Bitcoin: Magic, Fraud, or Sufficiently Advanced Technology?: Part I


         Bitcoin: Magic, Fraud, or Sufficiently Advanced Technology?: Part I

Arthur C. Clarke’s third law famously states: “Any sufficiently advanced technology is indistinguishable from magic.” What Bitcoin makes possible can at first seem almost magical, or just impossible (and therefore most likely fraudulent or otherwise doomed). The following describes the basic technical elements behind Bitcoin and how it brings them together in new ways to make seeming magic possible in the real world.

Clarke’s second law states: “The only way of discovering the limits of the possible is to venture a little way past them into the impossible.” And this, we can see in retrospect, is basically what Bitcoin creator Satoshi Nakamoto did. Few at the time, even among top experts in relevant fields, thought it could really ever work.

It works.

One reason many people have a hard time understanding Bitcoin is that it uses several major streams of technology and method, each of which is quite recent in historical perspective. The main raw ingredients include: an open-source free software model, peer-to-peer networking, digital signatures, and hashing algorithms. The very first pioneering developments in each of these areas occurred almost entirely within the 1970s through the 1990s. Effectively no such things existed prior to about 40 years ago, a microsecond in historical time, but a geological age in digital-revolution time.

Some representative milestone beginnings in each area were: for open-source software, the GNU project (1983) and the Linux project (1991); for peer-to-peer networking, ARPANET (1979) and Napster (1999); for digital signatures, Diffie–Hellman theory (1976) and the first RSA test concept (1978); and for hashing algorithms, the earliest ideas (around 1953) and key advances from Merkle–Damgård (1979). Bitcoin combines some of the best later developments in each of these areas to make new things possible.

Since few people in the general population understand much about any of these essential components, understanding Bitcoin as an innovation that combines them in new and surprising ways, surprising even to experts within each of those specialized fields, is naturally a challenge without at least a little study. Not only do most people not understand how the Bitcoin puzzle fits together technically, they do not even understand any of the puzzle pieces! The intent here is not to enter into much detail on the content of any of these technical fields, but rather to provide just enough detail to achieve a quick increase in the general level of public understanding.

What Bitcoin is about in one word: Verification

It may help to focus to begin with not on the details of each field, but at how each part contributes strategically to Bitcoin’s central function. This is to create and maintain a single unforgeable record that shows the assignment of every bitcoin unit to addresses. This record is structured in the form of a linked chain of blocks of transactions. The Bitcoin protocol, network, and all of its parts maintain and update this blockchain in a way that anyone can verify. Bitcoin revises the Russian proverb, “doveryai, no proveryai,” “Trust, but verify,” to just “verify.”

If a single word could describe what the Bitcoin network does, it would be verification. For a borderless global currency, relying on trust would be the ultimate bad idea. Previous monetary systems have all let users down just where they had little alternative but to rely on some trusted third party.

First, the core Bitcoin software is open source and free. Anyone can use it, examine it, propose changes, or start a new branch under a different name. Indeed, a large number of Bitcoin variations with minor differences have already existed for some time. The open source approach can be especially good for security, because more sets of eyes are more likely to find weaknesses and see improvement paths.

Open source also tends to promote a natural-order meritocracy. Contributors who tend to display the best judgment also tend to have more of their contributions reflected over time. Unending forum discussions and controversies are a feature rather than a bug. They focus attention on problems—both real and imagined—which helps better assure that whatever is implemented has been looked at and tested from diverse angles.

Many computers worldwide run software that implements the Bitcoin protocol. A protocol is something roughly like a spoken language. Participants must speak that language and not some other, and they must speak it well enough to get their messages across and understand others. New protocols can be made up, but just as with making up new languages, it is usually rather unproductive. Such things only take off and become useful if enough others see a sufficient advantage to actually participate.

