Bitcoin Detective - day 1 homework

It should now be clear from day one of the course that the Block- chain is just a massive online ledger where everyone shares a copy via a massive peer-to-peer network.

Revisiting the Metaphor

Let's revisit our £5 note metaphor. This time people will only accept a £5 pound note if it has the signature of the person handing the note over (purchaser) and the signature of the person they originally got it from (person before the purchas- er). In our imaginary system the details of each transaction and signature is kept in our massive online ledger that records each and every occasion the £5 pound note is transferred be- tween owners. This Ledger contains the date, time, signature and details of each person's wallet where the £5 pound note is kept (In our scenario, each person's wallet is stamped with a unique serial number). Now imagine that there is no actual £5 pound note, only the unique serial number and a huge online digital Ledger containing the transaction details with a record of each 'digital' signature detailing the transfer of ownership. A person's digital signature is created, via a mathematical al- gorithm, from the unique serial number taken from their wal- let. Now if any person tries to introduce a '£5 pound' where the digital signatures do not match up with the details on the ledger, this bogus '£5 pound' will be rejected by the Ledger. In other words, rejected by the Blockchain.

Another Bitcoin definition

Bitcoin is an online non-fiat currency. That is, it is a digital currency that is not owned, or controlled, by any country or organisation. Bitcoin operates on the back of peer-to-peer technology and can be considered, due to the high levels of cryptography, a crypto-currency. In short, Bitcoins are processed via a massive network of computers running Bitcoin software. This software is known as the Bitcoin Client.

Just like people trust fiat currency, they trust bitcoin. The system is simply a method of transferring value. It is just numbers that represent value. Say a person A purchases a product from person B. The value of the product, the value in numbers, is deducted from person A's bitcoin account and these numbers are added to person B's account. This transaction is both recorded and verified by the Bitcoin network and record- ed on the blockchain within a block; a block can be considered as a single page in the ledger. Note, this is a one-way transaction i.e. here is no facility to 'charge-back' as with bank accounts and Credit Cards.

Fiat Currency

A Fiat currency is a currency controlled by the government of a country. The government is able to control the currency supply by simply printing more money when required (often referred to as ‘quantitative easing’), or not printing and destroying old notes in circulation. In reality this is a very inefficient system where government and banks often make errors which can negatively impact upon an economy, resulting in a domino effect around the globe (sound familiar). Bitcoin can be viewed as a digital currency where money, as a value, is exchanged electronically. As Bitcoin is transferred directly between two people, it is referred to as a decentralised currency – as op- posed to a centralised Fiat currency that relies on banks, government and a mint to print the money.

Bitcoin Lifecycle

Bitcoin Life cycle can be viewed as a six phase process: Conception, Primary Ownership, Consecutive Ownership, Post Consecutive Ownership, Execution Data and Mining.

Conception: This is where a Bitcoin is actually created and is born out of Block mining. A Block is a record of Bitcoin trans- actions taken from the execution data. For this to occur, the Block has to be decoded as a Block is actually a complex equa- tion that has to be solved in order to confirm the Bitcoin trans- actions. Once this is complete the decoded Block is placed into the public Block chain browser. People use their computers by employing Bitcoin mining software to process these Bitcoin transactions. As a reward for processing the transactions (Block mining), Bitcoins are released and shared amongst the miners. Hence, new Bitcoins! This process is designed to continue until twenty one million (21,000,000) Bitcoins have been released. All twenty one million Bitcoins are designed to be released by the date 2140. After 2140, no more Bitcoins will be released.

Primary Ownership: This is the point when the miner takes possession of the Bitcoin as a reward for Block mining. The reward, or value, is a direct result of the computing power ap- plied by the miner (person owning the computer) to the Block mining process. In other words, the faster and more powerful the computer the greater the reward.

Consecutive Ownership: The miner that has received the Bitcoin can transfer the Bitcoin to another person as a payment for goods and services. Consecutive Ownership is the outcome of this transfer from the original owner to a Bitcoin wallet address.

