How Bitcoin Actually Works (Computers for Cynics #7)

hi i'm ted nelson coming to you from the catacombs of the internet archive in august 2014 with issue number seven of computers for cynics today's disquisition tonight's disquisition is how bitcoin actually works hook something up here here we go last year i published a video guessing who the designer of bitcoin was after which people started asking me to explain bitcoin itself so here goes tonight i'm going to present an overview of bitcoin i'm sorry the script is so long but i haven't got time to cut it down first let me say that bitcoin is brilliant and nobody knows who created it a masked man who left a silver bullet and called himself satoshi nakamoto bitcoin is very complicated an absolutely amazing structure system and plan with multi-sided ingenuity all around a unified center when you understand the center all the other parts make sense and i'll try to get you to that point it's all about recording transactions making sure no one can challenge the record of transactions or changing it or change it i am certain bitcoin was created by an individual it had to have been designed in one mind by a brilliant individual with a lot of imagination persistence determination and patience and very good at detail to put it technically there is no way in hell that bitcoin could have been designed by a committee because no committee could have possibly contemplated and designed the totality of parts and no i am not satoshi nakamoto though i wish i were it looks like he's cut himself quite a retirement package a million bitcoins or five percent of the ultimate supply if satoshi is the man i named in the other video he will be 65 which will be the japanese retirement age in 2034. if the value of a bitcoin goes to a thousand dollars by then he will have a billion dollars if the value of a bitcoin goes to a million in 2014 he will be the richest man in the world and to think that i imagine that creating bitcoin was a selfless act of benevolence well what the hell he deserves it and i can't think of anyone more likely to do good with it so here's the bitcoin story someone calling himself satoshi nakamoto published an article proposing a system of money with no authority in november 2008 then released working software for it three months later open source software which has gone on working ever since with very few problems my guess in the video i made last year was that satoshi nakamoto is actually a certain princeton grad who teaches mathematics in japan i still think he's the man an individual of spectacular intellect and diligence comparable to isaac newton remember that in addition to his scientific discoveries newton ran the royal mint now satoshi nakamoto is a very interesting pseudonym satoshi in japan means clear thinking or wise naka means inside and moto means foundation i think i thank shirley syluk for this insight so in the very name he chose satoshi is saying i am one who sees in depth which he certainly does why is a bitcoin intro in my computers for cynics series i am not cynical about bitcoin itself but i am cynical about people's misinterpretations misimpressions of it especially journalists misinformation about bitcoin and the resulting public confusion to paraphrase mankind no one ever went broke underestimating the intelligence of journalists but they have their deadlines to deal with and their hangovers and many of them are smart and good and they often spend time talking to other journalists which is how a lot of true information gets around as well as a lot of misinformation however the world lives by stereotypes that's just how it is and the best we can do is try to correct them one at a time so here goes you can find many explanations of bitcoin in text and in video from many angles i'm not criticizing any of them but this is the introduction i would have wanted to hear so of course i had to research it myself i've had help on this but any errors are my own i'm going to try to tell you how the whole system works i'm not going to tell you how to use bitcoin or whether to use bitcoin or what's going to happen with it economists can't predict anything how can i i'm not a lawyer and not a financial advisor any actions you take are your own responsibility my only legal financial advice is obey the law and pay your taxes do not write to me about bitcoin at the end of this video i want to tiptoe away from the subject but of course i am available professionally to speak on or to explain pretty much anything there are many myths and stereotypes about bitcoin i'll run through a few of them here myth it's a ponzi scheme there is nothing ponzic about bitcoin carlo ponzi was a con man of the 1920s he got you to trust him you gave him your money for a while and you didn't know where it was the first comers got big profits the late comers lost everything with ponzi you had to trust him and you didn't know where your money was with bitcoin you know where your money is at all times and you don't need to trust anybody what you trust is the system itself myth it's used only by bad guys and drug traffickers so it's illegal or going to be bad guys use bitcoin but they also use telephones and bicycles bad guys use everything well you can't outlaw everything and it's probably impossible to outlaw bitcoin there is continuing harassment as various politicians elbow to denounce it but there's no plausible way to make it illegal if governments try to control the channels it uses bitcoin can hop to other channels freely it's like sexting and porn it's there can't be stopped get over it it's impossible to stop bitcoin though it could be prosecuted and driven underground but since there are many many users and their use cannot be easily tracked prosecution is not practical there are plenty of laws already against money laundering and crime let the government enforce those catch the people who are using bitcoin to disobey the law as with the silk road guy they cut it's proprietor ross william ulbricht was arrested on charges of alleged murder for hire and narcotics trafficking the point is this guy was a criminal probably uh not innocent until proven guilty but caught good and proper for doing things that were bad and improper it seems not for using bitcoin myth anybody could just change the software and undermine the system what's that you say what if you were to sneak in and change the software why can't somebody just use different software to break the system not bloody likely it all revolves around a specific data structure and anyone is allowed to write software that writes to that data structure but the validity of the data structure is checked by everyone in the bitcoin community specifically the shared ledger around which the system result revolves is checked in many ways by the standard software itself and by different parties using that software the legitimacy of the record is constantly checked by the people who maintained the ledgers the miners whom we'll discuss and then checked again by the citizens receiving the new blocks of the ledger satoshi worked out the mathematical difficulty of subverting the system to be astronomical you can't counterfeit fictitious bitcoin value you can't send in a transaction with a bitcoin you don't own double spending is prevented by the software a malofactor could try to take back a transaction but it would be an enormous effort to underdo to undo just one for illicit software to subvert the system satoshi calculated that the bad guys would have to take over more than half of the aggregate computer power of all the citizens maintaining the system not impossible but not an easy black hat job myth bitcoin is completely anonymous bitcoins and anonymity is interesting but not perfect you could call it semi-anonymous while you can take steps to be anonymous every transaction in the great ledger can be studied and they go all the way back there have been various research papers that figured out the ident the identity of many participants but mainly of the more public users so if you care don't talk about it in public myth bitcoin is going to lead to a libertarian new world order there are those who think they can overthrow all government and that bitcoin will be the first step lots of luck in the meantime those of us who live in real countries get to use it for real purchases myth bitcoin has no basis no intrinsic value what is intrinsic value all kinds of things with no intrinsic value have been used for money beads cowrie shells printed paper and there's gold does gold have intrinsic value genetically it seems to be built into the human species to like gold but we trust gold as a repository of value because everybody is used to everybody trusting the value of gold why does anybody trust any money money is a representation of value mutually agreed on by some people but how do you get to that agreement possibility one the central authority says so that's not enough we all know that money issued by a central government may be worthless as has happened time and again the real