Chapter 01

What is Bitcoin?

Last updated: 26th January 2018

To cut through some of the confusion surrounding bitcoin, we need to separate it into two components. On the one hand, you have bitcoin-the-token, a snippet of code that represents ownership of a digital concept – sort of like a virtual IOU. On the other hand, you have bitcoin-the-protocol, a distributed network that maintains a ledger of balances of bitcoin-the-token. Both are referred to as “bitcoin.”

The system enables payments to be sent between users without passing through a central authority, such as a bank or payment gateway. It is created and held electronically. Bitcoins aren’t printed, like dollars or euros – they’re produced by computers all around the world, using free software.

It was the first example of what we today call cryptocurrencies, a growing asset class that shares some characteristics of traditional currencies, with verification based on cryptography.

Network, Globe

Who created it?

A pseudonymous software developer going by the name of Satoshi Nakamoto proposed bitcoin in 2008, as an electronic payment system based on mathematical proof. The idea was to produce a means of exchange, independent of any central authority, that could be transferred electronically in a secure, verifiable and immutable way.

To this day, no-one knows who Satoshi Nakamoto really is.

In what ways is it different from traditional currencies?

Bitcoin can be used to pay for things electronically, if both parties are willing. In that sense, it’s like conventional dollars, euros, or yen, which are also traded digitally.

But it differs from fiat digital currencies in several important ways:

1 – Decentralization

Bitcoin’s most important characteristic is that it is decentralized. No single institution controls the bitcoin network. It is maintained by a group of volunteer coders, and run by an open network of dedicated computers spread around the world. This attracts individuals and groups that are uncomfortable with the control that banks or government institutions have over their money.

Bitcoin solves the “double spending problem” of electronic currencies (in which digital assets can easily be copied and re-used) through an ingenious combination of cryptography and economic incentives. In electronic fiat currencies, this function is fulfilled by banks, which gives them control over the traditional system. With bitcoin, the integrity of the transactions is maintained by a distributed and open network, owned by no-one.

2 - Limited supply

Fiat currencies (dollars, euros, yen, etc.) have an unlimited supply – central banks can issue as many as they want, and can attempt to manipulate a currency’s value relative to others. Holders of the currency (and especially citizens with little alternative) bear the cost.

With bitcoin, on the other hand, the supply is tightly controlled by the underlying algorithm. A small number of new bitcoins trickle out every hour, and will continue to do so at a diminishing rate until a maximum of 21 million has been reached. This makes bitcoin more attractive as an asset – in theory, if demand grows and the supply remains the same, the value will increase.

3 - Pseudonymity

While senders of traditional electronic payments are usually identified (for verification purposes, and to comply with anti-money laundering and other legislation), users of bitcoin in theory operate in semi-anonymity. Since there is no central “validator,” users do not need to identify themselves when sending bitcoin to another user. When a transaction request is submitted, the protocol checks all previous transactions to confirm that the sender has the necessary bitcoin as well as the authority to send them. The system does not need to know his or her identity.

In practice, each user is identified by the address of his or her wallet. Transactions can, with some effort, be tracked this way. Also, law enforcement has developed methods to identify users if necessary.

Furthermore, most exchanges are required by law to perform identity checks on their customers before they are allowed to buy or sell bitcoin, facilitating another way that bitcoin usage can be tracked. Since the network is transparent, the progress of a particular transaction is visible to all.

This makes bitcoin not an ideal currency for criminals, terrorists or money-launderers.

4 - Immutability

Bitcoin transactions cannot be reversed, unlike electronic fiat transactions.

This is because there is no central “adjudicator” that can say “ok, return the money.” If a transaction is recorded on the network, and if more than an hour has passed, it is impossible to modify.

While this may disquiet some, it does mean that any transaction on the bitcoin network cannot be tampered with.

5 - Divisibility

The smallest unit of a bitcoin is called a satoshi. It is one hundred millionth of a bitcoin (0.00000001) – at today’s prices, about one hundredth of a cent. This could conceivably enable microtransactions that traditional electronic money cannot.

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Read more to find out how bitcoin transactions are processed and how bitcoins are mined, what it can be used for, as well as how you can buy, sell and store your bitcoin. We also explain a few alternatives to bitcoin, as well as how its underlying technology – the blockchain – works.

 

Authored by Noelle Acheson. Network image via Shutterstock.

 

Disclosure Read More

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 02

How Can I Buy Bitcoin?

Last updated: 26th January 2018

So you've learned the basics about bitcoin, you’re excited about the potential and now you want to buy some*. But how?

(*Please, never invest more than you can afford to lose – cryptocurrencies are volatile and the price could go down as well as up.)

Bitcoin can be bought on exchanges, or directly from other people via marketplaces.