Bitcoin Wallet: This is the place where you store, receive and send bitcoins. Bitcoin wallets come in various flavours; online, on your computer or on your mobile device. Your Bitcoin wallet contains your Private and Public encryption keys. A Bitcoin wallet address is generated from the Private key and you can generate as many addresses as you wish. This Bitcoin wallet address is the address you provide to receive payment.

Post Consecutive Ownership: Post Consecutive Ownership is at least three steps away from the point where the Bitcoin was actually created. The Bitcoin can continue to change hands, or ownership, through the Digital Signature Process. The Digital Signature is created from the Private Key. The Person Sending the Bitcoin signs the Bitcoin with a Digital signature. The Digital signature proves the Sender is the Sender and that they own the Bitcoin. The Digital signature also prevents the Bitcoin from being altered during transit.

The following diagram is taken directly from the original paper 'Bitcoin: A Peer-to-Peer Electronic Cash System' by Satoshi Nakamoto. This diagram details how the transactions are a chain of digital signatures.

Execution Data: These are the publicly available transaction records held in the Block chain. Every single transaction that has ever occurred is available, allowing you to potentially link all the transactions made from the same wallet.

Mining: Anybody can start Bitcoin mining as long as they have a computer and an internet connection. To reiterate, Bitcoin transactions are hashed into a Block. This Block must be ‘solved’ via mathematical computations to produce the relevant 256 bit Hash value necessary for the Block to be added to the block chain. This solving of the mathematical computations is essentially Bitcoin Mining. Once the block has been solved it is copied throughout the network, resulting in a verification of all the transactions within the Block. The Bitcoin Miner that solves the Block with their computer is rewarded with Bitcoins. Most people mine Bitcoins in a syndicate and the Bitcoins are shared out in proportion to the supplied computing power i.e. the person contributing the most computing power will get the greater proportion of Bitcoins.

Buying and Selling Bitcoins

The easiest way of buying Bitcoins (once you have your wallet setup) is via a money transfer into a Bitcoin exchange. Once you have money in your exchange account, you can buy Bitcoins in a similar way to buying shares i.e. the value of a Bitcoin changes regularly in the same way as traditional fiat currencies change value against another currencies.

A Brief History of Bitcoin

In November 2008, persons unknown calling themselves 'Satoshi Nakamoto' posted a paper called 'Bitcoin: A Peer-to- Peer Electronic Cash System'. On 3rd January 2009, 'Nakamoto' mined the first Fifty Bitcoins. This initial block (the very first page in the Ledger) is referred to as the

'Genesis Block'. January 2009, beginning of Bitcoin transactions, the value of Bitcoin is zero. The first official item bought with 10,000 bitcoin is recorded as two Papa John's Pizzas bought by computer programmer called Laszlo Hanyecz. These 10,000 bitcoins where initially purchased for $50 by another computer programmer called Gavin Andresen. Gavin gave these bitcoins away on a forum, with Laszlo taking ownership. February 2010, Bitcoin begins to have a financial value, how- ever this value is less than $0.01. By February 2011, Bitcoin is valued at $1. The price steadily increases to an initial peak of around $980 November 2013. This sharp increase is fuelled, primarily, by the Cyprus Banking crisis. Eventually the price plummets to around $550 following the collapse of the Mt.Gox exchange in Japan. The price continued down until around August 2015 where it made a turnaround. Since this turna- round, the value has been steadily rising, hitting a new high of around $1,240, February 2017.

Summary

This chapter takes you from an imaginary metaphor designed to take a high level approach to bitcoin concepts. It should be clear that bitcoin is just a trusted system used to transfer val- ue. The key points are that it is international and not con- trolled by any government. The Bitcoin ecosystem exists simply as software running on a large number of computers; not on a central server or servers. Inflation is controlled by the software and is fixed. The system self regulates the supply of new bitcoins which is fixed in the bitcoin code. Any influence occurs at exchanges where bitcoins can be exchanged for fiat currency. Ultimately, from a law enforcement perspective, the criminal is vulnerable at the point when they wish to exchange their bitcoins to fiat currency.