Bitcoin Explanation

This is the best explanation of the Bitcoin protocol that I have read.

Posted on December 9, 2013 at 11:33 AM • 33 Comments

Comments

Brian M.December 9, 2013 12:59 PM

And here I thought you'd mention the NSA playing WOW for "intelligence"! Apparently they may not have actually infiltrated the servers, but were only able to play the game... Hmmm... I wonder how the contact protocol for that was worked out: "Stand outside of Ghost Spawn Investments in the evening. Cast a spell of opaque amber light upon a fairy, and wait for a goblin carrying a pink jar of ogre fingernails to ask you about the price of maiden's eyes. Reply that the market is volatile, and recommend investing in steam engines."

On topic: The explanation is interesting, but I would have liked to have seen details on wallet security. From a brief reading, the wallet appears to be a serious weakness. Too bad the Bitcoin protocol didn't go through a security review before everybody jumped onto it.

DanielDecember 9, 2013 1:09 PM

Part of the problem in understanding Bitcoin is a fundamental lack of comprehension of economic principles, especially the distinction between money and currency. Bitcoin can be thought of as money insofar as it represents both a store of vale and a medium of exchange. But it is highly doubtful that it will ever be accepted as a currency. This is because a currency is more than just money, currency is a representation of a political and even cultural value. Both the Central African Franc and the Dollar are money but they have not achieved the same currency.

Ultimately, although some people try really really hard, one cannot separate money from politics. Bitcoin is being tolerated because no political entity sees it as serious threat. But it has no long-term future as a currency unless it becomes adopted by a political entity and that political entity becomes culturally powerful.

People have been inventing and promoting new currencies since the dawn of recorded history. Most of them fail. Given the fact that rumors of the Euro's demise still circulate it would be a remarkable historical fact if Bitcoin is anything other than a passing fad.

This doesn't mean that Bitcoin has no technological value but the whole idea that it will open up "new vistas in human relationships" is pie-in-sky snickerdoodle.

ChristianODecember 9, 2013 1:20 PM

Or BitCoin in short how much I understood of it:

Distributed Concencus (Paxos) in P2P suffers from vulnerability from Sybil attacks. BitCoin (as many before it) hampers Sybil attacks asking to show proof of compute power for decisions. BitCoins are used as incentive for people to provide compute power.

Michael.December 9, 2013 1:29 PM

One reason I like Bitcoin (and the idea of similar things) is that it doesn't matter if it is not a "store", so it doesn't have to be either currency or money. It is more important that it is a method of transfer.

Let's take an organisation called Xilimeaks (pronounced zili-meaks) who publish stuff that is sent to them. They are sort of a news organisation. However, there are some other organisations that control most of the money transfer system (Maymal, Nastycard and Wisa) that don't like Xilimeaks, and so say, right, no one can send them any money.

Well, with Bitcoin, that's irrelevant. Because there is no central authority. That's what I like about it.

BenDecember 9, 2013 3:42 PM

Ways for governments to control Bitcoin:

1. Ban it outright.

2. Pretend not to ban it, but actually ban it. Think anti-money-laundering (AML) regulations which might require knowledge of the identity of a counterparty.

3. Forbid transactions with certain parties, and where those parties touch any bitcoin legally require that the bitcoin be assigned to the government pending investigation, with criminal penalties for anyone in the jurisdiction for failing to do so. Again, AML regulations could do this.

The fundamental traceability of bitcoin is its Achilles heel. You can convert dollars to bitcoins, but once it has touched an illegal transaction you will have trouble converting it back. They might leave Joe Bloggs alone but Mt Gox won't touch it.

Since bitcoin lacks intrinsic value, and is not a physical object like gold which can be melted down, and cannot even be untraceably moved, that point is a killer. All the US Government have to do is say "That bitcoin is now bad" and the bitcoin loses value.

Gold, remember, is an important industrial metal, and will always be valuable, even if not necessarily quite as valuable as at present.

4. Allow it to continue, and acquire the identities of every wallet owner.

AndreDecember 9, 2013 4:16 PM

It's good for people to start understanding Bitcoin's underlying protocol.

