Bitcoin of gold that were replicated in Bitcoin

Bitcoin
is a non-centralised version of people’s digital currency. A peer
to peer electronic cash system. Idea
behind the Bitcoin
is to digitally replicate the gold and
hence Bitcoin is always compared with gold.
Primary
features of gold that were
replicated in Bitcoin
are 1)like gold, anyone can test it and recognise it, 2)like gold,
resource
is scarce and limited(only
21 million Bitcoins
exists)
3)like gold, one needs to mine the
Bitcoin
4) like
gold, value
increases, during the time of crisis and inflation.5)like
gold, accepted as mode of paying day
to day transactions. 6)like
gold, it is convenient
and safe. Additional features that are added in Bitcoin
are 1)Decentralisation(No central authority to monitor)
2) no risk of confiscation 3) no forgery(one cannot create a fake
Bitcoin)
4) no double spending 5) no need to carry along (Bitcoins
are available on BTC wallet online in PC).6)
universally accepted.
Bitcoin
has a mutli-level cryptographic system. It has a scripting language
for multi-transactions. Bitcoin was created by anonymous individual
or individuals, who
left unidentified and
left
only the silver board
of the extra ordinary software that runs it –source code
that is clever and deep. It
was in October 2008 A paper was published under the name Satoshi
Nakamoto
on
bitcoin, later website bitcoin.org was created.
Around
mid 2010, Control of the open source code repository and network
alert key was handed over to the Lead developer of the Bitcoin –
Gavin Andreson. Up until then, all the modifications to the source
code was done by Satoshi Nakamoto alone.

Before
analysing
whether Bitcoin replaces the gold in the near future, Understanding
the technical details of Bitcoin is crucial, that includes 1)Digital
signature &
cryptography
2) The
Ledger is the currency 3)Decentralisaion 4) Proof of work 5) Block
chain &
cryptographic hash functions. We
will analyse each point in detail and finally connect all the dots

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Bitcoin
is the first implemented example of cryptocurrency
and now there are thousands more on exchanges with traditional
currencies. To
understand cryptocurrencies.
Lets
take below example.
If
for example 5 friends exchange money pretty frequently(could be
because they travel a lot together,for
dinners etc).
It will be inconvenient
to exchange cash all the time and
so they
might keep a communal ledger to keep the track of the payments.
This ledger has to be public to everyone
to ensure anyone can add lines to the ledger
and at the end of the month one settle up with
real money.One
problem with the public ledger like this is any one can add lines.
Here
it is easy to manipulate
the truth. How are we supposed to trust that all of these
transactions are what the spender meant them to be?
Ledger-Trust+cryptography=cryptocurrency,
first
bit of cryptography- Digital
signatures are used to
solve the problem.
Digital
signatures are infeasible for others to forge the transaction. X
is
able to add
something next to the transaction that proves
that Y has seen it and has approved
the transaction. How
do we prevent forgeries with digital signatures. The way it works
is, everyone generates
a
Public
key(PK) &
a Private
key pair (SK).Each
looks like some string of bits. The private key is sometimes also
called secret key, this private key is not to
be
shared by anyone. In
the
real world hand written signature looks the same in
every transaction or in general in every document, However the
digital signatures
are
much stronger as they
change
for different messages. Signature
looks like some strings of 1’s and 0’s together
they are 256
bits and altering the message
even slightly, completely changes the signature. Producing a
signature involves a function that depends both on the message itself
and private key. (Signature = (message, SK)), the private key ensures
only X
can produce the signature, and the fact that it depends on the
message
means no one can just copy one of X’s
signatures
and forge it on another message.
Hand in hand with this there
is
a second function that
is used
to verify whether
the signature is valid and
that is a
Public
key, All
it does is gives
an
out put either
true or false, like below.
TRUE/FALSE
= (verify(message,
(SK),
PK)).
Therefore
it is completely
infeasible to find the valid signature if one
doesn’t
know
the secret key. Specifically there is no better strategy then
guessing and checking random signatures
using the public key everyone knows. Probability
of
signatures that
can be generated
with the length of 256 bits
is 2^256 possible signatures. This is an
extremely
large number. Right here, we
can confirm that if the signature is verified as valid, with utmost
confidence we can
say
that the
only way someone could have a produced, Is if they knew Private
key
associated with the public key that
is used
for verification. One
must remember message and signature combination remains valid.
message
should also include
some unique ID associated with that transaction,
this way multiple payments of the same transaction requires
completely
new signature. And
so digital signatures remove huge aspect of trust in the protocol.
What
if X over spends then what x has? Ledger
should be conditioned to reject
any transactions
as Invalid. For
this condition to be valid it requires you knowing historical
transactions of X. this
is true for all cryptocurrencies, there is very little room for
optimization. If
everyone in the world is using this ledger, one
could live the
whole
life sending and receiving on this ledger without
ever having to convert them
to real
domestic
currency.The
first important thing to understand about bit coin or any other
cryptocurrency. Bitcoin is a Ledger.
