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How Bitcoin Works Under the Hood — Transcript

by CuriousInventor · 4,409 words · 460 segments · language en · Watch on YouTube

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0:00the goal of this video is to explain how the Bitcoin works under the hood
0:03to give a clearer idea of what it really means to own, send,
0:06or mine bitcoins
0:08first a brief high-level overview of what Bitcoin is
0:12at its core Bitcoin is just a digital file that list accounts and money like a
0:15ledger
0:17a copy of this file is maintained on every computer in the Bitcoin network
0:21these numbers don't represent anything in the physical world, they only have
0:24value because people are willing to trade real goods and services for
0:27a higher number next to their account and believe others will do the same
0:31the numbers only have value because we believe they have value
0:34just like any other fiat currency
0:37to send money you broadcast to the network that the amount on your account
0:40should go down in the amount on a receiver's account up
0:43nodes or computers in the Bitcoin network apply that transaction to their copy of
0:47the ledger
0:48and then pass on the transaction to other nodes
0:51this with some math basic security is really all there is
0:54a system that lets a group of computers maintain a ledger
0:58While this may sound similar to the way a bank maintains a ledger
1:01the fact that the ledger is maintained by a Group rather than a single entity
1:04introduces a number of important differences
1:07for one, unlike a bank where you only know about your own transactions
1:11In Bitcoin
1:12everyone knows about everyone else's transactions. Also while you can trust
1:16your bank or you can at least sue it if something goes wrong
1:18in Bitcoin you're dealing with anonymous strangers so you shouldn't trust anyone.
1:22The Bitcoin system is amazingly designed so that no trust is needed
1:26special mathematical functions protect every aspect to the system
1:31the rest to this video will explain in detail how the Bitcoin allows such a group
1:34of strangers to manage each others' financial transactions
1:39At a basic level, for Alice to send money to Bob
1:41she simply broadcast a message with the accounts and the amount sent 5 Bitcoins
1:46from Alice to Bob.
1:46Every node that receives it will update their copy of the ledger
1:51and then pass along the transaction message. But how can nodes be sure that
1:54the request is authentic
1:56that only the rightful owner has sent a message. Bitcoin rules require a kind of
2:00password unlock unspent funds
2:02and this password is what's called a digital signature. Like a real
2:05handwritten signature
2:07it proves the authenticity of a message but it does so through a mathematical
2:09algorithm that prevents copying or forgery in the digital realm
2:14unlike a simple static password a completely different digital signature
2:18is required for every transaction
2:19keep in mind that in Bitcoin, you're dealing with complete strangers
2:22so you never want to reveal a password that could be copied and reused by
2:26someone else
2:27A digital signature works by utilizing two different but connected keys,
2:31a private key to create a signature and a public key that others can use to check it
2:35you can think of the private key as the true password and the signature as an
2:39intermediary that proves you have the password without requiring you to reveal
2:42it
2:43Public keys are actually the send to address in Bitcoin,
2:47so when you send someone money you're really sending it to their public key
2:51to spend money you must prove that you're the true owner of a public key
2:54address where money was sent
2:55and you do that by generating a digital signature from a transaction message
2:59and your private key
3:00other nodes in the network can use that signature in a different function to
3:04verify that it corresponds with your public key
3:06through the math behind the digital signature they're able to verify that
3:09the sender
3:10owned a private key without actually seeing the private key
3:13importantly because the signature depends on the message it will be
3:16different for every transaction
3:18and therefore can't be reused by someone for a different transaction
3:21this dependence on the message also means that no one can modify the message
3:25while passing it along the network
3:27as any changes to the message would invalidate the signature
3:30the math behind this is fairly complex and well I won't try to explain it fully
3:34now
3:34here are some topics you can google to get started. Elliptic Curve
3:38digital signature algorithm and mathematical trapdoor
3:42More at the end of the video
3:44so far we know that digital signatures are used to ensure a transaction is
3:48authorized
3:49but I've oversimplified how nodes in the network keep track of account balances
3:53in fact no records of account balances are kept at all
3:56if you don't keep track of how much money any given person has
3:59how do you know if they have enough to send to someone else? Instead of balances
4:03ownership the funds is verified through links to previous transactions
4:07here's how this works. To send five Bitcoins to Bob
4:10Alice must reference other transactions where she received five or more Bitcoins.
