"This planet has -- or rather had -- a problem, which was this: most of the people living on it were unhappy for pretty much of the time. Many solutions were suggested for this problem, but most of these were largely concerned with the movement of small green pieces of paper, which was odd because on the whole it wasn't the small green pieces of paper that were unhappy." (Douglas Adams, The Hitchhiker's Guide to the Galaxy (1979))
30-odd years later, the planet and unhappiness endure but the small green pieces of paper are teetering on the edge of archaism as much of life -- economy and trade included -- plays out increasingly in the 'digital realm'. Bitcoin -- the topic of our latest study group, led by Jake -- is a popular recent solution to the problem of making payments without recourse to anything so vulgar as physical matter; the upshot being, in place of notes and coins transferred from hand to hand one now exchanges solutions to hard mathematical problems electronically across a network.
The primary focus of the session was the technical workings of the system, but we were inevitably drawn into a variety of intriguing digressions on the 'value' of bitcoins (and the nature of value generally), the dependence of the system on majority consensus, and the difficulty of genuinely achieving the idealised goal of decentralisation with the introduction of powerful (and energy efficient) custom-built hardware miners. In what follows, I will give my best attempt at a technical overview, and then touch on some of the ideas and questions which came up in our discussions.
Bitcoin is a "peer-to-peer electronic cash system" proposed by the (presumed pseudonymous) developer Satoshi Nakamoto in 2008 [PDF] and released into the wild in early 2009. It aims to provide a network-wide-agreed payment mechanism which doesn't rely on any central authority or (as long as there's an honest majority) on mutual trust between the nodes in the network.
Jake began his explanation of the Bitcoin system by describing a transaction: A bitcoin owner possesses one or several 'addresses', each associated with a bitcoin balance and a public/private key-pair (P_k,S_k). To make a payment of (say) 8 BTC from an address with a balance of 10 BTC the owner broadcasts two transactions: one with a value of 8 BTC to the payee, and one with a value of 2 BTC back to himself. A transaction is a hash of the previous transaction, the value to be transferred, and the public key of the recipient, signed under the private key of the sender. It is recommended (but not mandated) that the sender generates a new key pair and address for the portion of the value that he 'keeps', in order to promote a degree of anonymity in the system (more about that later).
New transactions are gathered into blocks by miner nodes, at which point it becomes a race to find a difficult 'proof-of-work' for the block (see below) and broadcast it to the rest of the network. The network nodes check the proof-of-work, and the validity of the transactions in the block; if satisfied, a node drops the block it has been working on, adds the accepted block to the chain, and commences working on the next block. Because the new block contains the hash of the previous block, nodes are able to detect if they have missed a block and request it to keep their version of the chain complete. Likewise, if the chain forks (i.e., if different nodes receive different versions of the same block simultaneously), the fastest-growing branch is the one which is preserved (that is, majority consensus decides), and any nodes working on the discarded chain are able to self-correct according to the information in future blocks. (For this reason, verification checks must go back further than one step, and payees should ideally wait for 'confirmation' -- which happens when a block is sufficiently buried under new blocks -- before spending received bitcoins).
The 'proof-of-work' in this case is to find a nonce which, when hashed (twice with SHA-256) along with the rest of the block -- all new transactions, a reward transaction to the miner, a time-stamp, and some meta-data -- produces a value with a certain number of leading zero bits. The number required is specified according to the current difficulty level and evolves according to increasing computer power and varying network participation, the intention being to control the rate of block creation. Over time, new blocks become harder to mine, and the reward decreases (it began at 50 BTC, is currently at 25 BTC, and will be halved every 4 years), until the number of bitcoins reaches 21 million (estimated to happen around 2140) and thereafter remains constant.
Incentives to mine arise from the reward paid to the node which finds the proof-of-work, and an optional transaction fee which right now most nodes are willing to waive but which will play a more important role as the reward, and mining rate, decrease. Many miners cooperate in pools, which run from central servers and pay out mined bitcoins to all individuals in proportion to the computing power contributed. Incentives to obey protocol arise from the fact that only the longest chain (i.e. the one agreed on by the majority) will survive, so it is a waste of time trying to hash 'rubbish' or introduce invalid transactions: only with a colluding majority could valid transactions be rejected or invalid ones accepted.
We talked a little about the 'success' of Bitcoin as a currency. Ultimately, money only has value to the extent that it can be exchanged for 'stuff' -- "Surely use alone // Makes money not a contemptible stone" (George Herbert) -- and this extent is entirely dependent on the confidence of a community in money as a store of value and their subsequent willingness to accept it in exchange for said 'stuff'. Unsettling circular, no? The variety and quantity of goods and services available for BTC is still very limited, and prices tend to be fairly independent of the dramatically fluctuating Bitcoin-to-dollar/sterling/etc exchange rates. This reality, coupled with the deflationary bias of Bitcoin value (which national currencies work hard to avoid), provide strong incentives to hoard rather than to spend Bitcoin, so that it functions more like an investment than a currency -- potentially problematic given its lack of intrinsic value (if its value depends entirely on a community's willingness to accept it as payment, what becomes of it if nobody trades in it?)
And then there is the question of anonymity -- a motivating factor in the development of many electronic cash systems, Bitcoin included (the idea being that physical coins cannot be traced to previous owners, and one might naturally wish to emulate this functionality in an online setting). Anonymity in the Bitcoin system is achieved to a superficial degree, because the 'addresses' with which bitcoin balances are associated need not be publicly tied to an identity; however, the ability to link transactions to individual pseudonyms, coupled with the opportunity to exploit public information linked from outside sources, means that there is substantial scope for de-anonymisation (a problem which is by no means unique to Bitcoin).
We also talked about the rise of the Bitcoin ASIC miners, which are quickly concentrating network influence into the hands of a small number with exceptional computing capabilities. A participant's ability to mine essentially depends on their computing power relative to other participants. With the introduction of ASICs to the network, mining difficulty rapidly increased (to keep pace with mining speed) to the point where it is no longer cost effective for 'normal' users (with only CPU or even GPU capabilities) to mine -- the energy costs outweigh the reward. This is problematic because it undermines the Bitcoin 'philosophy' of decentralised power, by creating an elite core of uber-nodes with potential opportunity to over-rule the 'majority' because they hold the larger part of the computing power in the network. Various 'solutions' to the ASIC problem have been touted -- for example, switching to SHA-3 for future transactions. Of course, that would put the current ASICs out of useful action, but it would only be a matter of time before new SHA-3 ASICs were developed. Likewise, a dynamic system where the mandated inputs to the hash were periodically changed would only encourage the development of hardware miners able to operate with variable inputs.
Perhaps Bitcoin can never live up to the ideological hype surrounding it. But I think many of us came away from the session reinforced in our impression of it as an elegant piece of cryptography and a fascinating high-impact experiment with much to teach us about the challenges and possible solutions associated with the increasing dominance of the Internet in many aspects of personal and societal life, including the economy. (Of course, it goes without saying that the above opinions and ponderings are only my interpretation of a conversation which was not in any case intended to be authoritative or conclusive on what is a highly complex and potentially divisive topic -- I hope they will be taken in that light!)