Author: @DanielLHinton

“Aha” Moments

Many people are very quick to jump into “how” Bitcoin works. I believe it’s more important to understand “why” there might be the need for something like Bitcoin to exist in the world before attempting to understand “how” it works.

Without first beginning to grasp “why” Bitcoin was created, you will likely dismiss Bitcoin as a useless trinket (at best) and fail to grasp the sincerely enormous magnitude of what Bitcoin could mean for the world.

Interestingly, you need to understand surprisingly little of “how” the details of Bitcoin work (even though you should attempt to) in order to see “why” something like bitcoin could be beneficial to exist in the world. The goal of this section is to lay out several statements which will help you begin to see why Bitcoin is such a big deal.

Money

Money is Technology

It’s easy to initially take the statement “money is technology” to mean that the technology we use to help us use money (checks, Visa, PayPal, credit cards, banks) is technology. While this is true, it isn’t the meaning of the statement.

Money itself (glass beads, sea shells, Ria stones, gold, dollar, bitcoin) is technology – and if you want your money to be useful (over the short and long term), you’d better hope it’s a good technology.

Money is a technological tool to be used the same way a plate is a tool to be used. There are flimsy single-use paper plates and durable ceramic plates. Ceramic plates are more desirable than paper plates because they are a better technology.

If your money is a better technology than another money, it will prove more useful as a tool in accomplishing your goals.

As Technology Changes, Money Changes

Over the millennia, civilizations have used many things as money (glass beads, sea shells, Ria stones, gold). As access to and understanding of technology increased, civilizations have always adopted more technologically advanced money when it was introduced to, or thrust upon, them.

The two most striking examples of the phenomena where two cultures possess different technological capabilities are the island nation of Yap (Ria Stones) and Western Africa (glass beads).

Yap (Ria Stones) – This culture used large carved limestone wheels as money. The stones were quarried on a nearby island and shipped via sea to Yap where they were displayed prominently at the home of the individual owner. The stones were used as currency and a store of wealth in large transactions because of their inability to be counterfeited and the great effort required in quarrying and transporting additional supply. When outside traders, with advanced quarrying and transportation technology, initiated trade with the island, the traders could purchase goods from the Yap islanders with Ria Stones which were produced with little effort or expense.

Western Africa (glass beads) – This culture used small glass beads as money. Producing the beads was a labor-intensive process with the culture’s technology and the beads were used as a unit of accounting for wealth. When outside traders, with advanced glass-making and foundry skills, initiated trade with Western Africa, the traders could purchase goods from the Africans with glass beads which were produced with little effort or expense.

The effect in both cases was a large increase in the supply of Ria Stones and glass beads in the economy, greatly reducing the value of every stone or bead in existence, and rendering any wealth stored in these “monies” worthless.

Using money that was not the best technology caused both the Yap and Western African cultures serious harm. As the world becomes more connected, what technology will insulate you from trading your valuable time and hard-earned assets for trinkets which were produced with little effort or expense?

[See The Bitcoin Standard, by Saifedean Ammous for an excellent discussion]

Aha Moment: What is “money” will change when technology produces a better money.

The Internet is Going to be Big

As I’m sure you noticed, the internet is a pretty big deal. So big, that we probably don’t (and can’t) grasp all the ways it will impact our lives.

For a simple example, let’s say you are starting a business to sell t-shirts online and you hire:

• an Australian designer for mockups
• an Argentinian developer for the website, and
• a Chinese screen printer

It doesn’t make sense that you would pay all these people in physical US dollars, so you’ll be paying with some sort of digital currency. Each of their home economies operates in separate currencies and the US may not have official “banking” relationships with these countries so how do you get the “dollars” to them?

Because Bitcoin has no concept of nationality, it would be trivially easy to pay each party in the USD value in bitcoin and let them either keep the bitcoin or convert into their home currency.

It’s always hard to predict how the internet will grow or change but I think there is little doubt that there will be more financialization within the internet and ample uses for a native currency on the internet (i.e. Bitcoin).

Aha Moment: People will not use physical dollars to pay for things on the internet and across national borders. Bitcoin provides a way to pay anyone, anywhere in the world without having to ask permission.

 

Fiat Money Becomes Corrupted Over Time

What would happen if the US (or any global) economy fell into a recession? At this point it’s fairly predictable that central banks would lower interest rates (even into negative yields), print trillions of dollars, and try to “inflate” asset prices higher by making it less attractive to save money and more painful to miss out on rising financial asset (homes, stocks, bonds) prices.

Now that we live in a world with quantitative easing, it’s reasonable to assume (after seeing over nine years of results), that governments were fairly pleased with the effects of their efforts. Stocks have never been higher, unemployment has almost never been lower, and home prices in many markets have surpassed previous highs.

So, during the next recession, what will governments do?

My estimation is that they’ll do the same exact thing, but the scale of the bailouts will be 5-10x larger than before. Now that the big banks that were too big to fail 10 years ago are much bigger now, they know they will never be allowed to fail.

Elected politicians like to be reelected, therefore, they will never do anything to jeopardize their likelihood of being reelected. They aren’t to blame for this and it doesn’t make them bad people. They are just human and it’s natural to not preemptively put yourself out of a great job. We shouldn’t expect politicians to do things that we would not really expect ourselves to do, but we should not let ourselves be [forever and powerlessly] subject to the repercussions of such actions.

The bad news is that even if there is never another recession, due to defined benefit obligations it is mathematically impossible for the government to ever operate on a balanced budget again.

Aha moment: Governments will try to print their way into prosperity (and it won’t work).

Government Spending/Entitlements/National Debt

Steady-State Spending

The US economy is supposedly in the best shape it’s ever been: 93 months of positive job growth, exploding stock market and housing prices and consumer confidence at an all-time high.

So how do we explain a current $750,000,000,000 federal annual budget deficit? If we cannot produce a budget surplus in this “great” economy, how will we ever?

Entitlements

The average individual Social Security benefits exceed $1,400 per month and the system is now paying out more in benefits than it receives in income.

With Medicare, however, virtually all Americans are getting far more than they pay in taxes, which is 2.9% on all of one’s income, not including the new 0.9% surtax on high earners. The couple turning 65 in 2010 paid a scant $122,000 in Medicare taxes, but can expect to get $427,000 in benefits.

Ask yourself how long a system that loses $300,000 for every couple over 65 years old in Medicare expenses alone can last.

National Debt

At the time of this writing, the US national debt is $21,189,558,784,616 (Q2 2020 update $23,915,169,837,512 → Q3 2020 update $26,601,899,621,388 → Q3 2022 update $30,922,330,965,557 → Q2 2024 update $34,766,489,678,333). With numbers this big, I like to write them out to show how hilariously large they are:

Twenty-one trillion one hundred eighty-nine billion five hundred fifty-eight million seven hundred eighty-four thousand six hundred sixteen dollars

At 147-characters, under the old 140-character limit you couldn’t even tweet the number it is so large.

Clearly $21,000,000,000,000 is not a large enough number to worry about, but this raises the question of what number would be large enough?

The Greek debt to GDP is 180% and the US (Federal only) is 105% (Q3 2020 update 136%) so maybe after the next recession when we have a $5,000,000,000,000 annual deficit people will begin to take notice. https://fred.stlouisfed.org/series/GFDEGDQ188S

Monetary policy

What is the US’s monetary policy? I think it is to keep inflation at or under 2% but I can’t say for sure.

When will there be more dollars printed, bonds sold, QE injected? No one knows.

Contrast this to Bitcoin’s known and exact issuance schedule: every 10 minutes a block will be mined and the global network of nodes will validate the block reward and each transaction in the block.

Aha moment: A government (…just like any individual) will never live within its means if it does not have to.

War on Cash

Governments have taken the maxim “knowledge is power” to heart. There are of course many ways to acquire knowledge including studying and experimentation, but systematically requiring people to give you knowledge is likely the most powerful way to gain power.

A system that requires information sharing (need to report all cash transactions over $10,000) is powerful, but a system that necessitates it (all cash is digital and all cash transactions flow through a central clearing house) is a whole different level of power.

In the future, when governments need to stimulate the economy, they will just put a negative interest rate on your savings account and you’ll think twice about not “stimulating” the economy with your “selfish hoarding”.

Aha moment: If governments can digitize and control all cash, they can (and will) have all the knowledge (and power) they need to do whatever they want.

(Social and State Sponsored) Financial Censorship

Isn’t it great when the political party you align with is in power so that you can harass and censor the opposing party? No, it’s not – but this type of thing is beginning to happen more frequently.

“Morally” (as Opposed to “Legally”) Illegal Beliefs

If the CEO of Big Bank was a raging liberal, she could say “we will no longer offer banking services to [fill in the blank conservative issue] businesses”. If the CEO of Big Bank was a raging conservative, she could say “we will no longer offer banking services to [fill in the blank liberal issue]”. In either case, you are out of business because you don’t have a bank.

The point is not that businesses, including Big Bank, shouldn’t be able to have a say in who they serve as customers. The point is that the businesses being censored (and all legal businesses) shouldn’t be put out of business for the political leanings of their bank. If the bank chooses to not do business with them (and this will happen more and more in the future), the businesses should have an alternatively reliable way to access financial services to fulfill demand for their product or service.

Social Credit Score

What if you say/post/share something that isn’t currently politically correct? Systems are being implemented around the world today to restrict access to financial services and travel for those who don’t comply with the approved social message.

Aha moment: ”Censorship” will have new meaning when you can’t buy milk unless you have the ”approved” political beliefs.

Tax or Print?

Between the tradeoffs of increasing taxes or printing more money, I’m not sure which the Democrats prefer. However, I feel very confident that the Republicans will prefer printing many trillions more dollars to pay for our exorbitant and unfathomable debts than raise taxes (or cut spending).

Printing money is a much more indirect and “victimless” policy, the effects of which are slow to materialize and hard to pin down.

Aha moment: Elected politicians will always prefer to print money than tax voters.

Bitcoin’s Known Monetary Policy Sets It Apart

What if every government had the same monetary policy? What if every government kept interest rates near zero or negative, printed trillions, and ran continuous and increasing budget deficits?

Interestingly, if every government does all these things to a non-ridiculous level, not many noticeably bad things happen. The type of ridiculous monetary policy that the world’s governments are operating under actually works if everyone does it – but it means that there is nowhere for the conservative individual to “exit”. All global markets rise together and people in the US look around and think we have a pretty conservative monetary policy. After all, when the 10-year treasury is at 2.9% and the Japanese Yen is at 0.048%, investing in the US looks like a pretty great deal.

Most people (including myself) would never buy bitcoin if it didn’t have a known supply schedule and upper supply limit. There is no other currency in the world that can match these qualities.

In a world where Bitcoin exists and whose monetary policy is enforced by hundreds of thousands of sovereign and fully validating nodes, Bitcoin can serve as a viable store of value.

Aha moment: Bitcoin’s known and stable monetary policy make it unique compared to all fiat money systems.

What is Bitcoin?

Simple: Bitcoin (BTC) is a peer-to-peer electronic cash system.

Medium: 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.” – Satoshi Nakamoto, Bitcoin Whitepaper

Advanced: The Bitcoin network uses a framework of coins made from digital signatures (providing strong ownership controls) and a peer-to-peer network using proof-of-work (protecting against double-spending) to record a public history of transactions that quickly becomes computationally impractical for an attacker to change. ~Bitcoin Whitepaper

Why Bitcoin?

