@ -19,7 +19,7 @@ Bitcoin is a distributed, peer-to-peer system. As such, there is no "central" se
The Bitcoin protocol includes built-in algorithms that regulate the mining function across the network. The difficulty of the processing 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 halves the rate at which new bitcoin is created every 4 years, and limits the total number of bitcoin that will be created to a fixed total just below 21 million coins. The result is that the number of bitcoin in circulation closely follows an easily predictable curve that approaches 21 million by the year 2140. Due to bitcoin's diminishing rate of issuance, over the long term, the Bitcoin currency is deflationary. Furthermore, bitcoin cannot be inflated by "printing" new money above and 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. The bitcoin currency is really only the first application of this invention. Bitcoin represents the culmination of decades of research in cryptography and distributed systems and includes four key innovations brought together in a unique and powerful combination. Bitcoin consists of:
Behind the scenes, Bitcoin is also the name of the protocol, a peer-to-peer network, and a distributed computing innovation. Bitcoin represents the culmination of decades of research in cryptography and distributed systems and includes 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 ledger (the blockchain)
@ -68,8 +68,8 @@ Satoshi Nakamoto withdrew from the public in April 2011, leaving the responsibil
((("bitcoin", "use cases", id="GSuses01")))Bitcoin is an innovation in the ancient technology of money. At its core, money simply facilitates the exchange of value between people. Therefore, in order to fully understand Bitcoin and its uses, we'll examine it from the perspective of people using it. Each of the people and their stories, as listed here, illustrates one or more specific use cases. We'll be seeing them throughout the book:
North American low-value retail::
((("use cases", "retail sales")))Alice lives in Northern California's Bay Area. She has heard about Bitcoin from her techie friends and wants to start using it. We will follow her story as she learns about Bitcoin, acquires some, and then spends some of her bitcoin to buy a cup of coffee at Bob's Cafe in Palo Alto. This story will introduce us to the software, the exchanges, and basic transactions from the perspective of a retail consumer.
North American e-commerce retails::
((("use cases", "retail sales")))Alice lives in Northern California's Bay Area. She has heard about Bitcoin from her techie friends and wants to start using it. We will follow her story as she learns about Bitcoin, acquires some, and then spends her bitcoin to buy a laptop from Bob's online store. This story will introduce us to the software, the exchanges, and basic transactions from the perspective of a retail consumer.
North American high-value retail::
Carol is an art gallery owner in San Francisco. She sells expensive paintings for Bitcoin. This story will introduce the risks of a "51%" consensus attack for retailers of high-value items.
@ -100,6 +100,7 @@ Each of these stories is based on the real people and real industries currently
((("security", "wallet selection")))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. Better yet, moving keys or seeds between Bitcoin wallets is relatively easy, so it is worth trying out several different wallets until you find one that fits your needs.
[role="pagebreak-before"]
===== 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 Mac OS has certain security disadvantages, however, as these platforms are often insecure and poorly configured.
@ -110,6 +111,7 @@ Web wallet:: Web wallets are accessed through a web browser and store the user's
Hardware wallet:: Hardware wallets are devices that operate a secure self-contained Bitcoin wallet on special-purpose hardware. They usually connect to a desktop or mobile device via USB cable or near-field-communication (NFC), and are operated with a web browser or accompanying software. By handling all Bitcoin-related operations on the specialized hardware, these wallets are considered very secure and suitable for storing large amounts of bitcoin.
===== Full-node vs. Lightweight
Another way to categorize bitcoin wallets is by their degree of autonomy and how they interact with the Bitcoin network:
Full-node client:: ((("full-node clients")))A full client, or "full node," is a client that stores the entire history of Bitcoin transactions (every transaction by every user, ever), manages users' wallets, and can initiate transactions directly on the Bitcoin network. A full node handles all aspects of the protocol and can independently validate the entire blockchain and any transaction. A full-node client consumes substantial computer resources (e.g., more than 125 GB of disk, 2 GB of RAM) but offers complete autonomy and independent transaction verification.
Third-party API client:: ((("third-party API clients")))A third-party API client is one that interacts with Bitcoin through a third-party system of application programming interfaces (APIs), rather than by connecting to the Bitcoin network directly. The wallet may be stored by the user or by third-party servers, but all transactions go through a third party.
