tldr: Bitcoin

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Part of the tldr series, which summarizes papers I'm currently reading. Inspired by the morning paper.

Bitcoin: A Peer-to-Peer Electronic Cash System [2008]

Nakamoto 

Introduction

Nakamoto was motivated by how much electronic payments relied on trusting third-party financial institutions. Thus, they created Bitcoin, an "electronic payment system based on cryptographic proof instead of trust", which eliminates the need for a central bank. 

Transactions

An electronic coin is a chain of digital signatures. Each owner has a public and private key (also called a wallet). They can transfer a coin to the next owner by signing the hash(previous transaction + next owner's public key) with their private key, and appending this to the end of the chain of signatures.
 
Transactions also contain multiple inputs and outputs, so change is easy. (For example, let's say you wanted to pay someone 0.03, but you only have a previous transaction where you received 0.10. Then, you could have two outputs, where one output of 0.03 goes to the other person, and the other output of 0.07 goes to yourself.)
Spent transactions can be discarded to save disk space, by hashing them into a Merkle Tree.

Blockchain

Although the next owner can check that the signature is valid, they can't check whether the coin has already been spent. In current systems, it's the bank's job to make sure that double spending doesn't  happen. Bitcoin solves this by distributing the responsibility of the bank among all nodes in Bitcoin's network:
  • Transactions are publicly announced 
  • Participants can agree on one history of the order of transactions
  • The next owner has proof that the majority of nodes has agreed on the transaction 
Specifically, a public ledger called a blockchain keeps track of all transactions. Its name comes from how it's made up of blocks of transactions. Each block refers to the previous block, thus forming a chain.

Proof of Work

To make sure some adversary doesn't just flood the network with lots of nodes, a proof of work system makes it hard for nodes to validate transactions. The procedure, called mining, happens roughly like this:
  • A node (also called a miner) hears about new transactions, and add them its own pool of pending transactions. 
  • The node checks that each transaction is indeed valid by verifying them against its own copy of the current state of the blockchain. 
  • Before the node tells other nodes that the transactions are valid, it solves a proof of work puzzle. 
    • The node must find a hash(transaction + nonce) that starts with a specific number of zero bits, say n. 
    • Bitcoin uses a SHA-256 hash function. 
    • A nonce is a counter. The node increments the nonce until they find a hash that works. 
    • n is adjusted to account for CPU power and number of miners, such that one block is produced every 10 minutes. 
    • On average, this work is exponential in n, but can be easily verified. 
    • A miner’s probability of success in creating a block is proportional to the fraction of computational power they have. 

  • Once the node solves the puzzle, it broadcasts the block of transactions to other nodes.
    • Other nodes can easily verify that the hash satisfies the requirements. 
  • The node also receives a reward. 
    • This reward is needed to incentivize nodes to use a lot of computational power to verify other people's transactions. 
    • The reward halves every 210,000 validated blocks, so by the year 2140, the reward for mining will be the smallest unit of Bitcoin: 10^-8 Bitcoin, or a satoshi.
    • However, miners also get rewarded with transaction fees. If the output value of a transaction is less than the input value, then the transaction fee is the difference. 
As we can see now, the proof of work system ensures that there's one vote per CPU, and thus makes it very hard to change a block. A node would have to redo the work, so the probability of it catching up is negligible. 

Forks 

Sometimes, two nodes mine a block at roughly the same time. The other nodes hear about both of these forks, but work on the fork that's longer in their copy of the blockchain (in other words, whichever block they hear about first.) When one fork becomes longer, all nodes will switch to that fork. Transactions in the old fork that haven't been validated yet aren't lost, because nodes are still storing them in their pools. 

The longest chain has had the most work done by nodes to compute it, so it's the majority decision. Specifically, in Bitcoin, a transaction isn't confirmed until the block that its part of and the next 5 blocks have all been mined as part of the longest fork. 

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