To me, what's most fascinating about Bitcoin is that it introduces an open system and protocol for value exchange on the Internet with cash-like properties, most notably decentralized peer-to-peer transactions. Meanwhile, the zealots esteem it with more lofty Utopian dreams, which may serve more to incite dissent and controversy than they do to help Bitcoin gain acceptance.

With little time, the infrastructure necessary to make Bitcoin accessible to the general public can most likely be developed. The big trouble, however, is that Governments are unsure how to react.

My interest is purely in the technological possibilities cryptocurrencies open up, but it seems clear that there doesn't exist a modern model to help everyone comprehend the consequences of it. Economists and technologists should be working together on such a model.

I've wondered if the ultimate compromise will be a new protocol where wallets are government issued. Still a global cryptocurrency, but one where governments own liability for the money in the wallets it has issued. Might that reconcile cryptocurrencies with the Modern Monetary Theory model?

Brian M.December 9, 2013 4:42 PM

@Daniel:

From what I've been reading about money, and from what I've listened to on various programs, is that all currency is a fiat currency. It is valuable because we think it is valuable. Gold itself has had extreme highs and lows, all based on "market value."

Bitcoin is a form of traceable cash. Its value is backed by nothing but supply and demand. The Chinese banks officially view it as a "trade item," which is actually what any amount of cash actually is.

... And OOOH! The value went from $1200 to $600! Isn't fluctuation brought about by rampant speculation just amazing? Reminds me of what has happened in a number of other markets.

So. Demand has just plummeted, and some investors have lost their shirts.

Hmm, another thing to consider is that since there is a traceable record of Bitcoin transactions from the beginning, will Bitcoin choke on its own history? One fellow wrote in a blog post that when he started, the global transaction history was 2Gb. He decided that keeping the data wasn't worth it when it was over 25Gb. So as Bitcoin becomes ever more popular, that database baggage must grow, and finally command extremely significant resources. But who must, as in obligated, keep feeding this resource? It may prove to be a very hungry beast.

AnuraDecember 9, 2013 5:06 PM

Although I'm not sure about bitcoin specifically, but in theory you don't need every one to have a complete copy of the transaction log, just regular checkpoints that store the current values of every account. In this case you don't have to go all the way back to the beginning, just to the last checkpoint. The checkpoints themselves can be validated historically, but you only need everyone to agree on the checkpoints.

Now, if Bitcoin became the leading world currency, doing hundreds of thousands of transactions per second, I'm not sure how usable that would be even with the checkpoints. If people are constantly creating new addresses and sending transactions between them while using mixing services to anonymize their transactions, it gets especially costly, storage-wise.

Bauke Jan DoumaDecember 9, 2013 5:41 PM

T-shirts, Books, Squids.
Pretty soon the movie and the game? (-- reloaded(?))

Nothing much happening on the crypto front, I guess.
Everything's been said, been seen, been recorded.
Been blessed.
We are all Known Items.

Nick PDecember 9, 2013 6:30 PM

This is the kind of great writing that even laypeople might get that we need more of in the security community.

@ Brian M

I told a bunch of people about that. Funny thing is we used to joke back in 2002-2003 that they'd invade the world of warcraft looking for terrorists. Now a leak says they're doing it. Epic fail.

NSA analyst: "We've infiltrated a group that was just discussing 'incinerating everyone in an entire village, maybe the continent.'"
NSA operations head: "We need to do something about this before it's too late. Trace the IP's and pass the addresses to the drone program."

Now, if they intercepted communications in the game networks as part of the surveillance state that might make more sense. They're sucking up every piece of data that might eventually be of interest to them, including social networks. WoW would just be an extension of that.

But infiltrating the game? Whaaaaat!?

WhonuDecember 9, 2013 10:58 PM

@Nick P "But infiltrating the game? Whaaaaat!?"

Intelligence goes beyond passive surveillance of communications.

Interactions with other players can reveal information that might otherwise remain hidden.

Infiltrating games is also done to support recruiting and zersetzung operations.

FoxpupDecember 9, 2013 11:32 PM

@Brian M:

The explanation is interesting, but I would have liked to have seen details on wallet security. From a brief reading, the wallet appears to be a serious weakness.