Seigniorage is Magic

When a government prints a $100 bill, it doesn’t cost $100 to make. The difference in the value created and the cost of production is seigniorage – or profit made by a government by issuing currency.

Think about that. The government profits whenever they print money and we expect them to not do it. Every government that issues currency has this power and they all ultimately abuse it.

Without seigniorage – a magic genie that gives you money when you ask it to – governments would have to hold something of value behind every dollar created and would not be able to decree value from nothing.

Contrast to Bitcoin: As we’ll see later, although bitcoin is digital, there is a real-world cost to creating a bitcoin (in the form of mining hardware, electricity, and time). Unlike fiat money, no one can create a bitcoin without a substantial and tangible real-world cost.

Separation of Money and State

Governments Provide the Trusted-Money Layer

Everyone pretty much agrees that separation of church and state is a good thing. It might make just as much sense to separate money and state.

In the past, there was a good reason for the government to have a hand in creating and maintaining money. In a world before government money and without long-distance communication (internet, satellite, phone, etc.), it was hard for people to gauge the legitimacy of privately-issued money. When someone hands you a $20 bill from “First Chartered Bank of Western California” at your store in New York and you’ve never heard of the bank, you have no way to know if the note is legitimate.

By standardizing and monopolizing the money supply in a country, governments made it easier for businesses to engage in widespread commerce with people whose money they would have not otherwise been able to trust.

By providing a standard money, governments provided the trust that people needed for the economy to grow.

Bitcoin Removes the Trust Layer

In a world saturated with high-quality long-distance communication and computation, we now have the tools to maintain and control a money system with no tie to a sovereign state. [keep reading for details on these tools]

Contrast to Bitcoin: The takeaway is that when anyone runs a Bitcoin full node, without trusting – and even explicitly not trusting – any other participants in the network, your node will still end up building the consensus blockchain and UTXO set from scratch.

Therefore, we do not need a trusted source (i.e. government) to issue and validate the money supply since we can all do it ourselves now by running a Bitcoin full node.

Long Term Store of Value

Imagine you want to store value for a long time. How do you do it?

Financial assets (stocks, bonds, etc.) or real assets (real estate, land, etc.) are normally purchased to gain purchasing power rather than to store it. The reason purchasers of these types of assets expect a greater-than-risk-free return on their investment is because there are operational and execution risks between competing companies and geographies.

Money on the other-hand should carry little operational risk, because there is normally only one money – which earns a natural monopoly – in an economy. Therefore, money should, in theory, store value (purchasing power) well over time. The problem is that it doesn’t. In fact, as of fall 2018, there are over 840,000,000 people across 23 countries with annual inflation of at least 10%. These people will lose at least 61% of the purchasing power of any cash they keep for at least 10 years.

Conceptualizing it another way, any investments (financial or real assets) you purchase in these countries have to make at least 10% (+ marginal tax rate) to at least maintain your purchasing power. This means that even investing in the US stock market, which has averaged ~12% returns over time doesn’t even maintain your purchasing power after taxes. As you can imagine, maintaining any purchasing power in these economies is a challenge.

Bitcoin doesn’t promise purchasing power gains in your local currency, but it does promise a fixed supply. If you have 1 bitcoin, you can be confident that you own/control 1/21,000,000^th of the total network today and in the future.

In Bitcoin’s early years, there were a few unavoidable years of high (>10%) inflation, but the annual rate has already dropped below 4% and will continue to decrease exponentially with each 4-year halving cycle.

Purpose Designed

If you were designing money from scratch, what characteristics would it have?

(Note that these qualities are from the perspective of an ordinary citizen who uses money, not the government.)

Quality	Govt. Money	Bitcoin
Hard to Inflate	Politicians decide	Proof of work
Known Quantity	Unaudited supply	Consensus enforced inflation
Highly Divisible	Penny = $0.01	Satoshi = 0.00000001 BTC
Easily Transferable	Physical = Yes Over Distance = No	Physical = Yes Over Distance = Yes
Easily Verifiable	Look and feel	Run a full node
Private Transactions	Physical = Yes Over Distance = No	Yes
Censorship Resistant	Depends	Yes
Low Transaction Fee	Yes	Sometimes

Bitcoin is a Self-Reinforcing System

Well-aligned incentives (i.e. participants benefit from supporting Bitcoin) and protocol design (mining difficulty adjustment and supply schedule) make it more favorable to hold Bitcoin than other scarce elements.

Bitcoin benefits by being extremely scarce – maybe the most scarce thing ever.

Q: Aren’t all the elements on the periodic table (gold, silver, etc.) scarce as well?

Yes, they are scarce in the short term, but not the long term. If every human on earth stopped what we were doing and started mining gold today, we could produce a tremendous amount of gold. In effect, human effort is the only thing that limits any element’s available supply.

As you’ll see below, Bitcoin does not have this same quality. No matter how much effort is put into producing more bitcoin, there is no effect on the supply.

Take gold as an example and imagine each step takes place over a calendar year:

1. Gold becomes desirable (for any reason) and buyers buy all available gold, pushing price up
2. More people begin mining for gold (at new sites or old sites which were previously unprofitable at a lower price)
3. New miners are successful in adding gold to the global supply
4. New gold supply pushes the price back to lower equilibrium

In Bitcoin, the process is:

1. Bitcoin becomes desirable (for any reason) and buyers buy all available bitcoin, pushing price up
2. More people begin mining for bitcoin (at new sites or using old mining hardware or electricity rates which were previously unprofitable at a lower price)
3. New miners are successful in reaching a mining difficulty algorithm target adjustment more quickly, but produce no additional bitcoin than would have otherwise been produced
4. With no additional supply to meet buyer demand, price volatility continues until new buyers are exhausted

Steps 1 and 2 are almost the same with gold and Bitcoin.

Step 3: In Bitcoin, miners are free to enter or leave the network as they choose. This means that some periods will have more computer power contributing to mining than others. When there are more computers mining, time between blocks decreases (say to 6 or 7 minutes). When it decreases, time between blocks increases (say to 13 or 14 minutes). To keep the time between blocks relatively close to 10-minutes as it should be, Bitcoin changes how difficult it is to produce a block every 2,016 blocks. This means that if blocks have been produced every 6-minutes over the last period, the network will make it 66% more difficult to produce a block – to get the average time between blocks back to around 10-minutes (and vice versa for slower periods).

What this means in practice is that no matter how many people join the network and begin mining bitcoin, every 2,016 blocks (normally ~2-weeks) the network will adjust the difficulty of producing a block so that it takes 10-minutes to produce each block; thereby maintaining Bitcoin’s supply schedule and inflation target. The result is that price fluctuations and resulting mining power changes cannot increase (or decrease) the supply of bitcoin in the market.

Step 4: Because supply does not rise above the normal level, buyers end up competing over smaller and smaller available supply, driving the price higher than would otherwise be achievable in a normal commodity like gold. In a self-reinforcing cycle, the higher bitcoin price leads to more miners joining the market, increasing Bitcoin’s security against attack, and making bitcoin a more desirable asset to additional buyers.

Bitcoin hype cycles do ultimately run their course and prices do not go up vertically forever. Cycles extend until additional buyers are exhausted, not until supply increases to fulfil buyer demand as in traditional commodity markets. Bitcoin’s supply design may produce fiat price bubbles, but it does so for good reason – to preserve the supply schedule as the network transitions from paying for security through inflation to paying for security through transaction fees.

Conceptualized

No conceptualization is perfect, but I’ve found these to be helpful in beginning to understand Bitcoin in relatable terms. Bitcoin is hard to understand as well as describe so take it slow and really think about why each of these descriptions is important.

“Writing a description for this thing for general audiences is bloody hard. There’s nothing to relate it to.” Satoshi Nakamoto

All-in-One

Bitcoin combines several compelling factors into one system:

• Known monetary policy (i.e. like knowing what the Central Bank’s policy will be forever ahead of time)
• Scarcity of a physical medium of exchange (i.e. like gold coins)
• Convenience of a payment system (i.e. like Visa or PayPal)

Space Rock

Imagine you found a space rock with special qualities. The rock is extremely scarce and unforgeable. It also has special powers and can be transported anywhere in the world to anyone nearly instantaneously just by you telling it where it would go. You don’t need to ask permission from anyone for it to travel to its destination and no one can stop you from sending it to the recipient. If a bitcoin had a physical form, it would be very similar to this space rock.

Truth Machine

Bitcoin is a system built to validate bitcoin transactions – and nothing else.

Bitcoin is a machine that produces confidence in the truth of the state of the network – without having to trust any of the parties in the system. It takes in untrusted and adversarial participants and outputs a global, immutable source of truth (the Bitcoin blockchain and UTXO set).

It’s a Party!

Imagine the best party ever is happening somewhere in the universe without you. You want to party and you’re invited (as is everyone else) but don’t know where it is.

How will you get to the party and how will you know you are at the right party?

Bitcoin gives you a way to be able to find the party’s current location (i.e. UTXO set), because you can always ask a few folks who are at the party to give you directions for how to get there (i.e. the blockchain). If you get conflicting directions (Alice says turn left and Bob says turn right), you follow the directions that were the hardest to make (Alice’s is written on a napkin and Bob’s is a complicated app).

You ignore directions that are nonsense/invalid (i.e. Carrol says turn orange) no matter how difficult they were to produce.

You’ll stay at this location for about 10 minutes then the party will go somewhere else when someone produces new directions that everyone agrees were difficult enough to produce (i.e. mining).

Some people might leave to go home or stay for a while as the rest of the party goes on to the next spot. It’s no big deal though because they can just catch up to the rest of the party (using the blockchain as their guide).

You want everyone to be able to follow you, but you don’t want anyone to be able to lead you without doing the work required to be the temporary leader.

Bitcoin is Speech

Bitcoin is Data

Just like every database or piece of electronic information, the Bitcoin blockchain and UXTO set is just data – and data (along with writing, words, media, and lots of other things) is speech.

It’s obvious that a tweet is speech, so why is it hard to imagine that Bitcoin is as well? Bitcoins have a value today, but for about the first 1.5 years of the network’s existence bitcoins had no value – $0.0000.

For further proof that bitcoin is data and data is speech, see the text of a normal bitcoin transaction. Don’t worry about what the text means. Just recognize that this is plainly and irrefutably speech.

{
  "version": 1,
  "locktime": 0,
  "vin": [
    {
      "txid": "7957a35fe64f80d234d76d83a2a8f1a0d8149a41d81de548f0a65a8a999f6f18",
      "vout": 0,
      "scriptSig" : "3045022100884d142d86652a3f47ba4746ec719bbfbd040a570b1deccbb6498c75c4ae24cb02204b9f039ff08df09cbe9f6addac960298cad530a863ea8f53982c09db8f6e3813[ALL] 0484ecc0d46f1918b30928fa0e4ed99f16a0fb4fde0735e7ade8416ab9fe423cc5412336376789d172787ec3457eee41c04f4938de5cc17b4a10fa336a8d752adf",
      "sequence": 4294967295
    }
  ],
  "vout": [
    {
      "value": 0.01500000,
      "scriptPubKey": "OP_DUP OP_HASH160 ab68025513c3dbd2f7b92a94e0581f5d50f654e7 OP_EQUALVERIFY OP_CHECKSIG"
    },
    {
      "value": 0.08450000,
      "scriptPubKey": "OP_DUP OP_HASH160 7f9b1a7fb68d60c536c2fd8aeaa53a8f3cc025a8 OP_EQUALVERIFY OP_CHECKSIG",
    }
  ]
}

Some Speech is Valuable

Being speech and having value are not mutually exclusive.

