Understanding Bitcoin, How to Mine Bitcoin, and The Internal Workings Of Bitcoin and Explaining the Bitcoin Market

 What is bitcoin?

First, a caveat. I am aware that the name Nakamoto is pseudonymous, and, to the best of my knowledge, the author of the original paper remains unknown.

Next, a brief discuss on the relation between rarity, durability, beauty, and value.

Technically, we could use anything as a medium of exchange (money), we could use clams or daisies if we wanted; all we would have to do is agree on a value-per-clam, and hire someone (the state) to enforce, support, or guarantee that agreement, vis-a-vis Social Contract theory. But clams tend to decay and stink; daisies tend to disappear. We will want something more durable than clams or daisies, and for aesthetic or psychological reasons, we tend to use things that are (perceived as) rare and/or beautiful. For example, gold or diamonds (although the apparent rarity of diamonds is actually artificial).

So, if M is a candidate for medium-of-exchange, then M needs to meet 4 minimal conditions:

• 1. We need to agree on the nature and value of M.
• 2. We need to be able to enforce, support, or guarantee that agreement (issues of trust)
• 3. M needs to be reasonably durable over time.
• 4. M will (preferably but not necessarily) be rare and/or beautiful.

With the invention of modern paper money, the beauty condition seems to have been waived, but not entirely. If we actually examine a dollar bill or a physically real coin, we’ll notice that a good bit of artistic effort has been invested in it (hence, numismatists). Beauty is a matter of taste; gustubis non disputandum.

Having established this much, the relevance of which will become evident, what, exactly, is “bitcoin”?

A bitcoin is a large hash, or set, of randomly selected numbers. No two hashes (or sets) can be identical, for reasons to be discussed later. In the early days of the bitcoin market, hashes may have been smaller or simpler, but now they contain billions if not trillions of random numbers. The uniqueness of each hash (or set) has to be verifiable for reasons which will shortly become evident. (I hate “hash” as it reminds me of what I had for dinner last night, and will therefore use “set,” but only in the loose sense of “a collection of stuff”; not in the mathematical sense of a well-ordered set.)

In effect, therefore, a bitcoin is an incredibly large, randomly selected set of (electronic hexadecimal) numbers. These incredibly large sets of random numbers are – in the bitcoin market – our currency. So how can a set of digital numbers meet the 4 conditions above and work as a currency?

1. Accepting a gigantic set of random numbers as currency is an arbitrary decision, like deciding to accept daisies or clams or pieces of paper. We need to agree on the nature and value of bitcoin, and, at least traditionally, we need an overseeing authority to enforce that agreement, i.e., to assure our trust.

2. Nakamoto thinks cryptocurrency requires no regulation because it renders the “trust” requirement entirely immaterial. In an unregulated market (and cryptocurrencies are typically unregulated), the market itself determines the value of bitcoin.

Cryptocurrencies are in general built on a strongly laissez faire foundation because the algorithmic nature of the currency seems to render it immune to counterfeiting or other forms of manipulation, but I will have more to say about this later.

3. Bitcoin is reasonably durable over time – or at least as durable as digital technology in general – because each bitcoin (as we shall see below) contains not only its own history, but the entire history of the whole bitcoin economy. Let that sink in a minute. Imagine if every dollar bill had written on it not only the entire history of that bill – each time it changed hands – but the entire history of every time any dollar changed hands anywhere in the entire world. It boggles the mind…, until we factor in computing technology.

4. Bitcoin should be rare or beautiful. The rarity of bitcoin is guaranteed by the verifiable mathematical uniqueness of each bitcoin. There is one and only one of each coin, and you can’t get much rarer than that. The beauty is, again, a matter of taste. There is a certain kind of mind for whom a gigantic, absolutely unique collection of random numbers is indeed a thing of beauty. Again, gustubis non disputandum.

The above explanation should (I hope) clarify what bitcoin is and how it can function as a currency. The next natural question would be, “Ok, so how does a person earn or acquire bitcoin?” One way would be to pay (exchange) dollars for them. It’s the people who acquire bitcoin in this way who freak out whenever the market dips or slumps. There is, however, also a smarter, but harder, way to acquire bitcoin: Become the mint. Or, to use the term of art, “mine” for them.

To be clear, this is NOT an endorsement of bitcoin in any way, as an investment or as a medium of exchange; the intention here is merely to clarify what bitcoin (or cryptocurrency in general) is, and how it works.

II. How does one mine for bitcoin?

To enter the Bitcoin-market one must first of all possess at least one Bitcoin (or a fraction of a Bitcoin), so the primary question is, how does one acquire Bitcoin? How does an individual mint or mine for bitcoin, and why doesn’t this simply reduce to a matter of creating value (money) from thin air, like a counterfeiter?

The first and most obvious way to acquire Bitcoin is to purchase (or exchange) Bitcoin for cash. The problem here is that such a purchase is extremely unsafe because the Bitcoin market (and block-chain currency markets in general) are wildly volatile. That is to say, the exchange rate for Bitcoin might be $1,000 one week, $5,000 the next, and $5 the week after that. If you purchase any Bitcoin (or fraction thereof) for cash, then you should expect to develop a severe bipolar condition rather quickly. Each time the exchange rate rises you will be elated, and each time it falls you will be devastated. That kind of emotional roller-coaster is, in my opinion, unhealthy. However, there is another, more-or-less fail-safe way to acquire Bitcoin.

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The more-or-less safe way to enter the Bitcoin market is to mint them – or, to use the correct jargon, to “mine” for them.

Let me begin by reminding the reader what a Bitcoin is: A bitcoin is a large hash, or set, of randomly selected numbers. No two hashes (or sets) can be identical. In the early days of the bitcoin market, sets may have been smaller or simpler, but now they contain billions if not trillions of randomly selected numbers. The uniqueness of each set has to be computationally verified. In effect, a bitcoin is an incredibly large, randomly selected set of numbers. A set. Of numbers. These incredibly large sets of random numbers are – in the bitcoin market – currency.