4:14these reference transactions are called Inputs. Other nodes verifying this
4:18transaction will check those inputs to make sure Alice was in fact a recipient
4:22and also that the inputs at up to five or more Bitcoins.
4:25Let's look at a real transaction to see this in practice
4:28this transaction references 6 inputs for a total of 139.6 Bitcoins
4:34In the output section notice that there are two lines
4:37the first one of these is actually going back to the sender as change for the
4:40transaction
4:42a simple fine rule states that each input must be used up completely in a
4:45transaction
4:46so if you're trying to send an amount that doesn't exactly match one of your
4:49inputs
4:50you need to send any remaining amount back to yourself. Through these reference
4:54input linkages
4:55ownership of Bitcoins is passed along in a kind of chain with the validity of
4:58each transaction is dependent on previous transactions
5:02but how can you trust this previous transactions? You can't and you should
5:05check their inputs, too.
5:06in fact when you first install Bitcoin wallet software, it downloads every
5:10transaction ever made
5:12and checks each one's validity all the way back to the very first transaction
5:15remember you're dealing with complete strangers so it's important to verify
5:19every transaction for yourself
5:21this process can take over 24 hours but it only needs to be done once
5:24once the transaction has been used once it is considered spent
5:28and cannot be used again. Otherwise someone could double spend an input by
5:32referencing that in multiple transactions
5:35When verifying a transaction, in addition to the other checks
5:38nodes also make sure the inputs haven't already been spent.
5:42To be explicit
5:42for each input notes check every other transaction ever made to make sure
5:46that input
5:46hasn't already been used before. While this may seem time-consuming
5:50as there are now over 20 million transactions, it's made fast with an
5:54index of unspent transactions
5:54So instead of a ledger of balances
5:58Bitcoin nodes keep track of a giant list of transactions. Owning bitcoins means
6:02that there are transactions in this list that point to your name
6:04and haven't been spent, or in other words, used as inputs in other transactions
6:09One interesting consequence of this ownership structure is that figuring out
6:12your own balance requires
6:13iterating through every transaction ever made and adding up all your unspent
6:17inputs. Another interesting note about transactions is that the system can
6:21support more complex ones then simply sending funds to one person.
6:25You may have noticed a cryptic looking line of text in the output shown
6:28previously
6:28it turns out that outputs are more like puzzles to be solved rather than simple
6:32to addresses.
6:33Rather than emailing, sending money in Bitcoin is more like putting money in a
6:37public locker
6:37and attaching a math puzzle that must be solved to open it. The puzzle is defined using
6:41a special scripting language
6:43and while it's typically designed so that only a single owner other public key
6:46can solve it,
6:47more complex conditions are possible. For instance, two out of three signatures could
6:51be required for an escrow based transaction.
6:54Another example is the very first Bitcoin transaction ever made
6:57which was a puzzle that anyone could solve.
7:00While most Bitcoin software hides the scripting layer for you, you're free to
7:03write your own software and conditions, although this can be risky
7:07Over 2600 Bitcoins were lost in one batch of transactions due to a malformed
7:11address.
7:13This highlights an important part of Bitcoin, as there's no bank or credit card
7:17company you can appeal to
7:18any user error mistakes can result in permanent loss of Bitcoins.
7:21And not just from your own account but from the Bitcoin economy overall.
7:26if you lose your private key any funds associated with the corresponding public
7:29key will be gone forever.
7:31Because people will likely lose private keys due to hard drive crashes and
7:35insufficient backups
7:36this means the Bitcoin currency will eventually be a deflationary one.
7:41Before explaining the final piece that secures Bitcoin, mining,
7:44I want to highlight a few points about anonymity in Bitcoin.
7:48If you access Bitcoin through a TOR network that hides your IP address
7:52you can use Bitcoin without ever revealing anything more than your public
7:55key
7:56And to avoid someone linking your transactions together, remember they're
7:59all publicly stored on every computer,
8:01you can generate a new public key for every incoming transaction.