A bitcoin can have value without ceasing to be speech the same that owning the rights to a Hollywood movie can be valuable without the movie itself ceasing to be speech.

The difference is that while both a bitcoin and a movie (as digital items) can be copied endlessly, the movie can be played and utilized on any media player. A bitcoin, however, only has valuable use within the – one and only – Bitcoin network. You can make unlimited copies of a bitcoin private key, but the network will only recognize the first transaction spending the related UTXO to this private key, rendering all other copies of this private key worthless. This is how a bitcoin can be speech and very valuable at the same time. (It’s also a good example of why you should protect your private keys. “Not your (private) keys, not your bitcoin.”)

Big Set of Locks and Keys

Think of a bitcoin UTXO as a lock that is left closed all the time. You can unlock the lock anytime with your secret key (private key), without having to show anyone your secret key.

Anyone can look at an opened lock (spent bitcoin transaction) and conclude that: “This lock must have been opened by the owner who has the private key; no one else could have opened it”, but you still never shared the private key with anyone.

In Public-Private Key Cryptography, you can use your Private Key (without sharing it with anyone) in a way to create a message that is tied to your Public key.

Anyone can look at that message and your Public key and be able to deduce that the only way this message could have been generated is by someone who knows the Private key, even though they don’t know what the Private key is.

The fact that the message can be verified with your Public key and your digital signature proves (via cryptography) that you must know the Private key used to sign the transaction that is spending bitcoin.

Global Battery

Bitcoin is a global battery. It is not a battery that you can use to power your refrigerator but it is one that you can use to store value over long periods of time in order to preserve your value of your efforts.

Think of any manufacturing (aluminum, housing, iPhones) as a battery for turning energy into value.

When a company uses energy (electricity, human effort) to turn raw materials into finished products, the products eventually rust, rot, or are made obsolete by technological advances.

As a purely digital good which may be resistant to technological obsolescence (as discussed later), Bitcoin converts energy into value in an extremely efficient and durable form.

Bitcoin is Code. Bitcoin is an Idea.

Anyone can see and run the bitcoin code and it’s no surprise that an “electronic” cash system would have code you can use.

Bitcoin is also an idea. It is a system where participants are encouraged to “Don’t Trust. Verify.” but it’s also necessary to gain broad consensus for any proposed changes to the network to take effect.

The same way you can run bitcoin on a computer, participants should run bitcoin as an idea in their minds.

Bitcoin has been proven as a viable network for the last 10 years and even if the Bitcoin code is found to be faulty, but you can’t kill the idea of Bitcoin.

Foundational Questions

Q: How little or much bitcoin can a person own?

Simple: Anywhere from 0.00000001 BTC (i.e. 1 Satoshi is the smallest unit recognized on the blockchain) to 21,000,000 BTC (total supply)

Medium: A person never really “owns” any bitcoin, you “control” it. The bitcoin you think you own isn’t “in” your wallet or address, it is just a UTXO entry on every full node that exists around the world.

Advanced: In second layer solutions like the Lightning Network, the protocol can measure in payments of less than 1 Satoshi by applying computationally secure methods (ex: charging every 1,000^th person 1 Satoshi has the effect of the price being 1/1,000^th of a Satoshi to every participant over time). Because the inflation schedule is counted by blocks mined, not coins issued, there will never be 21,000,000 bitcoins (some early blocks did not properly claim their mining reward and are thus unclaimed forever) so you could not own all 21 million because that many will never exist.

Q: How is owning bitcoin different from owning a stock?

Simple: It’s not different from a stock in that you can own, buy, and sell both a bitcoin or a stock. It is very different in the power that owning one or the other gives in controlling the network or company represented by the asset.

Medium: Owning stock is a proof of stake system in that your ownership of the stock gives you certain control over the company through your voting power. There is no such voting system in Bitcoin.

Advanced: Owning stock (equity) in an organization entitles the owner to some claim on the underlying assets, cash flow, or management of the company. Most people never own enough stock in a company to affect change in the operations of the organization. However, if someone owned enough stock in any company, they could impose their will upon its operations to, for example, fire the CEO or shut it down. Owning any amount of bitcoin does not entitle you to have a say in the operations of the Bitcoin network. If someone owned 99.99% of the supply of bitcoin, the network would still function perfectly for the rest of the .01% share by confirming these transactions. The network gives the 99.99% owner no say in how the network functions, unlike a majority owner of a company.

Q: What problem does Bitcoin solve?

• Digital scarcity (Bitcoin makes it so that when you receive a bitcoin from someone, you can personally and unilaterally verify that 1) it is a valid transaction and 2) no one else can assert an ownership claim to or seize this bitcoin. Contrast this with any other digital file you have ever encountered.)
• Censorship resistant electronic cash (peer-to-peer node network)
• Decentralized currency issuance (distributed PoW mining)

Q: Will Bitcoin be replaced by something better? [we have seen so many big companies (Myspace, AOL, etc.) with existing network effects be disrupted]

A: Metcalfe’s Law states that the value of a network increases with membership. In the classic network effect, each telephone user gains more value from having a telephone with each new telephone user. The network effect companies build is different than the network effect that Bitcoin is building. As the Bitcoin network grows, its service becomes more valuable (as more people accept it) and, critically, its units become more valuable (relative purchasing power). So, the value that would have accrued to the network administrator (company) now accrues to the users of the network – creating a much stronger network effect than a normal company.

Hal Finney once described a scenario where Bitcoin was replaced by something “better”. In the scenario, the replacement will have implicitly acknowledged that it too will ultimately be replaced with a future improvement. Therefore, the replacement will not capture as much value as Bitcoin due to the fact that people will be more willing to abandon the first replacement in anticipation of a potential second replacement.

This scenario is different than moving away from one company’s service to another’s. When a company’s service is replaced by something better, you don’t mind if the company goes bankrupt. In Bitcoin, you are the company – and no one likes to see themselves go bankrupt!

Q: Why do people who like Bitcoin seem to have so much “faith” in it?

“People put more faith in a guy named Satoshi Nakamoto that no one has ever met than they do in the US Fed.” source

• “Faith” requires trust. In Bitcoin, participants are not required to trust anyone (other participants) or anything (Bitcoin code is totally open source) so it’s not correct to say they have “faith” in it
• Bitcoin works and has been battle-tested in the open for +10 years with over 99.99% uptime

Q: Who controls Bitcoin?

A: No one. Bitcoin is a system of rules without rulers. No party in the system can force another party to do anything they don’t want to do.

• Developers can write code but others don’t have to run their code.
• Full node operators can validate transactions but can’t force miners to mine certain transactions or types.
• Miners can include any transaction they want into a block but full nodes do not have to accept blocks that conflict with consensus rules.

Q: What is a bitcoin exchange?

A: A place (website or physical location) where buyers and sellers can meet to exchange something (usually fiat) for bitcoin. The same way you can have an online brokerage account to buy stocks, you can have an account at a bitcoin exchange to buy bitcoin. You can send USD to the exchange (from your bank or with a debit/credit card) which you can use to buy bitcoin from the exchange’s marketplace.

Q: How many bitcoins are there?

A: Currently approximately 17,500,000 which will rise to 21,000,000 around the year 2140, after which time no more bitcoin will ever be created.

Q: Do I have to buy (or earn) an entire bitcoin?

A: No, you can buy a fraction of a bitcoin. You can buy a very small dollar value of bitcoin regardless of the current price.

[Each bitcoin is made up of 100,000,000 units (“Satoshis”). A “bitcoin” is a convenient rounding tool – the same way that saying you have “100 dollars” is easier than saying you have “10,000 pennies”. In bitcoin, it is easier to say you have “1 bitcoin” than “100 million Satoshis”.]

Q: Can bitcoin go to zero?

A: Yes. Bitcoin is a developing system and there is no guarantee that there will be a market for it.

[Realistically, barring some extraordinary and unprecedented systemic failure, bitcoin will not have a zero value, but there is no guarantee it will not go down in value substantially.] Bitcoin exchanges (as opposed to Bitcoin itself) are susceptible to hacking and price manipulation as shown here with a MtGox flash crash to $0.01 in mid-2011.

Q: Bitcoin is a digital asset, can someone just create a bunch of bitcoins and sell them on the market?

A: No. Bitcoin’s distributed network of fully validating nodes know of and verify every single bitcoin transaction. Because of this, any attempt to transact via the blockchain with “fake” bitcoins would fail immediately.

Q: What is a bitcoin worth?

A: …who knows…

[Bitcoin’s “worth” depends on the world we live in and your personal situation. For the average American with a great deal of financial freedom, a bitcoin may not have a great deal of value to you at the moment. For an Indian whose currency is being devalued or a Venezuelan who needs food shipped into the country but doesn’t have access to an international bank account a bitcoin may be “worth” a great deal. Situations change and so do some people’s perception of what a bitcoin is worth.]

Q: What is Bitcoin “backed” by?

A: Just like the dollar, bitcoin is not “backed” by any physical asset like gold. Unlike the dollar, bitcoin is not backed by a government with taxing authority and the ability to mandate payment in its currency.

[Bitcoin is “backed” by its utility in the marketplace and a +10 year track record as a censorship resistant store of value and medium of exchange.]

Q: How is a bitcoin valued and what makes the price move?

A: Supply and demand. People either hold bitcoin for speculative, store of value, or general utility purposes.

[See Investment Theses section for more detailed discussion.]

Q: Does Bitcoin mining “waste” energy?

A: No. There is no question that Bitcoin mining currently uses a lot of electricity, but I do not believe this is a waste.

[Having a large and distributed Bitcoin mining industry provides the network a great deal of security in the immutability of the blockchain against attackers.]

Q: Is Bitcoin a Ponzi or pyramid scheme, etc.)?

A: No. Each of these schemes rely on early adopters bringing in future participants so that the system can provide a profit to the early adopters. Bitcoin doesn’t work this way. It’s undeniable that bitcoin has made many very early adopters incredibly wealthy, but this scenario arose from the fact that Bitcoin does do what it purports to do (peer-to-peer electronic cash), not because it doesn’t and is a scam. Also, do not confuse the fact that Bitcoin itself is not a scam with the fact that scams cannot take place on top of Bitcoin.

[The cryprocurrency industry does have many scams (Bitconnect and many others) masquerading as ICOs, coins, tokens, exchanges and any other scammy money-grab you can imagine. This is why education is key. If something doesn’t make sense to you and seems too good to be true, it is.]

Q: Why is mining necessary?

A: Mining (via proof of work) is the way the Bitcoin network agrees on what transactions have happened at any certain point in time and is necessary so that the system doesn’t have to rely on a central authority to document changes within the system. Mining is also how new bitcoins are issued into the system, which incentivizes miners to perform their function honestly.

Q: Is having my transaction processed a right or a privilege?

A: A privilege. Bitcoin is all about incentives. You cannot force anyone to do anything. You can only properly incentivize them to act in their best interest, by acting in your best interest.

