Bitcoin, Blockchain & Co.

Data that we can trust blindly?

If we could blindly trust data, it would have enormous consequences and that would completely change our future. Without overstating it, you could argue that it’s a fourth industrial revolution—that of the trusting society.

By this, I mean a society in which you can blindly trust any offer or transaction, even if it comes from a completely unknown third party. In this version of society, you can purchase real estate by mobile phone without a lawyer. You can have your medical files with you and any doctor, wherever you are, can rely 100% on the information contained in those files, meaning they treat you more quickly, effectively, and safely than ever before. That is the kind of life-changing impact trustable data can have.

In the following section, I will show you exactly how that works and what technical developments would need to be in place to ensure that data is always reliable and reflects the truth—without exception. I will illustrate how this system is constructed and why it is uniquely positioned to deliver the truth. Along the way, you will also discover the circumstances under which it is vulnerable to attack or could be manipulated. All of this is presented in a straightforward way, so that anyone can understand it without needing to be a software programmer.

In this book, I have drawn examples from private and professional areas in which confidential applications, dominated by the truth, deliver benefits, and how these new applications will influence the future. By the end of the book, you will fully understand why this will happen and why the development is inevitable and unstoppable. The toothpaste is just not going back in the tube!

What is the secret of such a trustworthy application, in which the truth and nothing but the truth is recorded?

If the problem is that of truth, the integrity of data, or centrality, it logically follows that the solution can only lie in a decentralized application. I’m sure this was also the exact logical progression that Nakamoto’s thoughts took when he began creating a solution.

Nakamoto built a truly decentralized application with Bitcoin—one in which data are kept simultaneously on several decentralized computers. This network of individual computers, also called nodes, always optimizes itself so that failures of individual nodes are automatically balanced. As a result, most nodes always have access to the truth. In this way, such a network is designed to safeguard against failure.

In addition, the data must always have a certain structure and be stored in a certain way so that subsequent alterations and manipulations are impossible. Through skillful linking of the individual data sets into a series of data blocks that are linked to each other, an unalterable record is produced, one which always corresponds to the unaltered truth.

The data must be stored unalterably forever, impervious to manipulation or censoring, and must be stored on many computers (nodes), completely independent of each other simultaneously. They must also, though, be linked with each other so that subsequent alteration by an unauthorized individual is denied and ignored by the majority of the computers.

House owners can relate: if the land registry has been tampered with, someone else will then suddenly own their property. That is an entirely plausible scenario that could occur through the malicious collaboration of a lawyer with an employee of the land registry or the escrow company, for example. However, this kind of manipulation would no longer be possible if the transfer of title had been registered and certified simultaneously in the first instance by many hundreds of independent places. That would mean that hundreds of lawyers and land registry officers would have to have collaborated on the deception. That is practically impossible.

Transactions without Witnesses

The real estate metaphor serves only as an example that it is—theoretically, at least—possible to manipulate information when only a small number of participants and witnesses are involved.

A simpler version of this same manipulation, is if you give someone 100 dollars in cash and he later claims to have never received the money. You have entered into a transaction within a centralized system without a third party to witnesses and corroborate the truth of the transaction. Even if you asked a friend to be present when you paid the other party, you still can’t be 100% sure that said friend is reliable enough to confirm that you gave the other party the 100 dollars. He could forget, or pretend that he had forgotten because he had been bribed by the other party. Humans error and susceptibility to manipulation is a large part of what makes the centralized system vulnerable and ineffective.

There is a huge amount of literature on this subject and many academics worldwide have tackled these connections. Game theory is a science that attempts to understand systems as a way to predict the behavior of people who interact when exposed to a variety incentives. What the game theoreticians want to understand is how much a recipient who owes 100 dollars must pay a friend for him to “forget” and thus no longer be a witness. In theory, there is always a sum that makes it lucrative to manipulate. Maybe not for 100 dollars; but with sums in the millions, it would not be exceptional or rare to discover that someone’s loyalty can be bought for a price.