You can pay for them in a variety of ways, ranging from hard cash to credit and debit cards to wire transfers, or even with other cryptocurrencies, depending on who you are buying them from and where you live.

1 – set up a wallet

The first step is to set up a wallet to store your bitcoin – you will need one, whatever your preferred method of purchase. This could be an online wallet (either part of an exchange platform, or via an independent provider), a desktop wallet, a mobile wallet or an offline one (such as a hardware device or a paper wallet).

Even within these categories of wallets there is a wide variety of services to choose from, so do some research before deciding on which version best suits your needs.

You can find more information on some of the wallets out there, as well as tips on how to use them, here and here.

The most important part of any wallet is keeping your keys (a string of characters) and/or passwords safe. If you lose them, you lose access to the bitcoin stored there.

BUYING ONLINE

2 – open an account at an exchange

Cryptocurrency exchanges will buy and sell bitcoin on your behalf. There are hundreds currently operating, with varying degrees of liquidity and security, and new ones continue to emerge while others end up closing down. As with wallets, it is advisable to do some research before choosing – you may be lucky enough to have several reputable exchanges to choose from, or your access may be limited to one or two, depending on your geographical area.

The largest bitcoin exchange in the world at the moment in terms of US$ volume is Bitfinex, although it is mainly aimed at spot traders. Other high-volume exchanges are Coinbase, Bitstamp and Poloniex, but for small amounts, most reputable exchanges should work well. (Note: at time of writing, the surge of interest in bitcoin trading is placing strain on most retail buy and sell operations, so a degree of patience and caution is recommended.)

With the clampdown on know-your-client (KYC) and anti-money-laundering (AML) regulation, many exchanges now require verified identification for account setup. This will usually include a photo of your official ID, and sometimes also a proof of address.

Most exchanges accept payment via bank transfer or credit card, and some are willing to work with Paypal transfers. And most exchanges charge fees (which generally include the fees for using the bitcoin network).

Each exchange has a different procedure for both setup and transaction, and should give you sufficient detail to be able to execute the purchase. If not, consider changing the service provider.

Once the exchange has received payment, it will purchase the corresponding amount of bitcoin on your behalf, and deposit them in an automatically generated wallet on the exchange. This can take minutes, or sometimes hours due to network bottlenecks. If you wish (recommended), you can then move the funds to your off-exchange wallet.

BUYING WITH CASH

2 – choose a purchase method

Platforms such as LocalBitcoins will help you to find individuals near you who are willing to exchange bitcoin for cash. Also, LibertyX lists retail outlets across the United States at which you can exchange cash for bitcoin. And WallofCoins, Paxful and BitQuick will direct you to a bank branch near you that will allow you to make a cash deposit and receive bitcoin a few hours later.

ATMs are machines that will send bitcoin to your wallet in exchange for cash. They operate in a similar way to bank ATMs – you feed in the bills, hold your wallet’s QR code up to a screen, and the corresponding amount of bitcoin are beamed to your account. Coinatmradar can help you to find a bitcoin ATM near you.

(Note: specific businesses mentioned here are not the only options available, and should not be taken as a recommendation.)

 

Authored by Noelle Acheson. Bitcoin image via Shutterstock.

Disclosure Read More

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 03

How to Store Your Bitcoin

Last updated: 20th January 2018

Before owning any bitcoin, you need somewhere to store them. That place is called a “wallet.” Rather than actually holding your bitcoin, it holds the private key that allows you to access your bitcoin address (which is also your public key). If the wallet software is well designed, it will look as if your bitcoins are actually there, which makes using bitcoin more convenient and intuitive.

Actually, a wallet usually holds several private keys, and many bitcoin investors have several wallets.

Wallets can either live on your computer and/or mobile device, on a physical storage gadget, or even on a piece of paper. Here we’ll briefly look at the different types.

Electronic wallets

Electronic wallets can be downloaded software, or hosted in the cloud. The former is simply a formatted file that lives on your computer or device, that facilitates transactions. Hosted (cloud-based) wallets tend to have a more user-friendly interface, but you will be trusting a third party with your private keys.

Software wallet

Installing a wallet directly on your computer gives you the security that you control your keys. Most have relatively easy configuration, and are free. The disadvantage is that they do require more maintenance in the form of backups. If your computer gets stolen or corrupted and your private keys are not also stored elsewhere, you lose your bitcoin.

They also require greater security precautions. If your computer is hacked and the thief gets a hold of your wallet or your private keys, he also gets hold of your bitcoin.

The original software wallet is the Bitcoin Core protocol, the program that runs the bitcoin network. You can download this here (it doesn’t mean that you have to become a fully operational node), but you’d also have to download the ledger of all transactions since the dawn of bitcoin time (2009). As you can guess, this takes up a lot of memory – at time of writing, over 145GB.