Second, as a peer-to-peer network, there is no center. Anyone can download core Bitcoin software and start a new node. This node will discover and start communicating with other nodes or “peers.” No node has any special authority or position. Each connects with at least eight peers, but sometimes many more. Some faster and always-on nodes relay more information and have more connections, but this conveys no special status. Any node can connect or drop out any time and join again later. A user does not have to run a full node just to use bitcoin for ordinary purposes.

It is common to say that Bitcoin is “decentralized” or doesn’t have a center. But then, where is it? Thousands of active peering nodes are spread over most countries of the world and each one carries an up-to-date full copy of the entire blockchain.

Some nodes not only relay valid transactions and blocks, but also join the process of discovering and adding new blocks to the chain. Such “mining” activities both secure the final verification of transactions and assign first possession of new bitcoin to participating nodes as a reward. Understanding basically how mining works requires a look at the distinct functions of several different types of cryptography.

Bitcoin cryptography dehomogenized

Bitcoin relies on two different types of cryptography that few people understand. Both are counter-intuitive in what they make possible. When most people hear “cryptography,” they think of keeping data private and secure through encryption. File encryption can be used to help secure individual bitcoin wallet files, just as it can be used for the password protection of any other files. This is called symmetric key cryptography, which means the same key is used to encrypt and decrypt (AES256 is common in this role). Encryption may also be used for secure communication among users about transactions, as with any other kind of secure traffic. This is called asymmetric key cryptography, which means a public key encrypts a message and its matching private key decrypts it at the other end.

However, all of this is peripheral. Nothing inside the core Bitcoin protocol and network is encrypted. Instead, two quite different types of cryptography are used. They are not for keeping secrets, but for making sure the truth is being told. Bitcoin is a robust global system of truth verification. It is in this sense the opposite of the “memory hole” from George Orwell’s 1984; it is a remembering chain.

The first type of cryptography within Bitcoin is used to create a message digest, or informally a “hash.” Bitcoin uses hashing at many different levels (the most central one is an SHA256 hash run twice). The second type is used to create and verify digital signatures. This uses pairs of signing keys and verification keys (ECDSA sepc256k1 for signatures).

The keys to the kingdom

Despite intuitive appearances to users, bitcoin wallets do not contain any bitcoin! They only contain pairs of keys and addresses that enable digital signatures and verifications. Wallet software searches the blockchain for references to the addresses it contains and uses all the related transaction history there to arrive at a live balance to show the user. Some of the seemingly magical things that one can do with bitcoin, such as store access to the same units in different places, result from the fact that the user only deals with keys while the actual bitcoin “exists,” so to speak, only in the context of the blockchain record, not in wallets. It is only multiple copies of the keys that can be stored in different places at the same time. Still, the effective possession of the coins, that is, the ability to make use of them, stays with whoever has the corresponding signing keys.

While software designers are working hard to put complex strings of numbers in the background of user interfaces and replace or supplement them with more intuitive usernames and so forth, our purpose here is precisely to touch on some technical details of how the system works, so here is a real example of a set of bitcoin keys. This is a real signing key (do not use!):


From this, a unique verification (public) key is cryptographically generated (compressed version):


This verification key is then hashed into a public address to which bitcoin can be sent. In this case:


Because this particular signing key has been made public, it has been rendered permanently insecure—sacrificed for the cause of Bitcoin education.

Part II will discuss hashing and the essential roles it plays in the technical structure of Bitcoin, as well how the system has been designed to be self-financing right from the beginning into the indefinite future.

To read Part II, click here!

About the Author

KonradGraf_04 - Version 2Konrad S. Graf (@KonradSGraf) writes on Bitcoin and monetary theory. This work so far is collected at konradsgraf.com/bitcoin-theory. He appeared on panel discussions on Bitcoin and economic theory and monetary history at the Bitcoin 2014 conference in Amsterdam, and in 2013, he presented on Bitcoin and social theory at the Mises Seminar Australia in Brisbane and via pre-recorded interview at the Bitcoin Singapore conference. He is currently focusing on additional research and writing in this area.


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