• People making bitcoin payments are incentivized to pay an appropriate transaction fee, so they can purchase the goods/services they need in a timely manner
• People accepting bitcoin payments are incentivized to run a full node, so they don’t get cheated into accepting an invalid bitcoin transaction
• Miners are incentivized to include transactions in blocks that pay a competitive fee, so they get a return on their mining equipment, power, and time investment

Q: What is Bitcoin’s governance model? / How do decisions get made in Bitcoin?

A: It’s slow and contentious – and it should be. Changes to a network storing hundreds of billions of dollars should be well-considered and necessary. While there is no system for voting on changes to the Bitcoin software (like a 1 person = 1 vote election), there are ways network participants state their preference for proposed changes.

• Miner Signaling: Miners include a small bit of information in the blocks they mine to state their position on an issue. If a certain threshold of miners (ex: 80% or 95%) signal for a feature over a certain period of time (2040 blocks or 2-weeks), the proposal can be activated for inclusion in the network. This is merely a signal, not a commitment, so miners may not always act in accordance with their signal.
• Node Signaling/Activation: Under the UASF (User Activated Soft Fork) model, users modify their nodes in a way that changes Bitcoin in some backwards compatible way. If enough nodes enforce the changes, miners will have a much greater incentive to make the change themselves as well
• Social Signaling: There is no Bitcoin headquarters or public relations office to release the official network policy on any topic. People use this feature to build their own community around features or improvements that are important to them. As ridiculous as it may seem, hats (actual baseball caps) and Twitter name icons (⚡) are popular signaling methods.

Q: What would happen to Bitcoin if the internet went (or was taken) down?

A: Regional – If the internet in any country or even continent went down, Bitcoin block production would likely slow temporarily, but would recover to a normal cadence within several weeks after a mining difficulty adjustment.

Global – If the global internet went down, Bitcoin would actually fare better than the existing banking system (and probably every other system) because:

• Transmission – Bitcoin transactions (and blocks) can be broadcast via any communication method (email, text, handwriting, short-wave radio, satellite, smoke signal, emoji, etc.), not just over the internet
• Block Production – Mining to produce proof of work relies on specialized hardware, not an internet connection
• Block Verification – Proof of work provides a way to know which chain of blocks represents network consensus chain (so you never need to trust another human to know the state of the network)

Q: Has Bitcoin ever been hacked?

A: No. The reason hackers like to steal bitcoin is because it is valuable. If they could hack the protocol, they wouldn’t need to steal it from users. There have however been many instances of bitcoin exchanges being hacked. This is the equivalent of some stealing gold from your vault – which is different than someone creating gold from lead.

Misconceptions and Confusion

Bitcoin is deflationary

Inflation is an increase in (the money) supply. Usually, more dollars in circulation leads to an increase in prices, but rising prices is an effect – as opposed to a cause – of inflation.

Bitcoin is not deflationary, it is just less inflationary than other currencies. After the year 2140, Bitcoin will cease to be inflationary when no more bitcoin is produced.

Bitcoin is anonymous

At best, Bitcoin is pseudonymous. Users control addresses which hold bitcoin. If you know someone’s address(es), you know how much bitcoin they have.

Bitcoin’s pseudosymmetry can be removed by assigning your real identity to an account with an exchange or wallet provider. The broader network will not know your real identity, but *someone* will.

What Did Bitcoin Improve Upon?

Bitcoin is the first (and many argue still the only) (digital) asset that is limited in supply, but it was not the first attempt at creating such a thing.

Bitcoin succeeded where others’ attempts failed because it was able to provide a way to prevent double-spending across the network without the need for a central (or trusted-third) party.

Satoshi’s breakthrough with Bitcoin was tying a distributed Proof-of-Work (PoW) process to the production of bitcoins and allowing the blockchain with the greatest cumulative PoW to serve as the authoritative record of events within the system.

Bitcoin is Terrible

Bitcoin is really cool and it is very good at some things. There are many other things it is either not particularly good at (and will never be) or is not currently good at (but could be in the future).

This section is intended to present issues rather than solutions. As you progress in your understanding of Bitcoin, you will likely see that there are viable solutions and answers to many of these problems.

• Bitcoin doesn’t solve a real problem
  • If you live in the US, there has likely never been a time you didn’t have a suitable way to store or transfer value in the current system so you don’t really “need” a censorship-resistant payment method or store of value
• Bitcoin doesn’t scale
  • Not only does Bitcoin not scale, blockchains do not scale (because they replicate the same data across every full node in perpetuity)
  • In its current form, the Bitcoin blockchain can only process approximately 500,000 transactions per day. This is nowhere near the scale required to serve the daily transactional needs of any significant population
• Bitcoin proof of work (PoW) mining uses too much energy
  • Mining uses lots of energy because Bitcoin’s mining difficulty is high and requires lots of attempts to solve for PoW. Bitcoin’s mining difficulty is high because bitcoins are valuable. If bitcoins become more valuable, more people will mine and further increase the difficulty which will use more electricity
• Bitcoin full nodes are unnecessarily distributed
  • Bitcoin is a distributed system, but how distributed does it need to be in order to accomplish its goals? While there is likely an upper limit where additional distribution doesn’t add much value, it is more difficult to determine where less distribution does not diminish value
• Bitcoin is beta software
  • Bitcoin Core (the most popular Bitcoin client) does not even have a version “1.0” (currently v0.16.1)
  • There is always the risk of some unforeseen, catastrophic vulnerability negatively affecting the network
• No one “has” to maintain or improve Bitcoin
  • Bitcoin is not a company with employees who “have” to show up or they get fired. All the participants in the Bitcoin system choose to participate, so it’s possible that at some point in the future there will be less incentive for participants to participate.
• Bitcoin is too complicated (to understand, to use)
  • Bitcoin is a combination of computer science, cryptography, economics, and game theory and all of these topics are extremely difficult to master
  • Bitcoin has a terrible user experience
• Bitcoin has high and uncertain transaction costs (fees)
  • The fee to incentivize miners to include your transaction into a block can be very volatile
• Bitcoin has slow confirmations
  • The time between blocks averages 10 minutes so it’s normally at least a few minutes before a transaction has the ability to be confirmed. That’s pretty slow considering how fast information travels over the internet.
• Bitcoin is over hyped
  • It’s really easy to see price charts or headlines and forget that this is experimental technology that cannot serve every person in the world in its current form
• Bitcoin is hard to secure, even for experts
  • Seeds, multisig, hardware wallets, encrypted files, Samir’s secret sharing…it can all be a little much for the average user
• Bitcoin is far from anonymous (and if it’s pseudonymous nature is linked with a real identity all of your transaction amounts are known)
• Altcoins solve many of Bitcoin’s problems
  • Want faster confirmations? There’s an alt for that!
  • It seems very easy for altcoins to pick and choose certain qualities they want to improve in Bitcoin and launch a coin with these qualities
• Bitcoin is terrible for small payments
  • Even if fees were $0.01, that’s still too high for true micropayments
• Bitcoin has limited scripting (smart contract) capabilities
  • Developers can’t build anything they want in Bitcoin’s limited stack-based language
• Bitcoin has no intrinsic value (unlike gold which can be used for jewelry)
  • You can’t eat a bitcoin or use it to make a necklace
• Bitcoin has divisive politics
  • People in Bitcoin don’t like being told what to do or how to think. Proceed with caution.
• We don’t even know who created Bitcoin
  • Who the heck is this Satoshi Nakamoto character?
• Eventually, Bitcoin will be replaced by something better
  • Some new technology always replaces the old technology. It’s only a matter of time.
• Bitcoin’s price is volatile
  • Something whose price can change +/-20% in a day isn’t a good store of value or medium of exchange
• Bitcoin has known bugs
  • There are small nuances like an off-by-one Time Warp bug in creating calculating mining difficulty that must be navigated and which cannot likely be fixed
• Bitcoin has unknown bugs (some of which have become known)
  • 184 billion bitcoin – Aug 15, 2010 – Exploit in the bitcoin client that didn’t check for overflow values when summed. Attacker/exploiter created an extra 184,000,000,000 bitcoin. Within 5 hours, a new version of the software was published and fixed the bug. Chain with the bug was no longer mined, which caused it to cease to be the chain with the most valid proof of work.
  • CVE-2018-17144 – Sep 17, 2018 – Bitcoin Core 0.14.X, any attempts to double-spend a transaction output within a single transaction inside of a block will result in an assertion failure and a crash. Instead of asserting that the output being marked spent was previously unspent, it only asserts that it exists. Thus, in Bitcoin Core 0.15.X, 0.16.0, 0.16.1, and 0.16.2 if the output being double-spent was created in a previous block, an entry will still remain in the CCoin map with the DIRTY flag set and having been marked as spent, resulting in no such assertion. This could allow a miner to inflate the supply of Bitcoin as they would be then able to claim the value being spent twice.
  • A small number of other scary bugs have made it into the production software and have been discovered/reported and corrected without major damage

Bitcoin’s Building Blocks

There are obviously some novel things about bitcoin that make it special, but the majority of the components have been around for a long time. Like many things, it’s how the components work together as a unit that make something special.

Open Source Software Protocol

Open Source

Common Sense: Bitcoin is computer software built by humans.

There is no Bitcoin company, CEO, or Board of Directors. Bitcoin is and has always been developed either on a volunteer basis or through a sponsorship from interested parties (i.e. it’s becoming more common for companies who work with Bitcoin to sponsor an open source developer).

Open source software is not a new concept and is utilized in many layers of the existing global computing system. To people outside of the software development world it does seem to beg the question “Why would you work on something you don’t get paid to do?”, but there is plenty of room in computer science to cement yourself as an expert and provide other value-added services to make your living.

Because Bitcoin is open source, it means it is freely available to anyone in the world to download and run on your local laptop for free. You can look at every line of code, audit the program, or build your own implementation as you like.

Software

Bitcoin is software (as opposed to a physical object or computer hardware) and software is never finished. There are many implementations of Bitcoin, but the most popular client is Bitcoin Core. As you see below, there have been 17,380 commits to the Bitcoin Core software from 550 contributors and the software was last updated 8 hours ago. While the Bitcoin software is very actively developed, large changes to the software are extremely well-tested and must achieve broad network consensus to be implemented.

Most people show their support for a certain client by running their software, so if Bitcoin Core implemented some change you do not personally support, you could easily either not upgrade to the new version or run an alternative client to show your support. If enough people agree with your position, this client will become popular and may outcompete Bitcoin Core in the market.

Protocol

Common Sense: Bitcoin is a protocol for transmitting value (usually over the internet). It will become more user-friendly over time.

Normal people don’t often think about protocols because you don’t have to. The whole point of protocols is that they just work, and the details are abstracted away by the user experience.

The internet runs on a number of protocols (TCP-IP, HTTP, FTP, and many others) that the end user never sees or thinks about. Bitcoin is a protocol for transferring value.

As the user experience improves, the innerworkings of the system will be abstracted away through simple, functional applications.

Digital Signatures

Common Sense: Digital signatures can be made that you and only you could have produced, but that anyone can verify as authentic very easily.

Everyone’s handwritten signature is unique, but an experienced forger could likely fool a stranger that their fake replica of your signature is legitimate. If you really needed to prove your identity, your DNA (3 billion base pairs) would probably be a more secure identifier.

Digital signatures work similarly to your DNA in that they are hard to fake and easy to prove.