If the handover of the 100 dollars is observed by 1,000 friends and all 1,000 are potential witnesses, then any judge will believe that the 100 dollars was paid—even if one, 10 or even 200 of the witnesses lose their memory. Thus, the greater the number of witnesses, the lower the risk of interference.

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Chapter 3 — How the Bitcoin Blockchain Works

The invention of the banking system

A solution to the problems existing in the international finance markets appeared in the Middle Ages, with the emergence of the banking system. During these early days, the banker was viewed as the harbinger of truth, and it was the Knights Templar who organized the transfer of money via a large network. Before this, an asset owner would have to carry his physical valuables on his person. As you can imagine, this was a very dangerous undertaking. It was not just Robin Hood waiting to pounce, there also were some really bad guys, too. Regardless of the malevolence of the highwaymen—or even the authorities themselves who imposed many forms of taxation—the valuables were generally lost. The Knights Templar revolutionized that with their network of branches, making it safer and more efficient than ever before to make transactions.

A nobleman who invested a pound of gold could pick up the equivalent somewhere else with an appropriate paper. The Templars also maintained a network of messengers who would report on the transfers. This was not a really trustworthy system because a seal could be forged here and there, messengers could give the wrong news, and all sorts of tricks and manipulations could lead to false information. The system relied on trust and worked because there was no better alternative, and because people had faith in the Templars as trustworthy third parties. They were usually heavily armed and did “God’s work”—a factor that, for those times, held incredible weight and should not be underestimated.

The trustworthy third party

This system implemented by the Knights Templar is the first in which a trusted third party played a role in a larger system. The idea of a trusted third party has survived the centuries and is well established in our modern society. We could keep our money under the mattress, but we place it in trusted third parties, like banks or building societies. Or, in terms of the social contract, we feel more comfortable lending our lawnmower to a relative stranger when he is a friend of a friend. In this scenario, our mutual friend is the trusted third party who ensures both sides are fairly treated.

The state has institutionalized the trustworthy third party in the form of the notarial system. Anyone wishing to found a company or purchase a property needs the help of the trusted third party—the lawyer. Another large, worldwide sector of trusted third parties are the auditors. These independent experts check companies’ accounts and confirm that all records are correct and verifiable. For example, they check if the company really does possess their declared cash and assets, which the stock value is partially derived from. Does the trustworthy third party really represent the truth, though?

Who has never been annoyed that they lent their lawnmower to that friend of a friend, who returned it broken or never returned it at all?

Who has never been annoyed when their bank suddenly charges some ridiculous fee for a minor infraction of the T&Cs—all because your never read the small print?

Who has never stood shaking their head at the lawyer’s office when buying or selling a property? Unclear issues of ownership are not unusual.

And then there are the auditors. Enron—and many other scandals in which investors lost billions—come to mind. When we consider the patterns of history, can we really say that the third-party system represents the truth?

Data in centralized systems can easily be changed

Information and data in distributed and centralized systems can be altered or manipulated by the operators of these systems, so the truth is not guaranteed. We just have to accept that’s how it is. Don’t we?

Actually, we don’t have to accept this anymore. In fact, we have the mysterious Satoshi Nakamoto to thank for not having to accept a flawed system anymore. His concept has demonstrated how we can guarantee the truth through the integrity of the data within a genuinely decentralized system. His concept, which is only now gaining mass awareness, is ideal for changing our systems. This revolutionary system of data and information processing can change the very foundations of our system, but also, leading on from that, our entire social structure.

In essence, Nakamoto combined a number of existing approaches in such a way that the combination creates a guarantee of truth. A core component is computer encryption. But that alone is not enough; a further building block is required: the linking of older data with new, so that a chain of data blocks is formed. Within this chain, the current data always relates to the previous and that in turn of its predecessor. That is the principle of what has come to be well-known as blockchain—a chain of data blocks that are linked to each other.

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Chapter 4 — Wallets, Exchanges and the P2P-Net

How you get and manage Bitcoin

This chapter is especially important because there are a few things that you must absolutely be aware of when you buy, own, or keep cryptocurrencies like Bitcoin. The author of this very book lost Bitcoin because he was not careful enough with his private keys. The instructions in this chapter could save your Bitcoins and should, therefore, be taken very seriously!

