Before the blockchain digital cash relying on a trusted third party to process the payments and prevent double-spending and Byzantine general problem (Chaum, 1983). Introduction to Bitcoin and blockchain.
Even though this system works well it suffered from the weakness of the trust-based model (Satoshi, 2008). Problems with relying on these third parties with our security and privacy are these third parties can be manipulated and compromised. To ensure our safety we will need to get more and more information from people we do the transaction over the internet.
Bitcoin was introduced as an alternative to this trusted model. Bitcoin uses cryptographic proof instead of trust. This allows transactions to happen without a trusted third party.
History of bitcoin
Few digital cash technologies made the pathway for Bitcoin.
In 1983 David Chaum created issuer based Ecash protocols. Ecash locally stores money that is cryptographically signed by a bank in the user’s computer. The user could spend this money at any shop that accepts Ecash. Ecash started to dissolve as credit cards became the currency of choice and by 1998 Digicash, the company that owned Ecash went bankrupt.
Even though Wei Dai’s b-money (Wei, 1998) was never released, it’s ideas were widely used on the creation of Bitcoin. b-money included a need for computational work to create the digital currency, verification of the transactions by the community in a collective ledger and rewarding workers, and use of the digital signatures.
Hashcash (Adam, 1997) was originally proposed as a mechanism to throttle systematic abuse of un-metered internet resources such as email, in May 1997 by Adam Back.
Hashcash uses a cryptographic hash-based proof-of-work algorithm. The Hashcash CPU cost-function computes a token which can be used as proof-of-work.
Two types of cost functions are used in Hashcash(Adam, 2002)
- Interactive cost functions
- With interactive cost-functions, the server issues a challenge to the client. Then the client computes the challenge and generates a token. The server will check the value of the token using an evaluation function, and only proceed with the protocol if the token has the required value.
2. Non-interactive cost-functions
- With non-interactive cost-functions, the client chooses its own challenge and generates a token. The server will then evaluate the token and proceed with the necessary protocol.
On 18th August 2008 Domain name bitcoin.org was registered. On 31st October that year Satoshi Nakamoto published a paper entitled “Bitcoin: A Peer-To-Peer Electronic Cash System”. This paper is about peer-to-peer electronic cash that allows online payments to be sent directly from one party to another without any central party. On 3rd January 2009, Satoshi Nakamoto mined the genesis block of 50 bitcoin (block number 0). The first open-source bitcoin client was released on 9th January 2009 at SourceForge. The first bitcoin transaction happened on 12th January 2009 when Satoshi Nakamoto sent 10 bitcoins to Hal Finney.
First known commercial bitcoin transaction was when Laszlo Hanyecz bought two pizzas for 10,000 bitcoins in 2010. 10,000 Bitcoins were worth around $41 at the time but now 10,000 Bitcoins worth roughly 66 million dollars.
How a Bitcoin transaction happens
Sender digitally signs the coins using his private key and sends them to the receiver’s public key. Then the receiver can prove the ownership and receive the money using his or her private key. Each of these transactions needed to be verified before recorded to a public ledger (Blockchain). So the transaction is broadcasted into every node in the network. These verifying nods(miners) need to check whether the spender owns the bitcoin through the digital signature verification and does the spender has enough bitcoin in his account by checking every transaction against the spender’s public key.
To do this each node collects new transactions into a block and works on finding a difficult proof-of-work for its block. If a node finds the proof-of-work it broadcasts the block to all nodes. Nodes will accept the block only if it is valid. Then all the nodes will work on creating a new block in the chain using the hash of the accepted block as the previous block.
Each of these blocks contains about 1 MB of transaction data and the hash of the previous block. Because of this, all the blocks are linked to each other in a linear chronological order.
Miners who donate their computational power to solve the puzzle and generate a block are financially awarded.
Difference between traditional digital currencies and cryptocurrencies
There are few fundamental differences between traditional digital currencies and cryptocurrencies like bitcoin.
Normal digital currencies use a centralized structure. That means the whole system depends on one central trusted institution. This institution may regulate transactions and works on preventing problems like double-spending.
Bitcoin is decentralized and regulations are made by the community. The community will work on preventing problems like double-spending.
Traditional digital currencies require users to share their identities with the trusted third party. Users have to give their details like name, residential address, etc before using the service. Even though the trusted third party is required to keep the user identities and transactions off from the public, they might have to share this information with law enforcement agencies under certain laws.
- Directive 2009/110/EC (EUROPEAN PARLIAMENT AND OF THE COUNCIL,2009)
- Article 4A of the Uniform Commercial Code USA
Bitcoin does not require users to share their private information. Bitcoin lets the public view every transaction happened on the blockchain but it keeps identities of users hidden. This is similar to how information released by stock exchange (Sathoshi, 2008)
Bitcoin was able to overcome problems digital currencies faced like double-spending problem and Byzantine agreement problem by using the blockchain and cryptographic proof-of-work algorithms. By fixing these issues bitcoin became the first fully decentralized digital currency. The success of bitcoin made a pathway for other cryptocurrencies like Ripple, Etherium, etc.
Blockchain technology introduced with bitcoin become a useful tool in a lot of fields not limiting its capabilities to cryptocurrencies. Blockchain is now finding applications in both the financial and non-financial sectors (Michael et al., 2016). Introduction to Bitcoin and blockchain
Both bitcoin and blockchain are reshaping our future. Introduction to Bitcoin and blockchain.