Combining these categorizations, many Bitcoin wallets fall into a few groups, with the three most common being desktop full client, mobile lightweight wallet, and web third-party wallet. The lines between different categories are often blurry, as many wallets run on multiple platforms and can interact with the network in different ways.
===== Custodial vs. Non-Custodial
A very important additional consideration is _who controls the keys_. As we will see in subsequent chapters, access to bitcoin (funds) is controlled by "private keys", which are like very long PIN numbers. If you are the only one to have *custody* and *control* over these private keys, you are in control of your bitcoin. Conversely, if you do not have custody, then your bitcoin is managed by a third-party custodian, who ultimately controls your funds on your behalf. Wallets fall into two important categories based on custody: _non-custodial_ wallets where you control the keys and the funds and _custodial_ wallets where some third-party controls the keys. To emphasize this point, the author of this book coined the phrase:
_Your keys, your coins. Not your keys, not your coins_.
Combining these categorizations, many Bitcoin wallets fall into a few groups, with the three most common being desktop full client (non-custodial), mobile lightweight wallet (non-custodial), and web third-party wallet (custodial). The lines between different categories are often blurry, as many wallets run on multiple platforms and can interact with the network in different ways.
For the purposes of this book, we will be demonstrating the use of a variety of downloadable Bitcoin clients, from the reference implementation (Bitcoin Core) to mobile and web wallets. Some of the examples will require the use of Bitcoin Core, which, in addition to being a full client, also exposes APIs to the wallet, network, and transaction services. If you are planning to explore the programmatic interfaces into the Bitcoin system, you will need to run Bitcoin Core, or one of the alternative clients.((("", startref="GSwallet01")))((("", startref="Wselect01")))
==== Quick Start
((("getting started", "quick start example", id="GSquick01")))((("wallets", "quick start example", id="Wquick01")))((("use cases", "buying coffee", id="aliceone")))Alice, who we introduced in <<user-stories>>, is not a technical user and only recently heard about Bitcoin from her friend Joe. While at a party, Joe is once again enthusiastically explaining Bitcoin to all around him and is offering a demonstration. Intrigued, Alice asks how she can get started with Bitcoin. Joe says that a mobile wallet is best for new users and he recommends a few of his favorite wallets. Alice downloads "Bluewallet" (available for iOS and Android) and installs it on her phone.
((("getting started", "quick start example", id="GSquick01")))((("wallets", "quick start example", id="Wquick01")))Alice, who we introduced in <<user-stories>>, is not a technical user and only recently heard about Bitcoin from her friend Joe. While at a party, Joe is once again enthusiastically explaining Bitcoin to all around him and is offering a demonstration. Intrigued, Alice asks how she can get started with Bitcoin. Joe says that a mobile wallet is best for new users and he recommends a few of his favorite wallets. Alice downloads "Bluewallet" (available for iOS and Android) and installs it on her phone.
When Alice runs her wallet application for the first time, she chooses the option to create a new Bitcoin wallet. Because the wallet she has chosen is a non-custodial wallet, Alice (and only Alice) will be in control of her keys. Therefore, she bears responsibility for backing them up, since losing the keys means she loses access to the bitcoin. To facilitate this, her wallet produces a _mnemonic phrase_ (explained more in <<mnemonic_phrase_intro>>), in the form of 12 English words that can be used to restore her wallet on any of the hundreds of compatible software or hardware wallets.
Alice takes a moment **away from Joe and all other parties** to write down the mnemonic phrase on a piece of paper. After creating her wallet and securing her mnemonic phrase, Alice can tap on her wallet to see her bitcoin amount, transaction history, as well as two buttons that allow her to either _receive_ or _send_ bitcoin, shown in <<bluewallet-welcome>>.
When Alice runs her wallet application for the first time, she chooses the option to create a new Bitcoin wallet, and takes a moment **away from Joe and all other parties** to write down a secret mnemonic phrase _in order_ on a piece of paper. As explained by the mobile wallet and by Joe earlier, the mnemonic phrase allows Alice to restore her wallet in case she loses her mobile device and grants her access to her funds on another device. After creating her wallet and securing her mnemonic phrase, Alice can tap on her wallet to see her bitcoin amount, transaction history, as well as two buttons that allow her to either _receive_ or _send_ bitcoin, shown in <<bluewallet-welcome>>.