8:05It is possible however to inadvertently link public keys together.
8:09In the transaction shown earlier, 6 input transactions were used as sources,
8:13and despite the fact that all those inputs were sent to different addresses
8:16they all became linked in that transaction
8:18the sender proved that he owned all those addresses by supplying the digital
8:22signature to unlock each one.
8:23Researchers have in fact use these links to study Bitcoin user behavior.
8:27You might think that generating a public key receiving address could potentially
8:30create a link to your true identity,
8:32but even this step is anonymous, and amazingly, can be done with no connection
8:36to the network.
8:37You simply click a button in your wallet software and it randomly generates a new
8:40private
8:41andn public key. Because there are so many different possible addresses,
8:45there's no reason to even check if someone else already has that key,
8:48Compare this to signing up for an email address, where almost everything you
8:51might try has been taken
8:53In fact, if you did get someone else's key, you would have access to all their
8:56money.
8:57This is the total number of possible Bitcoin addresses. These large numbers
9:01protect the Bitcoin system in several ways,
9:04so it's useful to try to appreciate just how big they are. Some estimates for the
9:08number of grains of sand in the entire world are
9:10around seven and a half million trillion
9:13now imagine that every grain of sand represented an entire other
9:16earth of additional grains you're still much smaller than the possible number of
9:20Bitcoin addresses.
9:22Let's recap the coin security so far. By verifying the digital signature
9:26we know that only the true owner could have created the transaction message,
9:30And to make sure the sender actually has money to spend, we also check each
9:33reference transaction,
9:34making sure it is unspent. But there's still one large security hole in the
9:38system that can make this
9:39unspent check unreliable, and this has to do with the order
9:43of transactions. Considering that transactions are passed node by node
9:46through the network
9:47there's no guarantee that the order in which you receive them represents the
9:50order in which they were created
9:52And you shouldn't trust a timestamp because someone could easily lie about the time
9:55a transaction was created.
9:57Therefore you have no way to tell whether one transaction came before
10:00another, and
10:01this opens up the potential for fraud. A malicious user,
10:04Alice, could send a transaction giving money to Bob wait for Bob to ship a
10:08product,
10:09and then send another transaction referencing that same input back to
10:12herself.
10:12Because of differences in propagation times, some nodes on the network would
10:16receive the second
10:17double spending transaction before the one to Bob, and when bob's transaction
10:21arrived
10:22they would consider invalid because it's trying to reuse an input.
10:25So by would be out both the shipped product and his money. Overall there would be
10:29disagreement across the network about whether Bob or Alice had the money
10:33because there's no way to prove which transaction came first. In light of this
10:37there needs to be a way for the entire network to agree about the order of
10:40transactions
10:41which is very much a daunting challenge in a decentralized system
10:44Bitcoin's solution is a clever way to both determine and safeguard the ordering through
10:48a kind of mathematical race
10:51The Bitcoin system orders transactions by placing them in groups called blocks
10:55and linking those blocks together in something called the Block Chain
10:58Note that this is different from the transaction chain we discussed earlier.
11:02The block chain is used to order transactions, whereas the transaction
11:06chain keeps track of how ownership changes.
11:08Each block has a reference to the previous block and this is what places
11:12one block after another in time.
11:14You can traverse the references backwards all the way to the very first
11:17group of transactions ever made.
11:18Transactions in the same block are considered to have happened at the same
11:22time,
11:22and transactions not yet in a block are called unconfirmed
11:26or unordered. Any node can collect a set up unconfirmed transactions into a block and
11:30broadcast it to the rest to the network as a suggestion for what the next block
11:33in a chain should be.
11:35Because multiple people could create blocks at the same time
11:38there could be several options to choose from, so how does the network decide
11:42which should be next?
11:43We can't rely on the order that blocks arrive because, as explained with transactions
11:47above,
11:47they may arrive in different orders at different points in the network.
11:50Part of the Bitcoin solution is that each block must contain the answer to
11:54a very special mathematical problem.
