The following is an excerpt from my upcoming book, The Great Blockchain Book. Get notified when the book is released by joining the Entrepreneur Hideout mailing list!
Unless you have been living in an igloo at the center of the Arctic without an Internet connection you have likely over the past 10 years heard of something called Bitcoin. You may not know what it is or how it works but you have certainly heard of it. And based on the stories of incredible fortune experienced by long-time holders of Bitcoin, you’re probably curious to learn more.
Back on October 31, 2008, while all hell was breaking loose in the midst of the Great Recession, a whitepaper titled, “Bitcoin: A Peer-to-Peer Electronic Cash System,” was hitting the virtual streets of the Internet by way of the Metzdowd.com cryptography email list. The whitepaper was authored by Satoshi Nakamoto.
The whitepaper is considered by many to reveal the next great technological innovation. Many technology experts and futurists consider the impact of the technology described in the whitepaper to be no less important than the personal computer, Internet and mobile phone.
Interestingly, the author of this game-changing thesis decided to remain a mystery. While there have been theories about Nakamoto’s identity, no one has to-date been able to confirm Nakamoto’s identity with absolute certainty. As such, Nakamoto’s identity continues to be the topic of many late night discussions among blockchain and cryptocurrency aficionados, making Nakamoto’s true identity one of the great modern mysteries.
No one has ever met Nakamoto face-to-face and according to The Economist‘s November 2, 2015 article by L.S., “Except for a few messages, most of which are believed to be hoaxes, he has not been heard from since [April 2011].”
Many believe that Nakamoto is not the author’s true name and that it is a pseudonym for the person or persons responsible for authoring the whitepaper.
The Perfect Storm
In the mind of many Bitcoin advocates, Nakamoto’s whitepaper could not have come at a better time. At the time of its release the globe was undergoing a financial meltdown caused largely by the actions of the world’s largest financial institutions.
On September 29, a month prior to the release of Nakamoto’s whitepaper, the stock market crashed, sending the Dow Jones Industrial Average down 777.68 points in intra-day trading. Until 2018, it was the largest single-day point drop in history. The crash was the result of Congress’ refusal to bail out the banking industry.
Then, on October 3rd, Congress succumbed and established the Troubled Assets Relief Program (“TARP”) to loan troubled banks $115 billion. The bail out, while necessary to save the U.S. financial sector, was seen by critics as self-dealing among the financial elite.
Many viewed the bail out as a way for the government to save the jobs of overpaid CEOs and bank executives, while consumers lost everything, including their jobs, homes and dignity. The result was a public disdain towards bankers and the banking industry.
A Crypto is Born
Nakamoto’s whitepaper was a welcomed arrival by those disgusted by the government bail out. The whitepaper described a framework for the creation of a decentralized peer-to-peer monetary system called Bitcoin.
The Bitcoin model is centered on financial institution disintermediation – something applauded by the banking industry’s harshest critics. Disintermediation means the elimination of banks and other financial institutions in everyday financial transactions. Based on the pain and suffering experienced by the masses during the Great Recession, many were ready for something new. Something that diminished the role of financial institutions.
Fast forward 10 years after its launch and you find Bitcoin as the first commercially viable and widely accepted cryptocurrency. Bitcoin’s framework is built upon the lessons learned from earlier cryptocurrency attempts. While Bitcoin is not the first cryptocurrency, it is the first to successfully solve certain fundamental design issues that contributed to the failure of previous cryptocurrencies.
Prior cryptocurrency attempts date back as far as 1983, when David Chaum developed his concept paper on ecash. Twelve years later, Chaum implemented his concept through the 1995 launch of Digicash. The 90s also saw the launch of Wei Dai’s B-Money (1998) and Nick Szabo’s Bit Gold (1998). These were just a few of the cryptocurrency attempts that provided Nakamoto with the lessons learned that ultimately led to the birth and global acceptance of Bitcoin.
Cutting Out the Middleman
The Bitcoin currency model not only eliminates the need for a “middleman,” such as banks, but it also eliminates the need for central banks, such as the United States Federal Reserve.
Under the Bitcoin model, no single government or entity controls Bitcoin. Control is left to the software. Contrast that with fiat currencies that have a formal “master.” For example, in the United States, the dollar is governed by the Federal Reserve. Through fiscal and monetary policies, the Federal Reserve controls and/or influences how the dollar performs.
