Bitcoin

Bitcoin

Bitcoin-Qt
Developer(s)	Satoshi Nakamoto (inactive, possibly a pseudonym),, Gavin Andresen, Amir Taaki, Luke Dashjr, Pieter Wuille, Nils Schneider, Jeff Garzik, Wladimir J. van der Laan, Gregory Maxwell, and others
Initial release	January 9, 2009 (2009-01-09)
Preview release	0.5.3.1 / March 16, 2012 (2012-03-16)
Written in	C++
Operating system	Windows, GNU/Linux, Mac OS X, FreeBSD
Available in	Dutch, English, French, Italian, German, Portuguese, Russian and Spanish.
Type	Electronic money
License	MIT License (open-source)
Website	www.bitcoin.org

Bitcoin is a decentralized electronic cash system using peer-to-peer networking, digital signatures and cryptographic proof to enable irreversible payments between parties without relying on trust. Payments are made in bitcoins, a digital currency issued and transferred by the Bitcoin network. Nodes broadcast transactions to the network, which records them in a public history, called the block chain, after validating them with a proof-of-work system. The Bitcoin network is by far the fastest distributed computing network in the world. (List of distributed computing projects)

The Bitcoin network began on 3 January 2009 with the issue of the first bitcoins. In the same month the creator, Satoshi Nakamoto, released the original Bitcoin client as open-source software.

Usage

Participants begin using Bitcoin by first acquiring a Bitcoin wallet and one or more Bitcoin addresses. Bitcoin addresses are used for receiving bitcoins, similar to how e-mail addresses are used for receiving e-mail.

A Bitcoin wallet can exist in several forms, including:

• A user can download the Bitcoin software, which stores the coins on the user's hard drive in a wallet file. The user can use the software to manage the coins and send them to other addresses.
• A user can register with an exchange or website that stores bitcoins. The user can send the bitcoins onward to another address through the website.
• A user can print a "paper wallet" using a website or program. The wallet consists of large strings of numbers and exists purely on paper, but can be reconstituted back into an electronic wallet. Bitcoins can be "sent" to the address printed on the paper wallet, where they remain unmovable until the paper wallet is re-imported back into a computer. Paper wallets are frequently used for long-term storage and safekeeping.
• Brainwallet: A user just needs to remember a sufficiently long phrase (12 words or more). No file or any other physical storage is necessary. Essentially, your Bitcoin funds are stored in your head.

Physical Bitcoins have also been created. They are essentially bearer tokens with miniature paper wallets embedded inside by the manufacturer. Once broken open, the paper wallet can be redeemed for digital bitcoins.

Advantages

Even though Bitcoin is currently considered experimental software, it provides several advantages over traditional forms of money. Some of these characteristics are new concepts never encountered before in history.

• International: Bitcoin is truly global. It does not discriminate its users on citizenship or location.
• Always running: No bank holidays. The Bitcoin network works 24/7.
• Inexpensive to secure: Unlike precious metals, there is no custody charge in Bitcoin. The mining rewards are enough to cover the creation of Bitcoins and the protection of the network.
• Low fees: Miners record transactions in the block chain for very low fees.
• No chargebacks: Person to person Bitcoin transfers are irreversible. On the other hand, chargebacks are possible when all parties involved in a transaction agree to use an escrow service.
• Non-manipulatable: Unlike fiat money, Bitcoin is decentralized and stable in supply, so quantitative easing is not possible.
• Non-confiscatable: Accounts can not be frozen by any government. In situations of political instability, bank runs, corralitos and wars, users can leave their country with no baggage at all and start a new life with their Bitcoin savings.
• New privacy model: Anonymity is possible. Total transparency is also possible. Several websites provide information of all transactions and the balance of all Bitcoin addresses.
• Zero counter-party risk: Each Bitcoin wallet holds the real assets, unlike the balance in a bank account, which is subject to fractional reserve banking.
• Value dense: A single Bitcoin address can store millions of USD.
• Divisible: Bitcoins are currently divisible to up to eight decimals.
• Recognizable: Unlike gold, which needs an acid test or even drilling the bullion to check for its purity, Bitcoins are immediately distinguishable thanks to state of the art cryptography.
• No need of banks: Bitcoins can be securely transferred person to person. They can also be stored in a file, so no banking system is necessary.

