Explain Bitcoin in non-financial terms

Factual Questions
21

The terminology came from the idea of olde tyme gold miners in the days when gold itself was used as currency.

e.g. Get a shovel, go dig a bunch of dirt, find a gold nugget or two and you’ve just created new money which you own outright & can now spend to buy goodies from the local farmer.

The complex puzzle is one which produces a cryptographically valid bitcoin. Other folks don’t pay the miner in bitcoins to go dig; they merely confirm that the fresh data he generated is really a bitcoin, not just digital lead. And they verify the bitcoin by accepting it in payment.

Sorta like the olde tyme miner taking his new nugget to the farmer and saying “I’d like to buy a cow; I’ll pay with this gold nugget”. The farmer wants to satisfy himself the nugget is the right weight, is unadulterated, is gold not pyrite, etc.

The good news is the verification calculation is easy, so any farmer can reliably serve the same function as the olde tyme assay office did: ensuring a nugget is really what it purports to be.
One of the other design shortcomings with bitcoin is over time the miners have gotten fancier mining equipment and can now mine up new coins more rapidly than the designers expected. Not too rapidly, but enough to put some strain on the overall monetary system. Imagine how differently the 1849 California gold rush would have gone if a couple months later somebody showed up with a modern mine’s worth of modern strip mining & gold refining equipment. All those sourdoughs with hand-held pans & sluices would have been blown out of the market overnight.

22

One way to think about Bitcoin is that it’s essentially a big accounting ledger.

In a traditional accounting ledger, there’s one entity who has control over it, so they know that it’s valid and correct because they’re the only one adding to it. If I want to transfer money from my bank account to yours, then I tell my bank to do so, they verify that I’m who I say I am and have the ability to transfer that money, then they make the change in their ledger, and now you have the money.

Essentially, all the math and cryptography of Bitcoin are there to move from the case of “one person controls the accounting ledger” to “anyone can add to the accounting ledger, but they have to do so in very specific ways.” If there were a free for all in adding to the accounting ledger, you’d never have any idea who owned what. But if you restrict additions using careful math, you can make the ledger open and public while still keeping individual bad actors from screwing it up (bad actors who collude can still potentially screw things up in a number of ways).

The process of Mining is essentially adding a block of new entries to the ledger. So, a mined block will contain a bunch of transactions like: “Account A sent 2.1 BTC to Account B”. “Account Q sent 0.0002 BTC to account R”.

Each of those transactions contains a mathematical proof that the person who controlled the originating account approved it. It’s a proof that anyone can verify, but that no one can fake (the power of cryptography).

As part of the Bitcoin protocol, everyone agrees that if you’re adding a block of transactions, you’re allowed to insert one transaction to yourself, for a specified amount of BTC (currently 25). So, if the miner’s account is account M, then the first transaction in his block is going to say “Account MagicBitcoinSource sent 25 BTC to Account M”. That’s where the “reward” from mining comes from, and it’s how Bitcoin are created.

The complex puzzle involved in mining is there so that you can’t just add blocks over and over and constantly give yourself 25 BTC. Everyone is racing to find a solution to it, and the difficulty of doing so is adjusted so that it takes on average 10 minutes to find one.

23

Thanks for the explanation, walrus. So is the following scenario correct?

  1. A has a bc account. It’s got 1000 bitcoins in it. He wants to add another 100 to it. The act of doing so opens A’s account and makes it potentially vulnerable, but the BC authors came up with an encryption that prevents any outside interference.

  2. M is a miner. He has some kind of software that alerts him whenever anybody makes a bc transaction. His bots access the account and verify that the transaction is kosher. He’s a third-party service that acts as protection. Since Bitcoin isn’t a centralized bank, it can’t offer the same type of protection. Do miners run into each other frequently?

  3. M saves the data transaction info as an invoice and pays himself a reward from a Magic Bank. Does the Magic Bank actually have money, or does the 25 bc payment come out of thin air?

24

The bitcoins that a miner gains come out of thin air. They’re completely new bitcoins, and in fact that’s how every single bitcoin in circulation originated.

25

  1. This is completely wrong. There is minimal risk to keeping bitcoins in a wallet that is also used for mining or transactions (though most people will keep their botcoins airgapped for extra security).