Elimination of the middleman provides for faster transaction settlement. It also makes transactions cheaper, as the elimination of the middleman also eliminates the middleman’s commissions and/or fees.
For example, in the U.S. it generally costs $35 to $50 to send an international wire transfer from one bank to another. Further, it can take up to a couple days for the funds to arrive in the recipient’s bank account. Less costly remittance services such as Western Union can charge a consumer $10 to $15 for the transfer of a relatively small amount. Depending on the amount of money being remitted, the fees can represent a significant percentage of the transaction.
An international remittance via Bitcoin costs a nominal amount and can be credited to a recipient’s Bitcoin account in minutes – not days. Once credited the recipient can transact with the Bitcoin directly, withdraw the Bitcoin in local currency using a Bitcoin ATM or convert the Bitcoin to local currency and transfer to a local bank account.
What is Meant by Decentralized?
Nakamoto provided what many wanted by letting people work directly with each other through a peer-to-peer financial system that did not rely on an expensive, slow and corrupt (in the minds of many) central entity, such as a bank.
The term decentralized (as part of a decentralized peer-to-peer monetary system) refers to how the responsibility for processing transactions and maintaining the Bitcoin database of transactions, or “decentralized ledger,” resides with each computer, or “node,” on the Bitcoin network – and not at one specific location.
In the traditional financial world, the banks that facilitate a financial transaction each keep a record of their transactions within their servers. Since Bitcoin eliminates the middleman, it also eliminates the use of a centralized server. There is no central authority, processing center or database. Instead, there is a worldwide network of computers that work on processing transactions. Each node also possesses a continuously updated copy of the Bitcoin transaction ledger.
Similar to the way that Napster years earlier removed record labels from being at the center of music distribution, Bitcoin removes banks from financial transactions and lets people conduct transactions directly with each other using a platform that is relatively fast, secure and trustworthy.
With Bitcoin it does not matter where the parties are located. Even if the two parties to a transaction are on opposite sides of the world they can conduct transactions directly and nearly in real-time, while saving on the cost and delays created by financial institutions.
A key advantage to using a decentralized model is the elimination of the risk of a single point of failure in the event of server corruption or other catastrophic server event. This ensures that the Bitcoin network is operational 100% of the time.
On the Internet, if a domain name server goes down and is unable to route Internet traffic, the job of routing Internet traffic gets picked up by other servers. The Bitcoin network resembles the Internet in the sense that if a node goes down or goes offline, the transaction and recordkeeping processes are conducted by the remaining nodes on the Bitcoin network.
Another benefit is that altering the Bitcoin ledger is practically impossible due to the encryption and encoding technologies used by the Bitcoin software. Due to techniques not discussed in this article, the cost and time associated with attempting to hack the Bitcoin ledger makes it an extremely time consuming and expensive proposition.
Blockchain and the Public Ledger
A term that is impossible to escape these days is “blockchain.” Like the term Bitcoin, blockchain is all over the news. The term blockchain has taken on celebrity status in most industries. What’s interesting is that while the term is everywhere, most people have no idea what it means. Clearly, blockchain is important. But why?
are credited with giving birth to the idea of the blockchain. In 1991, the two men released their whitepaper on creating a cryptographically secured chain of blocks. Nakamoto was clearly influenced by their work. Bitcoin was the first commercially recognized product that incorporated the use of a blockchain.
Blockchain can be interpreted differently by different people depending on their use or perspective. For purposes of this article blockchain, means a technology that is used to process financial transactions and store the resulting transaction information in modules, or blocks, which are linked together (a blockchain), from oldest to most recent. The data are stored on the public Bitcoin network using a reliable network and trustworthy software that eliminates the need for a middleman. Since the data are stored on the public Bitcoin network, anyone can download the entire transaction history and few the details.
Pros and Cons
While an advantage of Bitcoin is the elimination of the middleman, other benefits also exist. First, distributing a complete record of all Bitcoin transactions to all full nodes on the network eliminates the single point of failure. If the hard drive of one node becomes corrupted, there are thousands of other nodes that will continue to work and keep the network up and running.
Fraud prevention is another benefit. It is much easier for a fraudster to manipulate a single source of data located with a bank than it is for a fraudster to manipulate thousands of data sources located throughout the world. The blockchain technology makes it extremely difficult (read: nearly impossible) for someone to successfully commit fraud by changing the data. This is due to the protocols, algorithms and encryption used when processing the transaction data.