Let's elaborate a bit on the mnemonic phrase, next.
==== Mnemonic Words
[[mnemonic_phrase_intro]]
==== Mnemonic Phrase
A modern Bitcoin wallet will provide a _mnemonic phrase_ (also sometimes called a "seed" or "seed phrase") for Alice to back up. The mnemonic phrase consists of 12-24 English words, selected randomly by the software, and used as the basis for the keys that are generated by the wallet. The mnemonic phrase can be used by Alice to restore all the transactions and funds in her wallet in the case of an event such as a lost mobile device, a software bug, or memory corruption.
Most modern non-custodial Bitcoin wallets will provide a _mnemonic phrase_ (also sometimes called a "seed" or "seed phrase") for their user to back up. The mnemonic phrase usually consists of 12 English words, selected randomly by the software, and used as the basis for the keys that are generated by the wallet. A sample mnemonic phrase is shown in <<mnemonic_phrase_sample>>.
[[mnemonic_phrase_sample]]
.Alice is shown a 12-word mnemonic phrase that she must backup (offline on paper)
image::images/mnemonic_phrase_sample.png[".Alice is shown a 12-word mnemonic phrase that she must backup (offline on paper)"]
This mnemonic phrase can be used by Alice to restore *all* the transactions and funds in her wallet in the case of an event such as a lost mobile device, a software bug, or memory corruption. The mnemonic phrase is based on a common standard and therefore can be restored on any compatible software or hardware wallet. This allows Alice to try different wallets and also removes any dependency on the software or hardware maker of the wallet.
[TIP]
====
The correct term for these backup words is "mnemonic phrase". We avoid the use of the term "seed" to refer to a mnemonic phrase, because even though its use is common it is incorrect.
====
Of note, when receiving funds to a new mobile wallet for the first time, many wallets will often re-verify that you have securely backed-up your mnemonic phrase. This can range from a simple prompt to requiring the user to manually re-enter the phrase.
[[mnemonic-storage]]
==== Storing the Mnemonic Safely
@ -148,22 +168,36 @@ Once Alice has recorded the mnemonic phrase, she should plan to store each copy
====
Never attempt a "DIY" security scheme that deviates in any way from the best practice recommendation in <<mnemonic-storage>>. Do not cut your mnemonic in half, make screenshots, store on USB drives, email or cloud drives, encrypt it, or try any other non-standard method. You will tip the balance in such a way as to risk permanent loss or theft. Many people have lost funds, not from theft but because they tried a non-standard solution without having the expertise to balance the risks involved. The best practice recommendation is carefully balanced by experts and suitable for the vast majority of users.
====
****
[[bluewallet-welcome]]
.Alice uses the Receive screen on her Bluewallet mobile Bitcoin wallet, and displays her address to Bob in a QR code format
image::images/mbc2_0101.png["BluewalletWelcome"]
==== Running the wallet application
((("addresses", "bitcoin wallet quick start example")))((("QR codes", "bitcoin wallet quick start example")))((("addresses", see="also keys and addresses"))) The main wallet view displays the bitcoin amount, transaction history, and _Receive_ and _Send_ buttons. In addition, many wallets feature the ability to purchase Bitcoin directly through an exchange or similar service where you can offer fiat money in return for cryptocurrency, which is done by <<bitcoin_price>> and selling to the wallet user at or above this price. The _Buy Bitcoin_ button would allow Alice to purchase Bitcoin in this fashion.
Alice is now ready to start using her new bitcoin wallet. ((("", startref="GSquick01")))((("", startref="Wquick01"))) Her wallet application randomly generated a private key (described in more detail in <<private_keys>>) which 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 random 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. In fact, in most wallets, there is no association between a Bitcoin address and any externally identifiable information including the user's identity. Until the moment an address is referenced as the recipient of value in a transaction posted on the bitcoin ledger, the Bitcoin address is simply part of the vast number of possible addresses that are valid in bitcoin. Only once an address has been associated with a transaction does it become part of the known addresses in the network.
