Bitcoin((("Bitcoin", "operational overview", id="bitcoin-operational-overview"))) is a collection of concepts and technologies that form the basis of a digital money ecosystem. Units of currency called bitcoin are used to store and transmit value among participants in the Bitcoin network. Bitcoin users communicate with each other using the Bitcoin protocol primarily via the internet, although other transport networks can also be used. The Bitcoin protocol stack, available as open source software, can be run on a wide range of computing devices, including laptops and smartphones, making the technology easily accessible.
and the system is called "Bitcoin", with a capital _B_.
====
Users can transfer bitcoin over the network to do just about anything
that can be done with conventional currencies, including buying and selling
goods, sending money to people or organizations, or extending credit. Bitcoin
can be purchased, sold, and exchanged for other currencies at
specialized currency exchanges. Bitcoin is arguably the perfect form
of money for the internet because it is fast, secure, and borderless.
Unlike traditional currencies, the bitcoin currency is entirely virtual. There are no
physical coins or even individual digital coins. The coins are implied in
transactions that transfer value from spender to receiver. Users of
Bitcoin control keys that allow them to prove ownership of bitcoin in the
Bitcoin network. With these keys, they can sign transactions to unlock
the value and spend it by transferring it to a new owner. Keys are often
stored in a digital wallet on each user’s computer or smartphone.
Possession of the key that can sign a transaction is the only
prerequisite to spending bitcoin, putting the control entirely in the
hands of each user.
Bitcoin is a distributed, peer-to-peer system. As such, there is no
central server or point of control. Units of bitcoin
are created through a process called "mining," which involves repeatedly
performing a computational task that references a list of recent Bitcoin
transactions. Any participant in the Bitcoin network may operate as a
miner, using their computing devices to help secure
transactions. Every 10 minutes, on average, one Bitcoin miner can add security to
past transactions and is rewarded with both brand new
bitcoins and the fees paid by recent transactions. Essentially, Bitcoin
mining decentralizes the currency-issuance
and clearing functions of a central bank and replaces the need for any
central bank.
//-- Math for following paragraph --
//total_btc = 0
//for i in range(0, 10_000_000):
// total_btc += (50 / (2**int(i/210000)) )
// if total_btc / 21e6 > 0.99:
// print(i)
// break
The Bitcoin protocol includes built-in algorithms that regulate the
mining function across the network. The difficulty of the computational
task that miners must perform is adjusted dynamically so that, on
average, someone succeeds every 10 minutes regardless of how many miners
(and how much processing) are competing at any moment. The protocol also
periodically decreases the number of new bitcoins that are created,
limiting the total number of bitcoins that will ever be created to a fixed total
just below 21 million coins. The result is that the number of bitcoins in
circulation closely follows an easily predictable curve where half of
the remaining coins are added to circulation every four years. At
approximately block 1,411,200, which is expected to be produced around
the year 2035, 99% of all bitcoins
that will ever exist will have been issued. Due to Bitcoin's
diminishing rate of issuance, over the long term, the Bitcoin currency
is deflationary. Furthermore, nobody can force you to accept
any bitcoins that were created beyond the
expected issuance rate.
Behind the scenes, Bitcoin is also the name of the protocol, a peer-to-peer network, and a distributed computing innovation. Bitcoin builds on decades of research in cryptography and distributed systems and includes at least four key innovations brought together in a unique and powerful combination. Bitcoin consists of:
* A decentralized peer-to-peer network (the Bitcoin protocol)
* A public transaction journal (the blockchain)
* A set of rules for independent transaction validation and currency issuance (consensus rules)
As a developer, I see Bitcoin as akin to the internet of money, a network for propagating value and securing the ownership of digital assets via distributed computation. There's a lot more to Bitcoin than first meets ((("Bitcoin", "operational overview", startref="bitcoin-operational-overview")))the eye.
