Sorry for the interruption

21 Apr

Saturday 4/20/5

The nice weather has completely sidetracked my plans for posting articles on this blog.  However, I have had a long article on the mechanics of Bitcoin prepared for some time.  I will post it now  and then try to finish the other two two threads I’ve already started.

Chapter One – A Brief Introduction to the Future of Money

 On November 1, 2008, the following message was posted on an internet mailing list devoted to the topic of cryptography;

“I’ve been working on a new electronic cash system that’s fully peer-to-peer, with no trusted third party.

The paper is available at:

http://www.bitcoin.org/bitcoin.pdf

 The main properties:

– Double-spending is prevented with a peer-to-peer network.

– No mint or other trusted parties.

– Participants can be anonymous.

– New coins are made from Hashcash style proof-of- work.

– The proof-of-work for new coin generation also powers the network to prevent double-spending.”

 The message continues with an abstract of the paper, titled Bitcoin: A Peer-to-Peer Electronic Cash System, and is signed, “Satoshi Nakamoto”.

 Over the next year and a half, Satoshi Nakamoto largely implemented the protocol for the “electronic cash system” proposed in his paper, making his work freely available to the open-source software community. Contacts among the members of this community typically take place electronically, and this was entirely the case with Nakamoto. No one knows the actual identity of the person or group using this name, and it is widely assumed to be a pseudonym.

Other members of the community took on an increasing role in the development and refinement of the software. The first functional Bitcoin network began operating in 2009. In 2010, messages from Satoshi Nakamoto began to grow less frequent, and he (or she, or they) finally vanished completely from the message boards by the last half of the year. But the work that Nakamoto started has taken on a life of its own. His “Peer-to-Peer Electronic Cash System” has grown into a network of thousands of highly specialized nodes which enable more than 160,000 cash transactions daily.

 But what exactly are Bitcoins, and why should anyone care about them? Simply stated, Bitcoin is an entirely new form of money. It is not the intent of this work to delve too deeply into the technical details behind Bitcoin. For interested readers of a technical bent, copious documentation right down to the open-source code implementing this technology is available on the internet. A good starting point is bitcoin.org. What follows is a very high level introduction, provided in the hope that readers at all levels of technical proficiency will be able to appreciate the basic Bitcoin concept.

Bitcoin was created as a form of currency, meaning that Bitcoins (abbreviated as BTC) can be spent by a buyer to purchase a good from a seller. In this sense, BTC are exactly the same as gold or silver coins, or paper dollars. BTC differ from these earlier forms of currency in the fact that they only exist digitally, as electronic records in cyberspace. (In the remainder of this monograph, I will use “Bitcoin” to refer to the Bitcoin software and the network of processors and communications links that runs the software and enables the Bitcoin currency. I will use BTC to refer to the unit of currency. I will also use the term “Satoshi” to refer to the smallest unit of the BTC currency. 1 BTC = 100,000,000 Satoshi.)

Of course, there are already many electronic payment systems in existence, which record and track transactions denominated in an existing currency. For example, whenever I purchase a song from iTunes, some third party, a credit card company like Visa or a payment processor like PayPal, debits an account in my name, and credits the iTunes account in whatever bank iTunes uses. If I use a Visa account, I will have a debt, which I may pay in part or in full when my monthly bill comes due, by authorizing the transfer of dollars from my bank account. If I want to use Paypal, or a debit card account, I must make that transfer before I buy the song on iTunes. In any case, the transaction involves the transfer of some amount of USD (dollars) between bank accounts. The transfers occur digitally, in cyberspace, and result in records of amounts deposited in or owed to various banks. These records are kept by each bank involved in the transaction. So if BTC are simply electronic records, what makes them fundamentally different from these established payment systems?

 First, records of Bitcoin transactions do not refer to any other currency. If I want to buy something from a merchant with BTC, I will pay the BTC, not the USD, price. In other words, Bitcoin is not a system for maintaining records of purchases denominated in any existing currency. Instead, it is a system for enabling transactions in a new currency. Bitcoin stands as an independent currency, on a level playing field with the dollar, euro, yen, or even gold.

Secondly, and most importantly, Bitcoin does not depend on banks. Much of the remainder of this monograph will be devoted to explaining why banks were (until now) a necessary evil. Bitcoin is designed in such a way that anyone who owns a at least a smartphone may become a keeper of the complete record of all BTC transactions. Right now, the entire history of BTC transactions exists on thousands of computers across the globe. If all but one of these were to be destroyed tomorrow, Bitcoin, and all BTC balances, would survive.

