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By the end of this article you will understand:
1. The purpose of a whitepaper and its intended audience
2. The technological fundamentals
3. Bitcoin’s fundamental use case
4. How the Bitcoin network creates a structure for making payments without a third party
5. Why the Bitcoin whitepaper has a pseudonymous author
The Bitcoin Whitepaper: Decoded
Bitcoin is a digital payment network that enables the exchange of its own digitally scarce currency without a trusted third party.
Why Bitcoin was created and how its system functions without a central authority is explained in a document called the Bitcoin Whitepaper.
What is a whitepaper?
A white paper summarises a core concept or idea, often proposing a solution to a specific problem.
Before publishing their whitepaper, Satoshi Nakamoto (Bitcoin’s pseudonymous creator) invited discussion of their idea for a new monetary system. They asked for feedback from subscribers to a cryptography mailing list on October 31st, 2008. They then published the whitepaper on the domain.
Bitcoin: What, why and how
The Bitcoin Whitepaper tries to answer the three key questions: what, why and how. The Abstract starts with a good answer to the question of what Bitcoin is.
“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
The introduction section anticipates the obvious question that might follow: why do we need a person-to-person electronic cash system? What’s wrong with what we have now?
Why do we need Bitcoin?
The reasons Satoshi provides for why we need Bitcoin are criticisms of the existing, centralised banking system.
Mediation: Banks spend money resolving disputes, which customers pay in transaction fees.
Transaction limits: Mediation isn’t cost-effective enough for banks to allow micro-payments, which cuts out a potential user base in developing nations.
Reversible payments: Payments can’t be considered final as mediators can reverse them.
Trust: Banks require your personal information; you trust that your bank will protect that information.
Fraud: A trust-based banking system inevitably attracts scammers. Customers suffer the costs of this.
Trust in central authority: Satoshi saw the need to trust authorities to control the money supply as a significant problem to fix.
To get from the problematic centralised banking system to their decentralised vision, Satoshi had to overcome a significant problem that previous attempts at decentralised money had failed to solve: how to ensure funds aren’t spent twice (the double spend problem).
Solving the double spend with a chain of ownership
The Bitcoin network solves double spend by defining a ‘coin’ as a historical chain of ownership. Alice can send bitcoin to Bob by providing a valid signature (private key) of ownership and the public details (address) of the next person in the ownership chain, Bob.
Bitcoin’s signatures are cryptographic to ensure anonymity and security. However, moving coins forward using signatures can only work with a system for verifying they were spent only once, which requires verifiable timestamps.
Timestamping & the blockchain
If Alice, Bob and the larger network maintain a record of transactions, the one piece of information that could settle any dispute over valid entries is an immutable timestamp – immutable means unable to be changed.
Satoshi created a decentralised version of the work of Stuart Haber and Scott Stornetta who in the 1990s used classified ads published in the New York Times as an analogue method for timestamping.
Bitcoin transaction data is grouped together in data blocks, given a timestamp and hashed (run through a cryptographic algorithm to produce an identifier of uniform length). Importantly, the timestamp of the previous chronological block of data is included in the hash to create a chain – now commonly known as a blockchain.
The next challenge Satoshi faced was how to decide which of the Nodes get to add that block of timestamped data, and how to incentivise them to be honest.
Proof-of-work (PoW) & block rewards
For a Node to submit a block of bitcoin transactions, they must prove they’ve done sufficient work to prove their intentions are genuine. If it were too easy, the network would be spammed by fake data.
The solution was to require Nodes to compete in a type of lottery, where the winners get to add a new block to the chain. The lottery is an algorithm that adjusts in difficulty depending on the number of participants to ensure a winner is found roughly every ten minutes.
This process creates the following sequence for continual block generation and coin issuance.
- New transactions are broadcast to all Nodes.
- Each Node collects new transactions into a block.
- Each Node competes to find the PoW for its block.
- When a Node finds a PoW, it broadcasts the block to all Nodes.
- Nodes accept the block only if all transactions are valid and not already spent.
- Nodes express their acceptance of the block by working on creating the next block in the chain.
Use of incentives
As running the algorithm uses electricity, PoW incurs a cost. To ensure Miners participate, the winning Node gets a block reward of newly created bitcoin, plus fees paid by users to send the transactions.