In this chapter we'll get started by explaining some of the main concepts and terms, getting the necessary software, and using Bitcoin for simple transactions. In the following chapters, we'll start unwrapping the layers of technology that make Bitcoin possible and examine the inner workings of the Bitcoin network and protocol.
.Digital Currencies Before Bitcoin
****
The emergence of viable digital money is closely linked to developments in cryptography. This is not surprising when one considers the fundamental challenges involved with using bits to represent value that can be exchanged for goods and services. Three basic questions for anyone accepting digital money are:
1. Can I trust that the money is authentic and not counterfeit?
2. Can I trust that the digital money can only be spent once (known as the “double-spend” problem)?
3. Can I be sure that no one else can claim this money belongs to them and not me?
Issuers of paper money are constantly battling the counterfeiting problem by using increasingly sophisticated papers and printing technology. Physical money addresses the double-spend issue easily because the same paper note cannot be in two places at once. Of course, conventional money is also often stored and transmitted digitally. In these cases, the counterfeiting and double-spend issues are handled by clearing all electronic transactions through central authorities that have a global view of the currency in circulation. For digital money, which cannot take advantage of esoteric inks or holographic strips, cryptography provides the basis for trusting the legitimacy of a user’s claim to value. Specifically, cryptographic digital signatures enable a user to sign a digital asset or transaction proving the ownership of that asset. With the appropriate architecture, digital signatures also can be used to address the double-spend issue.
When cryptography started becoming more broadly available and understood in the late 1980s, many researchers began trying to use cryptography to build digital currencies. These early digital currency projects issued digital money, usually backed by a national currency or precious metal such as gold.
Although these earlier digital currencies worked, they were centralized and, as a result, were easy to attack by governments and hackers. Early digital currencies used a central clearinghouse to settle all transactions at regular intervals, just like a traditional banking system. Unfortunately, in most cases these nascent digital currencies were targeted by worried governments and eventually litigated out of existence. Some failed in spectacular crashes when the parent company liquidated abruptly. To be robust against intervention by antagonists, whether legitimate governments or criminal elements, a _decentralized_ digital currency was needed to avoid a single point of attack. Bitcoin is such a system, decentralized by design, and free of any central authority or point of control that can be attacked or corrupted.
****
=== History of Bitcoin
Bitcoin was first described in 2008 with the publication of a
paper titled "Bitcoin: A Peer-to-Peer Electronic Cash
lottery every 10 minutes on average, allowing the decentralized network to
arrive at _consensus_ about the state of transactions. This
elegantly solves the issue of double-spend where a single currency unit
can be spent twice. Previously, the double-spend problem was a weakness
of digital currency and was addressed by clearing all transactions
through a central clearinghouse.
The Bitcoin network started in 2009, based on a reference implementation
published by Nakamoto and since revised by many other programmers. The
number and power of machines running the Proof-of-Work algorithm
(mining) that provides security and resilience for Bitcoin have
increased exponentially, and their combined computational power now
exceeds the combined number of computing operations of the
world's top supercomputers.
Satoshi Nakamoto withdrew from the public in April 2011, leaving the responsibility of developing the code and network to a thriving group of volunteers. The identity of the person or people behind Bitcoin is still unknown. However, neither Satoshi Nakamoto nor anyone else exerts individual control over the Bitcoin system, which operates based on fully transparent mathematical principles, open source code, and consensus among participants. The invention itself is groundbreaking and has already spawned new science in the fields of distributed computing, economics, and econometrics.
.A Solution to a Distributed Computing Problem
****
Satoshi Nakamoto's invention is
also a practical and novel solution to a problem in distributed
computing, known as the "Byzantine Generals' Problem." Briefly, the
problem consists of trying to get multiple participants without a leader
to agree on a course of action by exchanging information over an
unreliable and potentially compromised network. Satoshi Nakamoto's solution, which uses the concept of
Proof-of-Work to achieve consensus _without a central trusted
authority_, represents a breakthrough in distributed computing.
