Bitcoin - How does it work?

[ussusimiel]

I did a search and couldn't find a topic for this. Can anyone explain, in simple non-technical terms, how Bitcoin works?

I've done a bit of reading about it and it doesn't seem to make any sense. There's talk of mining and there's talk of an upper limit of 21 million of them. None of it seems to make sense in the economic terms that I think in.

u.

[wayfriend]

In a nutshell, bitcoins are cryptocurrency - digital bits of information that cannot be forged due to various cryptographic technics. It's essentially the same idea as making a twenty dollar bill that can't be counterfeited, except it is digital.

But it doesn't work unless you have banks that can be trusted to generate cryptocurrency in exchange for other currency. These banks also track where the cryptocurrency goes so that they know who has it when, and this data is made public and spread far and wide to ensure integrity.

It's only as good as how well you trust the banks who run it.

And it's only as valuable as it is trusted.

If you have ever read Cryptonomicon by Neil Stephenson, and every mortal being on this planet should, then you would understand fairly well through the expediency of a well-told and gripping yarn.

[Vraith]

If you have ever read Cryptonomicon by Neil Stephenson, and every mortal being on this planet should, then you would understand fairly well through the expediency of a well-told and gripping yarn.

oh, god...couldn't agree more, nor disagree more.
What a fucking SLOG. But some interesting points.
Great insights on particular things followed by outright stupidity on exactly the same thing.

ONWARDS: Bitcoin PRETENDS to be different than any other currency.
But it isn't.
The "mining" is a digital mining that operates [as analog] to physical mining of physical gold. you just "solve" increasingly complex problems instead of digging through increasing amounts of rock to get the same amount of gold. [in the beginning, you could just pan for gold in any likely mountain stream and get some...now you have to have outrageous resources to eek out a small trickle of profits...unless you want to play the market instead of actually PRODUCE anything]
It is the gold standard for confused code/math geeks.

BTW: one of the biggest "banks" just vanished...like a day or two ago. Without any warning whatsoever. Massive amounts of coin was "discovered" to be stolen/missing and [apparently] was being skimmed and scammed since the beginning.

Stay the fuck away.

[Hashi Lebwohl]

The idea of digital currency is perfectly fine but there are risks just like with any currency. I don't care how great the encryption and the certification processes are, at some point someone will figure out how to counterfeit Bitcoins and throw that virtual economy into a tailspin. The bank which vanished, as Vraith notes, was hacked according to the story I heard--just like an old-fashioned bank robber someone broke into the vault and stole the coins.

Purchasing Bitcoins can potentially put you on the radar of various government agencies who will be curious why you are trying to purchase currency which is normally not traceable by the usual means. The Silk Road (don't ask), which went down recently....then came back up under new ownership, accepted Bitcoin purchases as did/does The Armory (again, don't ask).

Cryptonomicon was a good read but I do admit that it was really boring in places. Also, just because Stephenson describes it doesn't mean that it is real--it highly doubt that it is possible to exploit the refresh rate of a monitor to engage in the sort of phreaking he details. At least, not with modern monitors.

[Fist and Faith]

Never heard of this before. But Hashi, wf said it's traced, and whereabouts are available to the public. That's way more traceable than the bills in my wallet. So why would the government be concerned with me purchasing it based on being difficult to trace?

And what's this about getting some by solving puzzles?? I guess it's off to Google.

[Hashi Lebwohl]

Never heard of this before. But Hashi, wf said it's traced, and whereabouts are available to the public. That's way more traceable than the bills in my wallet. So why would the government be concerned with me purchasing it based on being difficult to trace?

It is because places like Silk Road and The Armory would accept only Bitcoin as payment. Governments with laws against various drugs and weapons tend to dislike places on the Internet facilitating people's ability to purchase those items. There was also concern that people would try to hide money to avoid taxes and that always gets the government involved.