Network

Owners transfer bitcoins by sending them to another Bitcoin address using a website or program designed for this purpose. Under the hood, the software transfers the coins by generating a digital signature to link the prior transaction with the public key of the next owner. Bitcoin nodes record all data necessary to make any valid transaction in a publicly distributed database called the block chain. Nodes build the block chain using a proof-of-work system that prevents double-spending and confirms transactions.

Addresses

Bitcoin uses public-key cryptography using Elliptic Curve DSA. Any user in the Bitcoin network has a digital wallet containing a number of cryptographic keypairs. The wallet's public keys are transformed into Bitcoin addresses, which act as the receiving endpoints for all payments. Addresses in human-readable form appear as strings of numbers and letters around 33 characters in length, always beginning with the digit 1 or 3, as in the example of 1HULMwZEPkjEPeCh43BeKJL1ybLCWrfDpN. The wallet's private keys are used to authorize transactions from that user's wallet.

Transactions

A Bitcoin software client uses a wallet, a collection of the user's addresses and corresponding private encryption keys. Users can create as many Bitcoin addresses as they wish. When user A wants to transfer bitcoins to user B, A creates a transaction message indicating that some of the balance associated with their Bitcoin wallet is to be sent to the address of B, and A's Bitcoin client signs the transaction with the address's private keys.

Because of the asymmetric cryptographic method, only the owner's private keys are able to create a valid signature to send coins from their Bitcoin wallet. The private keys cannot be determined from the signature - they are a secret known only to the address owner. The owner's node broadcasts the resulting message to send money, the transaction, on the peer-to-peer network. Other members of the peer-to-peer network validate the cryptographic signatures and the amounts of the transaction before accepting the money transfer.

Confirmations

The main chain (black) consists of the longest series of blocks from the genesis block (green) to the current block. Orphan blocks (grey) exist outside of the main chain.

To prevent double-spending, the network implements what Nakamoto describes as a peer-to-peer distributed timestamp server, which assigns sequential identifiers to each transaction, which are then hardened against modification using the idea of chained proofs of work (shown in the Bitcoin client as confirmations). In his white paper, Nakamoto wrote: "we propose a solution to the double-spending problem using a peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions."

Whenever a node broadcasts a transaction, the network immediately labels it as unconfirmed. The confirmation status reflects the likelihood that an attempt to reverse the transaction could succeed. Any transaction broadcast to other nodes does not become confirmed until the network acknowledges it in a collectively maintained timestamped-list of all known transactions, the block chain.

Target

Every generating node in the Bitcoin network collects all the unacknowledged transactions it knows of in a file called a block, which also contains a reference to the previous valid block known to that node. It then appends a nonce value to this previous block and computes the SHA-256 cryptographic hash of the block and the appended nonce value. The node repeats this process until it adds a nonce that allows for the generation of a hash with a value lower than a specified target. Because computers cannot practically reverse the hash function, finding such a nonce is hard and requires on average a predictable amount of repetitious trial and error. When a node finds such a solution, it announces it to the rest of the network. Peers receiving the new solved block validate it by computing the hash and checking that it really starts with the given number of zero bits (i.e., that the hash is within the target). Then they accept it and add it to the chain.

Block chain

The network confirms a transaction when it records it in a block. Further blocks generated further confirm it. After six confirmations, most Bitcoin clients considers a transaction confirmed beyond reasonable doubt. After this, it is overwhelmingly likely that the transactions are part of the main block chain rather than an orphaned one, and impossible to reverse.

Eventually, the block chain contains the cryptographic ownership history of all coins from their creator-address to their current owner-address. Therefore, if a user attempts to reuse coins he already spent, the network rejects the transaction.

