don’t send money from your bank account. Instead, you say something like this: “I am sending you $5 from the money my dad sent me”. People check if your dad really sent you money. • Your dad said something like this while sending you: “I am sending you $5 from the money my boss sent me”. • So, that goes back to Satoshi’s first transaction.
- 21. Changes • UTXO is indivisible just like a coin that cannot be cut in half. So when your unspent money is bigger than amount of the transaction, your wallet does two transactions: 1- to receiver(s) 2- back to yourself • Let’s say you have 5 coins and transferred 3 coins. 2 coins doesn’t stay in your sending account because there is no account. You (actually your wallet in behalf of you) create another receiving address for you and transfer 2 coins to yourself as changes. • So everything is transaction. No database.
- 22. Flow of Transactions Bob Alice 5 BTC 3 BTC David Alice 2 BTC Sue Alice • Alice must refer to Bob’s unspent transaction to send 3 BTC to David. • Since Alice only wants to send 3 BTC, remaining 2 BTC from Bob’s transaction should be recorded as a transaction. So she transfers 2 BTC to herself. To send 9 BTC to John, Alice should refer to Sue’s and her own transactions. We had to use 2 inputs for John’s transaction. John 9 BTC 7 BTC
- 23. Wallets • Wallets keep your digital signatures. It’s free to produce new keys. You can use more than one key. Wallets manage all your keys. There are hardware wallets as well as software wallets available in the market. • Wallet can collect all your unspent transactions and calculate your balance etc… • If you lose your keys, you cannot reach your coins. Not only you, nobody can use your coins. Simply they stay orphaned in the network. (*) (*) James Howells famously lost 7,500 Bitcoins in 2013 when he accidentally threw out an old hard disk containing his private key.
- 24. Public Ledger • An open public ledger system keeps records of all transactions. Anyone can see who did which transaction to whom starting from 2009 to today. • But remember, bitcoin is a pseudonymous network. So you will only see public digital signatures instead of real world identities. • The ledger is distributed across the network. Nodes hold a copy of it. This makes bitcoin decentralized.
- 25. ≠ Decentralized and Distributed Public Ledger vs Single Central Private Ledger
- 26. How It Works Under the Hood Hidden note to me: Put a nice image here
- 27. Blocks vs Transactions Block N Block N+1 Block N+2 . . . Transaction 1 Transaction 2 Transaction M . . . Transaction 1 Transaction 2 . . . Transaction P Transaction 1 Transaction 2 . . . Transaction R
- 28. Block and Transactions • Every 10 minutes the system creates a new block. So depth of chain -actually it’s called height- increases. • Number of transactions can be different in each blocks. • Winner miners pick transactions to add to the block. • Sometimes for technical reasons some transactions cannot be processed in the current block so they stay in a queue for the next block.
- 29. Block Header • A block header contains below header meta data: Version hashPrevBlock hashMarkleRoot Time Bits Nonce • Note that, block body holds transactions.
- 30. Block Integrity • As you can see each block has the hash value of previous block. That ties all blocks to each other. So it creates chain of blocks. How? • No one can change any block in the network. Although transactions are public, nobody can change it. Because a simple change, even a dot, can cause the change of the hash value completely. Since each block has previous block’s hash value even other blocks become inconsistent. • Each block is sticked to one another.
- 31. Blocks vs Transactions • Don’t confuse. Rewards are for block creations not for transactions. Approx. every 10 minutes 1 block is being created. The system needs blocks to record transactions. • Each block has a list of transactions happened last 10 minutes and couldn’t be processed with the previous blocks. • A transaction is incomplete until it becomes part of the global distributed ledger, the blockchain.
- 32. Transactions • Transactions have a defined structure. • The most important parts of a transaction are inputs and outputs. • Inputs represent the sources of money. • Outputs represent the receivers.
- 33. Coinbase • The coinbase transaction is a special type of transaction that pays the miner his block reward. Every block must have a coinbase transaction as its first transaction, other transactions are optional. • The coinbase's output is used to send the block reward plus transaction fees, to the miner's address. • The coinbase transactions have no input as coins comes from the system instead of nodes. Remember, coinbases are the source of money.
- 34. Mining • Finding a new block is called as mining. • The system requires miners to solve a math problem. Who first solves the problem she earns the reward. That’s called proof-of-work. • Why we need proof-of-work? It’s because: • To regulate bitcoin production • To discourage dishonest nodes from abusing the system
- 35. Mining • Thousands of miners join in a global race to find the next block. That requires quadrillions of hashing operations per second across the entire bitcoin network. • Miners repeatedly hashes the header of the block and a random number (nonce) with the SHA256 cryptographic algorithm until they find a hash value less than the predetermined target hash. The first miner to find such a solution wins the round of competition and publishes that block into the blockchain. • That race happens every 10 minutes and each time the problem changes.
