The Basics of Bitcoins and Blockchains - Book Review
I am a newbie in to the world of Blockchain and Web 3.0 . I am blown away by the rapid developments that are happening in the Web 3.0 world. There is a healthy dose of skepticism towards Web 3.0 technologies by incumbents, while there is whole hearted enthusiasm from many of the newer players, FinTechs, startups . The recently concluded Singapore FinTech Festival was all about Web 3.0 . Being a newbie, I did not understand most of the terms that were being used by the speakers. For some reason, I was living in a shell and did not pay attention at all to what was happening in the external world. Coming out the shell after 5 years, I see that there are whole communities of people who are working on Blockchain and Web 3.0 technology. It is high time I understand this piece of technology and see if I can make any sense of this exciting field, that is set to revolutionize the field of financial services. Being a newbie, I looked around and found this book as a guide to my first step towards understanding Blockchain.
This post summarizes the main points from the book titled, “The Basics of Bitcoins and Blockchains” written by Antony Lewis.
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The following are the summary points from the book:
- Cryptocurrencies and tokens are both types of cryptographically secured digital assets, sometimes known as crypto assets. Tokens have different characteristics from cryptocurrencies and from each other.
- Think of a token as a digital version of a cloakroom ticket, issued by a cloakroom clerk and redeemable for your coat. If the underlying item is an agreement, product or service, you can think of a token as something like a concert ticket issued by a concert organizer and redeemable for entry to a concert at a later date
- What do coins and tokens have in common ? All transactions related to them including their creation, destruction, changes of ownership, and other logic or future obligations are recorded on Blockchains: replicated databases that act as the ultimate books and records
- The first bitcoin was created on Jan 3, 2009
- Bitcoin protocols are written out as Bitcoin code which is run as Bitcoin software which creates Bitcoin transactions containing data about Bitcoin coins recorded on Bitcoin’s Blockchain
- Digital money differs from physical money in that it relies on bookkeepers who are trusted by their customers to keep accurate accounts of balances they hold.
- online payment vs offline payment - the mechanics are different
- Do payments need to be linked to identity ? is the question that is driving most of the debate around the world ?
- Money needs to fulfill three functions:
- Medium of exchange means it is a payment mechanism - you can use it to pay someone for something. To be a good medium of exchange, it need not be universally accepted but it should be widely accepted in a particular context
- Store of value means that in the near term your money will be the worth the same it is today. You must be reasonably confident that your money will buy you more or less the same amount of good and services tomorrow, next month or next year
- Unit of account means it is something that you can use to compare the value of two items, or to count up the total value of your assets
- Good Money should fulfill all the above functions, others think that the three functions can be fulfilled by different instruments
- The purchasing power of USD has fallen over 96% since the Fed was created in 1913
- Bitpay is a good example of this kind of cryptocurrency payment processor
- Bitcoin as
- Medium of exchange - reasonably ok
- Store of value - debatable
- Unit of account - questionable
- As Bitcoin got bigger and bigger, the volatility has not gone down but has become higher
- Bitcoin’s supply is inelastic - If there is a spike in demand, there is no impact on the rate at which bitcoins are generated
- Bitcoin has been declared dead over 300 times
- Existence of barter system is a myth
- Commodity money - the physical token that is transacted is itself valuable, for example grain, which has intrinsic value, or precious metals which have extrinsic value
- The two factors in Bitcoin that create demand are:
- It is the most recognized instrument of value that can be transmitted across the internet without needing permission from specific intermediary
- It is censorship resistant
- Representative money is a form of money whose value is derived by being a claim on some underlying item, for example a receipt from a goldsmith for some gold they are safekeeping
- Representative money differs from Commodity money in that it relies on a third party to be able to supply the underlying item on the redemption of the tokens - so there is some counterparty risk
- Fiat currency is the one that is declared by law as legal tender and is the type of money that is accepted as tax payments
- Money through the ages
- 9000 BCE - Cattle as Commodity Money
- 3000 BCE - Banks evolved from the warehouses that were places for the safekeeping of commodities
- 2200 BCE - Silver was accepted as money
- 1800 BCE - Regulation by Hammurabi
- 1200 BCE - Shell Money
- 700-600 BCE- Mixed Metal Coins
- 600-300 BCE - Round coins in China
- 550 BCE - Pure Precious Metal coins
- 345 BCE - Origins of the words mint and money
- 336-323 BCE - Gold to Silver Peg
- 323-30 BCE - Warehouse receipts as Representative money
- 118 BCE - Leather Banknotes
- 30 BCE - Tax Reform
- To 270 CE - Debasement and Inflation
- 306-337 CE - Gold for the Rich, Debased coins for the Poor
- 435 CE - No more coins for Brits for 200 years
- 806-821 CE - Fiat Money in China
- 1300s - British Pennies Shrink
- 1600s - Rise of Goldsmiths
- 1660s - Central Banking
- 1727 - Overdrafts
- 1800 - 1860 Cowrie Depreciation
- 1913 - Birth of US Fed
- 1999 - Euro
- 2009 - Bitcoin
- Types of Gold standard
- Gold Specie standard
- Gold bullion standard
- Non-convertible gold bullion standard
- Fiat currencies are defined by not having intrinsic value
- Zimbabwe uses USD as the main currency for pricing goods and for government transactions, but lists a number of currencies as legal tender
- Currency peg is when someone in charge declares that one currency is worth a fixed amount of another currency and then attempts to maintain that exchange rate by matching the supply of either currency with the demand.
