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[[ch00_intro_what_is_bitcoin]]
== Introduction
=== What is Bitcoin?
((("bitcoin")))
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.
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.
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.
=== History of bitcoin
==== A brief history of money
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:
* Lightweight and portable
* Hard to counterfeight
* Scarce in the local environment (doesn't grow on trees)
* Fungible (each unit is indistinguishable and interchangeable with another, a penny is a penny)
((("precious metals")))
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. While precious metals are excellent for storing value they are easier to counterfeit (alloys) and not lightweight or portable in large quantities.
Digital money appeals to many people because it tends to combine some of the characteristics of precious metals (fungible, scarce, store of value) with the characteristics of paper money instruments (lightweight, hard to copy). In the past, currencies represented a compromise of sorts between the various desired characteristics of money. Bitcoin appeals to many as it is seen to be "no compromise" money.
=== History of Cryptographic-Currencies
((("crypto-currency")))
Cryptographic currencies depend on cryptography to control the ownership of a piece of digital data. Using cryptographic digital signatures, a user can sign a digital asset or transaction and securely prove the ownership of that asset.
Since the late 1980s when cryptography started becoming more broadly available and understood, many researchers started 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.
While these earlier digital currencies worked, they had several fatal flaws. Firstly, early digital currencies used a central clearinghouse to settle all transactions at regular intervals, just like a traditional banking system. Secondly, these central clearinghouses and the organizations issuing the digital currency, were highly centralized organizations, usually corporations. Unfortunately, in most cases these nascent digital currencies were targetted by worried governments and eventually litigated to death.
Bitcoin's major breakthrough is the removal of any central authority or clearinghouse. Bitcoin is decentralized by design and does not have a central issuer or clearinghouse. It is the first fully decentralized digital currency. To achieve this amazing feat, bitcoin has replace the need for a central clearinghouse with a form of distributed _consensus_ based on participants proving they are contributing to the network security via a _proof-of-work_ algorithm.
The result of this deliberate decentralization is that bitcoin has removed two major areas of risk for digital currencies:
* Third Party Risk - Counterparty Risk
When a transaction occurs in a traditional financial payment network there are at least three parties to the transaction: the buyer, seller, and counteparty clearing house. This introduces a source of risk in the system - counterparty risk. Buyers and seller must not only trust each other, but also trust the central clearinghouse. With national currencies the central clearinghouse is the central bank and is therefore inextricably connected to the political process. Trust in the counterparty (central bank) is simply an extension of trust in the government and democratic process. Where digital currencies struggled to create the clearinghouse and imbue it with trust, bitcoin completely removes the need for counterparty trust by removing the counterparty.
* External Risks
All world currencies today are controlled by sovereign nation states. This control has significant political and economic benefits and is, of course, zealously protected. As a result, attempts to create competing and independent digital currencies, have quickly come under legal, or sometimes extra-legal, attack. Without a central organization, clearinghouse or controlling authority, bitcoin is not easy to attack. It is resilient to interference because control of the network and security of the currency is distributed as much as possible.
==== Quick Glossary
bitcoin::
((("bitcoin")))
The name of the currency unit (the coin), the network and the software
address (aka public key)::
((("bitcoin address")))
((("address", see="bitcoin address")))
((("public key", see="bitcoin address")))
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.
wallet::
((("wallet")))
Software that holds all your addresses. Use it to send bitcoin and manage your keys.
secret key (aka private key)::
((("secret key")))
((("private key", see="secret key")))
The secret number that unlocks bitcoins sent to the corresponding address
transaction::
((("transaction")))
In simple terms, a transfer of bitcoins from one address to another. More precisely, a transaction is a signed data structure expressing a transfer of value. Transactions are transmitted over the bitcoin network, collected by miners and included into blocks, made permanent on the blockchain.
hash::
((("hash")))
A digital fingerprint of some binary input.
block::
((("block")))
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. Valid blocks are added to the main blockchain by network consensus.
network::
((("network")))
A peer-to-peer network that propagates transactions and blocks among all nodes.
blockchain::
((("blockchain")))
A list of validated blocks, each linking to its predecessor all the way to the genesis block.
genesis block::
((("genesis block")))
The first block in the blockchain, used to initialize the crypto-currency
proof-of-work::
((("proof-of-work")))
A piece of data that requires significant computation to find. In bitcoin, a hash that is less than a target.