Most wallets in use today are “light” wallets, or SPV (Simplified Payment Verification) wallets, which do not download the entire ledger but sync to the real thing. Electrum is a well-known SPV desktop bitcoin wallet that also offers “cold storage” (a totally offline option for additional security). Exodus can track multiple assets with a sophisticated user interface. Some (such as Jaxx) can hold a wide range of digital assets, and some (such as Copay) offer the possibility of shared accounts.

Online wallet

Online (or cloud-based) wallets offer increased convenience – you can generally access your bitcoin from any device if you have the right passwords. All are easy to set up, come with desktop and mobile apps which make it easy to spend and receive bitcoin, and most are free.

The disadvantage is the lower security. With your private keys stored in the cloud, you have to trust the host’s security measures, and that it won’t disappear with your money, or close down and deny you access.

Some leading online wallets are attached to exchanges (such as Coinbase and Blockchain). Some offer additional security features such as offline storage (Coinbase and Xapo).

Mobile wallets

Mobile wallets are available as apps for your smartphone, especially useful if you want to pay for something in bitcoin in a shop, or if you want to buy, sell or send while on the move. All of the online wallets and most of the desktop ones mentioned above have mobile versions, while others – such as Abra, Airbitz and Bread – were created with mobile in mind.

Hardware wallets

Hardware wallets are small devices that occasionally connect to the web to enact bitcoin transactions. They are extremely secure, as they are generally offline and therefore not hackable. They can be stolen or lost, however, along with the bitcoins that belong to the stored private keys. Some large investors keep their hardware wallets in secure locations such as bank vaults. Trezor, Keepkey and Ledger and Case are notable examples.

Paper wallets

Perhaps the simplest of all the wallets, these are pieces of paper on which the private and public keys of a bitcoin address are printed. Ideal for the long-term storage of bitcoin (away from fire and water, obviously), or for the giving of bitcoin as a gift, these wallets are more secure in that they’re not connected to a network. They are, however, easier to lose.

With services such as WalletGenerator, you can easily create a new address and print the wallet on your printer. Fold, seal and you’re set. Send some bitcoin to that address, and then store it safely or give it away. (See our tutorial on paper wallets here.)

Are bitcoin wallets safe?

That depends on the version and format you have chosen, and how you use them.

The safest option is a hardware wallet which you keep offline, in a secure place. That way there is no risk that your account can be hacked, your keys stolen and your bitcoin whisked away. But, if you lose the wallet, your bitcoin are gone, unless you have created a clone and/or kept reliable backups of the keys.

The least secure option is an online wallet, since the keys are held by a third party. It also happens to be the easiest to set up and use, presenting you with an all-too-familiar choice: convenience vs safety.

Many serious bitcoin investors use a hybrid approach: they hold a core, long-term amount of bitcoin offline, while having a “spending balance” for liquidity in a mobile account. Your choice will depend on your bitcoin strategy, and your willingness to get “technical.”

Whatever option you go for, please be careful. Back up everything, and only tell your nearest and dearest where your backups are stored.

For more information on how to buy bitcoin, see here. And for some examples of what you can spend it on, see here.

(Note: specific businesses mentioned here are not the only options available, and should not be taken as a recommendation.)

 

Authored by Noelle Acheson. Wallet image via Shutterstock.

Disclosure Read More

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 04

How to Sell Bitcoin

Last Updated: 20th January 2018

These days virtually all the methods available to buy bitcoin also offer the option to sell.

The exception is bitcoin ATMs – some do allow you to exchange bitcoin for cash, but not all. Coinatmradar will guide you to bitcoin ATMs in your area.

All exchanges allow you to sell as well as buy. What type of exchange you choose to sell your bitcoin will depend on what type of holder you are: small investor, institutional holder or trader?

Some platforms such as GDAX and Gemini are aimed more at large orders from institutional investors and traders.

Retail clients can sell bitcoin at exchanges such as Coinbase, Kraken, Bitstamp, Poloniex, etc. Each exchange has a different interface, and some offer related services such as secure storage. Some require verified identification for all trades, while others are more relaxed if small amounts are involved.

(Of course, don’t forget to declare any profit you make on the sale to your relevant tax authority!)

You can, if you wish, exchange your bitcoin for other cryptoassets rather than for cash. Some exchanges such as ShapeShift focus on this service, allowing you to swap between bitcoin and ether, litecoin, XRP, dash and several others.

Another alternative is the direct sale. You can register as a seller on platforms such as LocalBitcoins, BitQuick, Bittylicious and BitBargain, and interested parties will contact you if they like your price. Transactions are usually done via deposits or wires to your bank account, after which you are expected to transfer the agreed amount of bitcoin to the specified address.