Digital currency is running into the same resistance that paper money first encountered when it was being developed. People wanted actual hard currency--coins minted in some valuable metal--rather than a piece of paper that says "this paper is worth x". Similarly, your Bitcoins may have a total value of $1 million but until you exchange those back into an actual currency you have nothing but someone's claim "oh, yes--your coins are worth $1 million at today's exchange rate". If your digital currency bank disappears like what happened here...well, you're just SOL.

[ussusimiel]

Thanks for the info guys. I get some of it and I've read The Cryptographer, which I enjoyed a lot

I suppose some of my confusion come from my MMT knowledge. The idea of making a fiat currency out of thin air seems like it could be destabilising to the wider global economy. That it gets harder and harder to 'mine' begins to make some sense then. Do the calculations that you have to do to get a new bitcoin serve any purpose or do they just use up computer resources?

It all seems a bit too virtual and hackable for my taste, and with no regulation or backing it also seems like a huge gambling and speculation gig. (With the added factor of Dark Web and criminality thrown into the mix )

If it's a truly new medium then it will also have new effects that we haven't seen before. (Time to go off and read some Marshall McLuhan )

u.

[Avatar]

Yeah, looks like the owner of SR2 claimed a hack that lost their repository 2.4mil BtC, but seems like he actually stole it.

Anyway, it's not anonymous, otherwise there couldn't be a record of your transactions proving how much you had or whatever.

And it has other problems than just hacking...if anybody acquires 51% of the production power it will crash the currency too.

Yet it has potential. I love the idea. But it doesn't matter...as soon as the bank get involved it will be in the realm of regulated regular currency just like everything else.

--A

[wayfriend]

The MMT angle on Bitcoin is fairly interesting. It's not a sovereign currency; it represents no government's IOU. In fact, it's completely dependent on there being another sovereign currency it seems to me, as the only way to obtain bitcoins is to trade them for other currency (or goods). This gives Bitcoin a bit of a parasitic position in my opinion.

BTW, my impression of the term "mining" is that it derives from the fact that those who participate as gateways into the system can derive bitcoins for having provided the service. So it's a dwarf analogy ... they work hard and dig up money. (Okay, maybe that's a second way to obtain bitcoins.)

There is a lot of number crunching involved to create bitcoins and to record transactions, due to the cryptography involved. This involves generating very random numbers, which can involve all sorts of weird tools.

Yes, although bitcoins do not name names, the nature of the system tracks where the bitcoins go, and who has them. There is a certain lack of anonymity, but it's not quite absolute non-privacy either.

Bitcoin will probably fail. But it's an interesting experiment. A lot will be learned, and an improved, next generation will probably follow. That's all to the good.

[ussusimiel]

Thanks, wf. Since Bitcoin is not a sovereign currency it seems to me that it is closer to other mediums of exchange like gold or precious stones. While those have actual physical substance the neat trick with Bitcoin seems to be getting people to trust something that has no actual physical substance, but does have physical effects e.g. it will be accepted in exchange for physical good and services.

Another thing that I don't understand about it is the absolute upper limit of 21 million. I suppose I can see the analogy with a limited physical resource like gold, but again the actual mechanics of it escape me.

Does this upper limit also mean that this kind of currency cannot become truly global? And, can the units be broken down into the equivalent of pounds, shillings and pence?

u.

[Hashi Lebwohl]

I would presume that an absolute limit on the amount of Bitoins available would have to be so that the value doesn't degenerate into worthlessness. If there were an infinite amount of Bitcoins then having 10,000 of them means nothing.
Imagine any of a variety of video games in which there are exploits that essentially allow you to break the economy of the game. For example, Fallout 2. If you spend the skill points to get your gambling up to 110 or 120 then you hit New Reno you can bet $20 at the tables and sit there until you hit the in-game max of $99,999. From there you can head to San Francisco, buy really great equipment, then head back to New Reno to regain all your money.
A similar occurrence happened back in the 1980s when casinos were still using metal tokens. This guy got a token, ground it down until it was a featureless square, then had a metallurgist analyze it. After that, he bought the raw materials, smelted an alloy which matched the token, made a mold of a regular token, then started minting his own. He would then make regular trips to the casino, spend a couple of hours there to make it look good, and cash in a box of tokens. This worked so well at casino A that he started doing it at casinos B, C, and D, as well. They couldn't catch him because his fake tokens were so well-made that they were identical to the real ones. It wasn't until they started keeping an inventory of the tokens and found a surplus that they were able to figure out what was going on.