The network must store the whole transaction history inside the block chain, which grows constantly as new records are added and never removed. Nakamoto conceived that as the database became larger, users would desire applications for Bitcoin that didn't store the entire database on their computer. To enable this, the system uses a Merkle tree to organize the transaction records in such a way that a future Bitcoin client can locally delete portions of its own database it knows it will never need, such as earlier transaction records of bitcoins that have changed ownership multiple times, while keeping the cryptographic integrity of the remaining database intact. Some users will only need the portion of the block chain that pertains to the coins they own or might receive in the future. At the present time however, all users of the Bitcoin software receive the entire database over the peer-to-peer network after running the software the first time.

Difficulty

As more people use more (or less) computing power to try to generate valid blocks, the rate of block creation increases (or decreases). To compensate for this growth and to keep the rate of block creation close to the desired average of one block every ten minutes, Bitcoin changes the difficulty of finding a valid block every 2016 blocks. Each node in the network adjusts the difficulty so the distribution mean is λ = 2016 blocks per two weeks, so that there are roughly ten minutes between the creation of new blocks on average (the wait times between events in a Poisson process follow an exponential distribution). The network sets the difficulty to the value that would have most likely caused the prior 2016 blocks to take two weeks to complete, given the same computational effort (according to the timestamps recorded in the blocks). All nodes perform and enforce the same difficulty calculation.

In addition to the pending transactions confirmed in the block, a generating node adds a "generate" transaction, which awards new bitcoins to the operator of the node that generated the block. The system sets the payout of this generated transaction according to its defined inflation schedule. Nakamoto compared the generation of new coins by expending CPU time and electricity to gold miners expending resources to add gold to circulation. The "miner" that generates a block also receives the fees that users have paid as an incentive to give particular transactions priority for faster confirmation.

A strong correlation exists between the price of bitcoins in the free market and the hashing power of the network at any specific time. Difficulty is the automatic stabilizer which allows to keep mining for bitcoins profitable in the long run for the most efficient miners. This holds true independently of the fluctuations in demand of Bitcoin in relation to other currencies.

The proof-of-work problems are especially suitable to GPUs and specialized hardware. Because of the growing computing power behind the system driving the difficulty to high levels, individual contributors with typical CPUs are no longer likely to solve a block on their own but can still receive small portion of the bitcoins generated in a new block by contributing their processing power to a mining pool. This increased difficulty makes it cost prohibitive for an attacker to perform double-spending attacks, benefiting network integrity.

The network never creates more than 50 BTC per block and this amount will decrease over time towards zero, such that no more than 21 million will ever exist. As this payout decreases, the incentive for users to run block-generating nodes will change to earning transaction fees.

Transaction fees

Miners have no obligation to include transactions in the blocks they try to solve. The client can associate a transaction fee with any transaction, giving miners an incentive to put the transaction in a block, as miners collect the transaction fees associated with all transactions included in blocks they solve. Very small transactions, or those that use relatively new coins, have low "priority" and the network may require a transaction fee to reduce spam. Most bitcoin clients, including Bitcoin-Qt version 0.5.2 (beta), enforce a minimum fee for low priority transactions of 0.0005 BTC.

Privacy

Because transactions are broadcast to the entire network, they are inherently public. Unlike regular banking, which preserves customer privacy by keeping transaction records private, loose transactional privacy is accomplished in Bitcoin by using many multiple unique addresses for every wallet, while at the same time publishing all transactions. As an example, if Alice sends 123.45 BTC to Bob, the network creates a public record that allows anyone to see that 123.45 has been sent from one address to another. However, unless Alice or Bob make their ownership of these addresses publicly known, it is difficult for anyone else to connect the transaction with them. However, if someone connects an address to a user at any point they could follow back a series of transactions as each participant likely knows who paid them and may disclose that information on request or under duress.