Bitcoin does have its disadvantages. First, the Bitcoin network is significantly slower than other payment networks, such as Visa, MasterCard and PayPal. With a large decentralized network it takes longer to complete transactions and have records received by all nodes on the network.
Second, Bitcoin is also fairly volatile.The value of a Bitcoin can change like that of a stock. As such, it does not make a good stable store of value for everyday purposes. For example, in recent times, Bitcoin’s value has risen to nearly $20,000 per Bitcoin, only to fall down to around $6,000, within a short period of time.
Third, Bitcoin is not universally accepted by merchants or online. While this is slowly changing, as of today, Bitcoin is not a broadly accepted payment method. As more consumers become comfortable with holding Bitcoins, the number of merchants accepting Bitcoin will rise.
Regardless, interest in Bitcoin and cryptocurrencies is growing fast. We’ll know Bitcoin has made it prime time when we see McDonald’s and other major chains accept Bitcoin. Until then, consumers can hold Bitcoin and convert to local currency when needed to make purchases.
Blockchain is Not Bitcoin
Contrary to popular belief, blockchain is not Bitcoin but Bitcoin is blockchain. While Bitcoin is blockchain’s most significant implementation to-date, blockchain can be used for much more than cryptocurrency. In fact, many argue that it is blockchain – not Bitcoin – that is the greater innovation.
The easiest way to visualize how a data is processed is to imagine a spreadsheet. Every time a Bitcoin transaction takes place (example, Anne pays Bob two Bitcoin) a new row is added to the spreadsheet containing details of the transaction. Every 10 minutes or so the nodes in the Bitcoin network process a set of pending transactions contained in the spreadsheet. Of course, there is no spreadsheet. Transaction details are maintained by the Bitcoin software.
The processing of transactions begins with validating the transactions. This includes making sure that all parties sending Bitcoin to other parties actually have the Bitcoin to send. Once the transactions are deemed “valid” the nodes continue to process the transaction data. The end result is a set of transaction data that has been transformed using complex algorithms and encryption technology that makes the data secure, trustworthy and tamper-proof.
Once the transaction processing is completed the results are packaged into a block and linked to the prior block. The collection of blocks is also called a blockchain.
Each node receives a copy of the new block to ensure that all nodes maintain a complete set of all processed transactions. Note that old data is never updated or changed. Instead, new information is recorded within the blocks that reference changes to previously recorded data (for example, the amount of Bitcoin Anne has available). Then the process starts over again with the next set of transactions.
This is a very elementary and high-level description of how data is processed and blocks created. While the process appears simple, it is actually very complex and requires significant computing resources.
Show Me the Money!
The heavy lifting is conducted by the Bitcoin network, which is comprised of connected computers, referred to as “nodes,” located throughout the world. The nodes on the Bitcoin network process the transactions conducted by Bitcoin users. Transaction processing is referred to as “mining” and the nodes performing the mining are referred to as “miners.”
The Bitcoin model was designed to generate new Bitcoins over time as transactions are conducted. The process is called “mining.” In order for Bitcoin transactions to be validated and entered in the public Bitcoin record (blockchain), the transactions undergo a series of computations that are performed by computers (nodes) around the world.
The computers that perform the intensive computations are called “miners.” Miners are rewarded in Bitcoins for successfully validating (mining) a set of Bitcoin transactions. By taking part in the mining process, miners create new Bitcoins to add to the general circulation while facilitating the transactions that make Bitcoin a viable cryptocurrency.
Since Bitcoin is not issued by a government such as the United States Federal Reserve, it is not subject to the currency controls placed on fiat currencies such as the U.S. Dollar. Further, since it is a digital, or virtual currency, it can be used to settle cross-border transactions more easily than traditional fiat currencies.
Up until Nakamoto proposed the Bitcoin model there did not exist in the universe of digital currencies a manner to reliably prevent a party from remitting two or more digital payments using the same digital currency balance (double-spending). Double-spending is a problem unique to digital currencies because digital information can be reproduced with minimal effort. Physical currencies do not have this issue because they cannot be easily replicated, and the parties involved in a transaction can immediately verify the legitimacy of the physical currency.