source of value two mutual agreement and observation of behavior value is what people think something has when we trust a government government's money is by seeing that other people trust it it takes a leap of faith what has been called the tinkerbell effect if you believe incur in a currency clap your hands or your wallet so gold paper money and bitcoins are given value by the psychosocial prediction that some people will continue to value it you can't put bitcoins on your finger or hammer them into jewelry so it has no wired in human psychology to back it up but the real psychology is this the value of bitcoin is based on people believing that other people value it in that sense bitcoin was created not when satoshi created the first block of bitcoins the genesis block in january 2009 but when somebody actually accepted bitcoins for a pizza in may 22nd 2010 uh the genesis pizza for ten thousand bitcoins which established a worth of twenty five dollars then for ten thousand bitcoins which would be worth five million dollars now that was the moment that gave bitcoin the breath of life it's not just a psychological prediction that others will continue to value bitcoins for arbitrary personal reasons of their own it's a psycho social prediction that some others will continue to value bitcoins based on the same thought that some others will continue to value bitcoins thus it's a recursive psychosocial prediction some of us will continue to value bitcoins because they believe some of them will continue to value bitcoins because they believe some of this will continue to value bitcoins ad infinitum which is exactly how gold works let others scoff let unbelievers fall by the wayside thinking oh my god there's nothing there like looney tunes characters running off a cliff and then looking down as soon as as long as some people continue to believe that some people will continue to believe that some people will continue to believe that bitcoins have value there will be a market and a price and the game will go on no matter what others think and try to do to prevent it so how much should a bitcoin be worth how much would gold be worth that's no rational and a question that's no rash there's no rational answer it's a market question what does the market say right now about the value of a bitcoin there are now a little over 13 million bitcoins that is bitcoin value pools there's no such thing as a bitcoin object today the bitcoin unit is worth 500 bucks in other words a market cap of 6 billion 500 million dollars which shows that a lot of people believe in it for you market chartists out there there are lots of charts giving bitcoin history at blockchain.info today's 13 million bitcoins is a little half a little are a little more than half of what will ever be an arbitrary upper limit of 21 million bitcoins will be reached in about 21.40 that's a restriction satoshi built into the software like the value of gold which is very limited in its quantity this is intrinsically deflationary very likely to rise in its value also like the value of gold bitcoin seems to bitcoin value seems to go up in crisis times during the cyprus banking crisis of 2012 apparently as a way of getting money out of cyprus that's the key example indicating that in times of upheaval uncertainty war bad times it may dramatically rise again pessimists expecting alas that there may be more upheaval uncertainty war and bad times may see it as a good investment for this reason indeed a lot of people seem to think seem to be holding bitcoin as an investment in an analysis of bitcoin accounts by iran and shamir they found that over 50 of bitcoins are dormant probably being held as investments how high will bitcoin go if things got get worse in the world in the world situation could the value of bitcoin go to a thousand a million hey i'm just saying consult your qualified professionals on this matter they may not know anything either but at least they can signed sound authoritative hey i'm not a financial advisor as i said earlier economists can't predict anything how can i okay now we come to the legitimate the legitimation issue the bitcoin community is continually fighting for legitimacy in the eyes of the public fancy websites with lots of information the bitcoin foundation representing a lot of the heavy public bitcoin dudes including the committee that maintains satoshi sulfur and especially the winklevoss twins now you may have seen the the winklevoss twins uh in the movie the social network and thought they were made up characters but nobody could make them up they wear suits and they act like regular wall street types and they have made themselves public spokesman for the bitcoin system among the other suit wearing wall street types this year they announced that they owned one percent of all bitcoin value that's over a hundred million dollars as the crow flies so the winklevossen are the best dressed spokesman for the legitimacy of the system may they're one percent blossom and now bitcoin has legitimate legitimation by the us government on march 25 2014 the irs ruled that bitcoin will be treated as property for tax purposes as opposed to currency this means bitcoin will be subject to capital gains tax annoying in some ways but one benefit of this ruling is that it clarifies the legality of bitcoin perhaps more important when the criminal silk road operation was halted u.s marshals seized 30 000 uh bitcoin bitcoins at value of 30 000 bitcoins which they have now auctioned off that in my estimation was the real kiss of legitimation practical problem money exchanges the law in the u.s is that money exchanges have to keep track of their customers which is impossible with bitcoin this makes it difficult to get real money for your bitcoins in the usa but the news on these matters keeps changing meanwhile you can buy things with bitcoin in the usa without difficulty okay so much for preliminaries oh change my secret there are so many systems of online payment ebay has paypal second life has linden dollars i patent a system of online payment myself uh back in the day there are hundreds more money based on bitcoin and forking its program scott coyne israel coin ron poyle ron paul coin check them out now legally you can't call these money you can call them vouchers or tokens or script or units of account those are the legal things to call it probably not currency and certainly not money legally only the government can create money but for practical purposes we can call bitcoin electronic but until bitcoin all these systems have had a central authority and a point of trust government issues money and wants you to trust it a bank you say naturally has a central authority you can trust that keeps track of all its transactions paypal has a central authority very nannyish that are arbitrarily forbid some transactions or stalls on payment bitcoin has no center or point of trust however it has a central authority the central authority is the software but that authority is maintained by the community that runs it the serious bitcoin community we may call them the citizens of bitcoin the citizens are the ones who run the full bitcoin program and the more people there are that run it the more certain its authority becomes now just to be a bitcoin user you don't have to be a bitcoin citizen you can buy things with bitcoin but that doesn't make you a full citizen you can easily get a bitcoin wallet for example from blockchain.info you can easily buy bitcoins just google buy bitcoins but that doesn't make you a bitcoin citizen yet anybody can become a citizen of bitcoin all you have to do is download the full bitcoin software and keep it running which benefits and strengthens the system as a whole the bitcoin software packages are all variations of satoshi's original software all compatible at the protocol and data level some are maintained by the bitcoins foundation others are made by third parties it doesn't matter who creates the sensor who creates the software as long as the software supports the central ledger which everyone checks and if it doesn't support the central ledger it doesn't do any harm so the hell would it but to run the software as a bitcoin citizen you need a serious machine with a 24-hour connection it's not for laptops it needs to run all the time the software is called bitcoin core or bitcoin qt or sometimes bitcoin full node client satoshi client or satoshi code the overall software design they all follow is called bitcoin network protocol the data structures and message methods of the system these instantiations of the satoshi code will variously run on windows or mac or linux and you can download some several of them from bitcoin.org but the satoshi code is not for casual mac or pc users a full node client listens on port 8333 and must accept more than eight connections and most mac and pc users don't know how to set that up it comes in different packages called bitcoin d bitcoin client and bitcoin qt is mentioned bitcoin d is the command line version then there are third-party