Bitcoin (blockchain-based)

The cryptocurrency portion of Bitcoin is different from the blockchain itself. Bitcoin is an artificial currency. It has no commodity or value backing like gold. It is also not physical; it only exists in a network construct. Finally, the supply or number of Bitcoins is not determined by a central bank or any authority. It is completely decentralized. Like other blockchains, it is built up from public key cryptography, a large and distributed peer-to-peer network, and a protocol that defines the Bitcoin structure. While not the first to conceive of digital cash, Satoshi Nakamoto (alias) posted the paper in 2008 called Bitcoin: A Peer-to-Peer Electronic Cash System to a cryptography list. In 2009, the first Bitcoin network was online and Satoshi mined the first block (Genesis Block).

The concept of a blockchain means that there exists a block representing the current portion of a blockchain. A computer connected to the blockchain network is called a node. Each node participates in validating and relaying transactions by obtaining a copy of the blockchain and is essentially an administrator. 

A distributed network based on peer-to-peer topologies exists for Bitcoin. Metcalfe's Law applies here since the value of a cryptocurrency like Bitcoin is based on the size of the network. The network maintains the system of records (the ledger). The problem is, where do you find a source of computing willing to share their compute time for monitoring ledgers?  The answer is to build a reward system called Bitcoin mining.

The transaction process is shown in the following figure. It starts with a transaction request. The request is broadcast to a Peer-to-Peer (P2P) network of computers called nodes. The peer network is responsible for validating the authenticity of the user. Upon validation, the transaction is verified and combined with other transactions to create a new block of data for the distributed ledger. When a block is full, it is added to the existing blockchain, making it immutable. The Bitcoin authentication, mining, and validation process is shown below:

Bitcoin blockchain transaction process. 

Shown in the graphic is the exchange of 0.000554 Bitcoins between Alice and Bob with a service fee of 0.0001 BTC. Alice initiates the transaction by signing the contents of the transaction with the previous transaction hash against Alice's private key. Alice also includes her public key in the inputScriptSig script. The transaction is then broadcast to the Bitcoin P2P network for inclusion in a block and validation. The network competes to validate and discover a working nonce based on the current strength of complexity. If a block is discovered, the server broadcasts the block to peers for validation and then inclusion in the chain.

What follows is a qualitative analysis of the blockchain and in particular Bitcoin processing. It is important to understand these fundamentals which build on all the security foundations from earlier in this chapter:

