Bitcoin is a decentralized virtual cryptocurrency, launched in 2009 by an unidentified person known as Satoshi Nakamoto. It does not rely on any central services for managing the creation or flow of money. It relies on cryptographic algorithms in order to prevent abuse of the system. It is abbreviated as BTC and is powered by a peer-to-peer network in the public domain both in terms of issuing and valuation.
Until Bitcoin €™s invention, online transactions always required a trusted third-party intermediary. For example, if a person A wanted to send $10 to B over the Internet, he would have had to depend on a third-party service like Paypal. Intermediaries like Paypal keep a ledger of balance of account holders. When A sends $10 to B, Paypal deducts this amount from A €™s account and credits it to B €™s account. The digital money could be spent more than once without such intermediaries; this problem is known as “Double Spending”.
Bitcoins provide a solution to the double spending problem without involving any trusted third-party intermediary. It does this by distributing the transaction information among all the users on the network. Every transaction in a bitcoin economy is contained in a block which also contains the information about the previous block, forming a block chain. This block chain is available over the bitcoin network for users to verify that whether the bitcoin being transacted has been previously spent or not. The thousands of users present over the network act as the intermediary.
Terms related to Bitcoin
- Bitcoin — Bitcoin is the name of the project started by Satoshi Nakamoto to create the world €™s first decentralized crypto-currency. A Bitcoin is the name of a single unit of the Bitcoin currency, abbreviated as BTC.
- Address — An address is a key pair, including public and private key, used by user to access their bitcoins.
- Transaction — A Transaction is a single operation of moving Bitcoins from one set of one or more Addresses to another set of one or more Addresses. A Transaction is similar to a bank transfer.
- Block — A Block is a package of information containing most notably all Transactions created since the previous Block, as well as reference to that preceding Block.
- Block Chain — A Block Chain is a collection of linked Blocks from the most current one to the Genesis Block.
- Network — The Bitcoin Network is a collective name for all applications connected together that exchange information about Bitcoin Blocks, Transactions and connected Clients.
- Wallet — A Wallet is a set of Addresses created by the Client and saved locally in a file.
- Miner — A Miner is a computer machine and accompanying application dedicated to creating new Blocks.
Each user of Bitcoin owns a set of private and public key that are analogous to a bank account. In order to send someone else money, the user creates a Transaction and signs it with their private key. Each Transaction claims a reference to a previous Transaction that credited the user, meaning that Bitcoins can’t be created out of nothing. Moreover, the same Coins can’t be spent twice. Each Transaction is broadcasted through the Bitcoin Network in order to become valid and spendable.
Every 10 minutes, all Transactions are gathered together in a Bitcoin Block, which is like a ledger. Once a Transaction is a part of a Block, it is considered safe to spent, as Blocks are hard to forge. All the Blocks are linked together to form a Block Chain. The Block Chain is a record of all Transactions that ever took place and is a definite authority over how much money users have associated to their public keys. The Block Chain is secured using cryptographic algorithms, making it impossible to alter any part of it.
Bitcoin is a peer to peer network and there is no central authority like bank to control the creation of currency units or verifying the transactions, it totally depends on users present on the network, who provide their computation power to in order to verify the transactions occurring over the network. These users are termed as “miners” because they are rewarded for their work with newly created bitcoins. Bitcoins are “mined” or created by solving complex math problem i.e. decoding the hash present in the block of a block chain for new transactions. When a user successfully decodes a hash he obtains a bounty of bitcoins and also a transaction fee if the block was used in order to certify a transaction. As the bitcoins are mined around the world the size of the bounty reduces and the complexity of the code increases, making it more difficult to mine. Thus together these two effects reduce the rate of production of bitcoins just like gold, the more it is mined more difficult it gets to mine more. The bitcoin mining design mimics the extraction of gold or other precious metals from earth. The bitcoin mining process will not last forever. It is projected that the miners will mine the last “satoshi” (0.00000001 of a bitcoin) by 2140. As the complexity of the code increases with the mining of new bitcoins, it will be quite a challenging task to mine the last satoshi. When all the bitcoins will be mined the users will get the incentive for verifying transactions, which will keep the network running after the last bitcoin is mined.
Views on Bitcoin
Bitcoins are a very new concept that uses concepts familiar to some people in a new way, thus creating misconceptions quite easily. Different group of people have different views on Bitcoin, as per their area of expertise and interests.
- The IT/cryptography experts: Bitcoin has generally been very well received with the programmers and cryptography experts, the main reasons being its security, pseudonymity and innovative solution to most problems, but at the same time pointing out its problems that it does not provide fully anonymous transactions and might not scale in future. By far now, bitcoins don €™t have any concerning vulnerabilities.