versions q bitcoin pie node btcd written in ken thompson's latest language ken thompson creator of unix and c or any way b so there are lots of ways to run the full software as a full bitcoin citizen just running the program is good for the bitcoin system even if you're not a user you're increasing the security of the system if you just run the program you are reinforcing the bitcoin system against possible attackers by increasing the number of verified copies of the great ledger adding one more testimony to the verification pool keeping that ledger is like keeping the sabbath it's an act of faith to bitcoin citizens a holy act when i last looked at blockchain.info yesterday the size of the ledger was 20 gigabytes in some 318 000 blocks we'll talk about blocks later as time goes on all citizens do not have to store the full ledger they can be digest versions but even then the space required is non-trivial okay how many citizens are there how big is the serious bitcoin community there's no telling there's no census but i'd guess about 75 000 because that's how many people have watched my satoshi video and that number has stopped increasing but that's just an educated guess who are the citizens we don't necessarily know you can't see the other members they can come and go with not notice and so can you nobody knows who the others are unless they tell you and they could be lying so there's no no knowing who the others are in general but there's no need for trust in each other no need for acquaintance what you trust is the system so here's my overview the bitcoin community attached on the attached on the outside are the casual users down here casual users who just have wallets who have to trust the full members they connect with around the outside are the full members this is the bitcoin community so i'm seeing a mirror image of this around the outside are the full members of the big bitcoin community they are the regular users who have the full software keep the ledger and know something about the system they may be individuals or couples or groups of friends they may be companies vendors companies that sell things denominated in bitcoins agencies uh companies who do things around bitcoin some of these are exchanges transfer points operators of bitcoin atm's wallet companies some of the bitcoin citizens are its guardians the people who study the code and work on it respond to alarms and problems many of whom have a strong interest financially or ideologically in the system continuing to work this includes the bitcoin foundation some of the bitcoin citizens are miners who are really power users we'll get back to them some of the bitcoin citizens are bad guys thieves and scammers who are always trying to figure out how to break the system to their advantage they've sometimes found ways to steal bitcoin value but not to break the system but they too are often full bitcoin citizens the citizens share a visible bitcoin space we may call it the bitcoin commons where everybody can in principle what everyone can in principle see actually the bitcoin space i'll show you again consist of what the software can see and what citizens can see through the software okay i'm just listing what everybody has access to though the channels are many in the middle figuratively for all to see is this shared area or commons there's no tragedy of this commons it will be hard to spoil citizens can see or their software can see the great ledger we'll talk about that all the addresses inside that all the addresses that have ever received bitcoin value and how much value is in each one now a news feed over here of what transactions are floating in that have actually occurred but not yet finalized and new candidate blocks as they arrive one about every 10 minutes there is currently no overview of this but someone could program an animated overview just like this diagram to summarize the various feeds and shared knowledge note that not everyone can see exactly the same things the protocols assure that all the information will propagate to all the nodes but not simultaneously so this is in general the view that is shared though the specifics in each citizen's space will vary okay now let's talk about wallets a wallet is the interface is to your money in the bitcoin system you may have many wallets a wallet holds value and presents it to you when you wish to transfer a value you so instruct your wallet telling it the destination and the amount to transfer and providing to that wallet its specific secret key that amount then disappears from your wallet and shows up the address you have designated but the transfer may not be validated for minutes or hours or even longer alas due to the somewhat erratic timing of the validation process which i will explain to state the wallet systematically a wallet is a software object that receives incoming donations tells you how much money it contains and sends out value on demand your wallet requires a secret key by which you release money you're sending out the secret key is not stored readably in the wallet in case someone steals access to it you need to keep perfect track of your key you can even back the wallet up in case your first copy is lost but as with other backups there can be a problem keeping it up to date what exactly is in your wallet one might assume that bitcoins are numbered certificates like dollar bills nope there are no certificates there is no bitcoin object there is no such thing as a physical bitcoin although some people have made plastic bitcoins as novelties there's not even a data object that can be called a bitcoin there are only puddles of validated value derived from the events that put them there so the wallets hold some of your value puddles and shows them to you the wallet calculates its contents from the verified transactions of the gate ledger a wallet can only contain certifiable puddles of value resulting from validated transactions each provably signed with the donor's secret key even though that key cannot be seen so that brings us to transactions what is a transaction in the usual world the physical world when we say transaction we generally mean i give you something and you give me something back quid pro quo i give you quo you give me quid that's laughing for whatever here's my hot dog example fast food purchases are simultaneously simultaneous when i buy a hot dog i hold out two hands one with the money the other to receive the dog the risk is minimal it's simultaneous and there's no trust or delay on either side but most transactions in the world involve a risk to the first party the risk that the second party may welsh whoever delivers the delivers first either goods or the money is at risk slow food restaurants serve you before you pay before you pay the restaurant owner takes the chance that you might run away or try to get out of it or have a heart attack they are well practiced and ready for such situations but even so such losses are part of their business ladies of the night are said to require payment in advance so that delivery or delivery to the customer's satisfaction is less certain in all these real world cases the parties have risks each of these domains has its own conventions and risk of being stiffed in bitcoin however the usual transaction is only a one-sided transfer you're handing the money over how to get your quid how to grab your hot dog is your problem the same issue exists in bitcoin as it does for cash amazon guarantees satisfaction bitcoin is not whoever delivers first is at risk that's how it is and that's not a problem about cash and it's not a problem about bitcoin it's a problem about risk and precaution in any transaction there are movies with scary scenes where huge sums of money are exchanged in suitcases with machine guns on both sides that stuff is true you send them but you send the money bitcoin to an address that's all bitcoin knows how do you assure equal value received conventions vary in different areas of commerce and trust anywhere is precious it's your problem you're not in kansas or at the mall so there are several kinds of bitcoin transaction the most basic bitcoin transaction is the payment transaction a one-sided transfer of value as already mentioned it's a cryptographically signed record where the cryptographic signature is seen by the software but not by any party that reassigns ownership of some some bitcoin value to a new address party a relinquishes the money to party b's address the value leaves one address and goes to the other it's recorded in the ledger as a cash payment it's the quo the quit is not recorded this is not an exchange the donor transfers didn't donate bestows reassigns it there is no record of what it was for or whether you got what you wanted for it that's your social problem with the other party nothing is physically moved around any more than gold is physically moved when a bank lists a transfer of money from one kind one account to another all that happens is that a transfer is recorded moving value from one address to the other not