Or, you can sell directly to friends and family once they have a bitcoin wallet set up. Just send the bitcoin, collect the cash or mobile payment, and have a celebratory drink together. (Note: it is generally not a good idea to meet up with strangers to exchange bitcoin for cash in person. Be safe.)

(Note: specific businesses mentioned here are not the only options available, and should not be taken as a recommendation.)

 

Authored by Noelle Acheson. Graph image via Shutterstock.

Disclosure Read More

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 05

How do Bitcoin Transactions Work?

Last updated: 29th January 2018

Simple version:

If I want to send some of my bitcoin to you, I publish my intention and the nodes scan the entire bitcoin network to validate that I 1) have the bitcoin that I want to send, and 2) haven’t already sent it to someone else. Once that information is confirmed, my transaction gets included in a “block” which gets attached to the previous block - hence the term “blockchain.” Transactions can’t be undone or tampered with, because it would mean re-doing all the blocks that came after.

Getting a bit more complicated:

My bitcoin wallet doesn’t actually hold my bitcoin. What it does is hold my bitcoin address, which keeps a record of all of my transactions, and therefore of my balance. This address – a long string of 34 letters and numbers – is also known as my “public key.”  I don’t mind that the whole world can see this sequence. Each address/public key has a corresponding “private key” of 64 letters and numbers. This is private, and it’s crucial that I keep it secret and safe. The two keys are related, but there’s no way that you can figure out my private key from my public key.

That’s important, because any transaction I issue from my bitcoin address needs to be “signed” with my private key. To do that, I put both my private key and the transaction details (how many bitcoins I want to send, and to whom) into the bitcoin software on my computer or smartphone.

With this information, the program spits out a digital signature, which gets sent out to the network for validation.

This transaction can be validated – that is, it can be confirmed that I own the bitcoin that I am transferring to you, and that I haven’t already sent it to someone else – by plugging the signature and my public key (which everyone knows) into the bitcoin program. This is one of the genius parts of bitcoin: if the signature was made with the private key that corresponds to that public key, the program will validate the transaction, without knowing what the private key is. Very clever.

The network then confirms that I haven’t previously spent the bitcoin by running through my address history, which it can do because it knows my address (= my public key), and because all transactions are public on the bitcoin ledger.

Even more complicated:

Once my transaction has been validated, it gets included into a “block,” along with a bunch of other transactions.

A brief detour to discuss what a “hash” is, because it’s important for the next paragraph: a hash is produced by a “hash function,” which is a complex math equation that reduces any amount of text or data to 64-character string. It’s not random – every time you put in that particular data set through the hash function, you’ll get the same 64-character string. But if you change so much as a comma, you’ll get a completely different 64-character string. This whole article could be reduced to a hash, and unless I change, remove or add anything to the text, the same hash can be produced again and again. This is a very effective way to tell if something has been changed, and is how the blockchain can confirm that a transaction has not been tampered with.

Back to our blocks: each block includes, as part of its data, a hash of the previous block. That’s what makes it part of a chain, hence the term “blockchain.” So, if one small part of the previous block was tampered with, the current block’s hash would have to change (remember that one tiny change in the input of the hash function changes the output). So if you want to change something in the previous block, you also have to change something (= the hash) in the current block, because the one that is currently included is no longer correct. That’s very hard to do, especially since by the time you’ve reached half way, there’s probably another block on top of the current one. You’d then also have to change that one. And so on.

This is what makes Bitcoin virtually tamper-proof. I say virtually because it’s not impossible, just very very, very, very, very difficult and therefore unlikely.

Fun

And if you want to indulge in some mindless fascination, you can sit at your desk and watch bitcoin transactions float by. Blockchain.info is good for this, but if you want a hypnotically fun version, try BitBonkers.

(For more detail on how blocks are processed and on how bitcoin mining works, see this article.) 

Disclosure Read More

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 06

How Bitcoin Mining Works

Last updated: 29th January 2018

When you hear about bitcoin “mining,” you envisage coins being dug out of the ground. But bitcoin isn’t physical, so why do we call it mining?

Because it’s similar to gold mining in that the bitcoins exist in the protocol’s design (just as the gold exists underground), but they haven’t been brought out into the light yet (just as the gold hasn’t yet been dug up). The bitcoin protocol stipulates that 21 million bitcoins will exist at some point. What “miners” do is bring them out into the light, a few at a time.

They get to do this as a reward for creating blocks of validated transactions and including them in the blockchain.

rust, bitcoin

 

Nodes

Backtracking a bit, let’s talk about “nodes.” A node is a powerful computer that runs the bitcoin software and helps to keep bitcoin running by participating in the relay of information. Anyone can run a node, you just download the bitcoin software (free) and leave a certain port open (the drawback is that it consumes energy and storage space – the network at time of writing takes up about 145GB). Nodes spread bitcoin transactions around the network. One node will send information to a few nodes that it knows, who will relay the information to nodes that they know, etc. That way it ends up getting around the whole network pretty quickly.