Wallet security is not in any way part of the protocol, which is why it isn't mentioned, but you're right that it can be a serious weakness. As is so often the case with cryptographic protocols, the weakest link is not the protocol itself, but the way the user manages their private keys.

Hmm, another thing to consider is that since there is a traceable record of Bitcoin transactions from the beginning, will Bitcoin choke on its own history? One fellow wrote in a blog post that when he started, the global transaction history was 2Gb. He decided that keeping the data wasn't worth it when it was over 25Gb. So as Bitcoin becomes ever more popular, that database baggage must grow, and finally command extremely significant resources. But who must, as in obligated, keep feeding this resource?
Strictly speaking, only mining pool operators really require the entire transaction history, and they charge fees (by the kilobyte) to add transactions to it, so the cost of storage (and bandwidth, which is a far greater cost) is not a problem. Financial institutions wishing to deal in Bitcoin such as banks and payment processors may want to store the transaction history as this protects against certain attacks, but they will have to weigh the cost of storage against the extra security it provides, or pass the cost on to their customers. Ordinary users do not need to store the entire transaction history and are encouraged to use light clients such as MultBit.

DanielDecember 10, 2013 1:11 AM

Brain M.

"Fiat currency" is a term with more heat than light. Fiat is best understood as an expression of state power whereas in economics something is money based upon what people do with it. This is to say the metric is behavioral. If I give you a dollar bill and you give me a good in return then the dollar bill has served as a medium of exchange. If you take that dollar bill and two weeks later give it to a third party and they give you a good in return then the dollar bill has served as a store of value. Thus, the dollar bill is money because it serves as both a medium of exchange and a store of value. This is true regardless of whether the dollar bill is a fiat currency or not.

A good example of this later case is the use of the dollar bill in third world countries. There the dollar bill is money but it is not a fiat currency because the dollar bill has no legal meaning in say Turkey. So it is wrong to think of "fiat money" as being valuable simply because people think its valuable. Money is valuable either because of the function it serves or because it is backed by some external force.

Ping-Che ChenDecember 10, 2013 2:08 AM

I think Bitcoin is more similar to a commodity (e.g. gold) than a currency.

On the subject of government control, I think it's very difficult for governments to ban Bitcoin outright (Thailand does that, but I doubt it has any effect). What the government can do is to restrict certain bodies from dealing with Bitcoin. For example, China recently ban its banks from dealing with Bitcoin. This reduces confidence and avoid the possibility of banks investing in Bitcoin, pumping its value.

gurraDecember 10, 2013 4:04 AM

Daniel, bitcoin is the first of it's kind (in some sense). That's what makes it so interesting.

It already is a "remarkable historical fact". If it got any widespread use - that would literally be revolutionary.

TomDecember 10, 2013 4:16 AM

An important questions stays unanswered: Who controls the Bitcoin protocol?

From what I understand, there can be several protocol versions. Could the protocol be changed (and if so, by whom?)?

Could "they", for example, simply increade the total amount of bitcoins 5 orders of magnitude? Or in/decrease the difficulty of the proof-of-work problem by some arbitrary factor?

65535December 10, 2013 6:05 AM

@ Ben

I agree. The AML problem is big. US Lawmakers could regulate or even ban Bitcoin like the Chinese. Once the bitcoins are gone - they are gone.

@ Brian M.

$1200 down to $600 is a big move. More like commodity speculation dump and panic. I wonder if those Chinese bitcoins were vaporized.

Also, the guy with big 25 gig blockchain file (it seems larger than projected). That is not a good trait for future data blockchains.

And, I don’t like 60 minutes to verify a transaction (mention in the comments).

Back to the “mixers,” “banks” and "money launderers" dicussion (which seem to defeat the transaction logs or trails).

[Comments on DDI blog]

richnormand

“Makes me wonder about the news at various times about a major “theft” of bitcoins, mostly in exchanges. In order to benefit they would have to be converted or be re-introduced later on. Some of these were for large amounts and not really easy to hide, unless you just “sit” on them?”

[and]

Terikan

“Bitcoin has fascinated me...

“Maybe you can help me out with one part of this I don’t quite get. The signature. How does the block chain know that the address sending the coins is correct? The sender sends their sig to go with it, I assume paired up with the hash of the address allows the various nodes to validate right? But if you are sending your sig out then can’t any node have access to that private info. They would need to in order to validate. So can a sig only be used once, and if so how is it generated and what prevents it from being faked?”