even the sums in the respective bitcoin addresses are recorded those sums are calculated after the transaction is finalized that is the main form of bitcoin transaction it is called pay to public key there is also the generation transaction whereby a miner claims the reward for finalizing a new block finally there's a more arcane form of transaction called the pay to script transaction definitely not for beginners in the pay to script method savvy users can define new forms of transaction using a fourth like language that is part of the system pay to script transactions can be used to create used to create an arbitrary complex arbitrarily complex event with dependencies for example multi-party values transfers of value but pay description can be defined multi-party conditions and outcomes that are beyond simple imagination a transaction can also record some record of an event to prove the transaction happened after that time for instance satoshi locked a headline from the london times into the genesis block but this is now a deprecated practice okay to summarize the transaction types we've covered the main one-sided transfer which is called pay to public key we public pub covered the generation transfer transaction which rewards miners we've covered pay to script transactions so these are all the transaction types i know about that the bitcoin system records in its great ledger i haven't talked about the fact that you can speed up your transaction by bribing the miners with a tip but we won't get into that now let's talk about the great legend the great ledger is shared by all citizens it stretches back to the beginning of bitcoin the full ledger is available to public scrutiny with a slight blur at the present we'll talk about that it holds all the transactions of the past that is each bestowal of value to each address it is a cascading family tree of the history of value transfer between users since the beginning of the system with the genesis block so here we see what's in the legend schematically it's a series of transfers between accounts in the whole bitcoin universe sorry the ledger is assuming i'd point out the ledger is a series of value transfers and the current values are constantly computed from the previous transfers horizontal red lines represent transfers of money let's say value vertical is time it's like money being transferred from account to account within a bank except in a bank the transfers are specifically authorized by some banker and in bitcoin there's no banker you can see that all you can see all the addresses that hold value now these addresses are not urls they are addresses in bitcoin space also called bitcoin addresses you can see every transaction back to the beginning of time ie 25 2009 when satoshi started the software rolling by creating the first value of 50 bitcoins a chain of custody you can see and the software can check the pedigree of every drop of value backed backward to its creation the history of each puddle of value can be checked for legitimacy of its contributing transfers even if those original originating puddles of value are now empty what is maintained is the value itself not represented in any certificates or data blocks but in little pools of signed and authenticated persistence you can see all the value transfers even for wallets that have been lost but if the holders of these addresses have lost the passwords that value can never be taken out annoyingly everyone can still see the addresses and what's in them but if only the passwords hadn't been lost let that be a lesson most governments have laws saying they can confiscate inactive bank accounts but let them try to get the value out of inactive bitcoin addresses form of the ledger the bitcoin ledger is just the series of transactions transactions individually sealed for validity and gathered into blocks which are in turn sealed for validity so to sum up the method you probably asked at the beginning how do they carry out the function of a central authority to make sure the monies held are legitimate and all transactions are legitimate answer every transaction is confirmed for its validity and sealed into a block we'll tell you how later the total value of all these blocks total record of all these blocks is called the blockchain it would have been simpler to call it the ledger but never mind just as each swiss citizen is required to have a machine gun every bitcoin citizen is required to keep a copy of the blockchain every citizen every full member receives the finalized sealed blocks and the software checks each block automatically and adds it to the blockchain of each citizen so that the blockchain holds every transaction back to when every puddle each drop of bitcoin value is created this assures the legitimacy and correctness of every transaction without a central authority and with a simple system of low overhead anonymous transfer it may sound like high overhead to you but compared to having banks with employees and fancy buildings and help desks and executives and enormous executive bonuses for crete to bankers for creating phony derivatives and banks paying squillions of dollars to lobbyists to buy congress it's very low overhead indeed now let's talk about the validation process each transaction is validated and then sealed into the ledger this process is carried out by the so-called miners we'll discuss them a little later first let's talk about the new block when a new validated block arrives it is appended to each citizen copy of the great ledger the blockchain each new block must be added to every citizens blockchain but before accepting the new block everyone checks the valid continuation of all the values in the new block are we going out of focus here no each member software checks the validity of all the transactions in the block as hammered in by the miners we'll discuss that later to make sure that all the transfers of value are legitimate this prevents counterfeiting it assures that every transaction in the block is valid and that later so that later it too can be read reliably from the blockchain as part of the great history but these are summary checks not like the deep checks being made while the block is being constructed there is official efficient there is effectively a cellophane wrapper around each transaction and around the whole block to assure its integrity in the history as with a cellophane wrapper you know when it's been broken and the software can detect any difference these cellophane wrappers are the hash codes which i will discuss in the technical section which is not compulsory in this way the software makes sure that all the blockchains agree and the great ledger is the same in every citizen's record okay let's consider two fundamental questions in parallel how are transactions validated finalized and put into the great ledger and also how does new value enter the system there's a scarcity management problem satoshi only created a value of 50 000 bitcoins to start he couldn't put millions of value into the system at the beginning that would have been silly but as the number of bitcoin uses increases and more and more value is needed in the system how to create that new value you could have bitcoins rain down randomly nothing wrong really wrong with that it's doable but it violates people's work ethic and doesn't provide incentive for what needs to be done because certain work is needed to maintain the system so satoshi combined both these issues with a unified solution for both one permanently validating transactions and two adding new value to the system satoshi created a special role that of miner what do the miners do ship seats again what do the miners do any bitcoin citizen can be a miner when i say a miner it also refers to a mining company you can join a group you can join a group of miners which splits the work and splits the proceeds but what do they do and why are they called miners they're called miners because of the analogy with gold they do work to create new value like gold miners digging underground but they don't dig things out they bury them they seal the transactions into the great legend which is actually the reverse of physical mining it's embedding miners could as well be called authenticators or finalists or finalizers or archivists and as payment for the process they get new bitcoins and that is how new bitcoins enter the system so there's a work ethic here a protestant ethic and perhaps a japanese work ethic built into the system so first we'll discuss the benefit from the miners work and then how their reward once again what is the main problem of the bitcoin system the main problem satoshi defined is to make sure nobody can change the record his inspiration was to distribute it among a bitcoin citizenry keeping it absolutely unified and unanimous among all the citizens so here's what miners do to make the system work the miners validate authenticate certify finalize the transactions by specific processes one to prevent counterfeit transactions the miners software checks each