Anyway....keeping the amount limited is a way to control the value of each coin and to prevent counterfeiting.

[ussusimiel]

But doesn't that immediately lead to the inflation of the value of the coins in circulation. Because of limited supply as the coins come to represent more wealth their value is forced upwards. And the more successful they are the quicker their value will rise to the point where they become too large for normal transactions. How can I buy a $400 computer with a Bitcoin whose value is $1200?

MMT shows that you maintain a stable value for a currency by creating new currency to represent newly created wealth. The only upper limit on the amount of currency that you can produce is the capacity of an economy to produce wealth. Bitcoin seems closer to a commodity than a currency.

u.

[I'm Murrin]

But until it actually hits that limit, the mining functions the same way as generating new wealth, yes?

[Hashi Lebwohl]

But doesn't that immediately lead to the inflation of the value of the coins in circulation. Because of limited supply as the coins come to represent more wealth their value is forced upwards. And the more successful they are the quicker their value will rise to the point where they become too large for normal transactions. How can I buy a $400 computer with a Bitcoin whose value is $1200?

MMT shows that you maintain a stable value for a currency by creating new currency to represent newly created wealth. The only upper limit on the amount of currency that you can produce is the capacity of an economy to produce wealth. Bitcoin seems closer to a commodity than a currency.

u.

You would have to cash out your Bitcoins and then buy the computer. I don't think Bitcoin was created by a group of economists and I highly doubt they were thinking about things like MMT when they were in the process of creating it.

[Vraith]

Does this upper limit also mean that this kind of currency cannot become truly global? And, can the units be broken down into the equivalent of pounds, shillings and pence?

u.

To answer one question...bitcoins, being digital, can be broken down into any decimal, and are spent that way...
For instance, some pizza chain started accepting bitcoin. A $10. pizza cost .o134 bitcoins or some such tiny decimal amount...it just fluctuates constantly, and the software does the conversion.
You can also swap it for other currencies. [that pizza place has to turn it in to dollars at some point, to pay their taxes, bills, employees...unless they also accept it...still, at some point it has to be changed so the Gov't can get its share]
The rest I have to say is just pieces picked up randomly, never really closely followed it, don't vouch for the truth/accuracy.
One advantage some folk supposedly liked about it was that [I don't know if it's true or changed] when buying something that required switching currencies [like if I ordered something from the U.K. with my U.S. credit card] their was no slice taken by the bank system.

Bitcoin is a strange hybrid between a commodity and...what? A "distributed fiat"...I don't think there really is an existing word for it.
I mean, peeps say the dollar has no value except we agree it does...but that's not quite true...it is backed by the need to pay taxes and gov't guarantee and recognition. Bitcoin is one further step removed...no gov't, no tax insistence.
But it is an absolutely limited resource, so has all the problems of those currencies [like being a firm limit on wealth]...plus at least one.
"Mining" does indeed 'create new wealth,' as long as someone WANTS it, can USE it AND as long as digging one up earns you more money than the cost of getting it...but, with real gold, market conditions can make mining a losing proposition [at least temporarily], yet...even if the value drops you still have a useful piece of metal.
Gold has SOME value, no matter what...at least you can sprinkle it in your shots and have a pretty drink. [technically you could keep doing that nearly forever is you wanted to...ummm....recycle your waste.]