11:56Computers run the entire text of a block plus an additional random guess through
12:01something called a cryptographic hash
12:02until the output is below a certain value. A hash function creates a short
12:06digest from any arbitrary length of text.
12:08In our case the result is a 32 byte number. Here are some examples of the
12:12specific cash function Bitcoin uses,
12:15SHA256. Note how much the output changes in result of a single
12:20extra period at the end of the third example. The output is completely
12:23unpredictable.
12:24so the only way to find a particular output value is to make random guesses.
12:28It's very much like guessing the combination to a lock.
12:31You may get lucky on your first guess but on average it takes many guesses.
12:35In fact in Bitcoin, it would take a typical computer several years of
12:39guessing to solve a block.
12:40With every computer in the entire network or guessing numbers it takes
12:43about 10 minutes on average for someone to find a solution.
12:46The first person to solve a math problem broadcasts their block
12:50and gets to have their group of transactions accepted as the next in the
12:53chain.
12:53The randomness in the math problem effectively spreads out when people find
12:58a solution,
12:58making it unlikely that two people will solve it at the same time.
13:02Occasionally, however, more than one block will be solved at the same time,
13:06leading to several possible branches. In this case you simply build on top of the
13:10first one you received.
13:11Others may have received the blocks in a different order and will be building on
13:14the block they first received.
13:17The tie gets broken when someone solves the next block. The general rule is that
13:21you always immediately switch to the longest branch available.
13:23The math makes it rare for box to be solved at the same time, and even more
13:27rare for this to happen multiple times in a row.
13:29The end result is that the block chain quickly stabilizes,
13:33meaning that everyone is in agreement about the order of blocks a few back from the
13:36end of the chain.
13:39The fact that there's some ambiguity in the end of the chain has some important
13:42implications for transaction security.
13:44For instance, if your transaction finds itself in one of the shorter branches,
13:48it will lose its place in line within the block chain. Typically, this just means it
13:53will go back to the pool of unconfirmed transactions and be included in a later
13:56block.
13:57Unfortunately this potential for transactions to lose their place
14:00opens the door to the very double spend attack that was our original motivation
14:04for an ordering system.
14:06Let's look at how a double spend attack would work in the system described so
14:09far.
14:11A fraudster, Alice, sends money to Bob. Bob then waits for the transaction to get
14:15confirmed into the block chain,
14:17and then ships a product.
14:19Now because nodes always switch to a longer branch if Alice can generate a
14:22longer branch that replaces the transaction to Bob with one to someone
14:26else,
14:26his money will effectively get erased. Bob's transaction will initially get tossed
14:31back into the unconfirmed pool,
14:32but since Alice has replaced it with another transaction that uses its same
14:36input,
14:36notes will now consider Bob's transaction invalid because it's
14:39referencing an already spent
14:41input.
14:42So how does the ordering system prevent Alice from defrauding Bob?
14:46You might think that Alice could pre-compute a chain of blocks to spring on the
14:50network at just the right time,
14:51but the math puzzles in each block actually prevent this. We need to look a
14:55little deeper into the cryptographic hash explained earlier to fully
14:58understand why.
14:59As mentioned previously, solving a block involves trying to get the cryptographic
15:03hash of
15:04the block to be below a certain value, and you do that by trying different
15:07random numbers at the end of the block.
15:11Once solved, the hash output is like a fingerprint that uniquely identifies
15:14that block.
15:15If even a single character in the block is changed,
15:18the block's hash would be completely different, just like we saw before when
15:22an additional period was added.
15:26The hash output, or finger print, is actually what's used as the previous
15:29block reference.
15:30One result of this is that there's no way to switch out a block in the middle
15:34of the chain
15:35because the hash value for the new block would be different and the next box
15:38reference would no longer point to it.
15:40And subtly, but even more importantly, a block cannot be solved before the
15:44previous block is solved.
15:46The previous block reference is part of the text that goes through the hash
15:49function,
15:50so any changes to it would require resolving. Getting back to Alice,
15:55this is why she can't pre-compute a branch, she can only start solving blocks
15:59once the block she wants to build on is solved,
16:01and its hash value is known. She is therefore in a race with the rest of the
16:05network until bob ships the product, which is when she wants to present a
16:08longer branch.