  2. This is basically correct except for the last line. I’m sure multiple miners verify the same transaction, though that’s not in any way a problem.

  3. The bitcoins come out of thin air. He also can’t pay himself a reward unless he solves the puzzles before anyone else, so mostly he’s just verifying transactions and hoping for a payday.

26

No. The risk to an account is generally if someone steals or guesses your private key (basically a password).

Transferring money to an account is an action that anyone can do. It doesn’t even require that the owner of the account knows or approves. Transferring money out of an account requires proving to the network (which is composed of miners) that you actually own the account. That’s where the math comes in.

What people are talking about above is that using an account more than once can put you at risk of being identifiable. People can look at patterns of usage and figure out that Joe Q. Dimpleblat is the owner of Account A. There are a variety of reasons you might not want to be identifiable. Some of them involve doing things with Bitcoin that you don’t want others to know about. But, since Bitcoin is kind of like cash, you don’t really want the whole world to know how much you have. When Newsweek (mis?)identified someone as possibly being the creator of Bitcoin, they were painting a big target on his head: “Hey, this guy is worth hundreds of millions and you don’t even need a forklift to carry it away”.

To protect against being identified, it’s suggested that you never reuse an account number (this is easy to do in Bitcoin. Not a hassle like it would be in traditional banking).

Sort of. Bitcoin is just an idea about how to keep track of a distributed ledger and a collection of people running the software to do so. Miners aren’t really protection/security in a traditional sense. Think of them as independent contractors running the accounting system of the Bitcoin system. They’re all competing with each other to write down the next block of transactions (because they get a commission), and they keep each other honest because they can all check each others’ work (and, because the ledger is public, anyone else outside the system can always go back and check everyone’s work).

Thin air. Everyone using Bitcoin agrees that the place that new Bitcoin comes from is that every 10 minutes or so, someone manages to write a new page to the public ledger, and they get to award themselves with a pre-determined amount.

The very first page of the ledger ever (called the “Genesis Block”) just consists of a single transaction: “MagicBitcoinSource sends 50 BTC to Account A” (the reward used to be 50BTC).

27

Not as easy as people think. Suppose I’ve just earned $50 worth of bitcoins by selling something online. I create a new wallet, the buyer transfers the bitcoins from his wallet to my brand-new wallet, and then the seller discards his old wallet, never to use it again. So far, so good. I’m now the owner of a wallet containing $50 worth of bitcoins.

Well, naturally, like with any money, I want to spend it. Fortunately for me, my local sandwich shop accepts bitcoins, and will sell a sandwich for $5 or the equivalent. So every weekday for two weeks, I go in and buy a $5 sandwich for lunch.

But in order to do that, I had to re-use the same wallet ten times, because the wallet contains $50, and I’m only spending $5 per transaction. If I discard the wallet after the first transaction, then I’m throwing away 90% of my money.

Alternately, of course, I could pay the sandwich shop the full $50, and they could give me $45 worth of bitcoins in change (which I put into an entirely new wallet). But now that depends on the sandwich shop either having a wallet already that contained exactly $45 (or $40, or $35, and so on, on subsequent days), or on re-using one of their wallets to make the change from.

Now, maybe a sandwich shop doesn’t care about re-using their wallets: They’ve got nothing to hide. But the kinds of transactions that people do want to hide, usually both sides want to hide. How do you use bitcoins in fungible amounts to make such transactions?

28

This is the part that has me mystified. How can something appear from nothing? Who or what backs up the 25 btc payment?

29

What backs it up is nothing more, or less, than the fact that people recognise its existence and are willing to use it in trade. That, by the way, is the same as all money. There’s no fundamental difference between someone creating a Bitcoin out of nowhere and the Government printing more money out of nowhere.

Where it gets more interesting is how well Bitcoin can function as a store of wealth. With government-backed currencies, you can be reasonably sure that your Dollars or Euros or whatever will be usable for the foreseeable future, and so you’ll be willing to keep them rather than get tangible items immediately. This is rather different with an unbacked, immature currency that’s still developing.

30

Nothing!

There’s nothing at all that backs up the value of Bitcoin except the fact that people will accept them and trade things of real value for them, and everyone involved “agrees” that the current system (which creates 25BTC every 10 minutes) is how it works.