Some nodes are mining nodes (usually referred to as “miners”). These group outstanding transactions into blocks and add them to the blockchain. How do they do this? By solving a complex mathematical puzzle that is part of the bitcoin program, and including the answer in the block. The puzzle that needs solving is to find a number that, when combined with the data in the block and passed through a hash function, produces a result that is within a certain range. This is much harder than it sounds.

(For trivia lovers, this number is called a “nonce”, which is a concatenation of “number used once.” In the case of bitcoin, the nonce is an integer between 0 and 4,294,967,296.)

Solving the puzzle

How do they find this number? By guessing at random. The hash function makes it impossible to predict what the output will be. So, miners guess the mystery number and apply the hash function to the combination of that guessed number and the data in the block. The resulting hash has to start with a pre-established number of zeroes. There’s no way of knowing which number will work, because two consecutive integers will give wildly varying results. What’s more, there may be several nonces that produce the desired result, or there may be none (in which case the miners keep trying, but with a different block configuration).

The first miner to get a resulting hash within the desired range announces its victory to the rest of the network. All the other miners immediately stop work on that block and start trying to figure out the mystery number for the next one. As a reward for its work, the victorious miner gets some new bitcoin.

Economics

At the time of writing, the reward is 12.5 bitcoins, which at time of writing is worth almost $200,000.

Although it’s not nearly as cushy a deal as it sounds. There are a lot of mining nodes competing for that reward, and it is a question of luck and computing power (the more guessing calculations you can perform, the luckier you are).

Also, the costs of being a mining node are considerable, not only because of the powerful hardware needed (if you have a faster processor than your competitors, you have a better chance of finding the correct number before they do), but also because of the large amounts of electricity that running these processors consumes.

And, the number of bitcoins awarded as a reward for solving the puzzle will decrease. It’s 12.5 now, but it halves every four years or so (the next one is expected in 2020-21). The value of bitcoin relative to cost of electricity and hardware could go up over the next few years to partially compensate this reduction, but it’s not certain.

Difficulty

The difficulty of the calculation (the required number of zeroes at the beginning of the hash string) is adjusted frequently, so that it takes on average about 10 minutes to process a block.

Why 10 minutes? That is the amount of time that the bitcoin developers think is necessary for a steady and diminishing flow of new coins until the maximum number of 21 million is reached (expected some time in 2140).

If you’ve made it this far, then congratulations! There is still so much more to explain about the system, but at least now you have an idea of the broad outline of the genius of the programming and the concept. For the first time we have a system that allows for convenient digital transfers in a decentralized, trust-free and tamper-proof way. The repercussions could be huge.

 

Authored by Noelle Acheson. Bitcoin and bitcoin mining images via Shutterstock.

 

Disclosure Read More

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 07

Can Bitcoin Scale?

Last updated: 22 February, 2018

A few years after Satoshi Nakamoto unleashed his bitcoin paper on the world, the cryptocurrency’s users began to notice a potential problem: bitcoin wasn’t very liquid.

For a system that many claimed could replace fiat payments, this was a big barrier. While Visa handles around 24,000 transactions a second, bitcoin could process up to 7. Unless something could be done about this, bitcoin’s utility was limited.

Thus began the “scaling debate,” which polarized the community and unleashed a wave of technological innovation in the search of workarounds. Yet while significant progress has been made, a sustainable solution is still far from clear.

The problem arises from bitcoin’s design: Satoshi programmed the blocks to have a size limit of approximately 1MB each, in order to prevent network spam.

Since each block takes an average of 10 minutes to process, this works out to a relatively small number of transactions overall. An increase in demand would inevitably lead to an increase in fees, and bitcoin’s utility would diminish even further.

Don’t think so

A simple solution initially appeared to be an increase in the block size. Yet that idea turned out to be not simple at all.

First, there was no clear agreement as to how much it should be increased by. Some proposals advocated for 2MB, another for 8MB, and one wanted to go as high as 32MB.

The core development team argued that increasing the block size at all would weaken the protocol’s decentralization by concentrating mining power – with bigger blocks, only the more powerful miners would be successful, and the race for faster machines could eventually make bitcoin mining unprofitable. Also, the number of nodes able to run a much heavier blockchain could decrease, further centralizing a network that depends on decentralization.

Second, the method of the change was contentious. How do you execute a system-wide upgrade when participation is decentralized? Should everyone have to update their bitcoin software? What if some miners, nodes and merchants don’t?