Bitcoin transactions are signed with a private key and public key pair. Both the private key and public key are simply numbers, but the numbers are so large and obscure that on one would ever be able to guess them.

• Each bitcoin transaction will have a different public and private key pair (assuming you follow the best practice of not reusing addresses)
• No one other than you ever knows or sees your private key (as it is not needed for other people in the network to be able verify your valid signature)
• The public key is derived mathematically from the private key (using elliptic curve multiplication) such that it is impractical to back your way into the private key from a known public key, but easy to produce a public key from a known private key.
• You can always produce a public key from a known private key

Bitcoin currently uses the ECDSA digital signature algorithm to sign transactions, but there are several alternatives which could be added to the software in the future – namely Schnorr Signatures or BLS.

Cryptographic Hash Functions

Common Sense: Easily encode any value so it cannot be decoded but can easily be checked as valid.

A hash function is a one-way encoding where it is very easy to move from the input to the output, but impractical to derive the input from a known output.

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For example, one hash function used extensively in Bitcoin is SHA256. In this function, any input regardless of length will output to a 256-bit value (64 characters) and this output is produced anytime the exact same input is hashed. Notice you can hash short values (single words) or long values (entire US constitution) and the output is always 64 characters.

The power of hashing is that if you were given the hash output for the word “bitcoin” (6b88…107b), there would be no easier way to back your way into the input (“bitcoin”) than randomly guessing every possible input value.

The Bitcoin mining process uses hashing extensively. Miners use transaction data as inputs and iterate a nonce (placeholder value) trillions of times per second to produce output hashes with certain characteristics (ex: a hash beginning with 18 leading zeros). When a miner finds an output hash that matches the desired criteria, she transmits this data to the network as a newly “mined” bitcoin block. Because of the known characteristics of hashing, other miners know there was substantial work expended in producing this hash from the specific inputs and accept the hash output as proof of work performed to produce it.

Blockchain

Common Sense: Bitcoin’s blockchain is the map that allows us to arrive at the current UTXO set.

“A blockchain is a system for participants to agree on a single history of the order in which transactions were received.”Satoshi Nakamoto

A blockchain is a chain of blocks. It sounds snarky, but it’s true.

Blockchain

In Bitcoin, the system clears a set of transactions (i.e. adds a block to the blockchain) on average every 10 minutes. When a valid new block is mined, it is sent to all full nodes around the world and added to the tip (i.e. end) of each of their blockchains. Inside each block are anywhere between 0 and thousands of transactions. Miners choose which transactions get included in which block. Nodes determine if the blocks miners produce are valid.

Why do we put transactions in blocks?

It would be great if every transaction were globally and instantly verified. Unfortunately, there are physical limitations like the speed of light and computer processing time which complicate things.

In decentralized systems such as Bitcoin, there is a tradeoff between when transactions “clear” through the system and how often discrepancies arise within the system (i.e. how often the system “forks”).

The quicker the system clears transactions, the more often discrepancies needing resolution will arise and vice-versa. Grouping transactions together in blocks and verifying all of them at once every 10 minutes reduces the likelihood of users being able to confuse the network (by sending multiple transactions in quick succession and the recipients not knowing which is invalid) and the occurrence of miners wasting work on a chain which is not the agreed valid chain. Both of these qualities give users and miners confidence that results they see in the blockchain are valid and will not be overwritten.

Blockchain

Each block is an agreed-upon version of what happened in the last 10 minutes. Linking each block into a chain provides an agreed-upon version of what happened since the beginning of the blockchain.

Each block in Bitcoin’s blockchain is linked to the previous block in a special way (hashing) where changing any piece of data in an earlier block would invalidate the subsequent blocks from where the edit was made. This means that if anyone tried to add or exclude any transaction into or out of any block in the entire Bitcoin blockchain, the change would be immediately visible (i.e. blocks would no longer properly link to one another) and the attempt would fail.

Unspent Transaction Output (UTXO) Set

Common Sense: The UTXO set changes with each new block in the blockchain so it’s important that full nodes know the current set. In the directions analogy, the UTXO set is the current point on the “map” where we all agree we are at the moment.

The UTXO set is the current set of unspent transactions in the Bitcoin network.

When someone has a Bitcoin wallet and some number of addresses with positive bitcoin amounts, these amounts are “UTXOs”. A UTXO is any amount of bitcoin you have not already “spent”.

Think of the blockchain as a long list of instructions that have to be followed exactly in order to produce the current state of the UTXO set.

Functionally, the reason the blockchain exists is so that each full node can produce the current UTXO set independently. When a full node downloads the Bitcoin software and joins the network, it literally starts at the genesis block (block 0), receives new blocks with transactions from other peers in the network, and builds and adjusts the UTXO set as it progresses through the blocks in the blockchain.

It may not seem necessary for new full nodes to build the entire UTXO set from the full blockchain but fully validating each transaction from the genesis block is the only proven way to guarantee the current state of the network in its entirety.

When a new block in the blockchain is mined, it will direct full nodes to make changes to their existing UTXO database.

It is not possible to partially consume a UTXO, the same way it is not possible to pay for something by tearing off the corner of a $100 bill. The UTXO (or bill) is either entirely spent or unspent. UTXOs can be extremely small (less than a penny) or large (billions of dollars).

When people talk about Bitcoin solving the “double-spend” problem, they mean that no one has successfully spent the same UTXO twice.

Proof of Work (PoW)

As seen in the hashing functions section, there is no way to predict the output of a cryptographically secure hashing function such as the one used in Bitcoin’s proof of work system (SHA256). Bitcoin uses this feature to make miners “prove” that they performed a certain amount of computational effort (“work”) to produce a hash with an output value lower than a system defined threshold.

Because there is no shortcut to computing a valid hash output, when a miner distributes a block whose inputs produce a valid hash output, other miners can easily reproduce the hash on their computers and know the miner actually performed the work required to produce the hash.

Mining

Because there is no central authority saying which transactions have been finalized, Bitcoin needs a way to let transacting users know when their transactions are confirmed. Miners fill this need and perform two functions for the Bitcoin network:

• New bitcoin issuance (without a central authority)
• Determining the order of transactions

By giving miners the proper incentives to perform both of these functions, the network is secured against attackers and consensus can be formed around the blockchain with the greatest valid proof of work.

It is not the job of miners to decide if transactions are valid or to enforce consensus rules. This is the job of full nodes.

It’s a Great Game

Think of mining as a worldwide game that never ends. The game has 10-minute rounds where one winner is given a prize (bitcoin) for beating the defense. There are lots of offenses (each miner) playing against one global defense (mining difficulty algorithm). After each round, everyone begins back at the same place (the current end of the blockchain) to play again. If it turns out that the offense wins too quickly over time (say every 6-minutes), the defense self-adjusts to get stronger to bring the average time per round back to 10-minutes. The defense can also get weaker if rounds take longer than expected.

How to be Good at the Game

Being good at a game like this is very challenging and rewarding, but you have to have the right tools:

• Players (mining hardware that can do lots of hashing)
• Strength and conditioning (access to plentiful, cheap electricity to power your players)
• Coaching (workers to optimize your resources)
• Rulebook (full node so you don’t waste effort by breaking the rules)

Steps to Having a Transaction Mined

Note: Remember it’s impossible to determine the input of a hash from a known output, but easy to recreate the exact hash output from a known input.

Bitcoin Transacting User (Timing: Continuously)

1.User broadcasts their transaction to the network

2. Transaction is added to each node’s mempool (list of all pending transactions)

Miners (Timing: Every ~10 Minutes)

3. Assemble a block shell with a header that links to the previous block and a coinbase transaction to receive your block reward

4. Gather data to “mine”

Each miner selects a group of transactions (those with the highest fee) from the current mempool and treats this data as a block which they will try to “mine”. Your transaction may be included in the current block or not.

Each miner is free to select any transactions from the mempool they want to mine.

5. Solve for Proof of Work

To “win” the round by producing a block that is accepted by the network, the miner must produce “proof of work” (PoW). PoW is a block whose data, when hashed, produces a numerical hash lower than a certain point on a number line.

For example, a miner may be trying to produce a block whose hash starts with at least 18 leading zeros. Producing a hash which starts with 18 or more zeros proves that the miner did enough work to produce the hash. Because the miner can prove PoW, network participants will accept the block as valid (if all transaction data is also valid).

To produce PoW, miners iterate a nonce (as well as other non-transaction related data) within the block data through trillions of variations. Each nonce iteration produces a completely different hash. The miner will continue this process until they solve for PoW or see a valid block broadcast from another miner that wins the current round.

Your transaction data will be one of many included in a block whose hash provides PoW

6. Miners broadcast their valid PoW block data to their peers

Q: Say you are a miner who just discovered that the nonce 19,495,802,284,694 will produce a hash with 19 zeros (i.e. enough difficulty for the current target). You broadcast this transaction to one peer. Can the peer “steal” your work by saying they did the work and broadcast it as their own?

A: No. They can broadcast it but they cannot change the fact that an address you control is receiving the 12.5 bitcoin “block reward”. If they change that address, the nonce will no longer produce a hash with 19 zeros and will be worthless.

7. Other Nodes validate the block

When using Bitcoin, don’t trust. Verify. Nodes in the network receive broadcasted prospective blocks which each recipient full node validates independently. If the block follows the rules, it’s added to the blockchain. If even one transaction is signed incorrectly, the block will be rejected by all nodes, who will continue waiting for a valid block.

As a transacting user, this is when you see “1 confirmation” with your transaction. This means that the network has mined one block containing your transaction and the network is confirming its validity. It is still risky to treat a transaction with only 1 confirmation as irreversible, so it is best practice to wait 6 confirmations (i.e. until the block with your transaction has 5 blocks in the blockchain after it) until considering your transaction final.

Each miner begins the process again from [Step 3] for the next round.

New Bitcoin Issuance

Common Sense: New bitcoins are granted to miners as they produce acceptable blocks onto the blockchain until all bitcoins have been created.

Inflation schedule

There will only ever be 21,000,000 bitcoins mined. After the year 2140, blocks will still be produced but the network will operate on a transaction fee only model, as opposed to the current model of a mix between block rewards and transaction fees. The transition to a fee only model has already begun and will accelerate over time.

Mining Difficulty

In order for bitcoin’s supply to maintain its schedule, the quantity and timing of bitcoin issuance have to be enforced. Quantity is enforced by full nodes which validate each block.

Timing is enforced by the mining difficulty algorithm which changes how difficult it is to win each mining round so that blocks are produced on average every 10 minutes. Mining difficulty is recalibrated every ~2 weeks (2,016 blocks).

If the system could not regulate the difficulty of producing a block, blocks would be produced faster and faster as hash power joined the network – leading to higher than expected inflation – or slower and slower as hash power left the network – potentially making it too difficult to ever mine a block.

Incentivized Security

Bitcoin (network) has to make people want bitcoin (unit of account) for the network to survive. To make people want bitcoin, the network has to be secure. To be secure, the network has to be costly to attack. To be costly to attack, the network must make attackers consume resources to attack it. A secure network is necessary, but not sufficient to justify bitcoin having value.

Bitcoin’s proof of work system accomplishes a great deal of the explicit cost incurred in any would-be attack of the network via the high cost of hardware and electricity. There is a similarly large implicit opportunity cost to attack in that any attacker will destroy the value of their newly created bitcoins if their attack is successful in disrupting the network.