- 36. Coin Production • Bitcoin protocol regulates coin production. This is why we call it ‘the controlled supply’. • The protocol ideally wants to create 1 block every 10 minutes. If miners increase the computational power, the system increases the difficulty level of the problem and keeps the production always at the same level. That’s the first limitation of coin production. • Coins are rewards for the newly founded blocks. That rewards decrease geometrically with a %50 reduction every 4 year (precisely every 210.000 blocks). That’s another factor affects on the amount of coins.
- 37. Total # of Coins • In 2140, the latest halving period starts and the reward reduces to 0. It means no more coins will be producing. Because the only way to produce coin is to find the new block and get the reward from the system. • The system was initiated with 50 BTC reward in 2009. It was decreased to 25 BTC in 2013 (it is the first halving period, 4 years later). And now it’s 12.5 in 2017. The second halving period. • Total number of bitcoin will be 21 million in 2140.
- 39. Controlled Supply Block Reward Halving
- 40. Symmetric Encryption Msg Encryption key cypher Decryption Msg key D(E(Msg, key)) => Msg D: Decryption function E: Encryption function Msg: Original message key: Shared key Bob Alice Bob and Alice shares the same key
- 41. Asymmetric Encryption Msg Encryption Alice’s public key cypher Decryption Msg Alice’s private key D(E(Msg, A’s public key), A’s private key) => Msg D: Decryption function E: Encryption function Msg: Original message Bob Alice Bob uses Alice’s public key to encrypt message
- 42. Bitcoin ID • Bitcoin doesn’t use the real world identity. • Every user in the network has a public/private key pairs. Public keys are like your nicknames. • Users use public keys to verify IDs. Private keys have been using to create signatures. And only the owner can access or transfer her coins with a private key. • Not that, if you buy coins from a provider with your real money (USD) they may ask you your real world identity. It’s not about the bitcoin network.
- 43. Hash • Hash functions are functions that take an input of indeterminate length and generate a fixed-length value, also known as a ”digest”. • MD5, SHA-1, SHA-2 are well-known hash functions. • A simple change in the input produces completely different hash. Hi Alice. MD5: bc886a91672b718f0efccce0494ada37 Hi Alice, MD5: bbc0d3f172a9960cec60ca526f35c417
- 44. Hash y = Hash(x) • We can easily calculate y for a given x, but the inversion is computationally infeasible. Finding a specific input x that produces a desired hash y is almost impossible without trying every possible combinations. • So, the miners should waste the required time. They cannot cheat the network. • Bitcoin uses SHA-256 hash function to force miners to spend computational power to find a desired target hash.
- 45. Nonce • The system requires miners to find an x input that produces a hash under the target hash. • Block header includes an interesting field called nonce. Since the block header is constant, it’s not possible to produce the target hash with it. We need a variable field. • Miners are constantly changing nonce then calculating the hash value and checks if the value is under the target.
- 46. Difficulty • Target is defined by difficulty. System requires miners to find a hash that has a certain number of leading zero in its binary format. 000000000000000000000000011111110101010101010… • The number of leading zero is the difficulty. The smaller target (it means has more leading zero) the harder to solve. Because of smaller addressable space, chance of fitting in the space decreases.
- 47. Target Hash • Bits in the header is used to calculate the target hash value from a predefined formula. • Let’s say it’s 0x73829012 (hexadecimal). It’s little-endian. So we have to reverse bytes. 0x12908273 The first byte is the “exponent”, e = 0x12 The next 3 bytes are the “coefficient”, c = 0x908273, formula for target = c * 2**(8*(e - 3))
- 48. Fork • Imagine two miners Joe from USA and Chen from China find the next block almost simultaneously. Both of them broadcast the solution. Nodes in America and Europe first got Joe’s broadcast while Asia and Africa Chen’s broadcast. • At a time nodes may have different perspective of the blockchain.
- 49. Fork • So Asian nodes build the next block based on Chen’s block while Europeans Joe’s block. Block 1 Block N. . . Joe Chen Block N+2 Block N+1 Block N+1
- 50. Fork • So whenever Block N+2 is created, nodes work on Joe’s block just stop working and start to find N+3 from Chen’s fork. • As miners want to earn reward it’s useless to work on Joe’s block anymore. Since everyone knows N+3 is solved, no one will work on Joe’s block as it’s shorter than Chen’s. Because Joe’s N+3 will be late and invalidated by the system since as Chen’s is available. • So honest nodes always would work on the longest chain.
- 51. Last Words • Please follow me on Twitter and Medium with @bsimsekb handle. • After you read this presentation go and read my medium blog for my latest entry. It includes personal thoughts about Bitcoin’s feature and including some objections. • Feel free to ask me questions.
- 52. References • https://bitcoin.org/ • https://en.wikipedia.org/wiki/Bitcoin • https://en.bitcoin.it/wiki
- 53. Follow me on Twitter or Medium. “Thank you” Baris Simsek simsek@gmx.us Nov 19, 2017 @bsimsekb