==== Bitcoin addresses
Alice uses the _Receive_ button, which displays a QR code along with a Bitcoin address. 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. Next to the wallet's QR code is the Bitcoin address it encodes, and Alice may choose to manually send her address to Joe by copying it onto her clipboard with a tap. Of note, when receiving funds to a new mobile wallet for the first time, many wallets will often re-verify that you have indeed secured your mnemonic phrase. This can range from a simple prompt to requiring the user to manually re-enter the phrase.
Alice is now ready to start using her new bitcoin wallet. ((("", startref="GSquick01")))((("", startref="Wquick01"))) Her wallet application randomly generated a private key (described in more detail in <<private_keys>>) which 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 random 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.
[TIP]
====
((("addresses", "security of")))((("security", "Bitcoin addresses")))Bitcoin addresses start with 1, 3, or bc1. Like email addresses, they can be shared with other bitcoin users who can use them to send bitcoin directly to your wallet. There is nothing sensitive, from a security perspective, about the Bitcoin address. It can be posted anywhere without risking the security of the account. Unlike email addresses, you can create new addresses as often as you like, all of which will direct funds to your wallet. In fact, many modern wallets automatically create a new address for every transaction to maximize privacy. A wallet is simply a collection of addresses and the keys that unlock the funds within.
====
In most wallets, there is no association between a Bitcoin address and any externally identifiable information including the user's identity. Until the moment an address is referenced as the recipient of value in a transaction posted on the bitcoin ledger, the Bitcoin address is simply part of the vast number of possible addresses that are valid in bitcoin. Only once an address has been associated with a transaction does it become part of the known addresses in the network.
==== Receiving bitcoin
Alice uses the _Receive_ button, which displays a QR code along with a Bitcoin address, shown in <<bluewallet_receive>>.
[[bluewallet_receive]]
.Alice uses the Receive screen on her Bluewallet mobile Bitcoin wallet, and displays her address to Bob in a QR code format
image::images/mbc2_0101.png["BluewalletWelcome"]
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. Next to the wallet's QR code is the Bitcoin address it encodes, and Alice may choose to manually send her address to Joe by copying it onto her clipboard with a tap.
[WARNING]
====
Do not send money to the addresses in this book, it will be lost. Despite this warning people try to scan and send money, so the QR codes and addresses are blurred in the wallet screenshots.
====
[[getting_first_bitcoin]]
==== Getting Her First Bitcoin
@ -203,7 +237,7 @@ In addition to these various sites and applications, most bitcoin wallets will a
[[sending_receiving]]
==== Sending and Receiving Bitcoin
((("getting started", "sending and receiving bitcoin", id="GSsend01")))((("spending bitcoin", "bitcoin wallet quick start example")))((("spending bitcoin", see="also transactions")))Alice has decided to exchange $10 US dollars for bitcoin, so as not to risk too much money on this new technology. She gives Joe $10 in cash, opens her Bluewallet mobile wallet application, and selects Receive. This displays a QR code with Alice's first Bitcoin address.
((("getting started", "sending and receiving bitcoin", id="GSsend01")))((("spending bitcoin", "bitcoin wallet quick start example")))((("spending bitcoin", see="also transactions")))Alice has decided to exchange $100 US dollars for bitcoin. She gives Joe $100 in cash, opens her Bluewallet mobile wallet application, and selects Receive. This displays a QR code with Alice's first Bitcoin address.
Joe then selects Send on his Bluewallet smartphone wallet and is presented with a screen containing the following inputs:
@ -212,27 +246,27 @@ Joe then selects Send on his Bluewallet smartphone wallet and is presented with
* A transaction note (description)
* A transaction fee
[[bluewallet-mobile-send]]
[role="smallereighty"]
.Bluewallet mobile bitcoin wallet send screen
image::images/mbc2_0102.png["bluewallet mobile send screen"]
In the input field for the Bitcoin address, there is a small _Scan_ button. This allows Joe to scan the QR code with his smartphone camera so that he doesn't have to type in Alice's Bitcoin address, which is quite long and difficult to type. Joe taps the _Scan_ button and it activates the smartphone camera, scanning the QR code displayed on Alice's smartphone.