difficulty::
((("difficulty")))
A network-wide setting that controls how much computation is required to find a proof-of-work.
target difficulty::
((("target difficulty")))
A difficulty at which all the computation in the network will find blocks approximately every 10 minutes.
difficulty re-targetting::
((("difficulty re-targetting")))
A network-wide re-calculation of the difficulty which occurs once every 2106 blocks and considers the hashing power of the previous 2106 blocks.
miner::
((("miner")))
A network node that finds valid proof-of-work for new blocks, by repeated hashing
reward::
((("reward")))
An amount included in each new block as a reward by the network to the miner who found the proof-of-work solution. It is currently 25BTC per block.
fees::
((("fees")))
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.
confirmations::
((("confirmations")))
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.
=== Stories
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:
$1.50 USD
0.015 BTC
----
Or Bob might say _"That's one-dollar-fifty, or fifteen milibits"_.
Alice would use a smartphone to scan the barcode on display and send the payment. Her smartphone would show a payment of +0.0150 BTC+ to +Bob's Cafe+ and she would select +Send+ to authorize the payment. Within a few seconds (about the same time as a credit card authorization), Bob would see the transaction on the register, completing the transaction. Alice has purchased a cup of coffee for 15 millibits (or 0.015 bitcoin)
[TIP]
====
In the USA, it is customary to tip 20% for good service at coffee shops. Alice may choose to tip in dollars, or may add bitcoin.
====
==== A currency
((("bitcoin")))
Bitcoin is a currency, the operates much like any "foreign" currency. The main difference is that it is not issued by a national government. Bitcoin currency units are called "bitcoins". Unlike traditional currencies, bitcoins are divisible to much smaller units. The smallest unit is the _satoshi_, one hundred-millionth of a bitcoin (1/100,000,000). Bitcoin can be exchanged for other currencies at specialized currency exchanges that support crypto-currencies like bitcoin. There, a customer can exchange US dollars ($) or Euros (€) for bitcoin, at the prevailing market exchange rate.
Symbols: B⃦, Ƀ, ฿
Currency Code: BTC (unofficial), XBT (possible ISO standard)
((("bitcoin")))
((("millibitcoin")))
((("millibit", see="millibitcoin")))
((("microbitcoin")))
((("mike", see="microbitcoin")))
((("satoshi (currency unit)")))
[[table_bitcoinunits]]
.Table of bitcoin units from bitcoin wiki (https://en.bitcoin.it/wiki/Units)
[options="header"]
|=======
| Unit Name | Notation | Value
| bitcoin | BTC or B⃦ | 1 BTC
| millibitcoin or "millibit" | mBTC or mB⃦ | 0.001 BTC or 1/1000th
| microbitcoin or "mike" | μBTC or μB⃦| 0.000001 BTC or 1/1m
| satoshi | satoshi | 0.00000001 BTC or 1/100m
|=======
==== A network and protocol
((("peer-to-peer")))
((("P2P", see="peer-to-peer")))
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.
[[chart_bitcoin_decreasing_issuance]]
Chart of decreasing issuance over time
==== Transactions
People can pay for goods and services using bitcoin as the currency. mg
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:
----
...
- Address 27 gave 2 bitcoin to address 81
- Address 132 gave 1.05 bitcoin to address 22
- 25 bitcoin were mined to address 76
- Address 13 gave 0.5 bitcoin to address 52
- Address 52 gave 0.015 bitcoin to address 166
...
----
The ledger is a record of all bitcoin transactions and can be independently verified by every node.
==== The blockchain
((("blockchain")))
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.
[[blockchain_diagram]]
.Blockchain: A chain of blocks
image::images/blockchain.png["A chain of blocks"]
==== Mining for blocks
((("mining")))
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 transaction language
((("Script")))
((("transaction script")))
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)
((("JSON-RPC API")))
((("API", see="JSON-RPC 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.
=== Getting Bitcoin
((("bitcoind")))
((("bitcoin-qt")))
((("bitcoin client")))
There are many different implementations of bitcoin, from the front-end user interface to various libraries, servers and bitcoin network nodes.
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.
==== Full node client or lightweight client?
((("full node")))
((("lightweight client")))
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?
((("web wallet")))
((("mobile wallet")))
((("desktop 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.
[TIP]
============================================================================
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.