new transaction arriving in the commons against the blockchain for the validity of ownership of the value making sure that each new transaction is a legitimately signed transfer of value which is in turn from a previously certified transfer value etc and two the miner hammers these new transactions into the permanent record so they cannot be challenged the miner takes their recent transactions and freezes them into a new record called a block which is sent out to all the bitcoin citizens exactly how this is done i will discuss later in the optional technical section once this block is accepted by the citizenry this record of transactions can't be modified making the transactions permanent and irreversible so that no one can challenge the transaction or change it transactions don't actually get finalized until they're in the great ledger and that doesn't happen until a block has been accepted by the citizens how the acceptance is managed i'll explain in the optional technical section for now please accept this summary the miner puts a cellophane wrapper on the block that assures its integrity and this wrapping process takes a great deal of work by the miner's equipment assuring that it can't be easily counterfeited or replaced miners can all have their own methods each miner can have a different sequence or heuristic a or heuristic for guessing how to seal in the transactions miners may use any software they can choose to create and any heuristics or efficiency speedups they like miners can use their own software to try to get ahead it doesn't matter what software the you the miners use their work will be checked a minor reminding company begins to create a block by gathering transactions that have been broadcast checking them and when all are checked see sealing the collection of transfers into transactions into a final block so here is the miner's flowchart let's start here start new block okay start new block this means you're throwing down your tools and throwing away your previous work and starting a new block take select a new transaction test the priority of this transaction we haven't talked about priorities and the block the miner has an option of chucking it up it tests whether there's a tip in the tip jar the miner has the option of checking it out test whether the transaction is valid that's not optional if the transaction is up is not valid start again grab a new transaction and go through that again if the transaction is valid accept the transaction and seal the transaction and then add it to the transaction tree inside the block have we got enough transactions no okay go get a new transaction and continue this transaction loop until you have enough transactions and then if you haven't been interrupted by somebody else's successfully making a block seal the block okay that is the that is what takes an ungodly amount of time and uh seal the box seal the box seal the box seal the block and then when it's done broadcast it ring the bell but if you're interrupted during the sealing process throw down your tools the bell has rung and start the process again with a new beginning a new block if however your block has been accepted or broadcast no you rush to start a new block because you want to seal that block further in with more blocks so this is the this is the miner's rather difficult road to hoe creating a new block and sealing it in a new block is fish finished uh roughly every 10 minutes or 240 times a day yes satoshi has mechanisms to maintain that timing he doesn't miss a trick when the miner succeeds having sealed the block the miner throws it into the arena i.e broadcasts it through the bitcoin community in effect telling everyone append this to the great ledger the blockchain and then hastens to start a new block to follow behind that hoping to assure the success of the block just completed just completing the block does not guarantee its success or the miner's payment we'll discuss that meanwhile all the citizens who receive it begin checking the new block for correctness what about the other miners when the bell rings as it were signaling the arrival of a finished block all the other miners throw down their tools and start over they have to drop the block they're working on and begin again since they can assume some of the transactions that we're trying to seal right now are by now already sealed so the first thing the other miners have to do is examine the new block and compare it to the pool of transactions to find out which transactions are not yet sealed and start again assembling the transactions that weren't in the block that just arrived but two miners or mining groups may complete a block at the same time what happens then we'll talk about that later okay the miner's reward the new block sealed by the miners efforts freezes the transactions that have occurred and for this miner and for this the miner is rewarded with new bitcoin value right now in 2014 the miner gets a value of 25 bitcoins for creating a block that is a block that's successfully added to the blockchain that's twelve thousand five hundred dollars at today's value but every four years the reward for sealing a block will be cut in half and when the last bitcoin value has been mined in approximately the year 2140 the reward will be removed entirely at which point users will need to pay the miners there is a tip jar for every transaction but we won't get into that there's no hurry it's probably not profitable to be a miner i i said i wouldn't give advice so i'm going to be oblique here nobody knows how many miners there are nobody can know but it's a number growing every day it used to be that you could do the miners job with a standard computer but not anymore a growing number of miners is fighting for those 240 days which is 240 blocks per day with more and more stonking equipment the stonking processors being sold for bitcoin mining are not described in the billions of hashes per second that will become clearer in the optional technical session but suffice it to say that the bitcoin miner is competing with hundreds or thousands of others that have comparable super equipment it's not a promising occupation okay we've covered all the main stuff winding down now let me read you part of satoshi's summary from 2008 quote 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 we propose a solution to the double spending problem using a peer-to-peer network the network is robust in its unstructured simplicity nodes work all at once with little coordination they do not need to be identified since messages are not routed to any particular place and only need to be delivered to any delivered on a best effort basis nodes can leave and rejoin the network at will accepting the proof of work chain that is what the miners do as proof of what happened while they were gone they vote with their cpu power unquote this is a simple vision implemented with great intricacy making sure no one can challenge the transactions change it making it how do you make a digital record that can't be easily changed that is the problem satoshi saw naturally the complex details we've gone through are all in the service of this simple vision but as the 19th century shakers used to say god is in the details a slogan that has later been perverted by latter day mannequins satoshi seems to have a direct line to the god of details that so many of us revere okay you may want to quit now now you know more about bitcoin than most journalists or any politicians unless they've seen this video uh unless you want to get seriously involved with bitcoin or unless you enjoy technicalities you may want to stop at this point so for right now i'll just say be careful obey the law pay your taxes and don't forget capital gains tax applies when you sell your bitcoins for a profit sayonara still there okay now for the tricky parts for those who love technicalities or want to get seriously involved what if the miners disagree what if two blocks come in at the same time that takes us to technical topic one the section i call the fog of war fun class the great military theorist speaks of the fog of war in which commanders must operate trying to see what is happening through a screen of conflicting reports the commander may know what has happened yet what happened yesterday but can't be sure of what is happening now well in the bit kind of world there is a fog of war and uncertainty is that as to the true transactions like one close of its generals and captains all citizens know what happened yesterday but can't be sure of what is happening no this is not usually explained the fog in the system the dust in the air consists of varying views because propagation is not instantaneous and different citizens have different stuff in their comments the limbo of unfinalized transactions there are always unfinalized transactions and these issues resolve to the war of block against bloc minor against minor let's talk about that there are 240 new blocks every day being fought over by nobody knows how many minings miners and mining