White Paper Friday Episode 1: Bitcoin

Overview

Bitcoin is a peer-to-peer electronic payment system that improves on the current system by preventing the double spending attack via digital signatures and a peer-to-peer network. Using a chain of transactions and a hash-based proof of work system, Bitcoin is the electronic cash system of the future.

Problems with the current transaction system:

• Reliant on financial institutions as trusted third parties
• Cost of mediation increases transaction costs limiting the minimum practical transaction size and cutting off the possibility for small, casual transactions

Solution: Bitcoin, an electronic payment system base on cryptographic proof instead of trust.

How Bitcoin Works

Transactions: electronic coins (defined as a chain of digital signatures) are transferred between people via the digital signing of hashes of the previous transaction and the owner's public key. These transactions are instantly verifiable. To prevent double-spend transactions, the system keeps track of all transactions and always counts the earliest transaction.

Timestamp Server: in order to keep track of the "earliest transaction," the server timestamps blocks of items as they are received.

Proof of Work: basically, nodes randomly try to solve a puzzle -- just like when you randomly select lottery numbers to win the lottery. The more computational power to solve the puzzle, the better chance of winning and thus "proof-of-work is essentially one-CPU-one-vote." The winner of the puzzle gets to append the blockchain (a process described BELOW). To attack the system, an attacker would need to redo all the previous work, making attacks on the system generally unfeasible.

Network:
a) Transactions broadcasted to all nodes in the network
b) Each nodes collects received transactions into a block
c) Each node tries to solve proof-of-work puzzle
d) Winning node broadcasts its block to the network
e) Nodes in network accept the block if all transactions are valid
f) Nodes move on to the next block (begin solving the next proof-of-work) puzzle

Incentive: nodes that win the proof-of-work lottery create a special (coinbase) transaction to themselves (currently 12.5 BTC) and also receive mining fee's from each transaction in the mined block.

Reclaiming Disk Space: transactions are stored in Merkle Trees to save space since once a "coin is buried under enough blocks, the spent transactions before it can be discarded to save disk space."

Simplified Payment Verification: by keeping "a copy of the block headers of the longest proof-of-work chain" a user can link transactions to their place in the blockchain, verifying that a node has accepted the transaction. Thus, it is possible to confirm transactions without running a full node (full nodes are expensive and hard to run, taking many days to just download the entire blockchain).

Combining and Splitting Value: Transactions contain multiple inputs and outputs allowing value to be split and combined.

Privacy: The public can see all the transactions but can see only the public key addresses of the parties involved. Since these addresses are not linkable to identities, transactions are private. To ensure their identity is not linked to their public key address, it is recommended to use a new key pair for each transaction.

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