AFAICT, bitcoin only has interest cuz you can get it by being a geek and in the comfort of your own home and because people feel like they're getting away with something.
Some folk like it cuz they think the Gov't isn't involved so can't screw it up.
I'm not sure how they feel about Gov't now that roughly 400mil is gone and practically zero chance even 1 coin will ever be recovered...especially without gov't help.
This isn't the first heist, either. A while ago, 100mill was stolen and tons of people started hunting and tracking the "thief"...only to discover once they "caught" "him" they'd basically been chasing the "banks" accounts [really just following what the software does to keep functioning.]
No one ever came close to finding the actual thief, the best guess is that as soon as s/he stole it he traded it for real money and laughed all the way to a real bank. But it is just a guess.

[ussusimiel]

That you can pay with fractions makes sense, Vraith, otherwise it would be too unwieldy to be useful.

It doesn't generate wealth directly, but then no currency does. MMT would say that it represents wealth. Other commodities can generate wealth as they usually have actual uses rather than just being a medium to store wealth. If the computer resources used to generate a new Bitcoin did something useful with previously unused resources then I suppose an argument could be made that some actual wealth is generated.

AFAICT, bitcoin only has interest cuz you can get it by being a geek and in the comfort of your own home and because people feel like they're getting away with something.

This would be nice if only it were true, however, as has been mentioned upthread, Bitcoin has already been put to other darker uses.

...now that roughly 400mil is gone and practically zero chance even 1 coin will ever be recovered...

In The Cryptographer something similar happened, but it was more a hacking and destruction of the currency rather than a heist. The point made in the novel is that no matter how tough your cryptography, by its very nature, it can at some point be cracked (is this true in RL?).

u.

[wayfriend]

The point made in the novel is that no matter how tough your cryptography, by its very nature, it can at some point be cracked (is this true in RL?).

Yes. The "key size", a number of bits, dictates the security of your encryption. The larger your key size, the more possible combinations you need to try to brute-force crack a key. As computers become more powerful, and cracker algorithms get more sophisticated, it takes less and less time to do this. What used to take a year to crack now takes seconds.

The solution is to use larger and larger key sizes to keep ahead of the wave.

But not too much - the bigger the key, the slower it is encrypting and decrypting your data. So you have to stay within an upper and a lower bound that constantly moves.

Last year 1024-bit RSA encryption went dinosaur. 2048-bit surely will in a few years.

If Bitcoin is well designed, this would not matter, so long as it's design supported upgrading the cryptography strength as time went on. I don't know what kind of crypto it uses, but I see people estimating 1-10 billion years to crack a key with current technology. Seems off to me, but I am not an expert.

[Vraith]

That you can pay with fractions makes sense, Vraith, otherwise it would be too unwieldy to be useful.

It doesn't generate wealth directly, but then no currency does. MMT would say that it represents wealth. Other commodities can generate wealth as they usually have actual uses rather than just being a medium to store wealth. If the computer resources used to generate a new Bitcoin did something useful with previously unused resources then I suppose an argument could be made that some actual wealth is generated.

AFAICT, bitcoin only has interest cuz you can get it by being a geek and in the comfort of your own home and because people feel like they're getting away with something.

This would be nice if only it were true, however, as has been mentioned upthread, Bitcoin has already been put to other darker uses.

...now that roughly 400mil is gone and practically zero chance even 1 coin will ever be recovered...

In The Cryptographer something similar happened, but it was more a hacking and destruction of the currency rather than a heist. The point made in the novel is that no matter how tough your cryptography, by its very nature, it can at some point be cracked (is this true in RL?).

u.

well, of course I meant it as a representation...bill gates is worth many billions, but I doubt he has even a hundredth of it cash on hand, and I doubt he has any gold coins in a vault in his house. [and even that wouldn't matter if the world went wonky and he had tons of coins and no one had any food to buy with it] Kinda what I meant by implying bitcoin has some advantages as long as things keep going as they have...but also ALL the disadvantages of both fiat and commodity [and a couple more that neither of those does] if things don't.

Nevertheless it creates wealth...cuz as soon as you solve for X you have a bitcoin that never existed and you can get dollars [or yen, or whatever...or a pizza...] for it.


