Introduction to Bitcoin

BitCoin Coin

Bitcoin appears in the news often these days. I’ve found two resources that give an excellent overview of what it’s all about.

The Book

One is a self published Kindle book by David Seaman (not the ex-Arsenal goalkeeper) that – when I bought it – was 27 pages long and £2.51 to buy. As an aside, isn’t it great that publishing economics are such that you can buy a concise book with no useless “filler” to unnecessarily increase it’s page count? The book is:

A Talk

Alternatively, if you prefer to listen – particularly if you have a long train or car journey, I recommend one of the recent John Gruber Podcasts, entitled “Mind of a Gambler”. That’s not in itself a reference to Bitcoin, as he and guest Glenn Fleishman spent the first segment of the show talking about the game of Jeopardy, and then the best strategy when playing BlackJack. That included the findings of an IBM statistician (proven by getting a computer to play millions of games under different player strategies) that you should fold your hand as soon as you get two cards adding up to 12 or above, ie: not to twist if there’s any chance that the next card you twist could make you exceed 21. While it looks odd to quit so early to other human players, it is in fact the strategy that maximises your income on the table. But I digress.

The whole John Gruber “The Talk Show – Mind of a Gambler” (Show number 74) podcast can found at: http://www.muleradio.net/thetalkshow/74/. His guest is Glenn Fleishman, who has written articles for several publications, including The Economist, on the subject of BitCoin. The whole Podcast is 2 hours 24 minutes long, but the part pertinent to Bitcoin is between 26:28 to 1:55:22 – so about 90 minutes long.

Alternatively, if you prefer talks with pertinent slides as a subject expert goes along, there is a good YouTube video that summarised Bitcoin to students at Stanford University, given by one of their Chinese Alumni, Bobby C Lee. You can watch the presentation here; it’s under 75 minutes long and is an excellent summary.

Open Minded Governments (Seriously!)

It’s been really surprising to find how open minded some government institutions are about Bitcoin and other similar “Crypto” currencies – particularly in the USA and in China. A total polar opposite to the norms of the sensationalist tabloid press (who, at this time, are unusually quiet).

How it works

The central tenet of these currencies is that your “cash value” is stored as sophisticated, long number which only you can transact.

When you want to transfer any value to another party, you have to sign the transaction with a long private alphanumeric key (known only to you!), and details of that cash movement is recorded onto a transaction ledger. The main innovation with Bitcoin is that the ledger is viewable by anyone, and copies of it are distributed over many, many computers all over the Internet.

Once a cash transaction is made, many other computers do a complex piece of maths to keep guessing a checksum, which when one somewhere in the world successfully matches, is written back into the ledger to lock the transaction in the transaction history. This result is then written back to all the various distributed copies of the ledger, and the winner of the “be first to complete the checksum” lottery is awarded 25 BitCoins as a prize. This is what “Mining for Bitcoins” is.

The piece of the ledger currently under construction is called “the blockchain”.

Limited Reserves

There are two subsidiary characteristics of Bitcoin. One is that they’ll only every be circa 21 million bit coins minted. This is just like gold bars when major currencies were backed by country gold reserves. At one point, a UK pound or a US dollar was indicative of a share of the gold in the UK Treasury (for GB Pounds) or Ford Knox (for US Dollars). However, a more recent move was to disassociate currencies from underlying gold reserves, giving Governments to print as much money as they wanted with a value based on “trust” rather than a share of the underlying gold reserves. This has enabled successive governments to, in effect, keep devaluing their own currencies (aka “quantitative easing”), which economists have mixed views about. Some even point to what happened to the Roman Empire when such a long term devaluation strategy went to extremes. Bitcoin, by its very nature, cannot be manipulated in the same way; it is a return to the financial discipline of the Gold Standard.

“Mining” Arms Race

The other characteristic is that the processing power needed to enter the lottery to help confirm the validity of Bitcoin transactions in the current distributed public ledger “block chain” – termed “mining” – is getting ever more mathematically complex. What used to take a home PC, escalated into using the Graphics Co-Processors (which are 100’s of times faster at the calculations needed), and to running specialised “mining” computers based on ASICs (Application Specific Integrated Circuits). And people with their own specialised mining hardware started assembling themselves into co-ordinated groups (like lottery syndicates) to increase the chances of winning the blockchain lottery, even if they ended up with a small share of the 25 bitcoins on offer each time their team won.

Personal Security

From a security point of view, your Public Key is something you have to be absolutely inane to keep to yourself and no-one else. If someone else knows it, they can sign off cash transactions as if it were you. Some of the scare stories are where online wallet sites had poor security and leaked this – which is disastrous. You are heavily encouraged to keep your key offline and only to use it when you sign a transaction.

Anonymity – and concerns that go with it

One of the appeals of Bitcoin and other similar crypto currencies is that they are effectively cash, but the only public record is of transactions – not of the assets you may have associated with your private key. This has led to some concern that people can, on the one hand, claim absolute poverty, and in the next minute, throw a significant size transaction. Traditionally, there is no mapping from the owner of a public key to the real person sitting behind that ID – and hence a concern that Bitcoin could be used for illegal purposes.

A Proposal

Simon Wardley made some very valid points on his Bits & Pieces Blog yesterday (entitled “How to fix Bitcoin“) that suggested Governments should enforce a register of who physically sits behind each public key, so then their transactions would expose who they are, and who are they paying. The Chinese Government already enforce this type of registration. Given the transaction ledger is open to all, you could then ensure appropriate tax treatment; on the downside, there is then extreme transparency – anyone can see how much money you receive, how much you pay and the parties at either end of each cash move.

Gaps at the moment

While the desire is valid, I suspect a lot will depend on the veracity of Governments to monitor the creation of virtual tax entities (I think they call them Trusts, or Companies!) and to be able to routinely unwrap who the ultimate beneficiaries of trade with each are. This is a total mess in the world already, but with vested interests at all levels trying to keep the lid on what could be a sizable can of (taxes due) worms between various tax jurisdictions. The alternative is to dispense with monetary movement taxes altogether, but I suspect Simon is totally correct that the result of doing this would not be welcome by society as a whole (you’d then be taxing people on land and assets instead – and leaving insufficient funds to pay for what benefits the population at large).

The other effect is that you can see the amounts, sender and receiver metadata, but you can’t see what was physically traded in the exchange. Only the money values. However, that is why HM Customs and Excise have the powers they currently enjoy for our mutual good – the ability to go look wherever they need to without obstruction in anyones books should they suspect anything untoward exists.

No Transaction Charges!

For the time being, there are lots of positives being discussed by experts, and the market in Bitcoins (and other crypto currencies) is unregulated. You can set up an account on an exchange like Coinbase (in San Francisco, funded by VC Andreessen Horowitz) and set up a trading account to receive Bitcoins area. Effectively a Merchant account but with zero transaction charges.

The downside at the moment is that our current UK Government have hooked onto some nefarious sensationalist media claims that Bitcoin is used to trade in illegal goods, and were indicating that sites that include “Pay with Bitcoin” links as part of their “sites to blacklist” efforts with UK ISPs. Even though I have a Coinbase account set up, i’ve been reticent to put this payment option on my company web site (to pay £360 to pay for a website, at whatever the current GBP/BTC exchange rate is) for that reason alone so far.

I’m sure it will change in time when we have someone in Government with the appropriate cluestick back in the saddle.

Bright Future

For the future, if Bitcoin is to achieve the transaction volumes that Visa or Mastercard manage, the blockchains will need to grow sinificantly in size and some other approaches needed to get the transaction authorisation time down (currently it can take 10+ minutes for a Bitcoin transaction to be notified as being confirmed as complete). We’ll also likely see the unit of value drop by two orders of magnitude to be more representative of a unit of cash useful in people’s lives.

However, early days, interesting alternative approaches on the table and i’m sure an evolution into our ability to realise the potential of a crypto currency in the long term future. At that point, transferring monetary value will be as easy as sending an email – to anyone, worldwide.

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