History of Transactions=Currency.
So far I said that ledger is in public place. Like a website where
anyone can add few lines. That would require trusting a central
location namely who hosts that website. who controls the rules of
adding and subtracting the ledger lines(centralised).
To remove that bit of trust we will have everybody keep the copy of
the ledger. This
is the actual significant difference between normal ledger and
cyrptocurrency. It is Decentralised.
When
a transaction takes place in a ledger, The
information is broadcast
to the world for
people to hear
and to record into
their private ledgers.
But how could you get everyone to
agree
on
what
the right ledger is? Imagine
it,
how can you be sure that everyone is recording the transactions in
the same order? This is really the heart of the issue for
cryptocurrencies- the Double
spending. This
is the
problem
that
has
been addressed in the Bitcoin Paper. They
have come up with the protocol,1)how
to accept and reject transactions 2) broadcast transactions and
update them in the same order & 3) No over spending or double
spending. At High level the solution that Bitcoin
offers is “trust”, whichever ledger has the most “computational
work” put into it. is
accepted.
What
does
computational work mean? It involves the
so called
cryptographic Hash
functions(Ex:
SHA256 WITH RSA ENCRYPTION).
The general idea that we build is to
use computational work as basis of what to trust. Fraudulent
transactions and conflicting
ledgers would require infeasible amount of computations to bring
about (proof of work). What
is Hash function (SHA256(“message”)):()
The
inputs for one of these functions can be any kind message or file it
doesn’t matter and the output is string of bits of fixed number
(256).this output is called Hash or the Digest of the message. The
intent is that it looks or
appears random but it is not random.
If you slightly change the input like changing just a letter
of
the message,
the resulting hash changes completely.
The way the output changes is entirely unpredictable.
It
is infeasible to predict the input through
output.(in
reverse
direction). This
is a cryptographic
hash function, In order to figure out the input just by looking at
256 strings of bit. The
only better method to figure out the input is Guessing. Meaning we
need to guess 2^256 guesses.
It requires large computational work, knowing hash core logic as
well, so
far none could figure out the input.
How can
such
a function prove that a particular list of transactions is associated
with a
large amount of computational effort? Imagine someone shows a list of
transactions,
and they said that they
found the special number of
the output for the hash function SHA256(“message”)when
applied, i.e. The
first 30 bits of that output are all zeros. How hard do you think it
was for them to find that number. Well for any
random
message,
The probability that hash function SHA256()
happens to have first 30 bits of zero is 1/2^30 which is about 1 in a
Billion.
Because sha256 is cryptographic hash function, the only way to find a
special number like that is guessing and checking. So this person
almost certainly had to go through billion numbers before finding a
special number like that. Once you know that number that is very
quick to verify you just run the Hashfunction
to check if there are 30 zeros. So in another words you can verify
whether they have 30 zeros without going through the same effort
yourself. This is called a proof
of work.
Interestingly all of these work is
intrinsically
tied to list of transactions. If you change one of the previous
transactions even slightly it would completely change the Hash, so
you need to go through another billion guesses to find a new proof of
work: a
new number that makes it so that hash
function
of altered list together with this new number starts with 30 zeros.
Now
lets get
back to
the distributed list situation where
everyone
is broadcasting transactions. We want to wait for
them to agree on
what
the
correct ledger is. The
core idea behind the bitcoin paper is to have everyone trust
whichever ledger has the most computational work put into it. The way
this works, first organise this given ledger into blocks, where each
block consists of list of transactions together with the proof of
work, that is, there
is a special
number so that the hash of whole block starts with 30
zeros.
Later we will turn back to more systematic way you might want to
choose that number. Remember
transaction
is considered valid when its signed by the sender, the block is only
considered valid if it has a proof of work. To
make sure that there is a standard order to these blocks, we
will make it so that block has to contain the hash of the previous
block at its header, that way if we
need to
go back and change one of the blocks or swap the order of two blocks
you would change the block hash, which changes the block hash that
comes after it..and so on. That would require re-doing all of the
work. Finding a new special number for each of these blocks that
makes their hashes start with 30
zeros.
Because blocks are chained together like mentioned,
These are called block
chains
instead of calling it as ledger. As part of her updated protocol we
will now allow anyone in the world to be a block creator. What
it means
they are going to listen to the transactions being broadcast, collect
them into some block and then do
a lot of computational work to
find the special number that makes the hash of the block start with
in our example 30
zeros. Once they find the same they
broadcast out the block that
they found, To reward the block creator, for all this
computational
work that
one has put
together, A
block will allow to include a very special transaction at the top of
it in which X
gets 1 Bitcoin.
This is called Block
reward. Its an exception to our usual rule on whether or not to
accept the transaction. It doesn’t come from anyone and so it
doesn’t have to be signed and it also means that the total number
of bitcoins
in our economy increases with each new block. Creating blocks is
often called Mining.