Distributed Issuance

There is no such thing as a free lunch. Bitcoin distributes its only resource – bitcoins – to the miners who perform the most valid proof of work for the network. By distributing new bitcoins into the market via miners, and not a political system, the network efficiently allocates capital to those who have objectively provided the most value. In practice, this means that if you control 1% of the total network hash rate, you can expect to earn about 1% of the new coin issuance over time.

Coupling this distributed issuance with explicit costs of mining mean that miners must sell a portion of their block rewards into the broader ecosystem to pay for the work performed.

Q: How do miners actually produce the new bitcoin that they mine?

A: For this purpose, think of a bitcoin as a piece of structured data that the Bitcoin network will accept as a legitimate bitcoin. It’s easy for a miner to create the piece of data (i.e. create a private key, format it correctly, and insert this granting transaction entry into a block), it is hard to get the network to accept the data as legitimate (i.e. produce a block with this transaction included that the network will accept as valid).

Q: What is a miner’s incentive to participate in new bitcoin issuance?

A: Bitcoins are valuable and mining a block means you can “give” yourself bitcoins via the “block reward”. Miners have the right to claim a certain amount of bitcoin when they mine a block. This value is reduced by half every 210,000 blocks (~4 years). The current block reward (up to Summer 2020) is 12.5 bitcoins, meaning that for every successfully mined block, a miner can grant themselves up to 12.5 bitcoins. If a miner tries to give themselves 12.50000001 bitcoins, all full nodes will reject the block and the miner will have wasted a lot of money for no reward.

Ordering Transactions

Imagine I buy something from an online merchant with 1 bitcoin and before this transaction is included into a block I send the same UTXO to another address I control.

It would be foolish for the merchant to ship me the product before the transaction is included in least 1 mined block because they don’t know which of the two transactions will be mined first.

When bitcoin was a smaller network, it was commonplace for miners to operate on a “first-seen first-in” practice, meaning that if you saw two unconfirmed transactions spending the UTXO, you would mine the first one your node saw and ignore the other. As transaction fees became more common (and required) miners moved away from this model to a rational policy of accepting the transaction with the highest fee.

The same way miners have the option to claim a certain number of bitcoins when they produce a valid block, they have the option to claim transaction fees from transactions they include in valid blocks.

While it’s true that a miner could mine empty blocks, with no coinbase transaction or mempool transactions, miners include fee-paying transactions in blocks because they make money doing so.

Each coinbase transaction will grant the miner their block reward + applicable fees.

A System of Incentives

Layers of Decentralization

Decentralized (Software Running Around the World)

Many tens of thousands of individuals run the Bitcoin software on their computers as a “full node”. Each of these full nodes contains a complete, identical copy of the Bitcoin blockchain and UTXO set as every other computer running the Bitcoin software.

When people say “the” Bitcoin blockchain, they are collectively referring to all these full nodes that have reached consensus on the state of the blockchain, not a single node with “the” blockchain on it. A blockchain must be distributed or else it would just be a database.

So, if any small (or non-extremely large) number of these copies of the blockchain are disconnected from the network for any period of time, the network can still function properly without them. Additionally, because of the way proof of work works, full nodes can enter and leave the network at any time without disrupting the network’s ability to function and without risking following a non-consensus chain. Also note that the 10,000 nodes shown in the graphic are only the full nodes which are actively relaying transaction around the network. There are many (~85,000) non-listening full nodes which receive and validate transactions, but do not relay information out to additional peers.

Decentralized (Developers Around the World)

Bitcoin is a software protocol. Static software is often dead software and good software gets updated very frequently. Although the most popular client (i.e. node software) is the Bitcoin Core “Satoshi Client” there are several alternative implementations from development teams across the world including Bitcore, Bitcoin UASF, Bitcoin Unlimited and many more that a user could choose to run.

If one group of developers pushes an agenda (i.e. writes code) that runs counter to your understanding of what Bitcoin is or should be, you can stop running their software and move to another implementation (or make your own – there is nothing stopping you).Developers propose what Bitcoin could be by the code they write, but do not dictate what Bitcoin is because no one has to run the code they propose.

Decentralized (Mining)

If the point of PoW mining in Bitcoin is to make it so the network can operate without relying on any trusted third party as a central clearinghouse, there are several areas where the loss of decentralization in mining could negatively affect Bitcoin’s security.

Hardware Manufacturing

If a small number of mining hardware manufacturers control the supply of equipment, there is a risk of a systematic (intentional or unintentional) failure of such hardware.

Hardware Operation/Ownership

If a small number of mining operations control the majority of the network hash rate, it becomes easier to roll back transactions which were considered confirmed.

Geographic Location

If a small number of geographies contain the majority of the network hash rate, a government or natural disaster could disrupt or influence the network.

Pools

If a small number of mining pools direct the majority of the network hash rate, mining pool operators may construct blocks to contain only certain transactions.

Censorship Resistant

If you pay for something with physical cash, there is no practical way that an absentee third party can stop you from performing a transaction. In Bitcoin as with cash, a critical network function is the ability for any willing participant to transact freely. All bitcoins are completely fungible (i.e. each bitcoin is treated the same as all others). Unless you mined them personally, all bitcoins also have a transaction history which could, without fungibility, carry taint from a previous owner’s illegal actions.

Pseudonymous, Not Anonymous

In Bitcoin, every full node will ultimately know the relevant details of your transaction (to address, from address, bitcoin amount, fee, time) so it can be properly mined into a block. But no one will theoretically ever know the intimate details of the transaction (who, what, when, where, why). This possibility terrifies anyone with a lot of power in the current system.

Bitcoin is not anonymous as many people once falsely believed. It is pseudonymous (i.e. there is an identity tied to each transaction, we just don’t know whose identity it belongs to). For example, because everyone knows that Satoshi Nakamoto (Bitcoin’s creator) mined the first block and I know the Bitcoin address that received this block’s reward (1A1zP1eP5QGefi2DMPTfTL5SLmv7DivfNa), I now know that Satoshi controls this Bitcoin address. If someone knows your Bitcoin address, they know you control all the bitcoin in that address. To avoid being personally censored in a worst-case scenario, it is important to use a new address for each transaction (wallets do this for you) and use other advanced privacy enhancing features (lightning network, Schnorr signatures, confidential transactions, bulletproofs, zero knowledge proofs) as they become available.

Peer-to-Peer (full-nodes, transaction validation)

Full Nodes

A full node is a complete copy of the Bitcoin blockchain with every transaction (or entry) in the database since the beginning of the Bitcoin network in 2009.

Full Nodes Validate the Blockchain

There are approx. 170,000 Bitcoin full nodes in operation today. This means that every 10 minutes, 170,000 computers around the world all validate every Bitcoin transaction, accepting the valid transactions and rejecting the invalid.

Self-reliance (or more specifically non-reliance on trusted third parties) is an overarching theme in Bitcoin. Perhaps nowhere is this more evident than the fact that any person in the world can run a full node and validate every transaction that has ever occurred on the Bitcoin network.

Full Nodes Store the Blockchain

The “full” in a full node refers to the fact that a full (i.e. complete) record of the entire blockchain is stored in each full node. The blockchain currently contains over 526,000 blocks and grows by approximately 144 blocks per day (10 min/block = 6 blocks/hr * 24 hrs/day).

This means that the blockchain gets longer (or “higher”) as more blocks are appended to the most current state of the network. It also means that the database becomes larger as each bitcoin’s history grows and more transactions occur within the network.

Full Nodes Propagate the Blockchain

Each full node in the network is connected with several incoming (and possibly outgoing) connections with other full nodes in the network.

When miner provides sufficient proof of work (PoW) and “mines” a new block, the winning miner’s node will send the new block data to it’s connections. These connections will validate the legitimacy of the block and forward it to their connections. This process occurs very quickly (over a number a seconds) until the new block has “flooded” throughout the network of full nodes. If the miner’s block contains even one illegitimate transaction, it will be rejected by its peers and will not be forwarded to other nodes in the network. This structure of each full node validating every transaction and block provides an excellent incentive for miners to not try to “cheat” the system because they know that other miners will not “take their word for it” that the transactions are “good”, but will check everything themselves and only send information to the rest of the network if the information is valid.

Why is education important?

Bitcoin is New and Confusing

Do you remember learning about the internet and how to use it? Getting started with Bitcoin is a lot like this. I’d argue it’s even more difficult and important to understand because while the internet was sort of like a different version of your newspaper, phone, and tv – Bitcoin is sort of like a different version of your central bank, money and payment processor.

Everyone is a Scammer (i.e. Bitcoin 2.0, ICOs, “Blockchain, not Bitcoin”)

Unless you are a trained cryptographer, computer scientist, economist, and game theorist you probably didn’t “get it” when you first heard about Bitcoin. Practically no one does.

Each of these fields presents the casual observer with confusing terminology, so-called “experts”, and “proven” theories that sometimes stifle your natural curiosity for fear of being ignorant and seem to ask you to “just trust me”. “I like Blockchain, but just not Bitcoin” / “We are building the Bitcoin killer! Bitcoin 2.0” / “Our ICO will have all the benefits of Bitcoin, but with 1,000x throughput, better privacy, and a decentralized Uber 😊!” / “Missed out on Bitcoin? Don’t miss the NEXT Bitcoin!” — There are endless derivations of things that sound like Bitcoin, but lack any resemblance to the qualities that make Bitcoin unique. Education will help you ask the right questions and not fall victim to scammers promising unrealistic and unproven claims.

Manage Expectations

There are lots of people and projects that make technological claims and without some level of education and understanding, you have no way to know if they have actually developed a novel solution, are exaggerating, or are outright lying.

Question Everything

Don’t understand how/why something works? Ask someone or look it up. The systems that compose Bitcoin are almost always designed with a purpose in mind even though it may not be explicitly stated.

Don’t Trade on Emotion (Panic Buy/Sell)

If the answer to the question “Why are you buying or selling?” is some form of “I can’t stand to lose any more” or “I can’t stand to miss out on future gains”, you are going to get rekt.

Without education, you are effectively buying a name-brand. Don’t confuse marketing (i.e. the Pets.com Super Bowl ads) with product (i.e. you use an iPhone every day and love it).

Bitcoin is Not a Company

If you screw up a Bitcoin transaction (ex: send bitcoin to the wrong address or an incorrect address), there is no customer service department you can call to fix it. The bitcoins are gone forever. Bitcoin is the ultimate caveat usor system – user beware.

It Helps You Understand Why You Do What You Do

If you end up buying some bitcoin or not, education will help you understand why you made the decision. It may turn out your reasons were incorrect, but at least you will be able to test against your investment (or non-investment) hypothesis in times of doubt so as to not let current emotions decide your actions.

Build HODLers of Last Resort

In credit-based systems like the US dollar, a lender of last resort is a central bank who will create and lend money to the market in times of crisis.

In equity-based systems like Bitcoin, a HODLer of last resort is someone who will HODL and/or purchase bitcoin in times of crisis – adding liquidity and a price floor to the system.

The more HODLers of last resort the network has, the more resilient it will be to attack.

Know What You are Using or Buying

Q: How do you know it’s “bitcoin” in your wallet and not some other altcoin – or worse – just some pixels on a screen? à A: Run a full node, hold your private keys, and verify transactions with your node.