****
=== Getting Started
Bitcoin is a protocol that can be accessed using an
application that speaks the protocol. A "Bitcoin wallet" is the
most common user interface to the Bitcoin system, just like a web
browser is the most common user interface for the HTTP protocol. There
are many implementations and brands of Bitcoin wallets, just like there
are many brands of web browsers (e.g., Chrome, Safari, and Firefox).
And just like we all have our favorite browsers,
Bitcoin wallets vary in quality, performance, security, privacy, and
reliability. There is also a reference implementation of the Bitcoin
protocol that includes a wallet, known as "Bitcoin Core," which is
derived from the original implementation written by Satoshi Nakamoto.
==== Choosing a Bitcoin Wallet
Bitcoin wallets are one of the most actively developed applications in the Bitcoin ecosystem. There is intense competition, and while a new wallet is probably being developed right now, several wallets from last year are no longer actively maintained. Many wallets focus on specific platforms or specific uses and some are more suitable for beginners while others are filled with features for advanced users. Choosing a wallet is highly subjective and depends on the use and user expertise. Therefore it would be pointless to recommend a specific brand or wallet. However, we can categorize Bitcoin wallets according to their platform and function and provide some clarity about all the different types of wallets that exist. It is worth trying out several different wallets until you find one that fits your needs.
===== Types of Bitcoin wallets
Bitcoin wallets can be categorized as follows, according to the platform:
Desktop wallet:: A desktop wallet was the first type of Bitcoin wallet created as a reference implementation and many users run desktop wallets for the features, autonomy, and control they offer. Running on general-use operating systems such as Windows and macOS has certain security disadvantages, however, as these platforms are often insecure and poorly configured.
Alice is now ready to start using her new Bitcoin wallet. Her wallet application randomly generated a private key (described in more detail in <<private_keys>>) that will be used to derive Bitcoin addresses that direct to her wallet. At this point, her Bitcoin addresses are not known to the Bitcoin network or "registered" with any part of the Bitcoin system. Her Bitcoin addresses are simply numbers that correspond to her private key that she can use to control access to the funds. The addresses are generated independently by her wallet without reference or registration with any service.
The QR code is the square with a pattern of black and white dots, serving as a form of barcode that contains the same information in a format that can be scanned by Joe's smartphone camera.
[WARNING]
====
Any funds sent to the addresses in this book will be lost. If you want
to test sending bitcoins, please consider donating it to a
bitcoin-accepting charity.
====
[[getting_first_bitcoin]]
==== Getting Your First Bitcoin
The first task for new users is to acquire some bitcoin.
Bitcoin transactions are irreversible. Most electronic payment networks such as credit cards, debit cards, PayPal, and bank account transfers are reversible. For someone selling bitcoin, this difference introduces a very high risk that the buyer will reverse the electronic payment after they have received bitcoin, in effect defrauding the seller. To mitigate this risk, companies accepting traditional electronic payments in return for bitcoin usually require buyers to undergo identity verification and credit-worthiness checks, which may take several days or weeks. As a new user, this means you cannot buy bitcoin instantly with a credit card. With a bit of patience and creative thinking, however, you won't need to.
* Find a friend who has bitcoins and buy some from him or her directly. Many Bitcoin users start this way. This method is the least complicated. One way to meet people with bitcoins is to attend a local Bitcoin meetup listed at pass:[<a href="https://meetup.com" class="orm:hideurl">Meetup.com</a>].
* Earn bitcoin by selling a product or service for bitcoin. If you are a programmer, sell your programming skills. If you're a hairdresser, cut hair for bitcoins.
* Use a Bitcoin ATM in your city. A Bitcoin ATM is a machine that accepts cash and sends bitcoins to your smartphone Bitcoin wallet.
* Use a Bitcoin currency exchange linked to your bank account. Many countries now have currency exchanges that offer a market for buyers and sellers to swap bitcoins with local currency. Exchange-rate listing services, such as https://bitcoinaverage.com[BitcoinAverage], often show a list of Bitcoin exchanges for each currency.