teams i'm assuming thousands the main way for a minor mining team to get paid is to be the next to seal a perfect block for the blockchain and get it out of the world before some other miner does so what happens if two perfect blocks arrive in a citizen commons from two different miners at the same time well for instance look at the look here at first at the two sides we have a block a arriving and a block b arriving and note that block a may take in different transactions from block b so block a and block b can both be valid blocks each taking in a different section set of transactions and the question is which one is if two if two miners mine the same transactions in two overlapping collections where the collection of transactions in one block doesn't match the collection in another block which is correct each miner or team of miners will hope their block their new block will be accepted and finalized in which case they'll get paid but this is a realm of uncertainty as to who will be rewarded for finalizing which transactions what is the rational determinant way to decide which block wins satoshi foresaw the problem will it be a discussion will there be some comparison of which is better fog of war picture two competing blockchains suppose for example in this extreme case this user received block a while this user receive block d then this user received block b while this user received block e then this user received block c while this user received block f what's going to happen what will win satoshi's genius in solving the problem is to leave it to chance and competition this is a free market statement built into the software satoshi said we'll just see which chain gets longer the citizen who receives two blocks at the same time makes a guess that block a will win and appends it to the blockchain but within a few years hours it may turn up to turn out that block b has been more generally accepted the citizens software merely adjusts throws out block a and accepts the growing chain built on block b when one blockchain gets seriously longer the software decides it's the right one then that's that it's the final blockchain whichever miner's block reaches that final chain that miner will get the loot and i just don't mean final final final i mean final within the last couple of hours whichever miner's block reaches that final chain that miner will get the loop the miners get paid who make it to the longer blockchain the others don't it's like guys who apply for a patent later than the first guy they lose but it's a minor problem pardon the pun only if two blocks are finished simultaneously does the problem arise the statistical distribution of blocks over time is such that two blocks are rarely finished in the same time so that the first to finish cancels all the other block making by miners who haven't finished the blocks that don't make it to the final blockchain are called orphan blocks the number isn't great a couple a day often quoted as two percent rarely more than four a day left out of the successful 240 blocks mine this solution also takes care of the double spending problem suppose you have a hundred dollars in your bitcoin wallet and you try to send it to two different people even if you have dirty wallet dirty wallet software that permits it the blockchain won't only one such event will make it into the final blockchain because the way the transactions are checked by the miners the miners checking assures that both transactions cannot be falsely accepted two rival blocks could happen to contain the two rival transactions but only one spending of the same value can get into the ledger satoshi doesn't care which okay technical topic too let's talk about public key cryptography when i was a kid we'd send a box top and a quarter to captain midnight on the radio actually it was an ovaltine label and get a captain midnight decoder badge so on the radio captain midnight would say something like set your decoder to w15 here is your secret message and then a stringer string of numbers which we did we would adopt and it would a hint about tomorrow's plot heavy stuff well that's more or less how codes worked from the time of julius caesar yes he used something like that till recent times more recently they've used keys a key is a string of numbers or letters that is used to encode or decode something they now say encrypt and decrypt but the problem is how do you distribute the keys and keep them secret big problem until recently public key crypto systems were invented by whit diffie who doesn't get enough credit and developed to their present form by rivers rivest shamir and adelman the code called rsa for revest shamir and adelman is the backbone of commerce today even though u.s government tried to suppress it back in the day at that time in the 70s the u.s government was trying to actually control all cryptographic keys in a dramatic series of events the rsa mathematics was sent out to in sami's dot form to many computer scientists i got to said in the mail to assure that the government could not suppress it the joke is that the joke is that rsa code is used for all commercial transactions and government secrets we couldn't have a commercial internet without it using rsa codes you can send secret messages without having to give anyone a secret key here's how it works in a public key system you have two keys public and private they are alike different numbers but they they function identically but you use them differently you publish one and you must hide the other it goes both ways you can encrypt with the public key and decrypt with the private or encrypt with the private key and decrypt with the public they are like and symmetrical in the sense that either one could be your public key and either one can be privately your other one could be the private key but once you've decided that's it each of these keys is a long number that ties into a mathematical procedure for encrypting and decrypting here's how you send a secret message to a stranger you encrypt your message with that person's public key and he and he or she can read it with their private key or if you want to send a secret message to the stranger with the assurances from you you encrypt it with your private key the recipient the recipient looks up your public key to read it there are many other permutations public key christmas systems are used by banks the world wide web when it says https and everything in between bitcoin uses public key cryptography as well a word about the mathematics even though the two keys public and private are entangled mates one is no good without the other the two keys are generated together by a mathematical process that makes it virtually impossible to derive one from the other with today's methods so that in the foreseeable future no one will be able to figure out your private key for the public one even though they're soul mates here's how public key cryptography is used in bitcoin in bitcoin money is sent to particular addresses you may easily generate new addresses to send money each address is based on a public key but only you have the private key although the entire bitcoin world knows when money has been sent to that address only you with that private key can read it it can get it out that is send it on to another address so each address has its puddle of value visible to the world but only the owner of each address meaning the owner of its secret key can move that value along so much for public key cryptography i hope you understood it okay i've saved the worst tropic topic for last technical topic three hash coding and the ceiling of the block first i'll explain hash coding and then how it's used by the bitcoin block finalization process we'll skip a lot of details hash coding is used to lock in the authenticity of transactions lock the authenticity of a block which in turn determines who deserves the new value being minted providing a work ethic reward hash coding is a very simple concept but its ramifications go on and on requiring a lot of context to understand its meanings like virginity technically a very simple concept of requiring a lot of context to understand its ramifications and meanings hash coding is a technique for authentication used to prove the two bodies of data are the same especially to prevent anyone from messing with a body of data so it has to be hard to fake a hash code is like a check sum but much trickier a hash pro hash procedure is a program that chews on a block of data and results in a nonsensical string of bits this string of bits is called a hash code so here is your block of data it can be any size from one bit to a squiga byte and here is the hashing procedure which is the same ultimately regardless of what it's doing it is somehow taking all the bits of the data and messing with them you can add all the bits as if they were the hashing procedure can be anything you can add all the bits as if they were numbers flip the bits from one to zero and vice versa reverse the bits lengthwise multiply them interpret