Just because a website says you are buying “bitcoin” doesn’t mean you are. The website could have a different understanding of what bitcoin is than you do and may trick you into buying something you didn’t want. Here is an example of a very confusing website offering two versions of bitcoin, neither of which give the user enough information to know if they are buying bitcoin or an altcoin spinoff of bitcoin. The point of communication is to convey information. By confusing users (intentionally or via incompetence), the operators of this website attempt to harm bitcoin. In reality, they only harm themselves and uninformed users.

Investment Theses

This is obviously not investment advice. Don’t take my word for anything because as we’ve seen…everyone’s a scammer!

Bitcoin Black Hole

Common Sense: As bitcoin works for more people around the world in crises over time, more people stay in the network and bitcoin further proves itself as a viable store of value.

When countries around the world experience high/hyperinflation, the people desperately seek alternative stores of value. When a country experiences one of these shocks a certain (albeit likely small) portion of the population turns to Bitcoin to act as a store of value.

If Bitcoin does its job of serving as an uncensorable store of value, these people will fare much better than their countrymen. Over time, even after the country’s currency crisis subsides, these people will be unlikely to abandon Bitcoin so long as it continues to serve its purpose.

As one country after another (Greece, Cypress, Zimbabwe, Argentina, Venezuela, etc.) falls into financial ruin, Bitcoin’s network effect grows stronger by serving the needs of those with no other viable options. There are currently 19 countries with inflation rates greater than 10%. Bitcoin’s current inflation rate is ~4% and because of its known inflation schedule, this rate will decrease to less than 2% in mid-2020. The citizens of each of these countries are perfect candidates for those who could benefit from participating in the Bitcoin network.

People with Vested Interests (and Unconvincing Arguments) Call Bitcoin Bad Names

“It is difficult to get a man to understand something, when his salary depends upon his not understanding it!” – Upton Sinclair

Common Sense: People who own banks want to keep banks around. What they don’t immediately see is that many people will still “want” banks to handle their money for them (even if it’s bitcoin).

When the likes of Warren Buffett, Charlie Munger, Jamie Dimon, and so many more Big Bankers call Bitcoin terrible names, I have to wonder who they are looking out for, me or themselves.

Bitcoin is “probably rat poison squared.”
– Warren Buffett

“To me, it’s just dementia. It’s like somebody else is trading turds and you decide you can’t be left out.”
– Charlie Munger

“Suppose you could make a lot of money trading freshly harvested baby brains. Would you do it?” he asked. “To me bitcoin is almost as bad.”
– Charlie Munger

“I regard the whole thing as a combination of dementia and immorality. I think the people pushing it are a disgrace,” he concluded. “There ought to be some things that are beneath you, that you just don’t do, and this is one.”
– Charlie Munger

“I’d fire them in a second [if a JPMorgan trader began trading in bitcoin]. For two reasons: It’s against our rules, and they’re stupid. And both are dangerous.”
– Jamie Dimon

“It’s a fraud”
– Jamie Dimon

Did you ever hear any of these extraordinarily successful and prudent gentlemen use such abrasive and demeaning language speaking about anything else – ever? I’ve read Poor Charlie’s Almanac and Charlie’s statements came across to me as a bit hyperbolic and contrived.

I seriously question if any of these people have spent any considerable time learning how Bitcoin works.

Don’t get me wrong, the fact that these men own the biggest banks in the world doesn’t make their argument against it any more or less valid, it just makes me wonder why they don’t have better arguments. It’s almost like they want you to feel stupid for even wanting to know more about it because it’s clearly such an idiotic and immoral thing to do. There is a saying in Bitcoin, “Don’t Trust. Verify.” I suggest you make up your own mind if there is any validity to what Bitcoin is, how it works, and it there is any place for it in the world.

Bitcoin Actually Works

All the other theses up until now have been concerned with how things outside of Bitcoin will change and how that change may make Bitcoin appealing. One small detail to not overlook is that Bitcoin actually works. With only a laptop and some way to transmit data (usually, but not always, internet), you can send real value to anyone in the world – and no one can stop you. You don’t need permission, a license, or authorization – the system just works.

Scams and How to Spot Them

FOMO

Explicit: “This coin is going to the moon next week.”

Implicit: “I’d hate for you to miss out on the best investment of your life.”

Focus on Specific Returns

Similar to implicit FOMO, scammers may not explicitly state that they promise returns (if they do it’s definitely a scam) but they may overemphasize specific historical returns.

Saying someone using their “system” had a 2,371% return is so specific that it must be a legitimate number. This is meant for you to extrapolate this return into the future as your “expected” return and make you feel dumb for waiting to buy their product.

Appeal to Authority

“I know lots of rich people and venture capitalists, hedge funds, and big institutional investors are waiting to jump into the crypto market.”

“His work has been endorsed by [some official sounding authority].”

Connections with Popular Figures

Casually “name dropping” an influential figure into a conversation (or showing pictures of you with them) is a great way to lend yourself faux authority. Are you really best friends with the person or did you just see them and take a selfie at a conference?

Black Box “Strategies” or Trading “Systems”

Lots of scammers claim to have a proven “trading strategy” that will give you a return on your investment. If anyone ever asks you to put your money into a “black box” (mysterious, complex and undefined way to make money), run the other way. It’s a scam.

If someone advises you to actively trade cryptocurrencies, they are almost certainly scamming you. These markets are extremely volatile and you can absolutely lost to ton of money actively trading. They are also almost certainly “front running” you (i.e. trading before they tell you to so they get better prices).

Use the Phrase “Next Bitcoin”

Besides being lazy marketing, it’s just scammy to say this.

Blockchain

Someone saying they know the “best way to invest in ‘blockchain’” is like saying you know the best way to invest in car exhaust. They are both the outputs from complicated systems, but neither of them does anything valuable on its own.

Stablecoins

Some people think that bitcoin would be more usable as a currency if it didn’t have such volatile price swings. While this may be true, bitcoin and stablecoins differ drastically in how they seek to achieve this result.

I believe that bitcoin’s volatility will decrease as it nears the top of the adoption “S” curve (i.e. after it has cemented itself as a formidable alternative to state-backed currencies as a store of value) and this process is not something you can artificially accelerate.

One thing that has very little volatility is the US dollar. In the stablecoin model, the logic goes that if we create a cryptocurrency that is 100% backed by US dollars in a bank account, we can tokenize the dollar value of the account and have all the benefits of Bitcoin, with none of the volatility.

As with people who push the “blockchain, not bitcoin” narrative, always ask yourself “why does this system exist?” The answer for Bitcoin is simple – peer-to-peer electronic cash. What is the answer for stablecoins? To me, stablecoins will be centralized companies that are not open, permissionless, censorship resistant, or neutral and as such serve no purpose other than to separate fools from their money.

If you are confused if stablecoins are a good idea, ask what would happen if it was proven that the coin was used to buy illegal drugs.

• Could the government shut down the stablecoin operator’s bank account? Yes.
• Will the stablecoin operator let the drug dealer redeem the US dollar value of their drugs from the service? No.
• Will the government arrest the stablecoin operators? Yes.
• Will the stablecoin operators steal money from the bank account, prohibit or delay audits, and otherwise diminish the trustworthiness of their system? Yes.

Again, the point of the argument is not to say you should buy illegal drugs, the point is to say that digital currency systems shouldn’t add a central point of failure and call it a feature.

Initial Coin Offerings (ICOs)

Considering buying an ICO? Don’t. Do. It.

ICOs offer perhaps the easiest way for “innovators” (i.e. people who are not you and who control the new coin) to earn enormous amounts of money for little to no work.

Venture Capital (VC) investing is one of the riskiest ways you can invest money. In that model, a VC provides money to a growing company in return for equity in the hope that their capital and connections will increase the value of the company and in doing so, increase the value of their equity.

In the ICO model, people give money to strangers (sometimes anonymous strangers) with no code or working product in exchange for tokens (not equity). When you give money to an ICO, the money is purely a donation where the recipient gives you no warranty or promise of any kind. The founding teams of many ICOs have simply taken the money given to them and disappeared (i.e. “exit scam”). When you lose money in an ICO, you will get no sympathy because you deserve none.

Definite Language

Scammers can use definite language to make their claims sound powerful and authentic.

“Unlike sharding proposals or the lightning network, Elixxir teams cannot influence the consensus mechanism’s integrity as all aspects of block production are independently predetermined in a strict, verifiable, and immutable manner.”
https://cdn2.hubspot.net/hubfs/4816439/Elixxir_Technical_Brief.pdf

Contrast this with Satoshi’s language in the Bitcoin whitepaper

“The Bitcoin network uses a framework of coins made from digital signatures and a peer-to-peer network using proof-of-work to record a public history of transactions that quickly becomes computationally impractical for an attacker to change.” – Bitcoin Whitepaper

The effect of this computational impracticality is immutability of data included in the blockchain, but Satoshi didn’t want to overstate or misrepresent the qualities of the Bitcoin blockchain.

Actual Scams Which Happen to Use Cryptocurrencies

Some scams don’t acknowledge themselves as such while some have welcomed the title and have used it to drive use of their product.

One hilarious example is Fomo3D, which operates itself as a pyramid scheme (early players get paid by later players) and exit scam (last participant gets all the money). Players purchase and use a key which adds 30 seconds to the game clock. If the clock gets to 00:00, the last key user gets all the ETH. At the time of writing, there are over 20,000 ETH and over $6 million in play. This is the best example I’ve seen of greater fool theory in practice.

Meaningless Ways to Make a Coin Look “Successful”

Scammers are generally great at marketing and there are lots of ways marketing can lead consumers to false conclusions. Don’t be persuaded by marketing. Ask yourself if the coin does something useful and decide for yourself.

Features

Don’t ask what someone can do with the blockchain. Ask what no one can do to the blockchain.

Many altcoins market some feature (privacy, throughput, scripting) as a positive differentiator to Bitcoin. These may well be interesting features in a vacuum, but without a highly secure foundation, the entire system is at risk.

This is equivalent to saying your new car can go 10,000 miles on a tank of gas…but the wheels are made of paper. Once the car starts going down the road, you are stuck with the paper wheels so there is no way you’ll actually make it to 10,000 miles.

Building interesting features on an unsound foundation is a recipe for disaster.

Market Cap

Super easy to manipulate. Create 10 trillion coins. Sell 1 to your friend at $1 and you’ve just created a $10 trillion market cap coin.

Exchange Listing / Wallet Support

Ask exchanges (or wallets) to list your scamcoin. They will probably make you pay several million dollars to get listed, but that’s just a line item on the marketing budget or a small piece of the founder reward.

Exchange “Wash Trading” Volume

On many exchanges without trading fees, it used to be easy to create fake volume. Just create two accounts and trade back and forth between them very frequently. This is what many now-defunct Chinese exchanges were doing when they accounted for 98% of bitcoin trading volume (shown in blue).

On-Chain “Spam”

While open, neutral, and public blockchains don’t designate messages as “spam”, there are clear instances where manufactured transactions are produced in an effort to prove a point or press an agenda.

Number of Developers / Developer Activity

Not all developers have the same value. The first Bitcoin client was coded (at least materially) by Satoshi Nakamoto and Hal Finney over several months. The genius of software is how one mind’s creation can be leveraged by the whole world. For this, you need quality, not necessarily quantity.

Merchant Support / Enterprise Alliances

Businesses like to sound smart. Don’t confuse a press release saying a company is “supporting” something with real customers getting value from the thing.

