Bitcoin is digital money, a currency for and of the Internet. Bitcoin can be used to buy products or services online or in-person, just like cash or a credit card. Bitcoin can be transmitted as fast as an email from any person to any other person just by installing the software. Bitcoin is de-centralized: There is no central entity, not a bank or governing body that controls bitcoin. It operates by consensus, according to simple mathematical rules that are in the software for all to see.
Bitcoin is not owned or controlled by any company, group or country. It exists as a set of standards and reference software and as a running network with several thousand nodes worldwide. Behind the scenes, bitcoin is a network, a protocol, a standard and a currency. For now think of it simply as digital money that can be sent, received and stored by anyone, worldwide simply by downloading compatible software and joining a network.
Under the hood, bitcoin is the culmination of decades of research in cryptography and distributed systems and represents four key innovations brought together in a unique and powerful combination. Bitcoin consists of a de-centralized peer-to-peer network, a public transaction ledger, a de-centralized mathematical and deterministic currency issuance, a de-centralized transaction verification system and a set of powerful APIs. All of these are "bitcoin", and each of these aspects of bitcoin will be examined in this book.
More than all of these parts, bitcoin is a digital economy platform, just like the Internet is a digital communications platform. With bitcoin, it is possible to build entire new financial systems, transaction types and economies on top of a purely digital, instantaneous and frictionless platform, an Internet for money.
A bitcoin address looks like +1DSrfJdB2AnWaFNgSbv3MZC2m74996JafV+, they always start with a one. You can have as many as you like, share them so people can send you coins.
A grouping of transactions, marked with a timestamp, and a fingerprint of the previous block. The block header is hashed to find a proof-of-work, thereby validating the transactions.
An excess amount included in each transaction as a network fee or additional reward to the miner who finds the proof-of-work for the new block. Currently 0.5 mBTC minimum.
Once a transaction is included in a block, it has "one confirmation". As soon as _another_ block is mined on the same blockchain, the transaction has two confirmations etc. Six or more confirmations is considered final.
It is easiest to experience bitcoin from the perspective of a few specific stories that we will explore in detail throughout the book.
Each story represents a specific real use of bitcoin in different contexts.
==== Alice buys a cup of coffee from Bob's Cafe
Alice wants to buy a cup of coffee using bitcoin. She visits Bob's Cafe, a coffee shop that accepts bitcoin payments, as advertised by a sign declaring _"Bitcoin Accepted Here"_ in the window. At the counter, the prices may be listed in a local currency like Euros or Dollars. At the register, Bob would ring up a coffee, displaying
----
Total:
$1.50 USD
0.015 BTC
----
Or Bob might say _"That's one-dollar-fifty, or fifteen milibits"_.
Alice would use a smartphone to scan the barcode on display and send the payment. Her smartphone would show a payment of +0.0150 BTC+ to +Bob's Cafe+ and she would select +Send+ to authorize the payment. Within a few seconds (about the same time as a credit card authorization), Bob would see the transaction on the register, completing the transaction. Alice has purchased a cup of coffee for 15 millibits (or 0.015 bitcoin)
Bitcoin is a currency, the operates much like any "foreign" currency. The main difference is that it is not issued by a national government. Bitcoin currency units are called "bitcoins". Unlike traditional currencies, bitcoins are divisible to much smaller units. The smallest unit is the _satoshi_, one hundred-millionth of a bitcoin (1/100,000,000). Bitcoin can be exchanged for other currencies at specialized currency exchanges that support crypto-currencies like bitcoin. There, a customer can exchange US dollars ($) or Euros (€) for bitcoin, at the prevailing market exchange rate.
Symbols: B⃦, Ƀ, ฿
Currency Code: BTC (unofficial), XBT (possible ISO standard)
Bitcoin operates on top of a peer-to-peer network, also called "bitcoin". The bitcoin network is used to propagate transactions, new blocks and alert messages. The network operates using a relatively simple network protocol for peer discovery and blockchain replication.
One interesting feature of bitcoin is that the issuance of the currency decreases automatically over time, halving every four years, reaching an absolute maximum of 21 million bitcoins issued sometime around the year 2140.
