How does Bitcoin work?
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This document discusses how Bitcoin works through a 7 step process of imagining the creation of a cryptocurrency. It addresses key challenges like removing the need for central trust, preventing double spending, and incentivizing participation. Each step covers techniques like introducing unique identifiers, verifying transactions are not spent before, using proof-of-work to prevent vote buying and allow the first to confirm transactions, maintaining the longest blockchain, and defining consensus on who was first. Drawbacks of the Bitcoin system like performance, data storage needs, traceability, and mining costs are also outlined.
How does Bitcoin work?
- 1. How does Bitcoin work? Pavel Kravchenko Lecture 2
- 2. Challenges for decentralized electronic money creation How to remove the need of central organization and trust to one party? How to ensure honest voting process in anonymous, trustless, decentralized system? How to prevent double-spending? How to encourage users to join the system?
- 3. Now we will pass 7 steps towards imaginary cryptocurrency creation, during which we will cover possible attacks and their preventions
- 4. Step 1. The simplest e-money Digital receipt signed by the private key of the user
- 5. Step 2. How to distinguish copy from original? To distinguish copies of the same cheque we introduce unique receipt identifier
- 6. Step 3. Verification of the incoming cheque Everybody can verify unique identifier in their own copy of the database (blockchain).
- 7. Step 4. How to verify that incoming cheque was not spent before? You have to ask other participants – each of them provides a vote
- 8. Most important questions How many participants have to vote to accept or reject particular transaction? How can you define “participant”? Is it a person or a piece of code? How many participants take part in the voting process? Do they know and trust each other? Probably not. How to ensure honest voting process in such conditions?
- 9. Step 5. How to prevent buying votes To vote you have to present proof-of-work Only the first vote is counted There is a reward for being the first
- 10. How does “hard task” should look like? Everybody has a chance to win It should be able to prevent fraud Everybody can verify results The result of one participant cannot be stolen by another It should encourage participants to work more The closest analogue of such a task is participation in the lottery – everybody has a chance to win, but those who buy more will more likely win.
- 11. Mining in Bitcoin it is just a process of permanent checking answers for certain mathematical equation. It is not connected to transaction verification – it is just needed to prevent votes “buying”.
- 12. Step 6. Everybody competes to win Probability of being the first is equal to percentage of computational power that you have You can control the network if you have 51%+ computational resources System is trustworthy until honest participants control 51% of power Doesn't matter who out of honest participants will win
- 13. The fastest supercomputer in the world cannot even control 0.01% of power needed to control the system
- 14. It looks like brain-ring game – everybody wants to submit the answer (in our case after solving “hard task”) - but only the first gets the right to tell the answer
- 15. Step 7. How to define who was the first? 1. There are delays and attacks in the network 2. If fork occurred, both chains are saved 3. Each block (set of confirmed transactions) contains pointer on the previous one 4. Work continues in the longest chain 5. Transaction is fully confirmed if it is in the longest chain and there are 5 confirmed blocks after
- 16. Drawbacks of Bitcoin Low performance (3-7 transaction per second) A big amount of data to store (currently ~30GB) Traceability of transactions (database is public) Electricity consumption by miners (~$0.5M / day)