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Bitcoin is a crypto that is believed to have been invented by Satoshi Nakamoto. The Bitcoin Whitepaper that was published on this day, 13 years back (31 October 2008), contains the idea, working, and design of the Bitcoin electronic cash system. This article will summarize and simplify the contents of the Whitepaper. The contents of this Whitepaper have been divided into 12 sections, namely:
- Timestamp Server
- Reclaiming Disk Space
- Simplified Payment Verification
- Combining and Splitting Value
Diving into each of these sections individually would get a little too technical and so let us try to understand the working by focusing on the following questions based on the Whitepaper:
Need for Bitcoin
Bitcoin was created out of a need to make digital payments on a peer-to-peer basis without the presence of a regulator to facilitate the transaction. This would be an easy job if the payer and payee were trusted parties. The banks and the government act as the trusted parties for all legally recognized modes of digital payments at present.
What is Bitcoin?
The term ‘blockchain’ is used wherever a person attempts to explain bitcoin. The ‘chain’ here is a chain of electronic signatures that make up a single unit of the electronic coin – Bitcoin.
How does a Bitcoin transaction take place?
In a typical transaction, the payer transfers the coin to the payee. The payer attaches his digital signature to the ‘hash’ of the transaction, and the payee attaches his public signature to this at the end of the coin. Any transaction can be verified by verifying the chain of signatures attached to the coin. It is similar to the physical transmission of bills of exchange – by signing the name of the next owner at the back of the bill.
How are the Bitcoin transactions verified?
A party to the blockchain will verify the transaction using CPU power – the CPU will be used to compute whether a transaction, when hashed, returns a value that begins with the required number of ‘zero bits’. The hash will need to have the required number of ‘zero bits’ if it has to pose as a Bitcoin transaction. Such verification is called ‘proof-of-work’. This cryptographic proof-of-work acts as a substitute for a trusted party in the digital transaction.
How are the transactions ‘tamper-proof’?
The peer-to-peer distributed ledger ensures that everyone has a record of all the transactions that occur. All the nodes in the network can connect and disconnect at any time as they please. However, amongst all the ‘chains’ in the network, the longest chain of transactions which has the greatest proof-of-work invested in it will be deemed authentic. This means that if the majority of CPUs have carried out the proof-of-work on a chain of transactions, it will be considered as the authentic transaction. The proof-of-work is similar to votes in a democracy where one CPU is one vote. So, in theory, as long as a majority of the ‘honest nodes’ control a majority of the CPU power, the blockchain cannot be tampered with. Even if an attacking node were to try to tamper with a block or transaction, it would involve resolving the target block and also resolving all the blocks that were added after the target block, which is computationally infeasible. The chain of transactions creates a Merkle-tree-like structure with each block having its own header, the hash of the previous transaction, and the corresponding nonce. A shortcut way for the user to verify this transaction would be to verify whether the Merkle branch that his transaction belongs to has been accepted into the network at any point in time. While this could work under most scenarios, it can still be tampered with. Hence the Whitepaper also recommends that where businesses are largely making and accepting payments in Bitcoin, it is better to have a network node running through which they can download the whole chain and be completely sure that the transaction is genuine.
How is the chronological order of transactions maintained?
The proof-of-work, as explained above, is implemented by implementing what is called a ‘nonce’. Once the block is verified, a nonce is added to it until it gives the required number of ‘zero bits’, and it is only after this that the next block can be chained to it. This ensures that ‘double-spending’ does not happen, i.e., making payments at 2 or more points with the same currency (paying more than what you actually hold). One can imagine it to be similar to making a payment with the same ₹100 currency note twice. Of course, this is impossible in the physical world, but it is quite possible in the virtual world if it weren’t for a proof-of-work system.
How does the block start?
There is no central regulatory authority to distribute the currency and bring it into circulation. The first block will then have to be a special transaction that brings the block into existence. This transaction is called ‘mining’. The incentive for mining is that the amount of electricity, CPU, and other resources spent in ‘mining’ the block will be lesser than the value gained in the output transaction when the coin is transferred. The difference between output value and resources spent in mining the coin will be the incentive for the miner. Another incentive could be in the form of transaction fees, where the incentive is added to the block containing the transaction.
What if a person has gathered enough CPU power than all the ‘honest’ nodes?
While he will theoretically be in a position to manipulate the transactions, he will be faced with two choices:
- Use the CPU power to defraud people and steal bitcoins; OR
- Use the CPU power to generate more coins.
The Whitepaper illustrates that it will always be more profitable for such a person to use the CPU power and be an ‘honest’ node rather than an ‘attacker’ node since it has more incentive in it.
Other points to note
The Whitepaper also explains how a shortened ‘chain’ can be stored, how the value of the coin can be split or combined, how the information contained in a chain can be trimmed to use less memory space and some recommendations regarding maintaining privacy while making such transactions. It also provides calculations to prove that the probability of an ‘attacker’ node catching up with an ‘honest’ node to manipulate transactions is exponentially low. It is emphasized that the simplicity of the network is what makes it such a robust system of payments.Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.