Bitcoin transactions, which transfer value from one bitcoin address to another, are recorded in a distributed ledger, called the _blockchain_. In simple terms, think of the ledger as a book with lines like this:
Bitcoin's core innovation is the _blockchain_, a distributed, timestamped ledger. The ledger consists of a cryptographically verified chain of _blocks_, each of which contains transactions, new coins and a signature (hash) of the previous block. Each full bitcoin node in the network will keep a complete local replica of the blockchain, and independently verify all transactions and balances from that replica.
Bitcoin's security is underpinned by computation. The blockchain is formed by solving a problem, called the _proof-of-work_ (PoW) that requires a predictable computational effort, one that takes approximately 10 minutes for the entire network of bitcoin nodes to solve. The process is called _mining_, since it has diminishing returns, just like mining for precious metals. It works a bit like a global lottery, where every bitcoin miner attempts to find a solution to a cryptographic equation. The first miner to find a solution, broadcasts it on the peer-to-peer bitcoin network for others to verify and include in the blockchain. For any transaction to be included in the global blockchain, it must be verified and included inside a new block. Each block includes the fingerprint of the previous block int he chain and any new transactions that have occured in the intervening 10 minutes.
When a bitcoin miner discovers a new solution to the proof of work algorithm, they create a new block which includes newly minted bitcoin in a transaction that pays to the miner's own bitcoin address. Bitcoin miners earn the newly minted bitcoin as a reward by creating a transaction to pay themselves. They can do this only if they discover a solution to the proof-of-work problem, thus providing an incentive to participate in mining and thereby to computationally secure the transactions.
Essentially, the bitcoin currency units are issued through mining, just like a central bank issues new money by printing bank notes. The amount of newly created bitcoin in each block decreases every four years. It started at 50 bitcoin per block in 2008 and halved to 25 bitcoin per block in 2012. It will halve again to 12.5 bitcoin per block in 2016. Based on this formula, bitcoin mining rewards decrease exponentially until approximately 2140 when all 21 million bitcoin have been issued.
Bitcoin miners also earn fees from transactions. Every transaction may include a transaction fee, in the form of a surplus of bitcoin between the transaction's inputs and outputs. The bitcoin miner gets to "keep the change" on the transactions.
At the time of writing this, the fees usually represent 1% or less of a bitcoin miner's income, the vast majority coming from the newly minted bitcoins. However, as the reward decreases over time, a greater proportion of bitcoin mining earnings will come from fees, until after 2140 all bitcoin miner earnings will be in the form of transaction fees.
A simple bitcoin transaction transfers value from one bitcoin address to another. However, there is much more to bitcoin transactions than that. Each transaction is a signed script that is evaluated using a stack-based interpreter. The language of transactions is Forth-like and not Turing-complete as it does not include looping constructs.
A transaction script can make a bitcoin payment payable to the owner of a bitcoin address, to multiple bitcoin addresses, to anyone who solves a riddle, to anyone who guesses a number or to infinitely more complex requirements.
The transaction script language is extremely powerful and can be used to express very complex and novel transactions. It is examined in more detail in <<complex_transactions>>.
==== An Application Programming Interface (API)
The reference bitcoin software implementation, known as the _Satoshi Client_ and with the application name +bitcoin-qt+ or +bitcoind+, offers a client-level API. The API is available as a JSON/RPC interface and offers programmatic access to bitcoin wallets, th blockchain and the bitcoin network.
The reference implementation of bitcoin, which combines a full bitcoin network node, a wallet and a user interface is known as the _Satoshi Client_, or also as its executable name +bitcoind+ on Unix-like systems and +bitcoin-qt+ for the graphical user interface component. The Satoshi client is maintained by a network of volunteers as an open source project hosted on Github https://github.com/bitcoin/bitcoin.
A full node client is one that stores a local copy of the entire blockchain (the distributed transaction ledger), from the first block (the _Genesis Block_) to the most current block. The blockchain is usually stored in a database, to make indexing and retrieval easier. It is a multi-gigabyte file, at least 8GB at this time. As a result, a full-node client may take several days and quite a bit of disk space to become fully "synchronized" with the network, meaning it has downloaded a full copy of the blockchain up to the most recent block.