- Correspondent Bank accounts are accounts opened by a bank in another bank
- Central bank account - One of the roles of a central bank is to enable banks in its jurisdiction to pay each other electronically without each of them having to maintain accounts with one another
- There are two broad types of interbank settlement systems
- Deferred Net Settlement (DNS) systems
- Real Time Gross Settlement (RTGS) systems
- Clearing banks - In some countries only certain banks get to have accounts with the central banks and these are called clearing banks
- How does single currency transfers happen across borders ? - through correspondent bank or a clearing bank in the foreign land
- When someone send Pounds to a Singaporean citizen, Pound never leaves UK. All that happens is that the relevant accounts in UK are debited and credited
- If someone sends USD from UK to Singapore, the USD does not move out of USA. Currencies say inside their domestic one. It is correspondent banks or clearing banks where debits and credits are done
- Currencies can actually be created and exist outside of their domestic zones or home jurisdictions. For example. Euro-dollar, Euro-Sterling etc. The prefix ‘Euro’ indicates that the currency exists outside of its home zone
- Early wallets were provided by telcos but they lost their advantage due to their walled-garden approach
- E-Money wallets are easy to understand from payments perspective. Each operator has a bank account that is ring-fenced to contain only customer money
- Symmetric vs Asymmetric cryptography
- Bitcoin address is derived from the public key
- Cryptographic hashes are used in Bitcoin in a number of places
- In the mining process
- As identifiers for transactions
- As identifiers for blocks, in order to link them in a chain
- Ensuring that data tampering is immediately evident
- A digital signature is created by taking the message you want to sign and applying a mathematical formula with your private key. Anyone who knows your public key can mathematically verify that this signature was indeed created by the holder of the associated private key
- Bitcoins are digital assets whose ownership is recorded on an electronic ledge that is updated simultaneously on about 10,000 independent operated computers around the world that connect and gossip with each other. This ledge is called Bitcoin’s Blockchain. Transactions that record transfer of ownership of those coins are created and validated according to a protocol - a list of rules that define how things work and which therefore govern updates to the ledger. The protocol is implemented by software that participants run on their computer. The machines running the app are called ‘nodes’ of the network. Each node independently validates all the pending transactions whenever they arise, and updates its own record of the ledger with validated blocks of confirmed transactions. Specialist nodes, called miners, bundle together valid transactions into blocks and distribute the blocks to nodes across the network.
- Bitcoin - censorship resistant digital cash
- How to avoid having an administrator managing usernames and passwords ? Use Public Keys as account numbers
- How to avoid having a centralized book keeper - replicate the bookkeeping across nodes
- How do multiple bookkeepers stay in sync with each other ? Use blocks rather than atomized transactions
- Who can create blocks and How often ? Anyone can create blocks every 10 minutes
- How to incentivize miners ? Proof of work that is based on transaction fees and block rewards
- Mining is not equivalent to solving complex mathematical problems as widely described by the media. It is done via hashing and is a very boring task that you have to do it to get rewarded for mining
- How to control the supply of blocks ? By making sure that difficulty level rises so that the supply of coins meet the pre-set schedule
- How is double spend problem solved ? By waiting until the Blockchain has grown by 6 blocks so that it become computationally difficult to rewire the entire chain of 6 blocks
- Transactions are payment instructions of specific amounts of Bitcoin (UTXOs) from one user generated address to another
- mempool - The bookkeepers add valid transactions to mempool and distribute them to other bookkeepers that they are connected to
- Miners use special purpose chips called ASICS that are specifically designed and built to be efficient at SHA256 hashing.
- 90% of the value of BTC is owned by 0.7% of the addresses
- Bitcoin’s predecessors
- Digicash
- b-money
- Hashcash
- e-gold
- Liberty Reserve
- Napster
- Mojo Nation
- BitTorrent
- Software wallets are apps that can at least:
- Create new bitcoin addresses
- Display your addresses to someone who wants to send you a payment
- Display how many bitcoins are in your address
- Make Bitcoin payments
- Sometimes Bitcoin wallets can have a hardware component. Private keys are stored in chips on small handled devices
- Cold Storage is keeping a note of private keys on offline media, such as a piece of paper
- A hot wallet is a wallet than can sign and broadcast transactions without manual intervention.