So-called “wallets” are used within blockchain systems to manage the crypto-units, coins or tokens pertaining to a certain wallet, which contain addresses. It is these addresses to which the results of transactions have been or are assigned. Once again, it sounds complicated, but this time it really is not!

The concept of wallets has become well-established worldwide. A wallet is a place in which one can see the status or content of a certain address in a blockchain. It is through this wallet that one can both send and receive money. Put simply, it is special software, much like an online banking portal, in which you can call up your account balance and carry out payments.

A transaction in a blockchain is always a transfer of the cryptocurrency from one participant to another. Strictly speaking, it is from one address to another. The participants may be sensors or other computer units which can process the transferred data. If the temperature in the room exceeds 29 degrees, you should close the blinds, for example. You might not need a blockchain for that, but this should show what kind of value transfers could take place in our modern world. It is even clearer if you imagine an electric car stopping at a red light and the battery being automatically charged by an induction loop embedded in the road. For this, the car pays the road concerned for 32 seconds of electricity by supplying, for example, 0.00001 BTC from its crypto-wallet. This is a technology which is already being actively tested, so it is no science-fiction scenario. Of course, the participants may also be people who are transferring or receiving money. Or, in our case, transferring or receiving cryptocurrencies like Bitcoin, Ether and others, or perhaps an important medical certificate or identity documentation, which also count as transfer of values.

Addresses and wallets

Along with the term “wallet,” the term “address” is important in the context of blockchains. An address is basically nothing more than a postal address, just like 8 High Street is an address. Of course, it is a little more than that in a blockchain system because computers first have to resolve and translate 8 High Street into computer language to be able to work with it. That is no problem at all for a computer; it does that effortlessly with links.

The problem, however, is in the length and uniqueness of the address. As in real life, you can’t send anything to 8 High Street if you don’t know the postcode or at least the town or city. Just like a physical address consists of more than just the street name, the address in the context of blockchains has to be a little more detailed to ensure the unequivocal identification of the recipient.

Here is an example of an address for the crypto-token SIA:

2077ffcc79143aa8a1ba36ba934873f7e8d65085f212ce220dfacd267c8291e4d6ebc0923f09

And here is a Bitcoin address:

1Po9VrtwJzHQycEDS3i9JojUUT4dkYteMs

It is easy to see the difference between the two addresses—especially the difference between these and 8 High Street, Anytown.

Addresses must have one very important feature that is critical to the success of a blockchain system—they must be unambiguous.

In addition to this, there must absolutely be enough of them. The so-called “Address space” must be big enough to satisfy all possible requirements. In contrast with physical addresses, there are no upper limits because, in theory, everyone can have as many addresses as they wish. This is an important difference to the real world. In most countries, registration of one main residence is legally required, even though some people have a second or even third residence. However, these addresses, whether a summer home or a flat in the city, also generally have to be registered. With the blockchain, there are no such limitations or requirements.

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Chapter 9 — Nodes, Consensus and Mining

Why some work is needed

On the one hand, a blockchain consists of cryptographically connected data blocks in which the individual transactions of system participants are recorded. That is where the name “blockchain” comes from. A blockchain itself is relatively worthless because it is not safe in and of itself. The security is achieved by various measures. The single most important thing about this is that the chain is distributed over as many computers (nodes) as possible at the same time. Only this can make a blockchain secure, because if data is changed on only one part of the nodes, this change will sooner or later get overwritten and the data on the majority of the nodes becomes the truth. The truth then gets synchronized. The rules for maintaining this truth are also called the “Consensus Algorithm.”

This consensus algorithm must of course also be known to the nodes, just as with any other specifications they must adhere to. Software must basically run on every node to get that node to work at all. For all intents and purposes, that’s the node application. And this raises the interesting question . . . what software?

It was very easy to answer this question in 2009 because there was only one version—Nakamoto’s. Of course, the software was far from error-free. Actually, all software is. Working with other programmers, these errors were gradually eliminated. After every significant change in the code, the nodes were bought up to date with the latest version, so that all nodes ran on the same software. It was, and still is, called “Bitcoin Core.”