them as unicode and turn each one around and interchange the first and last half of a word etc all of the above and much more complex functions so a hash procedure is any well-defined process that makes a summary of a block of data any formula for deriving an unpredictable string of bits from that block of data and here is the resulting string of bits which is called a hash the hash procedure results on a string of data of a final certain length a cryptographic hash is a validated hashing procedure that's been certified as very unpredictable if you may make a change in the block of data you cannot know which bits will change in the resulting hash code or how many will change bitcoin uses more than one cryptographic hashing method the main one is called sha-256 which results in a 256-bit hash another one is the ripe him rip emd 160 which results in a 160 bit hash okay the resulting hash code that they derive is result reliably always the same is unpredictable so if you change one bit anywhere in the data it can change any and all parts of the resulting cache code unpredictably the hash can be given out separately from the data gives a summary of the data which can be reliably checked when the data arrives to make sure the data has not been corrupted hashes are mathematically determinate but their results are not predictable with existing computers and processes so why do you want a hash to be unpredictable so the bad guy can't make an arbitrary change and fob it off as the ident authentic data if a bad guy wants the hash to come out to a certain result it's got to take a long long time the same is true for a good guy if a good guy wants the hash to come out to a certain result it's going to take him a long long time satoshi uses this fact to the hilt as you will see there are multiple levels of hashing used in the bitcoin system i'll just talk about the main ones and the trend the transaction hash and the block hash the transaction summary hash every transaction as i've mentioned is checked for validity and then hashed to name it to nail in the individual transactions after the validity check the miner hashes the transaction locking the authenticated value transfer that hash now stands for the whole transaction it locks the transaction transaction in can't be counterfeited you post the hash and refer to the data anyone can check it so in the block all the transactions are hashed as a way of summarizing the content first once verified these are made into a tree of hashes here's a hash here's a hash those are hashed here's a hash here's a hash those are hashed those hashes are hash and so on until we come until this whole pile of transactions is represented at least at last by just one hash it's technically called call it the summary it's technically technically called the merkle root now for the real work the block hash that seals the whole thing the satoshi proof of work blocks cannot be generated lightly because they have to have this cellophane wrapper satoshi calls it a visible proof of work signature showing that somebody's system worked hard to lock it up this way why does there have to be a lot of work to see a lot of work to seal the block because otherwise a bad guy could easily counterfeit a block with phony tracks that transaction but if mining a block making a block mining a block takes a whole lot of work and a lot of good guys are mining that is trying to seal blocks the combined power firepower of the good guys is going to outgun anyone trying to subvert the system that was so she's calculation satoshi so satoshi designed a task for sealing a bitcoin block which is highly repetitive requiring lots and lots of attempts with escalating difficulty relying on constant effort of the good guys to keep the system valid that's why it's needed it is a very costly method in computational power for assuring the certainty of a block this is called in the computer world brute force doing something over and over experimentally instead of figuring it out which you can't okay so here is a diagram that sums up the miner's biggest chore the main final block hash here is the block to be sealed now reduced to a single number as we've said the summary or merkle root the number that all the transactions have been boiled down to the summary hash here it is the objective what is one is a final hash code the final summary i've been the cellophane wrapper i talked about that the miner is trying to create a hash code that meets a certain difficulty criteria here is where the hash code is supposed to go it has to begin with 64 zeros as of right now that number changes you could also say smaller than a given number which has which is smaller than the 64 0. satoshi has arranged for this difficulty criterion to be reset every two weeks to keep the to keep the blocks timed to every 10 minutes can you believe it okay and here is what is needed a number that will give you that final hash code a number we have to keep changing until the hash comes out the way we want it it's called a nonce in literature a nonce word is a word that is coined casually and not expected to be reused in cryptography announce is a number and likewise some number not expected to be reused so it comes down to this the principal work of the miner after the block has been set up with the sealed transactions is to find the nonce that seals the block with the correct number of zeros that's all that's all you have to do find the nonce that gives you a block cash with 664 leading binary zeros all you have to do is just repeat and repeat and repeat the sh5 the sh-265 hashing algorithm until the result repeat it repeat it until the result meets the criteria sounds easy doesn't it well if the source i have chosen is correct the average number of sha 256 hashes presently required to seal a block is 18 terra hashes that's 18 000 gigahashes or 18 quintillion that is 18 billion billion sha 256 calculations which some lucky manager miner manages to get through in about 10 minutes ahead of the others and so the power of bitcoin mining equipment is now measured in giga hashes per second meaning sha 256 hash calculations oh and by the way every miner is given a slightly different problem so there is no unique solution for a given block even if two miners happen to be sealing with the exact same set of transactions close the big bank in the sky we may think of the big the bitcoin system as one great big bank in the sky with many accounts transferring money among those accounts the whole record is readable of every transfer from account to account since the since the system started it's all done by a system of software that manages to filter to facilitate exchange prevent counterfeiting prevent double spending allocate new units the software runs peer-to-peer in that there's no center there are no servers software controls how value is bestowed maintained transferred and prevented from authorized and prevented from unauthorized use including unauthorized use by the owner i.e double spending nearly all the work in the bitcoin system is about validating and legitimizing the transfers of value and assuring the integrity of the great legend satoshi calculated the expansion of the system and so far it's tracking his predictions and directives with a new block every 10 minutes the bad news there's also bad news of various kinds about bitcoin one the visibility which may come as a surprise to some user two the valid the volatility of a bitcoin's value which goes with bitcoin being a small experimental market easily manipulated three perhaps worse but worst for the user the slowness and uncertainty of transactions based on the irregularity of the bitcoin of the blockchain method the transactions have to be buried under a certain number of blocks to be considered final the additional blocks that go on before different kinds of transactions are considered final the greatest threat to the i've skipped that part the greatest threat to the system may be its success there's the magnitude issue for me how can it possibly go on this way for millions of transactions a day let alone millions of transactions per second the transaction storm may outswamp the software meant to handle it both in the mining that is finalization of transactions and the size of the blockchain how can this method conceivably handle the millions of contemplated transactions per day per second beats me but satoshi has been right in so many judgments of magnitude i'll bet on him if the internet survives and event if mankind survives both of which i consider unlikely i'm betting bitcoin will too finally thanks i especially want to thank my lovely wife marlene mallika for granting me the time to do all this i want to thank edward betts and brewster kale of the internet archive for getting me interested in bitcoin i want to thank jason scott of the internet archive for graciously allowing me to disrupt his sleep in this room and finally i want to thank raj kumar of the internet archive for asking a lot answering a lot of my questions patiently and thank you