So, as to how Bitcoin works – As mentioned, Bitcoin is a distributed network of independent computers, connected by the internet and each running special software. There are two types of software on the network, the Bitcoin client and the Bitcoin miner. Most users of Bitcoin will only ever interact with a client, so let’s look at it first. Anyone can download a Bitcoin client from the internet for free, and install it on their laptop or mobile device. The software lets the user create a Bitcoin wallet, which can be locked (encrypted) with a password. The user can create Bitcoin addresses within the wallet. These addresses can be thought of as account numbers, and once an address has been created, the wallet owner can begin accepting deposits in the account. The wallet owner can create as many addresses he wants. This is useful, for example, if he wants to keep track of where deposits came from, by sending a different address to each person who he expects to send him BTC.

 You can use the client to send an email request for payment, with the amount requested and the address to send it to. If you have BTC in your wallet, you can send any fractional amount down to 1 Satoshi to another address. In a face-to-face transaction, a mobile device app can display the address of the receiving party as a QR code. The sending party scans the code with his mobile device, enters the number of BTC, and sends.

There are multiple versions of the client software available. Some store your wallet, as well as the entire Bitcoin blockchain (more on this in a moment), on your own computer. There are also web -based services that create your wallet in the cloud. In the coming months and years, users will undoubtedly encounter numerous other client interfaces for sending and receiving Bitcoin payments, as more and more merchants begin to accept payments in this new currency.

The second type of software is the Bitcoin miner. This software provides the core functionality of the network. Just like the client, the source code for the miner software is open source, and can be downloaded by anyone from the internet. The miner software maintains the database of Bitcoin transactions, and validates new transactions. Whenever a user sends BTC from his wallet to an address in another wallet, the message is sent across the Bitcoin peer-to-peer network of miners.

Each miner maintains a ledger of valid transactions, which are collected into blocks, which are linked in a chain. The chain begins with the block containing the first valid transaction, a transfer of 50 BTC (5,000,000,000 Satoshi) to the address of an undisclosed early adopter of Bitcoin. There is no address of origin, in other words, 50 new BTC simply became available that were previously unavailable thanks to the unassailable mathematical logic of thoroughly peer-reviewed and tested open-source (i.e. freely transparent to the technically literate) software code.

Each time a new block is added to the chain, another BTC deposit comes into existence, and is unfailingly added to an automated ledger with strict business rules, instantaneously backed-up to thousands of network peers, to the account of the owner of the cybernetic machine that performed the computational load of encrypting the new block. Much of the computational load is necessary for the successful maintenance of the integrity of the ledger against falsification, through virtually unbreakable cryptography.

Each miner competes in a lottery for the right to add each new block, where the drawing is the random numeric output of each peer’s execution of the encryption algorithm that seals the block and links it into the chain, and the prize is 50 BTC, awarded every ten minutes for four years, then 25 BTC every ten minutes for four years, and then 12.5 BTC…

Every other peer on the network can instantly verify the authenticity of each block, or of any other block in the chain, right down to the anchor block, by verifying that its public key decrypts a ledger of transactions identical to the relevant section of transactions in the full ledger maintained by each independent miner. This also implies that any node may freely join or leave the network at any time. If newly joined, the node will receive the entire valid block chain in a matter of hours, verified at each step by at least eight other independent/co-dependent nodes. Or the node may elect to download a validated archived copy of a recent state of the block chain from a trusted source, taking only minutes or even seconds to reconstruct a local copy of the block chain up to the present instant. At that moment it is woven into the network, monitoring the transactional traffic stream in real time, sending its own messages into the stream, messages that will instantaneously and reliably and with only a tiny amount of entropic leakage, balance and coordinate the wants and offerings of the node’s human owner with the production and distribution of goods by hundreds of thousands of capital owners, supervisors, and laborers. And this will be done in such a way that each of these people receives exactly the greatest amount of satisfaction in life that they are capable of attaining by their effort, thought, good will, and honesty.

For that is exactly what money does.

Unfortunately, there is something else that money must do. In addition to facilitating the production of goods and services, in short, of satisfactions, money must enable the building of safeguards and the execution of restraints against those who by their brutality, cunning, evil intent and soulless condition, seek to possess that which they have not produced, nor honestly traded for, nor were freely given out of love, or even out of pity.

