Decrypting Money: A Comprehensive Introduction to Bitcoin

Contents

Foreword

Introduction

PART 1: The History of Money

1. The Origins of Money

2. The Functions and Properties of Money

3. The Digitalization of Money

Part 2: Bitcoin, the First Cryptocurrency

4. Bitcoin History

5. Bitcoin Structure

Part 3: How Bitcoin Works

6. Bitcoin Fundamentals

7. Cryptographic Primitives

8. Bitcoin Mining

Conclusion

Glossary

Acknowledgments

About the Authors

Figure 0.1: The first block of the bitcoin blockchain contains the text The Times 03/Jan/2009 Chancellor on brink of second bailout for banks. A reference to the headline of The Times of that day left by the mysterious bitcoin inventor who called himself Satoshi Nakamoto. The block itself was mined at 6:15 p.m. (GMT) on January 3, 2009.

Please visit our website www.decryptingmoney.com for further information about the book and our contact details.

Foreword

by Garry Kasparov

Let me present a thought experiment: Imagine you are a dissident fighting for democracy in Venezuela. The government controls access to financial services through state institutions. Those loyal to the regime have access to the nation’s scant resources. Dissidents like yourself are locked out. The government monitors your every move, tracking what financial transactions you are allowed to make and chasing your footprints (both digital and physical) everywhere. What can you do? How can you survive and continue to speak out?

And what if the government also manipulates the national currency, printing money and playing with its value, trying—like Nero declaring war against Neptune—to wage war against economics itself? Can that be called stable? How can a company or family plan for the future when the basic block of saving, spending, and investment is subject to the whims and abuses of a malign ruler?

But this is not merely a thought experiment. This is real life, for both dissidents and ordinary people all around the world. One answer to this problem is cryptocurrency like bitcoin. For countless people around the world, in an age of ever greater control and surveillance, crypto means freedom.

I realize this may sound like an edge case, and specific to my advocacy as the chairman of the Human Rights Foundation. But most new technology first finds such fringe applications before becoming broadly understood and utilized in the mainstream. Early adopters take on risk, encounter challenges, and pave the way for the rest.

That’s where cryptocurrency is today, and we are lucky to have a book like Decrypting Money to help us move into the next phase. Placing bitcoin in the historical context of all currency—back to seashells!—is similar to the comparisons of the internet to the printing press.

I’ve always been obsessed with new tech, from my matches against chess supercomputers to lecturing about how AI will become augmented intelligence by making us smarter. Exploration has been one of my core values my whole life, even before chess. From tracing the paths of the great explorers on a globe with my father to taking on new challenges in my personal and professional lives, exploring is learning. Exploring means taking the road less traveled, often bumpy and lacking proper signage. It changes the way we think and, if we share our explorations, also changes the world around us.

So I was an eager audience when I met Marco Streng in spring 2019, recognizing him as a fellow explorer. I’m also a natural skeptic, however, so his passion for the subject of cryptocurrency wasn’t enough to convince me. It was his desire to look beyond the hype of the moment, all the speculation and the myths, to present coherent plans and prospects for internet money in the near and distant future.

This wasn’t only my habit of always looking a dozen moves ahead. My motto has always been to think big and be optimistic—but always have a plan. The authors of this book take context and planning seriously, realizing that this foundation is even more important than cool tech and social buzz when the goal is to change the world. And what could be a bigger change than reshaping the entire global economic relationship with money, from megabanks to food cart vendors, from dissidents to presidents?

I spend much of my time today thinking and writing about the intersection of rights and technology. Free speech in the internet age, for example, along with data ownership, privacy, and cybersecurity. In every case, tech has created endless possibilities, including new threats and exploits, just like nearly every new technology throughout history.

Cryptocurrency is no exception, so it’s critical to have a broader understanding of what it is and what it is not—and what it will one day be. Usually we speak of the past with certainty, the present with confidence, and the future with doubt. With bitcoin it is quite different. Its origin was unspectacular and its creator is still mysterious. Its present is ferociously debated, with extremes of curse and blessing. This is a status reserved only for the most powerful influences—again I refer to the printing press and the internet. As I often point out about artificial intelligence, our tech is agnostic, neither good nor evil. It’s how we use it.

But bitcoin’s future, there I am convinced. It IS the future, one where we will look back at our current bills, coins, and central banking standards the way we look back at those seashells today. I’m not sure I’ll live to see it, although I hope I will, because it will indicate that so many other positive transformations in personal freedom and societal change have come to pass. Cryptocurrency isn’t only on the cutting edge of technology, but also of human rights and the relationships between government, private enterprise, and individuals. As such, its success is a bellwether for human progress.

My gratitude to the authors for illuminating my path on this bumpy and exciting road, and I’m sure you will enjoy the ride as well. Just turn the page.