- The legal experts: Bitcoins to this date operate in a legal grey area – there have been no legal actions taken against any Bitcoin-related endeavor that reached any final conclusion, nor have there been any legislation that addresses any Bitcoin-like currencies. The main problem with determining the legal status of how Bitcoins should be handled is whether they are a currency, security, commodity, or something completely different. While Bitcoins are commonly referred to as a “currency” as they have many common characteristics of one, the legal definition requires a currency to be issued, used and accepted by a country, which is not the case with Bitcoin. Another problem with bitcoins is that not all the countries have legalized its use. For consumers some countries like Australia, Canada, Finland and Germany have legalized its use and have made it clear to apply normal earned income rules on Bitcoin, while many countries have yet not made a clear statement with the legalization and use of Bitcoin. The non-uniformity in the legalization of Bitcoin in different countries is a major issue.
- The economics experts: There have been surprisingly few noteworthy mentions of Bitcoins in economics circles. Professor Krugman, one of the world’s leading economists, wrote an article on Bitcoin, generally dismissing it as being just another type electronic payment system and resembling a gold standard – promoting money-hoarding, deflation and depression. Other economists similarly compare Bitcoin to a gold standard, and generally point out its flaws in comparison to traditional money – lack of a system that allows borrowing and lending, being hard to exchange and spend, and its built-in deflatory mechanics. There are also a few economists that believe a rise of currencies that are not owned by governments can be a good thing. Such currencies in the past have not experienced rampart inflation. All in all, Bitcoins don’t appear to be on the scope of too many economists as anything more than a curiosity or a means of investment.
- The common users: There have been many misconceptions among laymen about many aspects regarding Bitcoin. Even security experts claim that “the first five times you think you understand [Bitcoin], you don’t”, which can only be truer for non-tech-savvy users. Bitcoin is sometimes dismissed as bringing no new innovation to online payment systems. They are viewed as worthless because they are not backed by anything, or even being illegal because they are not a legal tender. Bitcoin is also compared to Liberty Dollars (a privately minted silver coin that was issued to be used alongside US Dollar, later ruled to be illegal) and called terrorism, as they might undermine the legal currency of the country. Most often, however, Bitcoin is a misunderstood concept, mistaken to be similar to such online payment processors like PayPal. All in all, Bitcoins aren’t popular enough to be understood by most Internet users, but more often than not with little research their perception of the project ends up pretty close to how it actually works.
Bitcoin Network Security
Despite the benefits that Bitcoin presents there are concerns whether hacking could compromise the bitcoin economy. One very large flaw in the design of Bitcoin is the probability of occurrence of 51% attack. In the further section we describe the 51% attack and propose a solution to defend against it.
The security of a block chain in bitcoin depends upon the total processing power of all the users present on the network. The 51% attack assumes that at a given time if a malicious miner contributed the majority i.e. more than 50% of the networks mining hash rate, then he would have a full control over the network and would be able to manipulate the block chain.
A 51% attack is theoretically possible as the network is free and open, so if someone was to have enough computational power they can get control over the network, as there is no bitcoin authority to stop them. But in order to get such computational power the attacker would have to invest a huge amount of money in the hardware for computing, which makes this attack less feasible. There are only a couple of things that an attacker can do with 51% attack. They can prevent any transaction of their choice from gaining any confirmation and thus making them invalid. They can reverse their transactions during the time they are in control of the network i.e. they can double spend bitcoins and prevent other miners from finding any block for a short period of time while in control of the network.
The attacker though cannot double spend the coins created before, create new coins or steal coins from other user €™s wallets. They can cause some serious mayhem for a very short period of time but cannot completely cripple the network with 51% attack.
With the rise of mining pools i.e. groups of people mining together as a single unit a 51% attack is possible, however the potential damage one can cause is very small, but enough to create panic among the users which would put the use of bitcoin as an online currency in jeopardy. With the current difficulty levels of block hash not even large-scale enterprises or governments can easily create a 51% attack. Though being physically possible a 51% attack is not feasible, as the amount of hardware required for controlling more than half of the network €™s mining hash rate can only be acquired with an investment of a huge sum.
Defending a 51% Attack
In an unlikely event of 51% attack the user can defend against it by ignoring a longer chain (i.e. the new chain created by the malicious attacker) which does not include the current best chain, if the sum of the priorities of all the transactions included in the new chain is less than the sum of the priorities of all the transactions which are a part of the current best chain and are not included in the new chain. This means that if the total priority of all the transactions present in the current best chain which is present on the network is greater than the total priority of all the transactions present in the new chain, then the new chain is easily identifiable as a malicious chain.
In order to avoid this method of identification of a malicious chain, the 51% attacker would need lots of computational power (which would require a huge amount of money) as well as lots of old, high priority bitcoins to avoid a transaction-denial-service attack. The high priority bitcoins are required to increase the priority of the transactions present in the new longer chain. Since, the attacker would run out of old, high priority bitcoins pretty quickly, thus will be forced to include the transactions of other users present on the network or have their chain rejected.
The bitcoin code has a concept of “bitcoin priority” which prevents transaction spams i.e. sending numerous numbers of tiny transactions to oneself, so as to keep everyone else on the network busy with the work of verifying and storing them. Extending this concept of “bitcoin priority” we can support this method of chain-fork-selection.