The mining reward is how the Bitcoin network programmatically issues new bitcoin and enforces scarcity, ensuring only 21 million will ever exist.
As each block contains the timestamp of the previous block in a chain, Nodes are discouraged from adding fake transactions (double spends) because they would have to keep winning the lottery to maintain the false data in the chain, and the network only respects the longest chain. These incentives encourage Nodes to be honest.
Merkle trees & disk space
At each step in the explanation of how Bitcoin works as a decentralised monetary system, Satoshi pre-empts challenges. If each data block required significant memory, the whole chain would take up too much disk space for an average PC, stopping the network from being decentralised.
Their solution was merkle trees, an efficient and secure verification system for condensing large data sets into a more manageable form.
Simplifying payment verification
Though the Bitcoin Whitepaper is intended for a technically proficient audience, Satoshi was thinking about the practicalities of end users.
The Bitcoin Network benefits from Nodes downloading full versions of the blockchain, but a small business that wants to offer Bitcoin payments might not be willing to make that commitment. Section eight of the Whitepaper explains how payments can be verified without running a full network node, often described as lightweight or pruned Nodes.
Combining & splitting transactions
Early in the Whitepaper a coin is described as a chain of signatures, but it doesn’t initially explain how coins can be split or combined. Divisibility is one of the key functions of money, so Satoshi addressed this by making transactions the aggregate of Inputs and Outputs.
An Input would usually be a larger previous transaction producing two Outputs: the spendable amount and any change which is returned as a separate transaction.
Put simply, think about how spending £10 from a £20 note splits it into a £10 payment, with a separate return of £10 change.
Privacy – anonymity vs pseudonymity
For Bitcoin to function as a decentralised system, all transactions must be publicly announced, allowing anyone to function as a Node.
Providing personal information within transactions would compromise the privacy of users. To protect personal information, the details you share with someone so they can send you bitcoin is an anonymous string mixing text and numbers.
However, it’s important to distinguish anonymity and pseudonymity. Public bitcoin addresses are pseudonymous because they can be associated with other information to reveal your identity.
This is why the Bitcoin Whitepaper mentions that with each new transaction a user should generate a new public address.
Calculating the chance of Bitcoin being attacked
Satoshi identified one significant threat: anattacker might try to change one of his own transactions to take back money he recently spent.
To double-spend a transaction, a sender must sign it honestly to satisfy the recipient while simultaneously creating another chain, where the transaction is removed. As Nodes always follow the longest chain, the fake chain must catch up to the honest. Satoshi broke down the various scenarios and probabilities of how hard it gets with each additional block, and the virtual impossibility to do so.
Given the successful function of Bitcoin for its entire life, without disruption or any double spend, we can assume Satoshi got his maths right. If you look closely at the Bitcoin logo, you’ll see the words vires in numeris, latin for strength in numbers.
Satoshi Nakamoto never shared their identity, and just over two years after publishing the Bitcoin Whitepaper ceased all communication. By disappearing, Satoshi bequeathed Bitcoin to its users and reinforced its decentralised quality.
The Bitcoin Whitepaper Decoded – A recap
A white paper summarises a core concept or idea, often detailing the solution to a specific problem.
The Bitcoin Whitepaper explains why Bitcoin was created and how its system functions without a central authority.
The Bitcoin Whitepaper includes seven reasons why a decentralised money system is needed:
- Cost of Mediation
- Transaction limits
- Reversible payments
- Trust and personal information
- Inevitability of fraud
- Problems of trust in a central authority Bitcoin succeeded whether other attempts at decentralised money failed by solving the double-spend problem and defining coins as a chain of ownership
- Timestamping of transactions in hashed data blocks that are chained together creates verifiable proof that coins haven’t previously been spent
PoW forces Nodes who add blocks of transactions to expend computing power participating in a pseudo-lottery, the cost of which discourages spam and dishonesty. PoW winners are rewarded with new bitcoin plus transaction fees, which is how new bitcoin are issued toward a maximum cap of 21 million.
Merkle trees minimise disk space requirement ensuring an average PC can run a Node.
Lightweight Nodes simplify the verification process for small businesses.
To ensure practical divisibility, coins can be split and combined using Inputs and Outputs. Bitcoin transactions are pseudonymous rather than anonymous; a crucial difference.