[TIP]
====
One of the advantages of
Bitcoin over other payment systems is that, when used correctly, it
affords users much more privacy. Acquiring, holding, and spending
bitcoin does not require you to divulge sensitive and personally
identifiable information to third parties. However, where bitcoin
touches traditional systems, such as currency exchanges, national and
international regulations often apply. In order to exchange bitcoin for
your national currency, you will often be required to provide proof of
identity and banking information. Users should be aware that once a
Bitcoin address is attached to an identity, other associated Bitcoin
transactions may also become easy to identify and track--including
transactions made earlier. This is one reason
many users choose to maintain dedicated exchange accounts independent from
their wallets.
====
Alice was introduced to Bitcoin by a friend so she has an easy way to acquire her first bitcoins. Next, we will look at how she buys bitcoins from her friend Joe and how Joe sends the bitcoins to her wallet.
[[bitcoin_price]]
==== Finding the Current Price of Bitcoin
Before Alice can buy bitcoin from Joe, they have to agree on the _exchange rate_ between bitcoin and US dollars. This brings up a common question for those new to Bitcoin: "Who sets the price
of bitcoins?" The short answer is that the price is set by markets.
Bitcoin, like most other currencies, has a _floating exchange rate_. That means that the value of bitcoin fluctuates according to supply and demand in the various markets where it is traded. For example, the "price" of bitcoin in US dollars is calculated in each market based on the most recent trade of bitcoins and US dollars. As such, the price tends to fluctuate minutely several times per second. A pricing service will aggregate the prices from several markets and calculate a volume-weighted average representing the broad market exchange rate of a currency pair (e.g., BTC/USD).
There are hundreds of applications and websites that can provide the current market rate. Here are some of the most popular:
https://bitcoinaverage.com[Bitcoin Average]:: A site that provides a simple view of the volume-weighted-average for each currency.
https://coincap.io[CoinCap]:: A service listing the market capitalization and exchange rates of hundreds of cryptocurrencies, including bitcoins.
https://oreil.ly/ACieC[Chicago Mercantile Exchange Bitcoin Reference Rate]:: A reference rate that can be used for institutional and contractual reference, provided as part of investment data feeds by the CME.
Joe then carefully checks to make sure he has entered the correct
amount, because he is about to transmit money and mistakes will soon become
irreversible. After double-checking the address and amount, he presses
Send to transmit the transaction. Joe's mobile Bitcoin wallet constructs
a transaction that assigns 0.001 BTC to the address provided by Alice,
sourcing the funds from Joe's wallet and signing the transaction with
Joe's private keys. This tells the Bitcoin network that Joe has
authorized a transfer of value to Alice's new address. As the
transaction is transmitted via the peer-to-peer protocol, it quickly
propagates across the Bitcoin network. After just a few seconds, most of
the well-connected nodes in the network receive the transaction and see
Alice's address for the first time.
Meanwhile, Alice's wallet is constantly "listening" for new
transactions on the Bitcoin network, looking for any that match the
addresses it contains. A few seconds after Joe's wallet transmits the
transaction, Alice's wallet will indicate that it is receiving
0.001 BTC.
[[confirmations]]
.Confirmations
****
At first, Alice's address will show the transaction from Joe as "Unconfirmed." This means that the transaction has been propagated to the network but has not yet been recorded in the Bitcoin transaction journal, known as the blockchain. To be confirmed, a transaction must be included in a block and added to the blockchain, which happens every 10 minutes, on average. In traditional financial terms this is known as _clearing_. For more details on propagation, validation, and clearing (confirmation) of bitcoin transactions, see <<mining>>.
****
Alice is now the proud owner of 0.001 BTC that she can spend. Over the next few days, Alice buys more bitcoin using an ATM and an exchange. In the next chapter we will look at her first purchase with Bitcoin, and examine the underlying transaction and propagation technologies in more detail.
