Mastering Bitcoin: Unlocking Digital Cryptocurrencies

By the time you look a few hundred feet down, you are looking at a snapshot of the past that has remained undisturbed for millions of years. In the blockchain, the most recent few blocks might be revised if there is a chain recalculation due to a fork. The top six blocks are like a few inches of topsoil. But once you go more deeply into the blockchain, beyond six blocks, blocks are less and less likely to change.

Bitcoin experts argue that deflation is not bad per se. Rather, deflation is associated with a collapse in demand because that is the only example of deflation we have to study.

Bitcoin is often mistakenly characterized as “anonymous” currency. In fact, it is relatively easy to connect identities to bitcoin addresses and, using big-data analytics, connect addresses to each other to form a comprehensive picture of someone’s bitcoin spending habits.

Bitcoin consists of: A decentralized peer-to-peer network (the bitcoin protocol) A public transaction ledger (the blockchain) A set of rules for independent transaction validation and currency issuance (consensus rules) A mechanism for reaching global decentralized consensus on the valid blockchain (Proof-of-Work algorithm)

Bitcoin’s Test Blockchains You might be surprised to learn that there is more than one bitcoin blockchain. The “main” bitcoin blockchain, the one created by Satoshi Nakamoto on January 3rd, 2009, the one with the genesis block we studied in this chapter, is called mainnet. There are other bitcoin blockchains that are used for testing purposes: at this time testnet, segnet, and regtest. Let’s look at each in turn. Testnet — Bitcoin’s Testing Playground Testnet is the name of the test blockchain, network, and currency that is used for testing purposes. The testnet is a fully featured live P2P network, with wallets, test bitcoins (testnet coins), mining, and all the other features of mainnet. There are really only two differences: testnet coins are meant to be worthless and mining difficulty should be low enough that anyone can mine testnet coins relatively easily (keeping them worthless). Any software development that is intended for production use on bitcoin’s mainnet should first be tested on testnet with test coins. This protects both the developers from monetary losses due to bugs and the network from unintended behavior due to bugs.

The purpose of mining is not the creation of new bitcoin. That’s the incentive system. Mining is the mechanism by which bitcoin’s security is decentralized.

The higher fee is not because Eugenia is spending more money, but because her transaction is more complex and larger in size — the fee is independent of the transaction’s bitcoin value.

Transaction fees are calculated based on the size of the transaction in kilobytes, not the value of the transaction in bitcoin. Overall,

The digital keys in a user’s wallet are completely independent of the bitcoin protocol and can be generated and managed by the user’s wallet software without reference to the blockchain or access to the Internet.

The concept of a balance is created by the wallet application. The wallet calculates the user’s balance by scanning the blockchain and aggregating the value of any UTXO the wallet can spend with the keys it controls. Most

Elliptic curve multiplication is a type of function that cryptographers call a “trap door” function: it is easy to do in one direction (multiplication) and impossible to do in the reverse direction (division). The owner of the private key can easily create the public key and then share it with the world knowing that no one can reverse the function and calculate the private key from the public key. This mathematical trick becomes the basis for unforgeable and secure digital signatures that prove ownership of bitcoin funds.

Paper wallets can be generated easily using a tool such as the client-side JavaScript generator at bitaddress.org. This page contains all the code necessary to generate keys and paper wallets, even while completely disconnected from the internet. To use it, save the HTML page on your local drive or on an external USB flash drive. Disconnect from the internet and open the file in a browser. Even better, boot your computer using a pristine operating system, such as a CD-ROM bootable Linux OS. Any keys generated with this tool while offline can be printed on a local printer over a USB cable (not wirelessly), thereby creating paper wallets whose keys exist only on the paper and have never been stored on any online system. Put these paper wallets in a fireproof safe and “send” bitcoin to their bitcoin address, to implement a simple yet highly effective “cold storage” solution. Figure 4-8 shows a paper wallet generated from the bitaddress.org site.

The word “mining” is somewhat misleading. By evoking the extraction of precious metals, it focuses our attention on the reward for mining, the new bitcoin created in each block. Although mining is incentivized by this reward, the primary purpose of mining is not the reward or the generation of new coins. If you view mining only as the process by which coins are created, you are mistaking the means (incentives) as the goal of the process. Mining is the mechanism that underpins the decentralized clearinghouse, by which transactions are validated and cleared. Mining is the invention that makes bitcoin special, a decentralized security mechanism that is the basis for P2P digital cash.

Bitcoin creates digital assets that have intrinsic value and can be stolen and diverted to new owners instantly and irrevocably. This creates a massive incentive for hackers.

The genesis block contains a hidden message within it. The coinbase transaction input contains the text “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.” This