Jeff Garzik, one of the Bitcoin developers, explained as much in an interview and concluded that "attempting major illicit transactions with bitcoin, given existing statistical analysis techniques deployed in the field by law enforcement, is pretty damned dumb". He also said "We are working with the government to make sure indeed the long arm of the government can reach Bitcoin... the only way bitcoins are gonna be successful is working with regulation and with the government"

Real estate metaphor

To understand bitcoin it helps to compare it to the way private real estate is managed. The block chain serves as the registrar of all bitcoin titles and transfers. The bitcoin address serves exactly the same function as a parcel number (although in bitcoin the parcels are highly subdividable and/or consolidatable). Proof of title is accomplished by possession of the private key corresponding to the bitcoin address. Successfully signing a new block grants a new land patent of (currently) 50 bitcoins. The term "wallet" is poorly named. A more accurate name would be "key safe" as it doesn't actually contain any bitcoins. It contains the user's private keys, enabling him to prove title for a transfer.

Client

Bitcoin software running under Windows 7

Read-only access to bitcoin addresses can be achieved using various websites or software to query the number of bitcoins associated with any address. Also, the transaction history of all bitcoins is freely available to query, and because all transactions are added to the bitcoin block chain, which is a distributed database formed by all bitcoin participants, a user's bitcoin software does not need to be running for that user to receive bitcoins.

In order to be able to send bitcoins from an address (such as when purchasing products or other currencies) one must be in possession of the private key associated with that address. These are typically referred to as "wallets", and the wallet, or private key, should be considered as valuable as the bitcoins associated with the address to which the private key belongs.

Wallets can be kept offline (i.e. not connected to the internet), and this is safer than storing a wallet online. Encrypting the wallet is also recommended. The more bitcoins that can be accessed using the wallet, the greater the effort that is recommended in keeping it secure.

Online wallets are usually that which is contained within the bitcoin client software, or could be an "ewallet" which is usually a web-based bitcoin client which serves multiple users.

Bitcoin payments are normally displayed to the receiver near-instantly, but the client initially displays them as unconfirmed, because the bitcoin system cannot yet assure that the transaction is permanent. The network may invalidate a transaction because of a conflict (such as the client sending the same bitcoins to two different receivers). This may happen if a sender malfunctions, or if a sender intentionally attempts to defraud a receiver. When the network processes the transaction, it adds an increasing number of confirmations every time the network extends the block-chain.

The process of confirming a transaction is accomplished by solving a computationally difficult proof-of-work problem. The problem is based on data from the transactions that must be confirmed, as well as the entire previous transaction history. This process makes it infeasible for an attacker to rewrite the transaction history without having more computing power than the rest of the bitcoin system. Nodes that process blocks of transactions are rewarded by receiving a programmed amount of bitcoin, which arises "out of thin air," as well as any transaction fees associated with the transactions they process. This compensates the operators of these systems for their computational work used to secure bitcoin transactions against reversal, and also accomplishes the initial wealth distribution for the bitcoin system as a whole. The network automatically adjusts the difficulty of the proof-of-work problem to maintain the average time between new blocks at ten minutes. All participating systems check the validity of every transaction and of every block and ignore any that violate the rules, such as blocks that bring the wrong amount of new bitcoin into existence, or transactions that would involve one sender spending the same bitcoin twice.

Implementations

Protocol implementations include the original C++ Bitcoin codebase and an open source implementation in Java called BitCoinJ. There are also many other implementations in development, including libraries for C++ (not based on the original codebase), Perl, Haskell, and Erlang.

Currency

As of 2012, over 8 million of the total 21 million BTC have been mined. An algorithm determines this number as described in Nakamoto's whitepaper. Because the block chain database represents all bitcoins in existence, the number is not only easy to determine, but all participants can quickly determine it with precision.

Anyone can view the block chain and observe transactions in real-time. Currency exchanges also exist between bitcoins and other real and virtual currencies, such as the US dollar and the Linden Dollar. By June 2011, the market had priced 1 BTC at more than twenty-nine USD. By October 2011, the price had fallen to less than three USD.

Monetary differences

Expected future bitcoin supply (for 10-minute issuance frequency).

Unlike conventional fiat currency, Bitcoin has no centralized issuing authority. The Bitcoin software hardcodes a limited controlled expansion of the monetary base.