And finally, an existential argument emerged. Bitcoin is bitcoin, why mess with it? If someone didn’t like it, they were welcome to modify the open-source code and launch their own coin (indeed, some have done just that).

What’s more, Satoshi is no longer around to tell us what he originally intended. And even if he were, would he care? Did he not design bitcoin to run itself?

I have an idea

In 2015, developer Pieter Wiulle revealed a solution that, at first glance, looked like it could appease all groups. Segregated Witness, or SegWit, increased the capacity of the bitcoin blocks without changing their size limit, by altering how the transaction data was stored. (For a more detailed account, see our explainer.)

SegWit was deployed on the bitcoin network in August 2017, via a soft fork (to make it compatible with nodes that did not upgrade). In spite of initial excitement about the benefits, however, uptake has been slow. While many wallets and other bitcoin services are gradually adjusting their software, others are reticent to do so because of the perceived risk and cost.

Take two

Several industry players argued that SegWit didn’t go far enough – it might help in the short term, but sooner or later bitcoin would again be up against a limit to its growth.

In 2017, coinciding with CoinDesk’s Consensus conference in New York, a new approach was revealed: Segwit2X. This idea – backed by several of the sector’s largest exchanges – combined SegWit with an increase in the block size to 2MB, effectively multiplying the pre-SegWit transaction capacity by a factor of 8.

Far from solving the problem, the proposal unleashed a further wave of discord. The manner of its unveiling (through a public announcement rather than an upgrade proposal) and its lack of replay protection (transactions could happen on both versions, potentially leading to double spending) rankled many. And the perceived redistribution of power away from developers towards miners and businesses threatened to cause a fundamental split in the community

In the end, the idea was dropped a few months later, just weeks from its target date of implementation

Meanwhile…

Other technological approaches are being developed as a potential way to increase capacity.

Schnorr signatures offer a way to consolidate signature data, reducing the space it takes up within a bitcoin block (and enhancing privacy). Combined with SegWit, this could allow a much greater number of transactions, without changing the block size limit

And work is proceeding on the lightning network, a second layer protocol that runs on top of bitcoin, opening up channels of fast microtransactions that only settle on the bitcoin network when the channel participants are ready.

Getting closer

So where are we now? Adoption of the SegWit upgrade is slowly spreading throughout the network, increasing transaction capacity and lowering fees.

Most blocks are just over the 1MB mark, and transaction fees – which shot up to over $50 in December 2017 – have fallen back down to around $4 at time of writing.

Progress is accelerating on more advanced solutions such as lightning, with transactions being sent on testnets (as well as some using real bitcoin). And the potential of Schnorr signatures is attracting increasing attention, with several proposals working on detailing functionality and integration.

While bitcoin’s use as a payment mechanism seems to have taken a back seat to its value as an investment asset, the need for a greater number of transactions is still pressing as the fees charged by the miners for processing are now more expensive than fiat equivalents. What’s more, taking into account that we are still at the beginning of cryptocurrency evolution, the development of new features that enhance functionality is crucial for the potential of the underlying blockchain technology to be realised.

Authored by Noelle Acheson. Steps image via Shutterstock.

Disclosure Read More

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 08

What is Bitcoin's Lightning Network?

lightning network

Last updated: 21 March, 2018

Hailed as one of the most potent solutions to cryptocurrency scaling currently under development, the lightning network effectively creates a layer on top of bitcoin, enabling fast and cheap transactions which can net settle to the bitcoin blockchain.

Proposed by Thaddeus Dryja and Joseph Poon in a 2015 white paper, the idea is based on a network that sits on top of the bitcoin blockchain, and eventually settles on it. The network is comprised of user-generated channels that send payments back and forth in a secure and trust-less fashion (trust-less means that you don’t need to trust or even know your counterparty).

Say, for instance, that I wanted to pay you for each minute of video that I watched. We would open up a lightning channel, and as the minutes rolled by, periodic payments would be made from my wallet to yours. When I’m done watching, we would close the channel to settle the net amount on the bitcoin blockchain.

Because the transactions are just between me and you and don’t need to be broadcast to the whole network, they are almost instantaneous. And because there are no miners that need incentivizing, transaction fees are low or even non-existent.

How it works

First, two parties who wish to transact with each other set up a multisig wallet (which requires more than one signature to enact a transaction). This wallet holds some amount of bitcoin. The wallet address is then saved to the bitcoin blockchain. This sets up the payment channel.

The two parties can now conduct an unlimited number of transactions without ever touching the information stored on the blockchain. With each transaction, both parties sign an updated balance sheet to always reflect how much of the bitcoin stored in the wallet belongs to each.

When the two parties have done transacting, they close out the channel, and the resulting balance is registered on the blockchain. In the event of a dispute, both parties can use the most recently signed balance sheet to recover their share of the wallet.