- There are sites that acts a bit like eBay for people wanting to buy and sell cryptocurrencies
- Ethereum is trustless validation and distributed storage and processing of data and logic. On Ethereum, you can submit transactions that create smart contracts. These smart contracts are run by all participants using a sort of operating system called a ‘Ethereum Virtual machine’
- There are forks for the main Ethereum, such as Ethereum Classic, which is also a public block chain
- How is Ethereum similar to bitcoin ?
- Has an inbuilt cryptocurrency
- Has a Blockchain
- Is Public and Permissionless
- Has PoW mining
- How is Ethereum VM different from Bitcoin ?
- EVM can run smart contracts
- Concept of Gas, Gas Price, Gas limit
- ETH Units can be of different denominations
- Blocks are smaller
- Blocktime is shorter
- Ethereum uses accounts
- There are two main steps that are performed via smart contract
- Uploading the smart contract to Ethereum’s Blockchain
- Making the smart contract run
- Ethereum software clients are written in Go, C++ and Python
- Vitalik Buterin described Ethereum in a white paper in 2013 and it was further developed by Dr.Gavin Wood in a technical white paper in 2014
- DaO hack happened in 2016
- Actors in Ethereum ecosystem
- Ethereum foundation
- Ethereum Enterprise Alliance
- When people use the word fork, they can mean two different, but related
things
- A fork of a codebase
- A fork of a live Blockchain
- Ownership of any crytoasset whether it is a crytocurrency or a token, is vested in the person who has the private key that corresponds to the address with which the token is associated. The private key allows that person to create and sign transactions releasing the token and assignment to someone else
- Tokens can be classified as
- Native blockchain tokens
- Asset backed tokens
- Currency tokens
- Platform tokens
- Brand Tokens
- Security tokens
- All Blockchains are fall under the broader category of ‘distributed ledgers’, but you can have distributed ledgers, that don’t have blocks of data chained together and broadcast to all participants.
- What is common to Blockchain technologies ?
- data store that records changes in the daaa
- replication of the data store across a number of systems in real time
- ‘Peer to Peer’ rather than client-server
- Cryptographic methods such as digital signatures to prove ownership
- Difference between Blockchain and database
- Difference between distributed database and distributed ledger
- There can be public and private Blockchains
- ICOs are token sales , a new way for companies to raise money without diluting the ownership of the company
- Prices of crytocurrencies are dependent on many factors such as
- sentiment
- gossip and chatter on social media
- technical successes
- technical failures
- celebrity endorsements
- founders getting arrested
- orchestrated pump and dumps
- manipulation by large holders of particular token
- Price of utility tokens - Priced in fiat and paid in tokens, Priced in tokens and paid in tokens
- Risks associated with cryptoassets
- Market Risk
- Liquidity Risk
- Exchange Risk
- Wallet Risk
- Regulatory Risk
- Scams
- Data on blockchain is not encrypted. It is there for everyone to see
- Very difficult to do fundamental analysis on crytocurrencies
- Transactions in a block are validated all at once or none
- Proof of stake is the new protocol in ethereum network
- More than 1600 deadcoins listed at https://99bitcoins.com/deadcoins/. Shitcoins are referred to those coins whose values have dropped to zero
- Nobody knows Satoshi but if he ever does a transaction, the Blockchain network will be able to figure out the address
- Price of any cryptocurrency has nothing to do with mining difficulty
- dApps can be built on Ethereum network
- Ethereum network has made writing smart contracts possible
- There could be parallel chains for any blockchain at any point in time, but eventually longer chain survives
- FBI agents who were incharge of investigating illegal transactions using bitcoin, defrauded the system
- The symbol for most cryptocurrency in data vendor systems start with X, similar to commodities naming convention
- Traditional VC models of funding startups are getting disrupted with the Web 3.0 technologies
- It is an arm of FED, FOMC that sets the monetary policy and makes announcements
- Bitcoins PROTOCOLS are written as Bitcoin CODE that is run on Bitcoin SOFTWARE and creates Bitcoin Transactions containing Bitcoin data about coin transfer and are written on Blockchain. The very first transaction written on a Blockchain is called coinbase transaction
- Rate of BTC mining is 12.5 BTC per 10 minutes
- Bitcoin uses elliptic curve digital signature algorithm for encryption
I found the book a great introduction for a newbie like me. There are many links, references mentioned in the book that will be very useful to dig deep in some of the fascinating aspects of Web 3.0