By comparison, a lightweight client does not store a full copy of the blockchain. Instead, it relies on selected trusted servers which can answer queries about the blockchain. As a result, a lightweight client can bootstrap instantly and start processing transactions. However, a lightweight client is always reliant on an external trusted source of data on the blockchain, whereas a full node client can independently validate any transaction without trusted third parties or the counterparty risks they introduce.
==== Desktop, mobile, web or hybrid wallet?
Bitcoin clients exist in many forms, and for many platforms. The examples in this book will use the reference client as well as several other desktop, mobile and web examples. For practical bitcoin use you may want to try a desktop, mobile and web wallet, or a web/mobile hybrid.
For the purposes of following the examples in this book, we recommend you download and install several bitcoin clients, to compare their capabilities and try out the examples. You must at least download the reference client +bitcoin+, as well as a lightweight client such as Electrum, or Multibit.
When you first run the bitcoin-qt application, it will start downloading the full blockchain, several gigabytes of data. It may take several days to fully synchronize the complete blockchain. During that time, the client will display "out of sync" next to balances and show "Synchronizing" in the footer.
[[bitcoin-qt-firstload]]
.Bitcoin-Qt - The Graphical User Interface, during the blockchain initialization
image::images/bitcoin-qt-firstload.png["bitcoin-qt first run"]
Money is a means of transferring or storing wealth, at its most basic. It exists in many abstract forms, least abstract (food) to highly abstract (personal cheque). Money has existed for thousands of years. The earliest form of money, recorded as an abstract account of value in written form, is heads of cattle. This is also the origin of the word "capital". Of course, a cow is not abstract, you can eat it. Very early in recorded history we see the emergence of money as an abstract token that represents some other value. Various cultures have used shells, coconuts, beans, salt, spices, feathers etc. These abstract forms of money may hold no inherent value but act only as a representation of value. Abstract forms of money are usually:
Precious metals have been the predominant currency for thousands of years across the world, usually stamped into coins. Modern paper money started as representative of precious metal deposits, but is now representative of treasury debt issued by the central governments. National currencies are issued by government "fiat" and are commonly referred to as _fiat currencies_ by economists. Most of what we consider common features of our monetary system are really only recent inventions, of the late 20th century.
Crypto-currencies are digital currencies based on cryptography. The development of crypto currencies started in ...... Essentially, crypto currencies aim to achieve an entirely abstract digital currency, one whose value can be transmitted digitally to a party as payment itself. There are two core challenges with a purely digital currency: how do you control the creation of new currency units and how do you prevent copying or counterfeiting.
Public-key cryptography, or assymetric cryptography, is a key part of a crypto-currency. Surprisingly, the cryptographic keys are not actually stored inside the bitcoin blockchain or the network. Instead, the blockchain only records transactions with digital signatures (hashes) of keys. The keys themselves are completely independent and can be generated and managed by the end users. This enables many of the interesting properties of bitcoin, including de-centralized trust and control.
In a nutshell, public-key cryptography is like a digital padlock, which can only be opened by the owner of a secret key. The owner of that key can hand out as many copies of the padlock as they want, and others can use it to "lock" bitcoins inside transactions recorded on the blockchain. Only the owner of the key can then unlock and "redeem" these transactions, as only they can open the digital padlock.
In more specific terms, bitcoin uses Elliptic Curve Cryptography (ECC) on the secp256k1 curve, defined by http://www.secg.org/index.php?action=secg,docs_secg[SEC 2: Recommended Elliptic Curve Domain Parameters version 2.0]. The name secp256k1 indicates a curve whose points are a prime field, with a 256-bit prime and the k indicating a Koblitz curve variant.
The end-user, or the wallet application they are using, will generate a new key-pair using a random seed. The key pair consists of a secret part the _private key_ and a public part, the _public key_.
In bitcoin, the public key is represented as a _bitcoin address_, which looks like this **`1HvHT6B3ZVT8nWCdVx3CKr8PRUMCNhZTqD`**.
The address itself is encoded in a format known as +Base58Check+, which is +Base58+ with a checksum. Base58 encoding is similar to a commonly used +Base64+ encoding used in HTTP and other protocols, but with a reduced 58-character set, removing ambiguous characters such as +O,0,o,I,i,l,1|+.
The Base58Check address includes a checksum, composed of the last 4 digits of the SHA256 of the address, appended to the address. The resulting 27-34 character string starts with the number **`1`**, which is the "main" network prefix. We will see examples of other prefixes on addresses, such as **`3`** for the test-net bitcoin test network as well as those denoting alternative crypto-currencies.