The resources and human effort required to build and man these safeguards and constraints must be paid for with money. One of the advantages of a digital currency is that safeguards can be embedded in the design of the enabling software system, so that the resources and human effort required for ongoing protection are minimal. A digital cryptographic currency achieves these safeguards with crytography, a computationally expensive technology. The most computationally efficient implementation of a digital cryptographic currency would simply put the fastest machine available on the job, adjusting the rate of production by command and control. One of the most brilliant design aspects of Bitcoin is the metering of the production rate coupled to a software feedback loop which controls the difficulty of successfully encrypting and publishing a block. The control mechanism is the adjustment upward or downward of a threshold number. The first peer to perform the encryption using a private key which produces an output value below the threshold number is authorized to publish the new block. The output value cannot be predicted from the private key in advance, and thus the output values generated are random, and each execution of the encryption algorithm stands an equal chance of producing a value below the difficulty threshold.

Without this difficulty control, on any kind of distributed network where nodes compete to complete a task and be compensated with rewards, the probability of the fastest node receiving all of the rewards is .99999999… Thus, little incentive exists to design such a network at all, rather to design for a Fast Central Server, with communications only sufficient to receive customer orders, and to transmit data backups to a few secure distributed vaults.

Until now, the model of central command and control of the production of money, and the interposition of banks and regulators between traders, is the only model that has really been tried outside of the small villages and towns of the pre-industrial world. It is the model of the bank, and in its mid-twentieth to early twenty-first century incarnation, the model of the credit card and of PayPal. If the minions of the state, against all likelihood, had been first to perceive the potential value of a new digital, cryptographic, global currency, this is the pattern they would have tried to build to. Even if they could conceive of the brilliant design concept embodied in Bitcoin’s difficulty controller, they would not dare to implement it, knowing full well it could destroy the illegitimate basis of their power.

With the difficulty control in place, even the fastest computer on the network will only be successful in the lottery to the extent that its processing power has contributed to the overall activity of the network. Every node, no matter how slow, has a calculable chance of being the winner in each new lottery. Much of the activity is ultimately useless in the production of BTC and maintenance of the integrity of the financial ledger of BTC transactions, but is incredibly valuable in providing the perfect incentive structure for the growth and protection of a self-organizing network. Thus, if the network can be freely joined, and if anyone with a computer and an internet connection can freely download both the executable and source code, and in fact even the record of all modifications and configuration changes ever made to the code, then some people will be incentivized to participate in the network by the prospect of receipt of 5 billion Satoshi even if no one else in the world can perceive the potential real value of that ledger entry, or of the ledger itself which actually encompasses the globe with a virtual omnipresence of utterly reliable and honest financial transaction data, guarded by exhaustively proven mathematical locks and keys and regulated by its unalterable control logic.

Admittedly, only technically competent individuals with their own ideas, interests, and pursuits in the somewhat arcane field of digital cryptography and the even more arcane field of anarcho-capitalist monetary theory, were likely to, and in fact did, see the hidden value of this new technology in its infancy, and to understand that it possesses the potential to render banking and the state obsolete relics of a past barbarous age, while preserving and even greatly enhancing the ability of free people to trade freely and honestly with one another, and so secure prosperity for the deserving, generous charitable provision for the unfortunate, adequate consideration for the undeserving, and just restitution from the justly proven transgressor. These individuals, starting with Satoshi Nakamoto, brought the Bitcoin network into existence and made its benefits freely available to the world. In return, some of them now likely own thousands or even hundreds of thousands, of BTC. For this, these people have been criticized as the authors of some sort of fraudulent scam, by critics envious of their success and too unimaginative or lazy to understand how it has been achieved. Since they have clearly profited by their actions, the builders and early adopters of Bitcoin have been decried as charlatans and hucksters, simply because they have, through their own foresight and reason, brought into the world an invention of incalculable value, making it freely available to the entire world, and then honestly competing with anyone else willing to invest capital in the production of the goods their invention enables. Their share of the harvest they have stored until it could be exchanged at a freely bargained price acceptable to themselves and to their willing customers. Yet they are accused of dishonesty for the creation of a wonder which anyone who wishes to examine can clearly see was designed to make dishonesty impossible within the limits of its workings.

If you encounter these criticisms, I hope you will take them for what they are.

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