It is useful to note that it is not necessary to set up a direct channel to transact on lightning – you can send payments to someone via channels with people that you are connected with. The network automatically finds the shortest route.

Development of the technology got a significant boost with the adoption of SegWit on the bitcoin and litecoin networks. Without the upgrade’s transaction malleability fix, transactions on the lightning network would have been too risky to be practical.

Without the security of the blockchain behind it, the lightning network will not be as secure, which implies that it will largely be used for small or even micro transactions which carry a lower risk. Larger transfers that require decentralized security are more likely to be done on the original layer.

Where are we now?

Although it was originally designed for bitcoin, the technology is currently being developed for a range of cryptocurrencies, such as litecoin, stellar, zcash, ether and ripple. Litecoin plans to launch its version at the same time as bitcoin’s.

In December 2017, startups behind the three most active lightning implementations (ACINQ, Blockstream and Lightning Labs) revealed test results, including live transactions, proving that their software is now interoperable.

Furthermore, version 1 of the lightning specifications, which set out the rules of the network, has been published. This will encourage the development of other implementations and applications.

However, the network is not yet ready for launch. Engineers have yet to release software with which real users can make transactions. Apps supporting lightning as a payment method are already cropping up, but so far they're not easy to use.

That has not stopped some of those working on projects from testing lightning transactions on the bitcoin network. Lightning developers discourage this, however – not only does it act as a distraction to developers, but it also puts users’ funds at risk.

Given the complexity of the code, and the need for rigorous testing (we are talking about payments, after all), developers are urging patience. In addition, lightning can’t be implemented at scale until SegWit is more widely extended – so, while some believe that there is enough SegWit support to run the network on mainnet now, others predict that a usable lightning network could be at least a year away.

In March 2018, California startup Lightning Labs announced the launch of a beta version of its software, making available what investors and project leads say is the first thoroughly tested version of the tech to date. It is still early days, however - transaction sizes are limited, and the release is aimed at developers and "advanced users".

Authored by Noelle Acheson. Lightning image via Shutterstock.

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The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 09

What are Bitcoin Mining Pools?

Last updated 10th March 2014

One of the first questions that anyone interested in mining cryptocurrencies faces is whether to mine solo or join a 'pool'. There are a multitude of reasons both for and against mining pools. However, if the hash rate distribution across the bitcoin network is anything to go by (and it is) then most miners are opting to join a pool. Here’s what you need to know.

Pros and cons

Pros and consIf you’re deciding whether to join a mining pool or not, it can be helpful to think of it like a lottery syndicate – the pros and cons are exactly the same. Going solo means you won’t have to share the reward, but your odds of getting a reward are significantly decreased. Although a pool has a much larger chance of solving a block and winning the reward, that reward will be split between all the pool members.

Therefore, joining a pool creates a steady stream of income, even if each payment is modest compared to the full block reward (which currently stands at 25 XBTC).

It is important to note that it is important for a mining pool to not exceed over 51% of the hashing power of the network. If a single entity ends up controlling more than 50% of a cryptocurrency network’s computing power, it could – theoretically – wreak havoc on the whole network. In early 2014, many voiced concerns that the GHash.io bitcoin mining pool was approaching this threshold, and miners were urged to leave the pool.

Currency difficulty

In bitcoin's case, the current difficulty level is so high that it’s practically impossible for soloists to make a profit mining. Unless, of course, you happen to have a garage full of ASICs sitting in Arctic conditions. If you’re a beginner, joining a mining pool is a great way to reap a small reward over a short period of time. Indeed, pools are a way to encourage small-scale miners to stay involved.

What to mine?

Flip coinsOf course, bitcoin is not the only currency out there – it’s easy to find lists of mining pools for your chosen cryptocurrency.

One method of mining that bitcoin facilitates is “merged mining”. This is where blocks solved for bitcoin can be used for other currencies that use the same proof of work algorithm (for example, namecoin and devcoin). A useful analogy for merged mining is to think of it like entering the same set of numbers into several lotteries.

First-time miners who lack particularly powerful hardware should look at altcoins over bitcoin – especially currencies based on the scrypt algorithm rather than SHA256. This is because the difficulty of bitcoin calculations is far too high for the processors found in regular PCs.

If you’re not sure which currency to mine, there is a pool called ‘Multipool’ which will automatically switch your mining hardware between the most profitable altcoin. Multipool updates every 30 minutes, and over time you’ll see balance grow in multiple altcurrencies. If required, the pool does allow you to fix your hardware on just one altcurrency too.