Blockchain Size

Looking at the chart below, a casual observer might think “Wow! Ethereum is doing way better than Bitcoin because their blockchain size is going up much faster!” Thinking this way misses the point that it is not “better” or “worse” to have a 200 GB blockchain over a 700 GB blockchain. What matters is that the blockchain continues to be stored and validated by all full nodes in the network.

Full node operators should be able to reasonably estimate the resources they will need to keep their node in consensus. Cryptocurrencies which require non-immaterial resources to store and validate their blockchain will either centralize or fail.

Bitcoin “Improvements”

Within the Bitcoin ecosystem there are many different levels of interaction between parties. Changes to some levels (like the Bitcoin protocol) require broad consensus to be successful. Changes to other layers that merely utilize the Bitcoin protocol (wallets, exchanges, mining infrastructure, etc.) can be made as desired without jeopardizing the stability of the underlying protocol.

It is a fact that there is a limit to the number of transactions that can physically fit into the Bitcoin blockchain in its current form. And as we have also seen, there are tradeoffs in scalability and decentralization.

The Bitcoin Core developers have been conservative in their approach to maintain a high degree of decentralization in the short term as scalability solutions are developed and tested.

How Do Changes Actually Get Made?

In Bitcoin Core (the most popular Bitcoin client), there is a rigorous proposal [BIP 2], testing, and review process for all consensus changes to the software.

The fact that a change has been made to the software doesn’t mean that people will run this version of the software. This heightens the need for broad consensus so that full node operators actually do “upgrade” to the version with the newly introduced change. People also have different views on what Bitcoin “is” based on how they use it (micro-payments, store of value, etc.) and nearly everyone has some belief that they “know what’s best” for Bitcoin whether they will admit it or not. The trick is to not take it too personally when it turns out that Bitcoin doesn’t care about your opinion or timeline.

One difficulty in changing Bitcoin is that while it is an extremely robust ecosystem, even well-meaning and seemingly innocuous changes to the way it works could have large unintended consequences to the incentives and functioning of the system over time.

The sample items discussed below are all previously implemented, proposed, or possible future proposals to the Bitcoin protocol, making them very meaningful. Whether they should be seen as “improvements” or “attacks” is up to you.

In general, people want to make Bitcoin more private (as digital cash) and more scalable (to be used by more people).

Block Size Increase

Status: Previous attempts failed (notably Fall 2017), further attempts will come (TBD)

Concept

Because Bitcoin blocks can only hold a certain amount of data – and thus a certain number of transactions – you can increase the number of transactions processed through the system if you make each block larger.

Pros

• Increase transaction throughput
• Decrease transaction fees (due to less scarcity for block space)
• Increase short term adoption by allowing more people to use Bitcoin on a daily basis

Cons

• Temporary solution – How big is big enough for blocks? If a 2mb block is good, a 100mb block will be better. If block size increases are the main route to scalability in Bitcoin, there will never be a block big enough to satisfy all the world’s transactions.
• Encourages inefficient use of blockchain space (exchanges and high-volume users have no incentive to implement best practices in their use of the blockchain if fees are always de-minimis)
• Delays the legitimate need to develop a material fee market (as the halving schedule continues toward a 0-bitcoin block reward). If Bitcoin is to survive in the long run, it must develop a viable fee model to secure the network once the block subsidy runs out.
• Only linear (not geometric) increase in transaction throughput
• Engineering complexity (block propagation and validation issues could increase orphan block rate, leading inefficient miner capital allocation)
• Decrease decentralization (due to increased cost and computational burden to run a full node)

Segregated Witness (“SegWit”)

Status: Completed (Fall 2017)

Concept

• Fixed a transaction malleability bug which could have been used to confuse address balances and hinder second-layer scaling solutions
• Fix was to move transaction witness (signature) data location to a different place within the transaction structure so the transaction ID cannot be maleated after a user signs a transaction

Pros

• Soft fork (i.e. backward compatible)
• Changed the way block size is measured to approximately 4x the number of transactions which can fit into a block (i.e. moved from measuring block size to block weight (SegWit format carries less weight than traditional format)
• Enabled much simpler and robust implementation of Lightning Network
• Enabled script versioning which will simplify future changes

Cons

• Eventually, nodes that need to deal with SegWit UTXOs will need to upgrade in order to trustlessly validate the blockchain
  • Nodes that do not implement SegWit will interpret SegWit transactions as valid (even if they have an invalid signature) because the portion of the transaction specifying who can spend the new output cannot be interpreted by the non-SegWit node
  • Running a non-SegWit node is effectively trusting that the longest chain that you’ve heard about has been verified by a SegWit node somewhere (since your node won’t be able to tell the difference between a valid transaction spending a SegWit output and an invalid transaction spending a SegWit output)

Lightning Network (“LN”)

Status: Advanced beta testing on mainnet in progress (Summer 2018)

Concept

Bidirectional payment channel network to allow “second layer” (i.e. off-chain) scaling. Users deposit bitcoin into one or more payment channels with other users. This structure creates a network of payment channels and enables users to pay users (with whom they do not have a direct channel connection) across the network in a trustless manner (no counterparty risk) and with the security of Bitcoin’s blockchain. Each payment within the lightning network is a valid Bitcoin transaction that is simply not broadcast to the network yet.

Pros

• First truly non-linear scaling solution (i.e. numerous (practically unlimited) transactions can happen between channel openings and closings with willing participants)
• Nearly trustless security model with very little risk of loss of funds (and good options to further reduce risk)
• Increased transaction privacy (all LN transactions are routed with TOR-like encryption, meaning intermediate hops do not know the origination or destination of the funds)

Cons

• Changes Bitcoin’s security model in that there are circumstances (albeit unlikely) where an attacker may steal funds (primarily by broadcasting a prior state of the payment channel under which he has more funds than the current state). This risk can be mitigated by running a high-uptime LN node or watchtowers and may be mitigated by developing update mechanisms like eltoo
• Relies on a well-functioning Bitcoin base layer (degraded utility if users cannot effectively open and close channels in the normal course of operation)

Cool Stuff

Watchtowers [Security] – Let users outsource blockchain monitoring to third parties. When making an LN transaction, users send a small data package to a Watchtower with a hint about the transaction. If seen, the watchtower can use the second part of the package they’ve received to reconstruct the penalty transaction. The penalty transaction can also be designed to let the Watchtower claim part of the funds as a reward, as an incentive to do its job.

Compact Client-Side Block Filtering (Neutrino) [Scaling] – Lightning users need to watch the blockchain (from their phone) to see if specific transactions happened. Neutrino makes it easier for small devices to run nodes and improves privacy (vs. current SPV bloom filters).

Atomic Multi-Path Payments (AMPs) [Usability] – Large payments can be “cut up” into smaller pieces across several channels, each with their own route from sender to recipient. Either all arrive and are accepted or all fail.

Channel Factories [Scaling] – Many participants open a channel together (with the help of Schnorr) and can open and close a virtually unlimited number of LN channels with each other, with only two on-chain transactions. Could reduce the number of required on-chain transactions by 90%.

Splicing [Usability] – Lets a user “top up” or “drain” funds to/from an existing channel while keeping the channel open.

Eltoo [Security] – Allows users to avoid penalty transactions (i.e. losing all channel funds to the opposing party) if an old channel state is broadcast.

Dual-Funded Channels [Usability] – Both channel participants can immediately send and receive payment upon opening a channel.

Submarine Swaps [Usability] – Alice wants to make an on-chain bitcoin transaction (but has bitcoin in a channel). Alice sends an LN payment to a middleman; the middleman then sends a corresponding amount of bitcoin to a regular (on-chain) Bitcoin address. The process also works in reverse. Importantly, the structure of the transactions make it impossible for either party to steal funds.

Atomic Swaps [Usability] – The LN protocol is not distinct to Bitcoin. It works with many different coins. Trustlessly transact between two coins (say Bitcoin and Litecoin) using LN. Many interesting use cases arise when parties can hold their preferred coin and transact trustlessly in different coins.

Schnorr Signatures (“Schnorr”)

Status: Proposed BIP (as of Summer 2018), not merged into Core yet

Concept

Improve transaction signature efficiency and privacy. Without Schnorr Signatures, whenever you have multiple inputs to a single transaction, the need for multiple signatures makes transactions large (and therefore expensive) in the blockchain. As UTXOs become smaller, Schnorr provides a way to aggregate signatures from UTXOs within a transaction into a single, yet verifiable signature in the blockchain. Schnorr would supplement Bitcoin’s current signature algorithm (ECDSA) and would be triggered by an additional script version as allowed via SegWit.

Pros

• Makes each signature (a little) smaller
• Aggregate signatures from multiple transaction inputs (UTXOs) or signers (multisig) for more substantial (~25%) space savings
• Compatible with Bitcoin’s current elliptic curve (secp256k1) and purely optional use (i.e. can still sign with ECDSA if desired)
• Soft fork implementation via SegWit script version
• Coinjoin incentive

Cons

• No technical cons that I have seen

Cool Stuff

Adapter Signatures – Make atomic swaps appear as normal transactions

• Lock both funds in two 2-of-2 multisig addresses
• Produce (and give to the other party) damaged signatures for both where you prove that each signature is damaged by the same amount
• Taking the funds will reveal the real signature in one transaction
• Calculate the difference between the real and damaged signature
• Apply the difference to the other damaged signature to produce a valid signature, letting the other party sweep their funds

MuSig

Concept

Multi-signature protocols allow a group of signers to produce a single signature on a message.

A standard signature scheme can be turned into a multi-signature scheme by having each signer produce a signature and concatenate all individual signatures. The problem with this is that the size of the multi-signature grows linearly with the number of signers. In order to be useful and practical, a multi-signature scheme should produce signatures whose size is (ideally) independent from the number of signers and close to the one of an ordinary signature scheme.

Schnorr by itself is good for aggregating UTXO signatures within the same transaction (with one signer). MuSig extends Schnorr to add a multi-signature scheme.

Pros

• First multi-signature scheme provably secure in the plain public-key model which allows key aggregation
• Solves the “rogue-key attack” and enables secure Schnorr multisig – recovers the ability to aggregate keys (Schnorr) without losing security that is compromised whenmultiple parties jointly produce a valid single-key signature for the sum of the keys
• Simple and efficient – same key and signature size as standard Schnorr signatures
• Allows key aggregation – the joint signature can be verified exactly as a standard Schnorr signature (a single “aggregated” public key which can be computed from the individual public keys of the signers)
• availability of key aggregation removes the need for verifiers to see all the involved keys, improving bandwidth, privacy, and validation cost
• Enhance the usability of low-trust escrow services and split-device security at no additional cost (transaction fee or size) to the user
• Improve fungibility and privacy by making multi-sig transactions appear to be normal transactions (because only 1 signature present)
• Increase privacy by obfuscating which parties sign a multisig transaction (ex: which 2 of 3) and the threshold needed (because it looks like 1 of 1). The example is that ExchangeX releases their new wallet service which uses 3-of-7 multisig and they are the only ones that do 3-of-7 on the network, without Schnorr and MuSig you can automatically identify which transactions are theirs

Cons

• Known flaw in the security proof of the 2-round version. Although there is no known attack against it, 2-round MuSig security does not appear to be provable. (Good news: 3-round has a valid security proof)
• Interactive scheme so signers need to coordinate