Bitcoin Core

Bitcoin Core is the software program which makes the nodes work─it is quasi-Word or Excel. At the same time, it’s the software which transfers the scope of functionality to the node, which would be by comparison the bold font or mathematical function symbols in Word and Excel formulae. The consensus algorithm, which defines which blocks the node can and may accept and in what form, is also in the scope of function of Bitcoin Core. Bitcoin Core defines the checks that a node must make to confirm the correctness of a block. For example, the node must measure the size of a block and it must be smaller than 1 megabyte. If the block delivered by the miner is larger than 1 MB, then it is ignored by the node and not added to the copy of the ledger which is stored locally─its blockchain.

The protocol is also defined for the miners in Bitcoin Core. The miners too must also know the format in which a block is generated for them to be accepted by the nodes. The miners only get the reward of 12.5 Bitcoins (from 2016 to 2020, from 2020 only 6.25 BTC) if the majority of the nodes accept the block and attach it to the existing chain. The size of the payment is also defined in Bitcoin Core.

To be sure that the blockchain cannot make an unpermitted split and that the transactions are secure and cannot be reversed on short notice, you should, as previously stated, wait at least six blocks before passing on the Bitcoins you have received. That is not defined in the protocol, but if a value that can be calculated. It is a result of the mathematics of the whole system. However, it’s also defined in the protocol that the miners only get their reward after 100 blocks─and it’s an important incentive─so that the miners cannot do anything silly or try to defraud.

All that and much more is defined in Bitcoin Core. Bitcoin Core is maintained by the so-called “Core developers” (Core devs) and alterations are only approved gradually, conservatively and with great care.

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The Famous Last Words

Over the last year and a half, I have seen many, many offers promising potential investors that they too can get rich quickly with cryptocurrencies. I’ve seen hundreds, if not thousands of these promises of salvation, from all corners of the earth. Printed offers and online, videos or on social media. In all languages. When I look at these offers, ninety-nine percent of them had one thing in common: they were nearly always frivolous. At the very least they were spreading false information, either intentionally or for the purpose of manipulation.

Unfortunately, the offers have not improved over the course of time. The more popular Bitcoin and the blockchain become, the more experts and people with the ultimate method for earning money, lots of money, crawl out of their holes and siphon it off. I know that I am using quite a coarse expression, but I am doing so deliberately because I find it disgusting how people try to rip off those who are not sufficiently familiar with this new crypto world. How they use every trick in the fraudster’s book and all sorts of scams to take money, reader, out of your pocket.

Only education can help in this regard because the law itself can’t at the moment. Bafflement reigns there too. If you don’t understand what is happening yourself, you can’t act or protect others adequately. Education is the best defense. Knowledge is power. Knowledge protects.

I hope that I have been able to give you some of this knowledge with this book, and I hope I have been able to raise your awareness and provide enough information for you to be able to distinguish the nonsense, rip-offs and con artists from the truth, and that you can enjoy Bitcoin and blockchain.

Of course, you will be told that the situation is not portrayed correctly in this book. Some will warn that a government will switch off Bitcoin at some point. You will be told that it is better to store your private keys with the miner or the exchange because blockchains are not secure. You will be told that everything will be cracked once quantum computers arrive. That is one (incorrect) perspective.

Those on the other side will praise this book and try to use it to lure you into some rip-off scheme, to sell you involvement in some crypto cloud so-and-so system, to lead you astray, to stimulate your natural greed. A mixture of both formulae will probably be used, depending what they have in mind.

Judge for yourself against the basics of the wise and ignore offers that do not correspond to the rules.

Those who want to tell you something else, show you something, or prove something are motivated by other reasons. For most of these people, the only focus is on your money or keeping up your diminishing power. Be strong. I have just one request to close with. If you have enjoyed this book, please pass the word on so that your friends and acquaintances can acquire this knowledge too. Everyone should have a basic knowledge of crypto so that they are not standing open-mouthed having to watch helplessly from the sidelines as the future passes them by.

With this in mind, I wish you all the best and juicy spoils.

Joe Martin

bitcoin-knowhow.com