  1. Digitally signed transaction: Alice intends to give Bob 1 Bitcoin. The first step is to announce to the world that Alice intends to give Bob 1 Bitcoin. Alice does this by writing this message: "Alice will give Bob 1 Bitcoin," and digitally signing it for authentication with her private key. Anyone can verify the message is authentic given the public key. However, Alice could replay the message and artificially forge money.
  2. Unique identification: To resolve the forgery problem, Bitcoin creates a unique with a serial number. US-issued money has serial numbers and Bitcoins do as well in a general sense. Bitcoin uses a hash rather than a centrally administered serial number. The hash that identifies the transactions are self-generated as part of a transaction. 
    A serious problem arises with double spending. Even if the transaction is signed and uniquely hashed, Alice could potentially reuse the same Bitcoin with other parties. Bob will check Alice's transaction and everything will verify. If Alice also uses the same transaction but buys something from Charlie, she effectively is cheating the system. The Bitcoin network is very large, but there is still a small chance that theft could occur. Bitcoin users protect against double spending by waiting for a confirmation when receiving payments on the blockchain. As a transaction becomes dated more confirmations arise, validating it becomes more irreversible.
  3. Security through peer validation: To resolve the double spending cheat, what is done in blockchains is that recipients of the transaction (Bob and Charlie) broadcast their potential payment to the network and request the peer network to help legitimize it. This service of requesting assistance in verifying a transaction doesn't come free.
  1. Proof of Work Burden: This still hasn't completely resolved the double spend problem. Alice could simply hijack the network with her own servers and claim all her transactions are valid. To finally resolve this issue, Bitcoin introduced the concept of Proof of Work. There are two aspects to proof-of-work concepts. The first aspect is validating the authenticity of a transaction should to be computationally expensive for a computing device. It must be more computationally burdensome than just verifying keys, logins names, transaction IDs, and other trivial steps in the authentication process. Second, users need to be rewarded to help resolve other people's money exchanges—this is covered in step 
  2. The method Bitcoin uses to force a work function on individuals validating transactions is to attach a nonce to the header of the transactions in process. Bitcoin then uses the cryptographically secure SHA-256 algorithm to hash the nonce and header message. The goal is to keep changing the nonce and deliver hash leading values that are less than 256-bit values, known as the target. A low target makes it much more computationally intensive to resolve. Since each hash basically generates a completely random number, many SHA-256 hashes must be performed. On average this takes about 10 minutes to resolve.
The 10-minute proof-of-work also implies that a transaction will take 10 minutes on average to validate. Miners work on blocks which are collections of many transactions. A block is limited (currently) to 1 MB of transactions which implies your transaction will not be processed until the current block is completed. This can have implications for an IoT device with real-time demands.
  1. Bitcoin Mining Incentives: To encourage individuals to build a peer-to-peer network to validate other people's spending, incentives are used to reward those individuals for their service. There are two forms of an reward. The first is Bitcoin Mining, which awards individuals who validate a block of transactions. The other form of award is a transaction fee. The transaction fee is rewarded to a miner who helps validate a block and is taken as part of the transaction. Initially, there was no fee, but as Bitcoins have gained popularity, the fee has grown. On average the fee is about $35 (in Bitcoin currency) for a successful transaction. As a further incentive, fees are dynamic and one can increase fees, which artificially forces the transaction to be processed faster for a user. Even when new Bitcoin generation is exhausted, there is still an incentive to manage transactions.
Initially, the reward was very high (50 Bitcoins) but that reduces by half about every four years after 210,000 blocks have been found. This will continue until the year 2140 when the halving rate will reach a point of exhaustion and rewards will be less than the lowest unit value of a Bitcoin (called a Satoshi or 10-8 Bitcoins).

 Given that a block is mined every 10 minutes and the reward is halved every four years, we can come up to the maximum number of Bitcoins in existence. We also know the initial reward for a mined coin is 50 Bitcoins. This produces a series that converges to the Santoshi limit: 50 BTC + 25 BTC + 12.5BTC... = 100 BTC. 210,000 * 100 = 21 million total Bitcoins possible.
  1. Security through chaining order: The order in which transactions occur is also vital to the integrity of a currency. If a Bitcoin is transferred from Alice to Bob and then to Charlie, you don't want the ledgers to record the events as Bob to Charlie then Alice to Bob. Blockchains manage the order by chaining the transactions. All new blocks added to the network contain a pointer to the last block validated in the chain. Bitcoin states that no transaction is valid until it is chained to the longest fork and that at least five blocks follow it in the longest fork. 
    This provision solves the asynchronous problem of what happens if Alice tries to double spend a Bitcoin with Bob and Charlie. She might try to broadcast the transaction with Bob for one set of the miners and with Charlie on a second set. However, the process will find this fraud when the network converges. Bob may win the transaction but the network will invalidate Charlie's transaction. 
    Even if Alice attempts to pay herself and attempts to pay Bob, the ordering rules stop her. She does this by sending Bob a Bitcoin and waiting for the moment when the transaction is verified (five blocks follow it). She then immediately pays herself the same Bitcoin which causes a fork in the chain. She now has to validate five additional blocks of Bitcoins. This takes about 50 minutes as stated in step 4. That requires an enormous amount of computing power as she has to process faster than all other miners combined.
Another interesting concept about blockchains is their use in managing the denial of service attacks. A proof-of-work system (or protocol/function) is an economic measure to deter the denial of service attacks. One conducting an attack intends to saturate a network with as much data as possible to overwhelm a system. A blockchain involving a work function reduces the effectiveness of such an attack. A key feature of these schemes is their asymmetry: the work must be moderately hard (but feasible) on the requester side but easy to check with the service provider.
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