Garry Kasparov

Chairman, Human Rights Foundation

Chairman, Renew Democracy Initiative

13th World Chess Champion

New York City

Introduction

The origin of this book stems from our individual stories of how we first encountered bitcoin. We would have almost certainly never met each other without bitcoin, and none of us could have imagined how life-changing bitcoin would be for us. Between 2011 and 2013, we all separately and in rather different ways were introduced to, learned about, and became involved with this cryptocurrency. Marco Krohn’s summary of his earliest experiences with bitcoin moves from initial skepticism to a changed perspective on economics, the nature of money, and tremendous business opportunities.

Marco first learned about virtual currency one afternoon in the summer of 2011 from what he was expecting to be the least interesting article in a computer magazine. That day, he read that a mysterious, anonymous figure had invented internet money and that anyone with adequate computer skills could generate more. He had a PhD in theoretical physics, a job in the banking industry, and an opinion: The idea was crazy. It couldn’t work.

This was, he remembered the next day, the same opinion he’d had when he first heard about Wikipedia. Somewhat humbled by the recollection, he gave bitcoin a deeper look, and fell right down the rabbit hole.¹ The more he understood, the more intrigued he became. The core principles, while not immediately obvious, were fundamentally solid, and the implications profound. The idea was crazy—like vaccination and heliocentricity had been. Eleven years and the founding of one of the world’s largest bitcoin mining companies later, he is even more convinced that this new form of money will be as significant as the microprocessor to individual, commercial, and world economies.

He gave up his banking job and, with a few friends, soon had a server farm set up and running in Bosnia-Herzegovina. A single cavernous room full of graphic cards and computers with constellations of blinking lights, it looked (and sounded) like a spaceship—and friends reacted to it in much the same way. Over and over, Marco and his partners found themselves explaining that their futuristic, noisy warehouse was printing money. And almost every time, people wanted in.

In the beginning the bitcoin community was small, full of people who had similar experiences and stories about how they discovered bitcoin. Anthony Jefferies, Marco Streng, Zoran Balkic, and Marco Krohn met in these early days, and were thrilled about bitcoin’s potentially wide-reaching implications.

That desire, they came to see, went well beyond their extended circle. A keen and growing population was interested in bitcoin. People had a tantalizing sense of fortunes being made on just the other side of some obscure information barrier and were frustrated that they didn’t understand what it did or how to participate.

In the same way that the power of personal computing needed a graphic interface to make it accessible to laypeople, bitcoin (or more generally cryptocurrency) needs an intermediary. Here, the necessary layer between humans and technology is informational rather than visual. People need a conceptual handhold on what cryptocurrency is and how it operates before they can interact with it effectively. However, unlike computers, which few people had experience with even fifty years ago, money is a tool we are confident everyone reading already uses regularly. Unfortunately, familiarity isn’t the same as understanding. In fact, it can get in the way.

Money is an incredibly useful abstraction that has evolved with human culture from shells on beaches to chips on cards, with each iteration improving if not perfecting it. Cryptocurrency exacts an intellectual and conceptual toll, asking an ante of intelligence and imagination of its participants.

If you ask the average person what money is, many will say it’s the bills in their wallets. When we first heard about bitcoin, our level of understanding wasn’t much more sophisticated, although we have degrees in mathematics or engineering, or worked in a bank!! We could understand and marvel at the math and coding behind bitcoin, but not until we learned more about the history, functions, and properties of money did we fully appreciate the true genius of bitcoin or recognize how profound and far-reaching its consequences could be.

Toward a Deeper Understanding

Bitcoin doesn’t have to be arcane, but books on the subject tend toward either the simplistic or the extremely technical. While there’s a lot of good information online, it can be difficult to find both a high-level overview and a sufficient level of detail combined in the same place. In 2013, when we realized bitcoin’s mathematical and conceptual complexities separated our friends and too many other interested non-experts from the chance to invest in (and profit from) bitcoin mining, we founded Genesis Mining to bridge that gap. This book is an extension of that bridge.

Through this book, we hope to share our excitement, to provide a direct path to a deeper level of understanding—skirting the most technically complex aspects of bitcoin without oversimplifying more than is necessary. This is neither an Idiot’s Guide nor a university-level text on cryptocurrencies and blockchains. Rather, it’s a comprehensive introduction for interested, intelligent laypeople who want to understand how this new internet money is used and made, and perhaps to make some of it for themselves.

To give readers a similar grounding, Part One of Decrypting Money provides an exploration of money, beginning, in Chapter 1, with one of its earliest forms—the cowry shell—and continuing through the rise of government-issued paper currency. This is not a comprehensive history, but a historically ordered representative sample of currencies chosen, in part, for their ability to illustrate those functions and traits of money that are the focus of Chapter 2.