With digital currency, there is a risk that the holder could make a copy of the digital token and send it to a merchant or another party while retaining the original. This was a concern initially with Bitcoin since it is a decentralized currency with no central agency to verify that Bitcoin used has not been previously used. However, Bitcoin has a mechanism based on transaction logs to verify the authenticity of each transaction and prevent double-counting.
Bitcoin requires that all transactions, without exception, be included in a shared public transaction log known as a “blockchain.” This mechanism ensures that the party spending the bitcoins really owns them, and also prevents double-counting and other fraud. The block chain of verified transactions is built up over time as more and more transactions are added to it.
Bitcoin transactions take some time to verify because the process involves intensive number-crunching and complex algorithms that take up a great deal of computing power. It is, therefore, exceedingly difficult to duplicate or falsify the block chain because of the immense amount of computing power that would be required to do so.
Hackers have tried to get around the Bitcoin verification system but their attempts have been met with only limited success. In fact, most Bitcoin thefts so far have not involved double-counting, but rather have been due to users storing bitcoins without adequate safety measures.
Without a solution to the double-spending challenge, digital currency in general, and Bitcoin in particular, could not achieve widespread adoption and acceptance as recipients of digital currency payments would always be subject to fraudulent duplicate transactions. Bitcoin solved digital currency’s double-spending challenge and eliminated a major obstacle to broad acceptance and trust in the Bitcoin currency model.
The Genesis Block
Genesis Block is a term used when working with blockchains. The Genesis Block is the first block of a blockchain. If you think of a blockchain as a chain composed of a bunch of connected links, the genesis block is the first link before any other links are connected to it. Bitcoin numbered the Genesis Block as block 0 (zero).
According to Investopedia, “The Genesis Block is the backbone of the entire bitcoin system and the origin of Bitcoin itself. If every transaction with Bitcoin were like a fork in the road, then all those roads would eventually lead back to the Genesis Block.”
In January 2009, Satoshi Nakamoto released the first Bitcoin software that launched the Bitcoin network. Nakamoto mined the Bitcoin genesis block (block 0) on January 3, 2009.
“The Genesis Block is the backbone of the entire bitcoin system and the origin of Bitcoin itself. If every transaction with Bitcoin were like a fork in the road, then all those roads would eventually lead back to the Genesis Block.”
The Bitcoin Organization
Bitcoin.org was set up by Nakamoto. Nakamoto’s involvement with Bitcoin, including working with Bitcoin software developers, continued until mid-2010. Towards the end of Nakamoto’s involvement, control of the Bitcoin source code and network alert key was transferred to U.S. Bitcoin developer Gavin Andresen.
Nakamoto also transferred several related domains to various prominent members of the Bitcoin community. These transfers were meaningful because up to that point Nakamoto made all modifications to the Bitcoin source code. Once all this was done Nakamoto faded into the background.
Satoshi Nakamoto: The Man Without a Face
While there exists no reliable information regarding the true identity or identities of Satoshi Nakamoto, there is no shortage of theories.
One theory suggests that the creator of Bitcoin was Hal Finney. Finney was the first person to receive a bitcoin transaction. If Finney was the creator we’ll never be able to confirm as Finney passed away in 2014 from ALS.
Another interesting theory is that Satoshi Nakamoto is comprised of four Asian technology companies. According to this theory, the name Satoshi Nakamoto came from the letters within the company names of Samsung, Toshiba, Nakamichi, and Motorola (Sa-Toshi Naka-Moto).
The Economist romanticizes Nakamoto’s disappearance. “Speculation about Mr. Nakamoto’s identity is likely to continue,” writes The Economist’s L.S. “Much like other evergreens such as who really killed JFK or whether Elvis is still alive.” Or what the true meaning is behind Kurt Cobain’s blissed-out smiley face graphic. It’s a mystery that may never be solved.
Seven Big Ones
Currently, there are approximately 980,000 bitcoins that sit in digital wallets and that were once controlled by Satoshi Nakamoto. According to research, only around 500 Bitcoins were used by Satoshi Nakamoto. The rest sit in Bitcoin’s blockchain unused. As of May 25, 2018, Nakamoto’s stake represented roughly $7 billion!
With billions of dollars at stake, it seems that if Satoshi Nakamoto were still alive he, she or they would have claimed their share. But given the lack of activity, my bet is that Satoshi Nakamoto is resting among the flowers. I mean, who can resist $7 billion dollars? Right?