Note that all modern currencies work this way to some extent, except there’s generally a central bank that decides when to create money out of nothing, rather than an algorithm. Yes, those other currencies are “backed up” by their respective governments, but that doesn’t stop plenty of them from failing and ending up worth nothing.

31

OK, Bitcoin conversation rate is currently 1 Bitcoin = 397.66 US Dollars. Whaaaaat!?

So 25 btc is nearly $10K! And that comes out of nowhere every 10 minutes. I understand that governments can create money when they deem necessary, but this seems more like a gentlemen’s agreement. This is nearly one and a half million dollars coming out of the ether every day. How does that happen? No wonder Economics is aka “The Dismal Science.”

32

Almost all miners join mining pools. This means that when one person mines bitcoins, they are distributed to everyone in the pool on the basis of how much computational effort they put in. I’m not sure how the mechanics of this work (how they stop people from just stealing all the bitcoins if they mine them), but it works well and makes it less of a lottery.

It is a gentleman’s agreement, but changing it would require rewriting the source code, compiling it, and then installing it on a substantial portion of the machines on the network. If you only change 1 machine everyone would just ignore it, so you’d need to get many machines to change the agreement. Basically, it’s too much work to be done, though I’m sure people have tried.

33

Each bitcoin represents a valid solution to a mathematical problem. This particular problem has about 21 million valid solutions, each representing a bitcoin*. So to answer your question, all bit coins are already in existence. People just haven’t found them yet. It’s analogous to gold mining. When a miner finds a gold nugget, that gold doesn’t poof into existence. It has just gone from being unknown and hidden in the earth to being known. Similarly, the miner becomes owner of that gold by virtue of being hte first one to find it.

*It’s actually more complicated than this, but this is a good enough explanation.

34

The gross world product was about $74 trillion in 2013. How much money there is in the world is very difficult to give an answer for, as it depends on interpretation, but the M2 money supply for US dollars alone is around $10 trillion. Given those sorts of numbers, that isn’t really a lot.

35

It happens because people are willing to pay that much for Bitcoins, based on the assumption that they will be able to spend them for that much, including the fact that some of what they’re paying for is anonymity.

This is no different from how any other currency is created. Admittedly Bitcoins are closer to casino chips that dollars, but people still spend thousands on them, and casinos create them out of thin air (and plastic). People buy them because they have a reasonable expectation of use and return. Same with Bitcoins.

36

In fact, the LIMIT on production of bitcoins is one concern a lot of economists have about them. Currently, production is expected to substantially cease in 2040 as the 21 million limit is approached. It has been hotly contested as to whether bitcoins are “deflationary” or a “a new gold standard”, accusations made and denied in the economic press.

37

It still doesn’t make a lot of sense. If somebody’s looking for anonymity, why not stick with something like a suitcase full of currency or a gold ingot? They have a much higher anonymity than bitcoins have.

As for the backing of bitcoins, they seem like the ultimate fiat currency. They don’t have any inherent value like gold, they’re not backed by any government like the dollar is, they’re not backed by any corporation like a casino chip is. They don’t even have a physical existence.

On the surface, bitcoins seem like an experiment that some economists came up with to design a financial unit that had every possible flaw.

38

Well, it’s hard to spend an ingot of gold on the internet… But apart from that, your objections aren’t unreasonable. It really comes down to whether you are willing to trust the community that uses Bitcoins to honour them, and if you don’t, then don’t use them. The same argument applies to any currency, so the US Dollar is about as solid as you can get due to the stability of the US government and its legal obligation to pay its debts, but their are certain third world currencies that, despite nominal government backing, are probably less sound than Bitcoins.

It’s worth pointing out that, these days, most money doesn’t have a physical existence, but exists only as numbers in a computer system. That’s true of Dollars, and isn’t a problem for most people.

39

This is a hard concept for me to grasp, as a bitcoin doesn’t have physical properties like a gold nugget would have. A gold nugget has predetermined value. I don’t understand the predetermined value of a bitcoin. Walrus said a bc is “an idea about how to keep track of a distributed ledger.” It’s a means of keeping track of your money without a bank, correct? Seems a difficult way to avoid bank fees. :slight_smile:

40

What is the predetermined value of a US dollar?