============================================================================
==== Obtaining the bitcoin software
===== Reference Client (bitcoind, bitcoin-qt)
Versions for Windows, Mac, Linux and source code can be found at http://bitcoin.org/en/download
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"]
[TIP]
============================================================================
For more immediate use of the bitcoin software, try downloading a lightweight client too, one that does not have a full-node copy of the blockchain.
============================================================================
===== Mobile client
On Android, you can find many bitcoin clients by searching for "bitcoin wallet" in the official application market. The most notable are:
* Andreas Shildbach's Android Bitcoin Wallet https://play.google.com/store/apps/details?id=de.schildbach.wallet
* Mycelium light-weight node https://play.google.com/store/apps/details?id=com.mycelium.wallet$$[]
* Blockchain.info hybrid web/mobile wallet https://play.google.com/store/apps/details?id=piuk.blockchain.android
Due to restrictions by Apple, there are no wallet applications for iOS. However, you can use web wallets in your iOS browser.
===== Web wallets
Web wallets are bitcoin wallets that are offered as a service by various online providers. These web wallets may be held by the online service, in which case the security of the funds depends entirely on that online service provider. This is very similar to a traditional banking environment where a third party has control and maintains security over your funds. However, unlike traditional banking these companies are rarely regulated. Therefore, web wallets should be used with caution.
Web wallets are extremely convenient for new users and a great way to introduce someone to bitcoin. However, they should not be used to store large amounts of value without taking security measures, most importantly two-factor authentication. Web wallets are vulnerable to hacks and also to remote compromise via trojans or key-loggers on your own desktop computer. Many users have lost bitcoin because their account was accessed from an insecure and compromised computer, which subsequently activated an unauthorized withdrawal.
[TIP]
====
Always use two-factor authentication on online wallets. The risk of compromise by key-logger or compromized desktop is very high. Additionally, do not store all your bitcoin online or in a single wallet, instead spread the risk a bit.
====
==== Public key cryptography and crypto-currency
((("public key")))
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.
==== Peer-to-Peer networks
((("peer-to-peer")))
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.
=== Finite monetary supply
Bitcoins are "minted" during the creation of each block at a fixed and diminishing rate. Each block, generated on average every 10 imnutes, contains a _reward_ that consists of entirely new bitcoins. The reward was 50BTC for the first four years of operation of the network. Every four years the reward is decreased by 50%, resulting in a dimishing rate of issuance over time. In 2012, the reward was decreased to 25BTC and it will decrease again to 12.5BTC in 2016. By approximately 2140, the last fragments of a bitcoin will be mined, for a total of 21 million bitcoins.
The algorithm that constrains bitcoin issuance to a geometrically decreasing curve, was modelled after the diminishing returns of mining for precious metals like gold, which are more and more difficult (costly) to extract over time.
The finite and diminishing issuance creates a fixed monetary supply that resists inflation. Unlike a fiat currency which can be printed in infinite numbers by a central bank, bitcoin can never be inflated by printing.
==== Monetary supply
Bitcoin's monetary supply is defined as the number of coins in circulation (minted). Like any other currency, this measure of monetary supply is called M0, which represents the narrowest measure of the money supply. Just like any other currency, bitcoin can also have a _fractional reserve banking_ which means that an organization can trade bitcoins "off blockchain" which are not part of the M0 monetary measure, but of the broader monetary supply measures M1-M3.
While the total bitcoins in circulation will not exceed 21m, that monetary base can support a much broader economy through fractional reserve banking and expansion of the available credit.
=== Divisibility and deflation
The most important and debated consequence of a fixed and diminishing monetary issuance is that the currency will tend to be inherently _deflationary_. Deflation is the phenomenon of appreciation of value due to a mismatch in supply and demand that drives up the value (and exchange rate) of a currency. The opposite of inflation, price deflation means that your money has more purchasing power over time.
Many economists argue that a deflationary economy is a disaster that should be avoided at all costs. That is because in a period of rapid deflation, the incentives for regular people are to hoard the money and not spend it, hoping that prices will fall. Such a phenomenon unfolded during Japan's "Lost Decade", when a complete collapse of demand pushed the currency into a deflationary spiral.
Bitcoin experts argue that deflation is not bad *per se*. Rather, we associate deflation with a collapse in demand because that is the only example of deflation we have to study. In a fiat currency with the possibility of unlimited printing, it is very difficult to enter a deflationary spiral unless there is a complete collapse in demand and an unwillingness to print money. Deflation in bitcoin is not caused by a collapse in demand, but by predictably constrained supply.