Channel: TheTedNelson

Views: 38,390

Rating: 4.9442062 out of 5

Keywords:

Id: 3CMucDjJQ4E

Length: 69min 12sec (4152 seconds)

Published: Tue Sep 02 2014

Reddit Comments

[u/AutoModerator]

Hello r/CryptoCurrency readers. Please try out the following links:

• To sort comments by controversial first, click here. Doesn't work on mobile.

• To potentially find CryptoWikis articles about the subject of this post, click here. To contribute to CryptoWikis, click here.

---

I am a bot, and this action was performed automatically. Please contact the moderators of this subreddit if you have any questions or concerns.

[u/Eric_Something]

Saved to watch later to inevitably forget about in the next 24 hours.

[u/Nickel62]

How can you not invest in Bitcoin after watching and understanding this video. Very informative.

[u/Draconieray]

Bold of you to assume I can learn anything

[u/sasaloti]

From the thumbnail and the first name, for a second I was like holy shit Ted Danson’s a bitcoin shill? (Hehe)

[u/Porkysays]

WE ARE EARLY, SHIRLY!!!!!

[u/Cryptardo]

Just tell me green number go up god dammit

[u/CanaKagan]

02:08 I think we got past the $1000 point a while ago. :)

This video is brilliant. Thanks so much for bringing attention to it.

[u/HundredSpears]

Great walk-through!.

If only my high school self was able to watch this back then