The darker uses is just one part of what I meant by people FEELING like they were getting away with something. They feel like they're Freedom/Revolutionary heroes sticking it to the Tyrants. But they're sharing their boat with the Dark Lords.
[[DUDE! I got a GREAT PRICE on this DIAMOND! [yea, you got that price cuz people died digging it up, and that's cheaper than buying diesel fuel for a machine to do it, among other things]]]

[Hashi Lebwohl]

Yes. The "key size", a number of bits, dictates the security of your encryption. The larger your key size, the more possible combinations you need to try to brute-force crack a key. As computers become more powerful, and cracker algorithms get more sophisticated, it takes less and less time to do this. What used to take a year to crack now takes seconds.

The solution is to use larger and larger key sizes to keep ahead of the wave.

But not too much - the bigger the key, the slower it is encrypting and decrypting your data. So you have to stay within an upper and a lower bound that constantly moves.

Last year 1024-bit RSA encryption went dinosaur. 2048-bit surely will in a few years.

This blog is from 2010 and so it is hopelessly outdated by now but at the time he was able to get his system up to 33 billion passwords per second. I suspect the cutting edge is easily 10 times that fast by now.

The real trick is not to rely solely or larger and larger keys; rather, the key to truly uncrackable encryption is iteration. Consider the function x^3 - x. It isn't too bad to look at, fairly easy to work with, and not terribly complex. Iterate it with itself, though, and you get x^9 - 3x^7 + 3x^5 - 2x^3 + x. Much more difficult to work with and definitely more unwieldy. Just for fun, though, do it again to arrive at x^27 - 9x^25 + 36x^23 - 87x^21 + 147x^19 - 189x^17 + 192x^15 - 156x^13 + 102x^11 - 54x^9 + 24x^7 - 9x^5 + 3x^3 - x. No, you won't be using these sorts of formulae for encryption but the idea holds--iterate by compounding a relatively simple function with itself multiple times to create something significantly more complex.

Take a relatively straightforward cypher which maps the regular alphabet, abcdefghijklmnopqrstuvwxyz, onto bcegjntkfpxyaoqsvhrldmuizw (in essence, I moved incremented each letter according to the Fibonacci sequence, moving 1, then 1, then 2, then 3, etc). Now, though, we are going to take advantage of a trick from psychology--if I rnoazdmie the ltertes in tehse wrods you can still utansndred them as long as the frsit and last lretets stay put. Now break the text into groups of five like they did in the old days (or seven just for something different, which is what we will do here): ifIrnoa zdmiet helter tesint ehsewro dsyouca nstillu tansndr edthema slongas thefrsi tandlas tlretet sstaypu trstlne (the last letters are fillers and you can make up your own sequence to use). Once I run these groups through the mapping we get
fnfhoqb wgafjlb kjyljhb ljrfolb jkrjuhq grzqdeb orlfyyd lborogh jglkjab ryqotbr lkjnhrf tandlas lyhjljl rrlbzsd lhrloyj
and when you remove the spaces you get:
fnfhoqbwgafjlbkjyljhbljrfolbjkrjuhqgrzqdeborlfyydlboroghjglkjabryqotbrlkjnhrftandlaslyhjljlrrlbzsdlhrloyj

which is going to look like complete gibberish at first glance. Even when you try to decipher it you would still have to be able to reverse-engineer the steps that went into it. Subdivide the letters into groups of 7 (count the letters and you will see that there are 105, which could be 15 blocks of 7 or 21 blocks of 5 in the old style but that is still a clue), then figure out the pattern via frequency mapping (e is the most common letter and maps to j, etc) *if* you also take into account that some of the letters are jumbled--this step will completely confuse non-English speakers. Anyway....the point is that layering simple things leads to something very complex. This is the future of encryption...or at least it should be.

Yes, that mode of thought is the key to my personal encryption algorithm. No, I don't use any of these steps. No, I am not an expert nor have I received specialized training in cryptology. Yes, it is a occasional hobby of mine.

hrm....odd....why aren't those WolframAlpha links working correctly?

[Fist and Faith]

I think we need to do away with the need for encryption.