However, Mark from nut2pools.com said of this type of switching pool: “Loyal coin followers hate them because as soon as the difficulty of a coin drops, the profitability of it rises. Then all the multipools swing round, push the difficulty through the roof in a few hours, then leave again. It leaves the loyal coin followers having to mine the difficulty back down again at very low profitability.”

Pool rewards

PaymentsWhen deciding which mining pool to join, you need to weigh up how each pool shares out its payments and what fees (if any) it deducts.

There are many schemes by which pools can divide payments. Most of which concentrate of the amount of ‘shares’ which a miner has submitted to the pool as ‘proof of work’.

Shares are a tricky concept to grasp. Keep two things in mind: firstly, mining is a process of solving cryptographic puzzles; secondly, mining has a difficulty level. When a miner ‘solves a block’ there is a corresponding difficulty level for the solution. Think of it as a measure of quality. If the difficulty rating of the miner’s solution is above the difficulty level of the entire currency, it is added to that currency’s block chain and coins are rewarded.

Additionally, a mining pool sets a difficulty level between 1 and the currency’s difficulty. If a miner returns a block which scores a difficulty level between the pool’s difficulty level and the currency’s difficulty level, the block is recorded as a ‘share’. There is no use whatsoever for these share blocks, but they are recorded as proof of work to show that miners are trying to solve blocks. They also indicate how much processing power they are contributing to the pool – the better the hardware, the more shares are generated.

The most basic version of dividing payments this way is the 'pay per share' (PPS) model. Variations on this puts limits on the rate paid per share; for example, equalised shared maximum pay per share (ESMPPS), or shared maximum pay per share (SMPPS). Pools may or may not prioritise payments for how recently miners have submitted shares: for example, recent shared maximum pay per share (RSMPPS). More examples can be found on the bitcoin wiki.

The other factor to consider is how much the pool will deduct from your mining payments. Typical values range from 1% to 10%. However, some pools do not deduct anything.

Starting to mine with a pool

Having decided which currency to mine and which pool you'll work for, it's time to get started. You need to create an account on the pool's website, which is just like signing up for any other web service. Once you have an account, you'll need to create a ‘worker’. You can create multiple workers for each piece of mining hardware you’ll use. The default settings on most pools are for workers to be assigned a number as their name, and ‘x’ as their password, but you can change these to whatever you like.

SilhouettePros and consCoin flip and Check mailbox images via Shutterstock

 

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The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.

Chapter 10

What Can You Buy with Bitcoin?

Last updated: 20th January 2018

After an initial flurry of interest among merchants in accepting bitcoin in their retail or online stores, interest has largely died down as increasing bitcoin transaction fees and volatile price movements made it less attractive as a means of exchange

That doesn’t mean that there are no outlets to spend your bitcoin, however, far from it. It’s just that bitcoin volumes at these outlets has generally not met expectations, and by the time you read this, some may have discontinued that option.

At time of writing, however, you can still buy a wide range of goods and services with the cryptocurrency. Among the advantages of doing so are the ease of cross-border transactions, and anonymity (unless you want physical delivery, of course). By accepting bitcoin, merchants get access to a broader market, and don’t have to worry so much about chargebacks (where the buyers cancels the payment after receiving the product).

If you want to use bitcoin to buy presents, the most obvious solution is gift cards, via Gyft or eGifter. The recipient will then be able to spend the gift card at one of a wide range of retailers.

You can pay for flights and hotels with bitcoin, through Expedia, CheapAir and Surf Air. If your ambitions are loftier, you can pay for space travel with some of your vast holdings, through Virgin Galactic.

Microsoft accepts bitcoin in its app stores, where you can download movies, games and app-based services.

Some musicians (Bjork, Imogen Heep) will let you download their music in exchange for cryptocurrency.

Need to furnish your house or buy a special present for someone? Overstock was one of the first big retailers to start accepting bitcoin, back in 2014, and its founder – Patrick Byrne – is still one of the technology’s most active proponents.

Fancy some gold? Sharps Pixley, APMEX and JM Bullion will take bitcoin off your hands in exchange for bullion.

And if you’re hungry and live in the US, PizzaforCoins will get a pizza delivered to your door (depending on where you live) in exchange for bitcoin.

If it’s knowledge you’re hungry for, several private and public universities as well as a couple of New York preschools accept bitcoin.

Some legal and accounting firms also accept payment for their services in the cryptocurrency.

Of course, you could always buy yourself some happiness by donating to one of the bitcoin-accepting charities or crowdfunding sites, such as BitHope, BitGive or Fidelity Charitable.

For a list of offline stores near you that accept bitcoin, check an aggregator such as SpendBitcoins or CoinMap.

(Note: specific businesses mentioned here are not the only options available, and should not be taken as a recommendation.)

 

Authored by Noelle Acheson.

Disclosure Read More

The leader in blockchain news, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups.