Book Review: "Inventing Bitcoin" by Yan Pritzker - Chapters 1-3 Demystifying the Technology Behind Cryptocurrency
CHAPTER 1: Introduction
Bitcoin is one of those technologies everyone pretends to know about, but very few people truly understand how it works. I making this summary often throw around crypto buzzwords and have carried out AML/Fraud investigations related to crypto currencies but can not in good conscience claim to genuinely understand the technology behind bitcoin or other cryptocurrencies. Same is the situation of Yan Pritzker, the author of “Inventing Bitcoin,” whom it took 5 years from hearing about Bitcoin to actually understand it. Mr. Pritzker came across Bitcoin in 2011 and influenced by the bubble peak bought some through a shady looking site called Mt. Gox. In 2013, influenced by another bubble when bitcoin rose to $1000 each, he bought some more. On both occasions, he saw his investments quickly decimate.
In the summer of 2016, Mr. Pritzker watched a seminar, Mastering Bitcoin by Andreas Antonopoulos which further piqued his interest in Bitcoin. When bitcoin reached $20000 in 2018, Mr. Pritzker abandoned his startup (Reverb.com) to work on bitcoin because he was convinced that Bitcoin is about to usher in a watershed moment and change the world as we know it. This proved to be a wise decision subsequently. He contended that the price of Bitcoin is mostly the reason we hear about it in the media, however, he approached his book from the standpoint of “…understanding all the things that come together to make Bitcoin work,” which makes the book an excellent starting point for any regular Joe that wants to learn about Bitcoin.
What is Bitcoin & Where it came from
Bitcoin is a “peer to peer (P2P) electronic cash,…a form of digital money that can be transferred between people or computers without any trusted middleman (such as a bank), and whose issuance is not under the control of any single party. The wake of the millennium saw a radical switch to digital payment systems with the majority of payments being made over the internet via middleman services such as Apple Pay, Visa, Mastercard etc. The author noted that the digital age also gave veto powers to despots and made what use to be dystopian science fiction, a reality. Example of this is the Chinese crack down on dissidents through the taking away of their purchasing ability. As a kid, I have always wondered how the Anti-Christ 2 described in the Bible (Revelation 13) will make it impossible to buy and sell unless one posses the mark of the Beast, but digital payment systems answered that question.
Bitcoin arrived in the early 2000s to address the problems created by digital money. Satoshi Nakamoto invented Bitcoin around 2008 AD. No one, but God, knows the identity of this person or group of persons? My personal opinion is that he is an alien from a far away galaxy who came to earth to nudge our monetary system in the right direction and after doing this, he has long returned to his planet. On February 11, 2009, Nakamoto wrote about an early version of Bitcoin on an online forum where nerds gather to discuss nerd stuff. In his publication, Nakamoto highlighted the problems with fiat currencies and how bitcoin solves them. Some of points highlighted include:
(i) Fiat currency is built on trust for the central bank and this trust is often breached. Bitcoin eliminated the need for a trusted third party.
(ii) Fiat currency can have unlimited supply, which expands at an unpredictable rate, bitcoin is limited and known in advance.
(iii) Fiat currency does not guarantee piracy and the banking system is not transparent while bitcoin client software can be run by anyone at anytime (Open Source) and relies on cryptography.
(iv)Bitcoin, unlike earlier attempts to create digital currencies, e.g. DigiCash, does not have a central server and cannot be arbitrarily shut down by any government as it involves hundreds of thousands of computers from around the world.
(v) It is genuinely scarce and there is no room for manipulation or additions.
CHAPTER 2: Removing the Middleman
In this chapter, Mr. Pritzker explained how the traditional banking system works. He described banks as just glorified ledgers of account and transfers. In the digital age, banks just try to maintain an uncompromised electronic ledger of transactions through a centralized system to avoid the double-spending problem. Bitcoin on the other hand does not have a centralized ledger but a decentralized one i.e. it is an open source network where every participant has a copy of the distributed ledger.
The problem of double-spending also arises with bitcoin, and since the middleman has been eliminated, the problem takes a unique form: reality needs to be defined and immutable, irrespective of who the participants are and cannot just be consensus-based since bad actors can collude to orchestrate a consensus failure. The distributed consensus problem is also known as the Byzantine Generals Problem and solving this problem was at the very heart of inventing the Bitcoin. Two problematic solutions were initially proposed: first, the proposition was to appoint honest ledger keepers who will keep tab of all transactions. This solution leads back to the need to trust the keepers and opens them up to external influence and possible intimidation. The second and equally problematic proposition is to go by way of democracy – i.e. elect each day who gets to write the ledger from the network. This solution also makes collusion and intimidation by bad actors possible which will eventually open up the system to Sybil attacks, a fancy nerd way of saying impersonation.
To rule out the possibility of ledger keepers being compromised, a lottery system was developed. This system randomly picks the writer to enter each transaction from a pool of thousands, the writer is then rewarded for entering a valid transaction into the ledger. This system makes it nearly impossible to compromise the participants but raises the question of how to run the lottery without a central authority in charge. This is where proof of work discussed in chapter 3 comes in.
CHAPTER 3: Proof of Work
The lottery system raises the question of who will sell the tickets and pick the winners, and how to ensure that the winner writes the right transaction into the ledger without trying to game the system. To answer these questions, the proof of work system which was actually invented in 1993 before Bitcoin, has the following features;
(i) It is possible for every participant to generate their own lottery tickets;
(ii) Participating in the lottery costs something tangible (electricity in the case of bitcoin); and
(iii)Verification/validation must be easy.
To win the lottery (write the ledger), participants must roll the die billions to quadrillions of times to find the winning number, which will cost a significant amount in energy consumption. Proof of work is a game of chance which requires many computations to find the winning number, however, verification only takes a single operation. This system punishes bad actors who won’t get the incentive for entering the ledger and would also have inquired about the energy cost.
Bitcoin’s asymmetric proof of work system involves using the hash function (sha256) to encrypt numbers and text i.e. you input a string of letters, numbers or other data and get out random numbers which always result in the same output when verified. Sha256 which is mathematically expressed as 2256 is a very large number and the estimated number of atoms in the known universe. This number is the possible output when any string is hashed with the sha256 function. Predicting this number would be akin to guessing 256 coin tosses in a row. Also, any slight addition or subtraction to the input string significantly changes the outcome and there is no way to look at the final outcome (numbers) and trace the strings that created it.
To win the proof of work lottery, a participant will have to hash a number smaller than the target number. To play, participants add a random number called nonce to their entry, this ensures that their strings are different from other participants. It may take multiple attempts to find a winning entry (a number lesser than the target), and a participant could potentially burn thousands of dollars in energy through billions of hashing computing to generate a number lesser than the target, but once this is achieved, other participants can immediately verify and “see the proof of work.” It is a transparent, mathematically process with astonishing and almost unfathomable odds.
To be continued…
Emmanuel Jonathan is a Certified Financial Crime Specialist with experience as an AML Investigator at Wise Payment Limited, where he conducted BSA/AML investigations and sanctions screening for a global fintech platform serving over 10 million active customers. He is currently pursuing an M.S. in IT & Management with Fintech Concentration at Dallas Baptist University and holds an M.A. in International Law & Human Rights from University of Tartu. Through his website techlawgical.com, he explores the convergence of technology, law, finance and compliance.