Transactions are facilitated directly without the use of a centralized financial processor between nodes, which makes reversal unlikely. Bitcoin transactions can represent many kinds of operations such as pure peer-to-peer escrow and deposits but currently developers have not developed user interface software for this advanced functionality. The Bitcoin client broadcasts transactions to surrounding nodes, which propagate them across the network. Corrupted or invalid transactions are rejected by legitimate clients. Transactions are free; however, clients may pay an optional, often necessary, fee to other nodes to prioritize transaction processing.

The network is programmed to grow the money supply as a geometric series until the total number of bitcoins reaches 21 million BTC.

By 2013 half of the total supply will be generated, and by 2017, 3/4 will be generated. To ensure sufficient granularity of the money supply, clients can divide each BTC unit down to eight decimal places (a total of 2.1 × 10¹⁵ or 2.1 quadrillion units).

The diminishing geometric expansion combined with the expansion of Bitcoin users provides an incentive for early adopters, who can obtain bitcoin at preferential exchange rates.

Bitcoin's design allows for pseudonymous ownership and transfers. Because of this, Bitcoin has privacy properties weaker than cash but stronger than traditional electronic payment systems. Although the network makes the complete history of every bitcoin transaction public, it can be difficult to associate bitcoin identities with real-life identities. This property makes bitcoin transactions attractive to some sellers of illegal products who assume police will not go to the trouble.

Currency exchange

Parties may exchange bitcoins directly, or with the aid of an exchange, such as Mt. Gox and Intersango (formerly Britcoin),.

Reception and concerns

Adoption

Wikileaks, Freenet, Singularity Institute, Internet Archive, Free Software Foundation and others, accept donations in Bitcoin. The Electronic Frontier Foundation did so for a while but has since stopped, citing concerns about a lack of legal precedent about new currency systems, and because they "generally don't endorse any type of product or service – and Bitcoin is no exception." Gavin Andresen, one of the main developers, is explicitly advising people "not to make heavy investments in bitcoins", calling it "kind of like a high risk investment". Jered Kenna, CEO of TradeHill, formerly a major Bitcoin Exchange, also cautions eager investors and stated to the The New York Observer that "Bitcoin is still an experiment and not to bet the house". As of July 2011, some small businesses have started to adopt Bitcoin. LaCie, a public company, accepts Bitcoin for its Wuala service. A frequent problem faced by retailers willing to accept Bitcoin is the high volatility of its exchange rate to the US dollar, as well as the absence of futures to hedge this volatility (although option contracts are available). In a review of the virtual currency, James Surowiecki opined that hoarding by speculators represented one of the largest hindrances to accelerating its adoption.

Initial distribution

Bitcoins are awarded to Bitcoin miners for the solution to a difficult proof-of-work problem which confirms transactions and prevents double-spending. This incentive, as the Nakamoto white paper describes it, encourages "nodes to support the network, and provides a way to initially distribute coins into circulation, since no central authority issues them."

The network currently requires over 1,000,000 times more work for confirming a block and receiving an award (50 BTC as of February 2012) than when the first blocks were confirmed. The network adjusts the difficulty every 2016 blocks based on the time taken to find the previous 2016 blocks such that blocks are created roughly every 10 minutes. Thus the more computing power that is directed toward mining, the more computing power the network requires to complete a block confirmation and to receive the award. The network will also halve the award every 210,000 blocks, designed to occur about every four years.

Those who chose to put computational and electrical resources toward mining early on had a greater chance at receiving awards for block generations. This served to make available enough processing power available to process blocks. Indeed, without miners there are no transactions and the Bitcoin economy comes to a halt.

Some criticize Bitcoin for being a Ponzi scheme in that it rewards early adopters. While early Bitcoin miners may benefit more than later ones, the returns on their investments do not come at the expense of others participating in the Bitcoin economy. The return (on invested computing power and electricity) is the award for doing useful work in the Bitcoin network by verifying blocks, and often costs nearly as much in electricity costs as they receive.

Prices

Prices fluctuate relative to goods and services more than more widely accepted currencies, since the price of a bitcoin is not yet sticky. Also, different exchanges quote different prices, implying the market is not yet efficient. On 19 June 2011, a security breach of the Mt. Gox Bitcoin Exchange caused the leaking of usernames, emails and MD5 hashed passwords of over 60,000 users onto the Web. The price of a bitcoin briefly dropped to $0.01 on the Mt. Gox exchange (but remained unaffected on other exchanges) after a hacker allegedly used credentials from a Mt. Gox auditor's compromised computer to illegally transfer a large number of bitcoins to himself and sell them all, creating a massive "ask" order at any price. Within minutes the price rebounded to over $15 before Mt. Gox shut down their exchange and canceled all trades that happened during the hacking period. The exchange rate of bitcoins quickly returned to near pre-crash values.

In March 2012, 1 BTC traded at around $4.80. Taking into account the total number of Bitcoins in circulation, the market capitalization of the Bitcoin network stands at over 40 million USD.

Security

Up until version 0.4.0, if an attacker had compromised the machine storing a particular Bitcoin wallet, then they could easily transfer any bitcoins to their own wallet. On 16 June 2011, computer security companies started publishing the discovery of malicious software that locates the wallet file on Windows computers and uploads it to a remote server. Users could prevent this attack by encrypting the wallet file; however, Bitcoin clients did not build this functionality in until wxBitcoin version 0.4.0.

Dan Kaminsky, a leading Internet technology security researcher, investigated Bitcoin. His examination reached various conclusions on Bitcoin, anonymity and its future scalability. In the area of security of the basic model he concluded Nakamoto designed Bitcoin well. This relates to the underlying Bitcoin model rather than any particular attack against a specific client, such as described above.

Covert "mining"

In June 2011, Symantec warned about the possibility of botnets engaging in covert "mining" of bitcoins (unauthorized use of computer resources to generate bitcoins), consuming computing cycles, using extra electricity and possibly increasing the temperature of the computer. Later that month, the Australian Broadcasting Corporation caught an employee using the company's servers to generate bitcoins without permission. Some malware also uses the parallel processing capabilities of the GPUs built into many modern-day video cards. In mid August 2011, bitcoin miner botnets were found; trojans infecting Mac OS X have also been uncovered.

Extralegal uses

Silk Road

Silk Road, a Tor hidden online service anonymous black market using Bitcoin, has unequivocally helped Bitcoin grow, and far from it being only a tiny fraction of the Bitcoin economy, it is actually a very large and very active part of it. In terms of its size relative to the Bitcoin economy as a whole, Silk Road is probably the second-largest marketplace, behind only the exchange of currencies themselves.

In a 2011 letter to Attorney General Eric Holder and the Drug Enforcement Administration, senators Charles Schumer of New York and Joe Manchin of West Virginia called for an investigation into Bitcoin and Silk Road. Schumer described the use of bitcoins at Silk Road as a form of money laundering. Consequently Amir Taaki of Intersango, a UK-based bitcoin exchange, put out a statement calling for regulation of Bitcoin exchanges by law enforcement.

LulzSec

The hacking organization "LulzSec" accepted donations in Bitcoin, having said that the group "needs bitcoin donations to continue their hacking efforts".

Creator

Satoshi Nakamoto designed the Bitcoin system and worked on the software in 2007. In 2008, Nakamoto self-published a paper outlining his work on the cryptography mailing list and then on 3 January 2009 released the open source project called Bitcoin and created the first block, called the "Genesis Block." Many people other than Nakamoto contributed to the development of the Bitcoin software.

See also

• Anonymous Internet banking
• Complementary currency
• Digital currency exchanger
• Digital gold currency
• Free banking
• Ripple monetary system
• Crypto-anarchism
• Economic secession
• Scrip

Digital money systems:

• DigiCash
• ecash
• eCache
• Pecunix
• Ven (currency)

External links

• Bitcoin website
• Bitcoin Block Explorer (Used to search transactions inside the Bitcoin block chain.)