Joe now has Alice's Bitcoin address set as the recipient. Joe enters the amount as $10 US dollars and his wallet converts it by accessing the most recent exchange rate from an online service. The exchange rate at the time is $100 US dollars per bitcoin, so $10 US dollars is worth 0.10 bitcoin (BTC), or 100 millibitcoin (mBTC) as shown in the screenshot from Joe's wallet (see <<bluewallet-mobile-send>>).
Joe now has Alice's Bitcoin address set as the recipient. Joe enters the amount as $100 US dollars and his wallet converts it by accessing the most recent exchange rate from an online service. The exchange rate at the time is approximately $50,000 US dollars per bitcoin, so $100 US dollars is worth 0.00194401 bitcoin (BTC) as shown in the screenshot from Joe's wallet (see <<bluewallet-mobile-send>>).
In the transaction note/description input, Joe enters "Alice". He can use this field to add some information regarding his transaction for future reference. This function is for his record keeping only. The transaction note will be stored in his wallet and only Joe will be able to see it. It will not be sent to Alice, nor stored on the blockchain.
He also selects a transaction fee for his transaction. The higher the transaction fee, the faster his transaction will be confirmed (included in a block by a miner). He selects the minimum transaction fee possible at that time (0 satoshis/byte).
He also selects a transaction fee for his transaction. The higher the transaction fee, the faster his transaction will be confirmed (included in a block by a miner). He selects the minimum transaction fee possible at that time (1 satoshi/vbyte).
[TIP]
====
The price of bitcoin has changed a lot over time, and an incredible amount since the first edition of this book was written. As of March 2021, a person would need approximately $54,000 USD to purchase one whole bitcoin. Many examples in this book reference real-life past transactions, when the price of bitcoin was much lower and transactions with zero fees were still possible. Think about how generous of a friend Joe would have been if he had made the same agreement with Alice today!
The price of bitcoin has changed a lot over time, and an incredible amount since the first edition of this book was written. As of October 2021, a person would need approximately $67,000 USD to purchase one whole bitcoin. When the first edition of this book was written, a bitcoin was worth less than $500 USD.
====
[[bluewallet-mobile-send]]
[role="smallereighty"]
.Bluewallet mobile bitcoin wallet send screen
image::images/mbc2_0102.png["bluewallet mobile send screen"]
Using Bluewallet, Joe carefully checks to make sure he has entered the correct amount, because he is about to transmit money and mistakes are irreversible. For simplicity sake, we will assume that Joe does not pay any transaction fees. The purpose and setting of transaction fees are covered in subsequent chapters. After double-checking the address and amount, he presses _Send_ to transmit the transaction. Joe's mobile bitcoin wallet constructs a transaction that assigns 0.10 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. In less than a second, most of the well-connected nodes in the network receive the transaction and see Alice's address for the first time.
Using Bluewallet, Joe carefully checks to make sure he has entered the correct amount, because he is about to transmit money and mistakes are irreversible. For simplicity sake, we will assume that Joe does not pay any transaction fees. The purpose and setting of transaction fees are covered in subsequent chapters. After double-checking the address and amount, he presses _Send_ to transmit the transaction. Joe's mobile bitcoin wallet constructs a transaction that assigns 0.00194401 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. In less than a second, 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" to published 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 0.10 BTC.
Meanwhile, Alice's wallet is constantly "listening" to published 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 0.00194401 BTC.
[TIP]
====
@ -243,4 +277,4 @@ Each bitcoin can be subdivided into 100 million units, each called a "satoshi" (
.Confirmations
((("getting started", "confirmations")))((("confirmations", "bitcoin wallet quick start example")))((("confirmations", see="also mining and consensus; transactions")))((("clearing", seealso="confirmations")))At first, Alice's wallet 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 ledger, 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_. This book will cover in detail the propagation, validation, and clearing (or confirmation) of bitcoin transactions.
Alice is now the proud owner of 0.10 BTC that she can spend. In the next chapter we will look at her first purchase with bitcoin, and examine the underlying transaction and propagation technologies in more detail.((("", startref="BCbasic01")))((("use cases", "buying coffee", startref="aliceone")))
Alice is now the proud owner of 0.002 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.((("", startref="BCbasic01")))
Andreas M. Antonopoulos
2 years ago