[answer – or - qualified answer]

Michael Nielsen (blog author)

“I’ve wondered the same thing. Some observations: if you copy someone’s private key, and then erase their copy, there is no way for them to prove that it was ever truly their key. And if two people both have a copy of the private key, how do you determine who “truly” owns it?

“The situation is complicated further by the possibility of laundering. If you quickly spend some stolen bitcoins on, then it becomes very different to later recover those bitcoins, since now they may be in possession of honest parties.”

[85 % down page]

http://www.michaelnielsen.org/ddi/how-the-bitcoin-protocol-actually-works/

It seems to me that Bitcoin needs validating.

paulDecember 10, 2013 9:15 AM

The whole point of a store of value -- something used for denominating transactions -- is that it's not supposed to have value in itself. Because when it does you get market distortions introduced by the conflict between people who are using the thing to conduct transactions and people who are using the thing as an investment vehicle. If I don't know what my bitcoins are going to be worth when I try to convert them to "real" money, then I'm foolish to try and do transactions in them. Unless I do enough bitcoin-only transactions in both directions, so that I effectively come out even. (This is true for other currencies, but the volatility is typically not nearly so huge.)

This also tells us when bitcoin will be a "real" currency: when people no longer adjust bitcoin-denominated prices to allow for fluctuations in the "real-money" value of bitcoins. Of course, that turnover point will shortly be followed by a complete market meltdown as arbitragers recognize the huge profits to be made by buying items in dollars and selling them in bitcoins or vice versa.

MelDecember 10, 2013 10:10 AM

The fluctuations in value make Bitcoin just as "real money" as the Icelandic krone was back when the FX raiders were playing. It's hardly a problem with Bitcoin. It's a problem with some of the games we play with money.

Natanael LDecember 10, 2013 10:58 AM

@Tom: It is a consensus protocol. That means that everybody controls it together, the power of the developers is limited by the community who can reject changes they do not like.

FroggyDecember 10, 2013 12:49 PM

A very interesting & easily followed account of the Bitcoin concept and protocol indeed.

Not that I have ever wanted to get involved in Btc myself - I may've been mistaken, but it always felt a bit of a scandal to waste computing resources and power for a useless, at best selfish, purpose.

Anyhoo the goal of this post was to report that, coincidentally or maybe not so coincidentally, the French guvment issued a warning against the inherent risk of bitcoin, just a couple days ago.

TomDecember 10, 2013 1:00 PM

@Natanael: Then for example a decrease of the total number of bitcoins, say by 50%, would double the currently available bitcoins' value and might thus get accepted easily by the community?

AnuraDecember 10, 2013 1:57 PM

@Tom - that wouldn't work, even with the US dollar, halving the supply wouldn't double the value since velocity would go up and economic activity would go down. With Bitcoin, the value is pure speculation, and halving the number basically means intentionally deleting transactions from the transaction log, which means losing all confidence and making it worthless.

TomDecember 11, 2013 1:51 AM

@Anura: Of course one wouldn't delete past transactions, but simply modify the protocol to give less reward for finding a solution, e.g. 5 BTC instead of 25 BTC as of now. But you're right, confidence would still be lost. Which means nobody inside the system should have an incentive to substantially alter the protocol. Which means the total number of bitcoins will by 30-something million as projected. Which means the bullish market might well keep being bullish for quite some time.

RobertDecember 16, 2013 10:15 AM

Bitcoin is losing its credibility in the market as the investors are blocking its trade. bit.ly/BitcoinLost

quarksympathizerJanuary 23, 2014 2:22 PM

The NSA aren't stupid re: videogames, they are just too soon.

Think ahead to 10, 20 years from now. The web will be a shadow of its former popularity and new protocols will rule the net.

Leave a comment

Allowed HTML: <a href="URL"> • <em> <cite> <i> • <strong> <b> • <sub> <sup> • <ul> <ol> <li> • <blockquote> <pre>

Photo of Bruce Schneier by Per Ervland.

Schneier on Security is a personal website. Opinions expressed are not necessarily those of Co3 Systems, Inc..