By sharing this bitcoin address (eg. 1HvHT6B3ZVT8nWCdVx3CKr8PRUMCNhZTqD), the owner of this address can request payments from others. When others "send" bitcoin to this address, essentially they are creating a transaction assigning ownership of pre-existing bitcoin in the blockchain to this address. This makes it possible for the owner of this address to create future transactions "spending" some or all of those pre-existing bitcoins, by using the secret key to sign a spending transaction.
Bitcoin is more than just a currency, it is also the payment network that carries all of the transactions of that currency. Well, almost all, as we will see in examining "off-blockchain" transactions later in this book.
The bitcoin network is a peer-to-peer network, which is formed by all the bitcoin clients that are running a full-node client. At any moment, the bitcoin network can range in size anywhere from a tens of thousands to hundreds of thousands of nodes. Only a tiny subset of those is required to operate, but good network propagation and distribution ensures resillience and survivability of the overall bitcoin network.
You can see a graphical representation of the nodes seen on the bitcoin network by visiting a popular chart on blockchain.info https://blockchain.info/nodes-globe
In the bitcoin peer-to-peer network, the nodes are much more sophisticated than most p2p networks. All nodes can validate the basic information inside a block for themselves and confirm the transactions. A full-node client can independently confirm each and every bitcoin in every transaction, in an unbroken chain all the way back to it's genesis in a newly minted block. The network therefore plays a subordinate role. It propagates transactions, but those transactions are independently verified by the nodes. The network is not trusted per-se, as each node does not depend on any third-party for trust. Instead, the network facilitates the propagation of blocks so that nodes that are mining can create new blocks and all nodes can verify them.
The bitcoin network essentially carries two types of data: unconfirmed transactions and mined blocks. The bitcoin network is used to propagate transactions between bitcoin users, ensuring that they are included in the blockchain when the next new block is mined. The networks gets the transactions to the miners and propagates newly mined blocks to all the clients.
A new bitcoin client can join the network and request any block, reconstructing the blockchain from the first (Genesis) block, all the way to the most recently mined block. Since each client also contains a static digital copy of the first block embedded in the source code, it can independently verify the entire blockchain. For example, a new client would request block with height "1", and verify that it is correct and contains the correct signature for block "0", the genesis block. Now, the client has bootstrapped the blockchain, independently verifying block "1", and now has a blockchain of height "1". From here, the client can request a block with height "2" from the network. If that can be validated as a valid block that can be added, then the blockchain is confirmed to height "2" etc. After a day or more, several hundred thousand blocks later, the network node can catch up and find that it has the same height as the majority of the network. Since the node has independently verified all of the blocks, it can confirm each transaction and bitcoin ever spent as valid without reference to any external authority. The only block trusted is the genesis block embedded within, the rest of the trust is derived experientially and independently.
Bitcoin's transaction fees are relatively flat and extremely low, compared to traditional payment networks. The current fee implementation is based on the size of a transaction's storage entry in the blockchain in bytes, with most transactions simply accepting the minimum fee of 0.5 millibits, or approximately 5 US cents at the time of writing, much lower than any other payment system.
Unlike traditional payment systems, bitcoin offers irreversible payments. Once a transaction is confirmed in the blockchain, the bitcoins are locked with the merchant keys and _cannot_ be reversed by anyone. This is especially important for merchants who operate online or shipping-based businesses, where a reversed charge on shipped merchandise is a significant and recurring problem.
Bitcoin is a developer's paradise. Where traditional banking and payment systems depend on exclusion as the means of securing the systems, bitcoin uses computation as the basis for its trust model. As a result, the network, protocol, transaction language and APIs are completely open and anyone can interact with the entire bitcoin system at any level. There is a wealth of progrmmatic interfaces at every layer, allowing developers and integrators to mash, code, hack and interface with bitcoin's internals.
Bitcoin is a strange asset class. It's not exactly a commodity, a currency, a stock or a fund. It is a bit of all of those and more, an asset class unto itself. Furthermore, there are other crypto-currencies and they can be traded for each other. Crypto currencies are a whole new world of asset classes that underpin independent and low-friction online economies.