In practice, it has become evident that the hoarding instinct caused by a deflationary currency can be overcome by discounting from vendors, until the discount overcomes the hoarding instinct of the buyer. Since the seller is also motivated to hoard, the discount becomes the equilibrium price at which the two hoarding instincts are matched. With discounts of 30% on the bitcoin price, most bitcoin retailers are not experiencing difficulty overcoming the hoarding instinct and generating revenue. It remains to be seen whether the deflationary aspect of the currency is really a problem when it is not driven by rapid economic retraction.
==== Why would I use bitcoin
===== As a merchant
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.
===== As a consumer
Bitcoin is a tremendously useful currency. It offers consumers the ability to operate their own bank account, which is global in scope and entirely controlled by the user. Consumers can use their bitcoin anywhere in the world, instantly and with very low fees, without revealing their identity or providing pages and pages of personal information just to buy a product. A bitcoin user can also transmit bitcoin to a friend or family member, instantly and anywhere in the world without the need for bank accounts, expensive wire transfers or the permission of their government.
===== As a developer, integrator
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.
===== As an entrepreneur
TBD
===== As an investor
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.
[[ch00_intro_what_is_bitcoin]]
== Introduction
////Introduction should be Ch01 as preface is Ch00 - AM ////
=== What is Bitcoin?
((("bitcoin")))
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.
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.
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.
=== History of bitcoin
==== A brief history of money
//// Would the audience for this book need an introduction to money? I think we can leave most of this out or incorporate it into a briefer description. -AM ////
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:
* Lightweight and portable
* Hard to counterfeight
* Scarce in the local environment (doesn't grow on trees)
* Fungible (each unit is indistinguishable and interchangeable with another, a penny is a penny)
((("precious metals")))
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. While precious metals are excellent for storing value they are easier to counterfeit (alloys) and not lightweight or portable in large quantities.
Digital money appeals to many people because it tends to combine some of the characteristics of precious metals (fungible, scarce, store of value) with the characteristics of paper money instruments (lightweight, hard to copy). In the past, currencies represented a compromise of sorts between the various desired characteristics of money. Bitcoin appeals to many as it is seen to be "no compromise" money.
////The comparison between digital money and precious metals/paper money is interesting but I think this could function well as a text box/sidebar element rather than its own section. -AM ////
=== History of Cryptographic-Currencies
((("crypto-currency")))
Cryptographic currencies depend on cryptography to control the ownership of a piece of digital data. Using cryptographic digital signatures, a user can sign a digital asset or transaction and securely prove the ownership of that asset.
In the late 1980s, when cryptography started becoming more broadly available and understood, 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.
While these earlier digital currencies worked, they had several fatal flaws. Firstly, early digital currencies used a central clearinghouse to settle all transactions at regular intervals, just like a traditional banking system. Secondly, these central clearinghouses and the organizations issuing the digital currency were highly centralized organizations, usually corporations. Unfortunately, in most cases these nascent digital currencies were targetted by worried governments and eventually litigated to death.
Bitcoin's major breakthrough is the removal of any central authority or clearinghouse. Bitcoin is decentralized by design and does not have a central issuer or clearinghouse. It is the first fully decentralized digital currency. To achieve this amazing feat, bitcoin has replace the need for a central clearinghouse with a form of distributed _consensus_ based on participants proving they are contributing to the network security via a _proof-of-work_ algorithm.
////You break from the history of cryptocurrency into Bitcoin's major breakthrough. With this headind you'd expect to read about the evolution of cryptocurrency from early iterations to Bitcoin's beginning in 2009. If you're not going to cover this, I might change the header or move this info. I would also avoid sweeping phrases like "amazing feat." - AM////
The result of this deliberate decentralization is that bitcoin has removed two major areas of risk for digital currencies:
* Third Party Risk - Counterparty Risk
When a transaction occurs in a traditional financial payment network there are at least three parties to the transaction: the buyer, seller, and counteparty clearing house. This introduces a source of risk in the system - counterparty risk. Buyers and seller must not only trust each other, but also trust the central clearinghouse. With national currencies the central clearinghouse is the central bank and is therefore inextricably connected to the political process. Trust in the counterparty (central bank) is simply an extension of trust in the government and democratic process. Where digital currencies struggled to create the clearinghouse and imbue it with trust, bitcoin completely removes the need for counterparty trust by removing the counterparty.
* External Risks
All world currencies today are controlled by sovereign nation states. This control has significant political and economic benefits and is, of course, zealously protected. As a result, attempts to create competing and independent digital currencies, have quickly come under legal, or sometimes extra-legal, attack. Without a central organization, clearinghouse or controlling authority, bitcoin is not easy to attack. It is resilient to interference because control of the network and security of the currency is distributed as much as possible.
////Again, this is good info, but I don't see how it fits into the History of Cryptocurrencies. I might include this in as introductory material in a section on security. - AM////
==== Quick Glossary
////Add text here -AM ////
////A glossary is normally alphabetical. If you keep it as "Quick Glossary" I'd rearrange to alphabetical order. Otherwise, you can keep it as a non-alphabetical list of terms, but change "Quick Glossary" and add text beforehand with something to the effect of "Here are some common terms that will be used in the following chapters..." -AM ////
bitcoin::
((("bitcoin")))
The name of the currency unit (the coin), the network and the software
address (aka public key)::
((("bitcoin address")))
((("address", see="bitcoin address")))
((("public key", see="bitcoin address")))
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.
wallet::
((("wallet")))
Software that holds all your addresses. Use it to send bitcoin and manage your keys.
secret key (aka private key)::
((("secret key")))
((("private key", see="secret key")))
The secret number that unlocks bitcoins sent to the corresponding address.
transaction::
((("transaction")))
In simple terms, a transfer of bitcoins from one address to another. More precisely, a transaction is a signed data structure expressing a transfer of value. Transactions are transmitted over the bitcoin network, collected by miners and included into blocks, made permanent on the blockchain.
hash::
((("hash")))
A digital fingerprint of some binary input.
block::
((("block")))
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. Valid blocks are added to the main blockchain by network consensus.
network::
((("network")))
A peer-to-peer network that propagates transactions and blocks among all nodes.
////Will a reader understand "blocks among all nodes" - AM ////
blockchain::
((("blockchain")))
A list of validated blocks, each linking to its predecessor all the way to the genesis block.
genesis block::
((("genesis block")))
The first block in the blockchain, used to initialize the crypto-currency
proof-of-work::
((("proof-of-work")))
A piece of data that requires significant computation to find. In bitcoin, a hash that is less than a target.
//// Will a reader understand "a hash that is less than a target"? - AM ////
difficulty::
((("difficulty")))
A network-wide setting that controls how much computation is required to find a proof-of-work.
target difficulty::
((("target difficulty")))
A difficulty at which all the computation in the network will find blocks approximately every 10 minutes.
difficulty re-targetting::
((("difficulty re-targetting")))
A network-wide re-calculation of the difficulty which occurs once every 2106 blocks and considers the hashing power of the previous 2106 blocks.
miner::
((("miner")))
A network node that finds valid proof-of-work for new blocks, by repeated hashing
reward::
((("reward")))
An amount included in each new block as a reward by the network to the miner who found the proof-of-work solution. It is currently 25BTC per block.
fees::
((("fees")))
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.
confirmations::
((("confirmations")))
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.
//// I would review this list and make sure that these terms and definitions are clear for your lowest common denomiator reader/audience. Some of these are still confusing/unclear after reading. - AM ////
=== Stories
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
//// Is this a realistic example of how Bitcoin is used right now? Should you be qualifying this example? - AM ////
----
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)
[TIP]
====
In the USA, it is customary to tip 20% for good service at coffee shops. Alice may choose to tip in dollars, or may add bitcoin.
====
//// I don' think this is necessary. - AM /////
==== A currency
((("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
////I think we need to work on organization here. I don't understand the transition between "Stories" and this section. What is the segue? - AM ////
Symbols: B⃦, Ƀ, ฿
Currency Code: BTC (unofficial), XBT (possible ISO standard)
((("bitcoin")))
((("millibitcoin")))
((("millibit", see="millibitcoin")))
((("microbitcoin")))
((("mike", see="microbitcoin")))
((("satoshi (currency unit)")))
[[table_bitcoinunits]]
.Table of bitcoin units from bitcoin wiki (https://en.bitcoin.it/wiki/Units)
[options="header"]
|=======
| Unit Name | Notation | Value
| bitcoin | BTC or B⃦ | 1 BTC
| millibitcoin or "millibit" | mBTC or mB⃦ | 0.001 BTC or 1/1000th
| microbitcoin or "mike" | μBTC or μB⃦| 0.000001 BTC or 1/1m
| satoshi | satoshi | 0.00000001 BTC or 1/100m
|=======
==== A network and protocol
((("peer-to-peer")))
((("P2P", see="peer-to-peer")))
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.
////These read like an expansion on your glossary/repetitive. - AM ////
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.
////Should this be a text box instead of its own paragraph? - AM ////
[[chart_bitcoin_decreasing_issuance]]
Chart of decreasing issuance over time
==== Transactions
People can pay for goods and services using bitcoin as the currency. mg
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:
----
...
- Address 27 gave 2 bitcoin to address 81
- Address 132 gave 1.05 bitcoin to address 22
- 25 bitcoin were mined to address 76
- Address 13 gave 0.5 bitcoin to address 52
- Address 52 gave 0.015 bitcoin to address 166
...
----
The ledger is a record of all bitcoin transactions and can be independently verified by every node.
==== The blockchain
((("blockchain")))
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.
[[blockchain_diagram]]
.Blockchain: A chain of blocks
image::images/blockchain.png["A chain of blocks"]
==== Mining for blocks
((("mining")))
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.
//// Is this repetitive? Haven't you covered block decreasing every four years already? - AM /////
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 transaction language
((("Script")))
((("transaction script")))
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)
((("JSON-RPC API")))
((("API", see="JSON-RPC 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.
=== Getting Bitcoin
((("bitcoind")))
((("bitcoin-qt")))
((("bitcoin client")))
There are many different implementations of bitcoin, from the front-end user interface to various libraries, servers and bitcoin network nodes.
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.
////So does this match the header of "Getting Bitcoin." What is the reader supposed to do with this information? - AM ////
==== Full node client or lightweight client?
((("full node")))
((("lightweight client")))
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?
((("web wallet")))
((("mobile wallet")))
((("desktop 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.
////I would not put the below in Tip format if it is something the reader needs to do to make use of the book. - AM ////
[TIP]
============================================================================
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.
============================================================================
==== Obtaining the bitcoin software
===== Reference Client (bitcoind, bitcoin-qt)
Versions for Windows, Mac, Linux and source code can be found at http://bitcoin.org/en/download
////Does this explain how the reader goes about getting up and running? - AM ////
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"]
//// This is confusing. I would explain in one section what the reader should do, whether for downloading the lightweight client or bitcoin-qt application. - AM ////
[TIP]
============================================================================
For more immediate use of the bitcoin software, try downloading a lightweight client too, one that does not have a full-node copy of the blockchain.
============================================================================
===== Mobile client
On Android, you can find many bitcoin clients by searching for "bitcoin wallet" in the official application market. The most notable are:
////Why are they the most notable? Why choose these over others? - AM ////
* Andreas Shildbach's Android Bitcoin Wallet https://play.google.com/store/apps/details?id=de.schildbach.wallet
* Mycelium light-weight node https://play.google.com/store/apps/details?id=com.mycelium.wallet$$[]
* Blockchain.info hybrid web/mobile wallet https://play.google.com/store/apps/details?id=piuk.blockchain.android
Due to restrictions by Apple, there are no wallet applications for iOS. However, you can use web wallets in your iOS browser.
////Links for web wallets? - AM ////
===== Web wallets
Web wallets are bitcoin wallets that are offered as a service by various online providers. These web wallets may be held by the online service, in which case the security of the funds depends entirely on that online service provider. This is very similar to a traditional banking environment where a third party has control and maintains security over your funds. However, unlike traditional banking these companies are rarely regulated. Therefore, web wallets should be used with caution.
Web wallets are extremely convenient for new users and a great way to introduce someone to bitcoin. However, they should not be used to store large amounts of value without taking security measures, most importantly two-factor authentication. Web wallets are vulnerable to hacks and also to remote compromise via trojans or key-loggers on your own desktop computer. Many users have lost bitcoin because their account was accessed from an insecure and compromised computer, which subsequently activated an unauthorized withdrawal.
////Links for web wallets? Notable ones? - AM ////
[TIP]
====
Always use two-factor authentication on online wallets. The risk of compromise by key-logger or compromized desktop is very high. Additionally, do not store all your bitcoin online or in a single wallet, instead spread the risk a bit.
====
////Haven't you already pointed this tip out in the paragraphs before? - AM ////
==== Public key cryptography and crypto-currency
((("public key")))
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.
==== Peer-to-Peer networks
((("peer-to-peer")))
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.
////Should this all be covered in the Introduction or could some of this be moved to a later chapter? - AM ////
=== Finite monetary supply
Bitcoins are "minted" during the creation of each block at a fixed and diminishing rate. Each block, generated on average every 10 imnutes, contains a _reward_ that consists of entirely new bitcoins. The reward was 50BTC for the first four years of operation of the network. Every four years the reward is decreased by 50%, resulting in a dimishing rate of issuance over time. In 2012, the reward was decreased to 25BTC and it will decrease again to 12.5BTC in 2016. By approximately 2140, the last fragments of a bitcoin will be mined, for a total of 21 million bitcoins.
The algorithm that constrains bitcoin issuance to a geometrically decreasing curve, was modelled after the diminishing returns of mining for precious metals like gold, which are more and more difficult (costly) to extract over time.
The finite and diminishing issuance creates a fixed monetary supply that resists inflation. Unlike a fiat currency which can be printed in infinite numbers by a central bank, bitcoin can never be inflated by printing.
////These blocks of info read like info dumps. We need to work on organization and making this more fluid for the reader. - AM ////
==== Monetary supply
Bitcoin's monetary supply is defined as the number of coins in circulation (minted). Like any other currency, this measure of monetary supply is called M0, which represents the narrowest measure of the money supply. Just like any other currency, bitcoin can also have a _fractional reserve banking_ which means that an organization can trade bitcoins "off blockchain" which are not part of the M0 monetary measure, but of the broader monetary supply measures M1-M3.
While the total bitcoins in circulation will not exceed 21m, that monetary base can support a much broader economy through fractional reserve banking and expansion of the available credit.
=== Divisibility and deflation
The most important and debated consequence of a fixed and diminishing monetary issuance is that the currency will tend to be inherently _deflationary_. Deflation is the phenomenon of appreciation of value due to a mismatch in supply and demand that drives up the value (and exchange rate) of a currency. The opposite of inflation, price deflation means that your money has more purchasing power over time.
Many economists argue that a deflationary economy is a disaster that should be avoided at all costs. That is because in a period of rapid deflation, the incentives for regular people are to hoard the money and not spend it, hoping that prices will fall. Such a phenomenon unfolded during Japan's "Lost Decade", when a complete collapse of demand pushed the currency into a deflationary spiral.
Bitcoin experts argue that deflation is not bad *per se*. Rather, we associate deflation with a collapse in demand because that is the only example of deflation we have to study. In a fiat currency with the possibility of unlimited printing, it is very difficult to enter a deflationary spiral unless there is a complete collapse in demand and an unwillingness to print money. Deflation in bitcoin is not caused by a collapse in demand, but by predictably constrained supply.
In practice, it has become evident that the hoarding instinct caused by a deflationary currency can be overcome by discounting from vendors, until the discount overcomes the hoarding instinct of the buyer. Since the seller is also motivated to hoard, the discount becomes the equilibrium price at which the two hoarding instincts are matched. With discounts of 30% on the bitcoin price, most bitcoin retailers are not experiencing difficulty overcoming the hoarding instinct and generating revenue. It remains to be seen whether the deflationary aspect of the currency is really a problem when it is not driven by rapid economic retraction.
==== Why would I use bitcoin
////Add text here - AM ////
===== As a merchant
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.
===== As a consumer
Bitcoin is a tremendously useful currency. It offers consumers the ability to operate their own bank account, which is global in scope and entirely controlled by the user. Consumers can use their bitcoin anywhere in the world, instantly and with very low fees, without revealing their identity or providing pages and pages of personal information just to buy a product. A bitcoin user can also transmit bitcoin to a friend or family member, instantly and anywhere in the world without the need for bank accounts, expensive wire transfers or the permission of their government.
===== As a developer, integrator
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.
===== As an entrepreneur
TBD
//// unfinished - AM /////
===== As an investor
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.
////A lot of this reads like information that needs to be part of a different/its own chapter. The introduction should be a brief _introductory_ peak at the topic for the reader and get them up and running with the tools they will need in later chapters. There doesn't seem to be a fluidity to the topics here and headings could be moved around without making a difference. I'm interested in your introduction of the "Stories" idea (may need to change this to case study, or Bitcoin in Real Life, or something) but it seemed oddly isolated from the rest of the chapter and I didn't get a sense of how we would be coming back to it throughout the book. -AM ////
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