Chapter 3 covers the evolution of digital currency, evaluates it by the functions and traits detailed in the previous chapter, and compares it with the example historical currencies from the first chapter. This will establish that (non-physical) digital money can have the traits and properties that in principle allow it to be used as (a digital form of) money. Part One concludes with an exploration of problems inherent to all forms of money and an overview of how several early digital currencies attempted to address some of these.

Part Two focuses on bitcoin, the original cryptocurrency. Chapter 4 begins with the mystery of Satoshi Nakamoto (the alias of the unknown person or people who invented bitcoin), his agenda, and his genius. It covers bitcoin’s introduction and early history, from the initial white paper through the famous bitcoin pizza, which is considered to be the most expensive pizza in the history of humankind.² In Chapter 5, we analyze bitcoin by the functions and traits of money that have been established. Finally, we compare it with the predominant money forms of our time, gold and fiat, and discuss its relative strengths and weaknesses.

Chapter 6 is an introduction to bitcoin fundamentals, introducing and explaining concepts like addresses, public-private keys, ledgers, wallets, exchanges, nodes, and mining. This chapter provides succinct explanations of the two primary ways people can start using bitcoin. This overview of bitcoin wallets, exchanges, ATMs, and mining provides high-level descriptions to help readers orient and protect themselves in the bitcoin landscape.

Part Three digs deeper into how bitcoin works. Chapter 7 provides a more in-depth, technical discussion of the cryptographic functions on which bitcoin depends. Chapter 8 focuses on how transactions are authenticated and new bitcoins are created, as well as explaining the blockchain: what it is, how it operates, and what both protects it and ensures its continuation. Part Three ends with Chapter 8’s description of the key process by which bitcoin is created: mining.

Both Philosophy and Currency

Bitcoin is more than a currency. It began as an almost philosophical conversation on a cypherpunk mailing list about what a better form of money would look like, and its origin shaped both it and its initial audience.³ That early demographic continues to comprise a significant portion of the people (and particularly the people most heavily) involved in bitcoin. This cohort is the cypherpunks. They come to bitcoin from an interest in cryptography and place a high premium on protecting individual privacy.

Privacy is necessary for an open society in the electronic age. Privacy is not secrecy. A private matter is something one doesn’t want the whole world to know, but a secret matter is something one doesn’t want anybody to know. Privacy is the power to selectively reveal oneself to the world.⁴

Cypherpunks are attracted by both the underlying philosophy of bitcoin and a method of transferring value that does not require them to reveal their identities. These people tend to be antiauthoritarian and distrustful of the state and traditional forms of government. For them, bitcoin is an ideology almost as much as it is a currency. It’s certainly a community.

The second demographic to enter the bitcoin community comprises what we think of as gold bugs and libertarians.⁵ These are people who believe that scarcity and value are inextricably linked. They have an inherent belief in bitcoin because it is (and will always be) scarce, and a deep distrust of fiat money because it is neither scarce nor backed by anything that is. This group shares a distrust of the state with the cypherpunks but tends to be much more heavily invested in gold than their counterparts and less ideologically driven. For this group, bitcoin is a digital form of gold, and they buy it as a way of diversifying their precious metal holdings.

Another group, the speculators, are attracted by bitcoin’s price history—from a percentage of a cent to thousands of dollars per bitcoin—and are hoping to get in on a rising tide and make a great deal of money quickly.

Figure 0.2: Bitcoin supply curve

While we have striven for objectivity in this book and encourage readers to seek information about bitcoin from a variety of other sources, we felt a responsibility to provide context about the different perspectives and biases that predominate in the bitcoin culture and to be explicit about where we position ourselves among them.

This brief demographic survey also helps explain some of the movement in the bitcoin market. Price spikes tend to attract an influx of new speculator market participants trying to exploit the rapid change in the price to make money very quickly.

The volatility of bitcoin is one of both its attractions and its risks. We can’t predict the future, and that’s not the purpose of this book. Rather, its goal is to communicate the fundamental principles of bitcoin and other cryptocurrencies, so that you are able to assess these important emerging technologies on your own.

About Us

This book is a collaboration. All of us have worked at the forefront of cryptocurrency and blockchain technologies since their earliest days and have founded and run companies based in that dynamic environment. But we each came to it from different backgrounds and with different strengths:

Marco Krohn’s knowledge about blockchain technology and cryptocurrencies benefits from his advanced studies in physics, mathematics, and economics, as well as over a decade of experience working in finance and investment banking. When he’s not working, Marco enjoys reading about new technologies. At heart, he is a tech junkie with an appreciation for clever, simple solutions. Marco especially enjoys learning of advancements in applied sciences that are both elegant and profound in their potential to radically improve the way people live their lives. Marco is from northern Germany and holds a PhD in theoretical physics.

With degrees in mathematics and engineering, as well as a PhD in computational fluid dynamics, Anthony Jefferies had already encountered some of