So how does one mine for – create or mint – a Bitcoin? The first point to note is that mining Bitcoin requires a dedicated computer. That is to say, the “mining device” (computer) cannot be used for any other purposes besides Bitcoin mining; you cannot use it for, say, logging into Facebook, playing games, or word-processing a document. Why is this? The reason is that Bitcoin mining is such a gigantic task that it will require 100% of the computer’s resources, and the mining device will be running 24/7/365; that is to say, the mining device will be running full-throttle, using 100% of the available resources, 24 hours per day, 7 days a week, 365 days a year. The computer is never shut off except in cases of power failure, disk crash, or – I assume – routine computer maintenance.

Dedicated Bitcoin mining computers do exist; they are designed specifically for the purpose of data mining, and they vary in price from several hundred to several thousand to several hundred thousand dollars. The memory, processing speed, and disk space on the mining devices are extremely important, precisely because of the magnitude of the task. We will see soon why.

The software requirements for Bitcoin mining are unknown to me and are not mentioned by Nakamoto; however, I assume this question could be answered by any seller of data mining computers.

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It is impossible to say exactly how long it will take to generate a useful Bitcoin because the necessary duration of mining time lengthens progressively each day; since more Bitcoins are generated throughout the world each day, the greater the complexity of the mining task. Why is this? Here we get into the really interesting part:

III. The internal workings of Bitcoin.

i. Proof-of-Work

The proof-of-work [PW] is the original set (hash) of random numbers generated in the initial mining process, the uniqueness of which must be computationally verifiable. In each market transaction, the PW must be transferred from the buyer of goods or services to the seller, a process during which the seller (or recipient of the Bitcoin in this transaction) algorithmically checks the PW for authenticity; i.e., the set is checked to make certain that it is random and unique. (Exactly how this is accomplished is a technical question beyond my scope.) As if this were not enough, the recipient of the Bitcoin must also verify the entire history of this particular Bitcoin. But how?

ii. Timestamp

With each transaction, all information concerning that transaction is embedded in the Bitcoin and now becomes part of the Bitcoin itself. This embedded information includes a timestamp (date, time and character of the transaction), as well as the “identities” of buyer and seller. Although the “identities” of each buyer and seller are built into the Bitcoin with each transaction, there is minimal threat to privacy because these “identities” would be multiply encoded; however, in the extremely unlikely event of fraud, the encoded identity could be traced.

In effect, therefore, each Bitcoin has its history built into it. To imagine this, consider a cash economy in which the entire history of each bill (i.e., every transaction without exception), from the moment it was minted until its ultimate destruction, was written onto the bill itself. It is not difficult to see how the history of transactions would very quickly become larger than the bill, so a bill would have to grow in spatial dimensions in order to contain its own history. In the actual world of paper or coin money this is, of course, impossible; but in the cyber world of Bitcoin, it is quite possible. But, that’s not the end of it.

iii. Network

Quoting Nakamoto here: “New transactions are broadcast to all nodes” [p. 4]. Or again, “When a node finds a PW, it broadcasts the block to all nodes” [p. 4]. What exactly does this mean?

In effect, Nakamoto is saying that each Bitcoin includes not only its own history, it also includes the entire history of every Bitcoin – and hence every transaction – in the Bitcoin economy. Suddenly the algorithmic task of a Bitcoin transaction has become more complex by a factor equal to the number of transactions in the Bitcoin market. This claim is somewhat mind-boggling, so let me return to my cash analogy. In order to appreciate what Nakamoto is saying, imagine a dollar bill on which is recorded not only the entire history of that particular bill, but also the entire history of every bill in global circulation. Not only would the bill be instantly filled with information, but it would have to continue growing (in spatial dimensions) indefinitely. Again, this kind of record would be impossible in the actual world of paper or coin money, but it is quite possible in the cyber-world of Bitcoin.

But even in cyberspace this is a rather daunting task, and so Nakamoto includes in his original paper sections entitled “Reclaiming Disk Space” and “Simplified Payment Verification.” These sections of the paper are highly technical and I will delve no further into them, except to point out that by any measure, the mining and exchanging of Bitcoin is a process the complexity of which grows at an exponential rate [Nakamoto, p. 3], so it becomes more and more obvious how important computer processing power is in the Bitcoin market.

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IV. Is it worthwhile?

Bitcoin mining requires a very powerful dedicated computer and an indefinite amount of time. As of the original date of this microessay, I was informed that the required mining time is not unreasonably huge, about 60 days by some estimates. However, it is possible to imagine a time in the future where entire banks of quantum supercomputers are dedicated to mining Bitcoin in a process that takes decades to produce a single Bitcoin.

Nakamoto claims that Bitcoin eliminates the need for “trust” in a free-market economy. This claim amounts to a prediction about the nature of future computing technology. I would agree that Bitcoin eliminates the need for trust or regulation of the economy in the foreseeable future, but, at the same time, I would not be surprised to see the invention of some hyper-fast quantum computer which will require “trust” or “state regulation” exactly as we see it in more mundane forms of currency. I would not consider Bitcoin a safe investment for the long term, although for the short term, it may be the quickest way to build wealth – bearing in mind that this notion of “quick” is going to become longer and longer with the passage of time.

Works cited:

“Bitcoin: A Peer-to-Peer Electronic Cash System” by Satoshi Nakamoto [available on-line]

James J. Pearce

NB: “gustubis non disputadum” – an old Latin proverb and means some like this, some like that, you can’t argue about the difference in peoples’s tastes.  More literally, “There’s no disputing taste.”

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