Understanding Bitcoin and Cryptocurrencies

Introduction

Bitcoin: A fully digital currency with no central authority (e.g., government or banks).
Objective: Understand how Bitcoin works by creating a simplified version of it step-by-step.
Goal: Understand what it means to have a Bitcoin and grasp the technical details.
Context: Recent hype and investment in cryptocurrencies.

Communal Ledger: A record of payments amongst friends to avoid physical cash exchanges.
Example Transactions: Alice pays Bob $20; Bob pays Charlie $40.
Protocol: Public ledger, end of the month settlement, tracking who owes and receives money.

Problem: Trust issues, anyone can add fraudulent transactions (e.g., Bob adding "Alice pays Bob $100").

Solution: Digital signatures to verify transactions.
Concept: Using a public key-private key pair to prove transaction authenticity.
Private Key (SK): Known only to the owner.
Public Key (PK): Available to everyone to verify signatures.
Signature Details: Dependent on the message and private key; changes with message changes.
Verification Function: Confirms if a signature was made by the proper private key.

Preventing Duplicates: Add unique IDs to transactions to avoid reusing the same signature.

Limitations: Trusting people to settle up debts in cash.
Potential Solution: Prevent excessive spending by limiting how much more one can spend than received.
Ledger Dollars (LD): A separate system abstracted from physical cash, transferable in exchange for real money.

Decentralization: Everyone maintains a copy of the ledger.
Transaction Broadcasting: Transactions are broadcasted and recorded by everyone.
Challenge: Ensure all copies of the ledger remain identical and ordered correctly.
Bitcoin's Solution: Trust the ledger with the most computational work - requiring proof of work (PoW).

Hash Function (e.g., SHA256): Converts any message to a fixed-length, seemingly random string of bits.
Property: Slight change in input results in an unpredictable, entirely different output.
Reverse Computation: Infeasible without guessing and checking due to the complexity of reversing a hash.
Proof of Work: A special number that makes the hash have a prefix of zeros, indicating significant computation.

Blocks: Transactions grouped into blocks, each with its PoW.
Chain of Blocks: Each block contains the hash of the previous block, forming a chain (blockchain).
Validity: Only blocks with PoW are valid.

Miners: Individuals who create blocks using PoW and are rewarded with new currency (block reward).
Block Reward: New currency generated with each block, introducing new currency into the system.
Protocol: Trust and adopt the longest chain (most work) to ensure a cohesive system.

Fraudulent Block: If someone tries to fool the system, it requires immense computational resources.
Decentralized Consensus: The majority of the network's computing power ensures the longest chain remains trustworthy.

Difficulty Adjustment: Number of zeros required in PoW adjusted to maintain a 10-minute block interval.
Payment Confirmation: Wait several blocks to ensure a transaction is legitimate and part of the longest chain.
Maximum Supply: Capped at 21 million Bitcoin, with halving events reducing the block reward over time.
Transaction Fees: Encourage miners to include transactions.
Economic Impact: High transaction fees due to limited transaction capacity per block.

Understanding Fundamentals: Essential before investing or using cryptocurrencies.
Acknowledgement: Thanks to supporters and the importance of sharing helpful information.