It
requires doing a lot of work and it introduces new bits of currency
into the economy. When we
hear or read about miners what they are really doing is Listening
to the transactions, creating blocks, broadcasting those blocks and
gaining the reward for doing so. From the miners perspective, each
block is a lottery. Every
one is guessing the number as fast as they can until one lucky
individual finds the special number that makes the hash of the block
that
starts
with many zeros and they get the reward. For
anyone else who just wants to use this system to make payments,
instead of listening to the transactions, they all start listening to
the blocks being broadcasts by miners and update
their personal copies of the block chain. Now the key addition to the
Protocol,
is if one
hears
two
distinct block chains with conflicting transaction histories. You
consider
the one with
longest computational work.
One
with the most work put into it. And if there is a tie, we
need to
wait until one
hears
an additional block that makes one of them longer. So even though
there is no central authority, and everyone is maintaining their copy
of the block chain, if every one agrees and
gives
preference to which ever block chain that
has the most computational work put into it then
we
have a way to reach
a Decentralised
consensus.
Notice
that means one
shouldn’t
necessarily trust a new block that one
hears
immediately. Instead one
should
wait for several new blocks to be added on top of it. If one
still haven’t heard of any longer block chains then
one
can trust that this block is part of the same chain that everyone
else is using. Earlier
I defined the proof of work might be defined by the special
number(output)
so that SHA256(“message”)
starts
with 30
zeros.
Well, the way the actual bitocoin protocol works is periodically
change that number of zeros so that it takes on average 10
minutes
to find a new block. As
there are
more
&
more miners added to the network, challenge gets harder and harder in
such a way that this lottery only has about 1 winner every 10
minutes.
Many new cryptocurencies actually have much shorter block times
than that. All of the money from Bitcoins
ultimately comes from some block reward. In the beginning these
rewards were 50 Bitcoins
per block. We
take a
look
at these on website: blockexplorer.
For
every 21 million Bitcoins.
Right now it is 15.5 Bitcoins
per block. Every 4 yrs that reward is cut in half every year. Because
this reward decreases geometrically 2100000(50+25+12.5+6.25+….)
overtime. It
means that there will never be more than 21 million Bitcoins
in existence. However this doesn’t mean that miners will stop
earning money. In addition to the block reward miners can also pick
up transactions fee, whenever one
makes
the payment
one can
purely optionally include the transaction fee with it which will go
to the miner whichever block includes that payment, the reason one
might to do that is actually incentivise
miners to actually include the transaction that one
broadcast into the next block. each block is limited to about 2400
transactions. Critics view this has unnecessary restriction. For
comparison VISA processes are an average have about 1700 transactions
per sec and are capable of handling more
than
24000 transactions p/s
max.
This comparatively
slow processing on Bitcoin
makes for higher transaction fee, and
so
the fee is what determines which transactions miners choose to
include in the block.
Now
let
us determine
if the Bitcoin will ever replace the gold?
Bitcoins
exists
only after they are mined, Just like the actual gold. You expand real
resources, real energy and
so there
is a cost associated in
creating
bitcoins. And also like gold there is a limit there is a scarcity,
there are only 21 million of bitcoins that can be mined into
existence. Like
gold, bitcoins are also divisible. One
bitcoin can
make one hundred and million fractional bitcoins like gold, that
collectively would have value of the whole coin. But
unlike gold, one
can
instantaneously
send them through internet for transactions. Bitcoin exist in
cyberspace. It
costs nothing in
storage, can be
kept
safe in digital wallet. However
gold needs
to be
protected
and
guarded,
there is a cost of storage.
Bitcoin almost replicated almost all the properties of gold, Except
the Intrinsic value attached to
the metal itself. The
reason gold became money is
because
it is valued as a commodity. Gold was uniquely suitable for money
over a lot of other commodities.
Domestic
currency not backed by gold also is a legal tender. Government only
accepts the domestic currency to pay taxes and so there is a
legitimate use of domestic currency whereas Bitcoins
do not
represent a store of value. Its
price
is highly
volatile. most of the bitcoins
are
hoarded by the miners and are not circulated and they are not being
used in the commerce. Day to day miniature transactions are not
convenient.
people who are entering the market by the spectacular
game price, are buying them because they believe prices are going to
increase.
They
don’t want to keep it with them. At
some point psychology
is going to turn, the prices are going to drop. If
there is so much volatility you cannot actually use Bitcoins
as money. Bitcoin
is
going up because it is a Bubble.
Bitcoin
can be viewed as
a cryptocurrency, and
as
one of fantastic technologies that is ever created that enhances the
decentralised version &
trust
aspect, but it cannot be
viewed as money. It might stay as a
background
for
an
intense
technological feature of many systems but not as money. Right now it
is only a
highly
speculative asset and
can never replace gold.

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