The Bitcoin Whitepaper Explained

The Bitcoin Whitepaper: Abstract

Bitcoin is a peer-to-peer digital currency. In other words it makes do without a financial institution to approve transactions.

There are some benefits as a result of this. Bitcoin solves the issue of double spending thanks to its technology. Double spending is a type of fraud which currently exists in our centralised financial system.

Additionally even though Bitcoin is peer-to-peer you can make payments without trusting the person you are paying. The blockchain verifies everything. So you can place your trust in the blockchain and not in the third party.

1. Introduction

We are largely dependent on using banks to process our transactions. There are those that use cash, but cash is being used less and less.

Additionally, banks are placed on the spot when they have to resolve disputes between customers and merchants. These disputes happen often and only end up escalating costs. As a result they make smaller transactions an operation loss for the banks.

Similarly they also make an operational loss for the merchant at times. The merchant would have delivered the service, but could have the money withdrawn from his bank account. This is done by the bank at the request of the customer. To clarify it could happen for legitimate as well as illegitimate reasons.

This lays out the ground work for a system based on cryptographic proof. In other words a system that does not require trust. This is where the idea of a peer-to-peer system comes in. Its purpose is to support transactions that are irreversible.

As a result this will prevent the merchant from being defrauded. However it would also allow escrow mechanisms to safeguard buyers and provide them with peace of mind. A win-win situation for both parties.

2. Transactions

This bit in the Bitcoin whitepaper explains how transactions work on the blockchain.

For one transaction there are several things going on in the background. Firstly when you send your Bitcoin, the blockchain needs to verify the transaction. The blockchain knows all the transactions that ever occurred on the network and does not allow double spending.

So the same Bitcoin is not allowed to make more than one purchase. As a result, if the same coins are used twice the blockchain only allows the first transfer to go through. That transactions is considered the legitimate transaction.

Hence that transaction is approved and publicly recorded in the blockchain. The blockchain discards the second transaction and in so doing it eliminates fraud on the network.

Consequently the order in which transactions are made is really important. This leads to the next section in the Bitcoin whitepaper which is dedicated to timestamping.

3. Timestamp server

This section is brief. It explains how transactions are recorded along with the time the transaction was made. Every time someone creates a transaction that gets approved, it is added to the list of transactions.

This forms a chain of transactions. That is to say each transaction reinforces the ones made previously.

4. Proof-of-work

This part of the Bitcoin whitepaper starts to get more technical because it deals with mining. Our explanation here is simplified to make it easier to understand.

Bitcoin is available on the blockchain to mine. Each block of Bitcoin is represented by a string of numbers and letters called a hash. To mine Bitcoin from the block a miner needs to correctly guess the combination to unlock the funds. To clarify they need to correctly guess the amount of zeros that are included in front of the hash sequence.

There is always a good number of computers competing to guess the right combination. In the end the computer that correctly guesses the correct answer first will win. As a result it can collect the Bitcoin reward.

There is a level of difficultly associated with guessing the number of zero’s. However it is easy to validate the answer to include on the blockchain. The solution is what is known as proof of work.

Why is this important? The network works this way to prevent fraud. Above all in the case of a malicious actor that would want to change the network to favour them. So this process makes it difficult or virtually impossible to change the transactions in the chain. This is because the hacker would need to progressively go back and change each transaction.

5. Network

The network takes the place of a bank. Satoshi goes through the steps it takes to run the network of the blockchain. The process is done by computers.

Each node or computer sends out a notification when a new transaction is made. After that it adds it to a block. Computers also go in search of new blocks to work on. That is to guess the amount of zero’s for the hash. Once a computer finds a hash it notifies other computers.

The computers compete against each other and work to solve the hash to get the Bitcoin reward. The winning computer will collect the Bitcoin. However this is only when other computers validate which computer has won the Bitcoin.

The computer that wins the Bitcoin is the one that got to the solution first. They verify this by using the timestamp. Computers express their validation of the block by progressing to work on the next block in the chain.

6. Incentive

Certainly one of the most important sections in the Bitcoin whitepaper is the incentive to the network. The whole system requires incentives for it to be viable so people want to use it. The Bitcoin that miners can mine is the dangling carrot for the network. As a result miners can continue to work and issue the coins into circulation.

Bitcoin mining uses computing power and needs electricity to run. If it is not profitable to mine the coins miners can charge a transaction fee. This fee is over and above the Bitcoin reward. However it will continue to incentivise the miners.

Miners can also apply transaction fees when all the 21 million Bitcoins are mined in future. Like this they can keep the network going. At this point the miners will take care of maintaining the system and validating transactions to make a profit.  

7. Reclaiming disk space

This section is fairly technical. Essentially, the network is constantly recording transactions. Consequently this takes up a lot of disk space on the blockchain. So the network needs to cut down on the amount of power and storage space required.

To do this, parts of the information of an executed transaction that are no longer required are removed. They are not included in the chain to help reclaim space.

8. Simplified payment verification

Only a part of the network is used to verify transactions. You can do this by using a branch of the longest proof-of-work chain. It comes in handy when you want to make transactions with Bitcoin, but you do not have enough computing power. For example when you make a transaction from your mobile phone.

Since the network selects the longest chain to use it ensures you will use an honest node. However it has its drawbacks. This is because it is more vulnerable to malicious actors who can hack it more easily.

9. Combining and splitting value

The network does not keep track of each cent. (In this case ‘Satoshi’ which is the smallest of all Bitcoin units). Most certainly because it would make things cumbersome. Instead the network combines coins or uses a portion of an amount of coins to make payments.

What does this mean? Let us say for example you have 100 euros. 70 came from rental income and 30 came from your business services. You want to make a payment of 90 euros for an item of furniture. You can make the payment from the 70 euros from rent and 20 euros from the 30 euros.

10. Privacy

There are addresses associated with wallets. However you do not know who is behind that address. This information is not stored in any way on the blockchain. Therefore the blockchain does not make this information public. As a result this maintains privacy.

11. Calculations

This section in the Bitcoin whitepaper goes through the likelihood of some scenarios. It states that it is practically impossible to create Bitcoin out of thin air. Additionally it is also hard to steal Bitcoin from other wallets.

Hackers of the blockchain that go tweaking the chain can only get so far. That is to say the honest chains will outrun the dishonest chain of the hacker.

The only way a hacker can get ahead of honest chains is if they use a 51% attack. This would mean that the hacker is in control of 51% of the computing power. To clarify this is highly improbable.

The Bitcoin whitepaper also features a calculation of the probability in this section. Any math whizzes might want to check this out to understand the likelihood of this scenario.

12. Conclusion of the Bitcoin Whitepaper

The conclusion nicely summarises everything that was said in previous sections of the Bitcoin whitepaper. That is to say Bitcoin and its blockchain are an electronic transaction system. It does not require you to have trust in the person you are making the payment to. However your trust is placed on blockchain technology.

The blockchain does not allow double spending and does this by using proof-of-work. Hacking the system would require a hacker to get majority control. In other words 51% of the computing power of the network which is practically impossible. 

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