16:11One last question is whether Alice might be able to outpace everyone if she had
16:14an extremely fast computer,
16:16or perhaps a roomful of computers. But even with thousands of computers
16:20she would be unlikely to win the race to solve a block because she isn't racing
16:24any ONE computer,
16:25but rather the entire network. You can think of it like a lottery.
16:28She can operate thousands of computers, or equivalently,
16:32buy thousands of lottery tickets, but even then, it's much more likely that someone
16:35else would win.
16:36She would need control of half the total computing power in the entire network to
16:41have a 50 percent chance of solving a block before someone else,
16:44and much more to have a high probability of winning several blocks in a row
16:47faster.
16:48So transactions in the block chain are protected by a mathematical race,
16:52one that pits an attacker against the entire rest to the network.
16:55A consequence of blocks building on top of each other is that transactions further
16:59back in the chain are more secure.
17:00An attacker would have to outpace the network for a longer amount of time to
17:04carry out a double spend attack.
17:05replacing a block further back in the chain. So the system is only vulnerable
17:10to a double spend attack near the end of the chain,
17:12which is why it's recommended to wait several blocks before considering
17:15received money final.
17:16One last comment on the block chain before explaining the final pieces of the
17:21Bitcoin system.
17:22Amazingly, nothing described so far requires any trust.
17:26When you receive information from strangers in the Bitcoin network,
17:29you can check for yourself that block solutions are correct. And because the
17:33math problems are so hard,
17:34you know that there's no way any attacker could have generated them on
17:37their own.
17:37The solutions are proof that the computing power of the entire network was
17:41brought to bear.
17:42Now that we've discussed how money is transferred through digital signatures
17:46and transaction chains,
17:47and how the order of those transactions is protected in the block chain,
17:51let's go over the final piece: where Bitcoins come from.
17:54To send money, you must reference a previous transaction where you were the
17:58recipient. But how to coins get into this
18:00ownership chain in the first place? As a way to slowly and randomly generate
18:05and distribute coins,
18:06a reward is given to whoever solves block. This is why solving blocks is called
18:10mining,
18:11although its real purpose is to verify transactions and safeguard the block
18:15chain.
18:15Every four years the block reward is cut in half so eventually no more coins will
18:19be released.
18:20About 21 million in total will be created. Bear in mind that you can send
18:24down to 1 100 millionth of a Bitcoin,
18:26so the total number available will likely not limit the currency's usability.
18:30once the block rewards cease, when incentive will miners have to process transactions?
18:35In addition to the block rewards, miners also get any transaction fees that can
18:39optionally be included with transactions.
18:41Right now miners will include transactions with no fees into blocks
18:45because their main incentive
18:46is the block reward, but in the future, transactions will likely be processed in
18:50order of the fees attached,
18:51and ones without fees will likely be ignored. Sending money in Bitcoin will
18:55probably not be free,
18:56but will hopefully still be cheaper than current credit card fees.
19:00As mentioned before, on average it would take several years for typical computer
19:04to solve a block,
19:05so an individual's chance of ever solving one before the rest to the network
19:09which, typically takes 10 minutes, is very low. to receive a steadier stream of
19:13income,
19:14many people join groups called mining pools that collectively work to solve
19:18blocks.
19:18and distribute rewards based on work contributed. These act somewhat like lottery
19:23pools among coworkers,
19:24except that some of these pools are quite large and comprise more than twenty
19:27percent above all the computers in the network.
19:29The fact that some of these pools are so large has some important implications
19:34about security.
19:35As mentioned before it's very unlikely for an attacker to solve several blocks
19:39in a row faster than the rest fo the network,
19:41but it is possible, and the probability increases as the attacker's processing
19:45power gains in proportion to the rest to the network.
19:48In fact, one of these mining pools, BTC guild, has solved six blocks in a row by
19:52itself,
19:53and has voluntarily limited its members to ward of distrust in the
19:56entire Bitcoin network.
19:57Even a substantial computing power, the further back in the block chain a
20:01transaction gets, the harder it would be for an
20:03attacker to change it. The current recommendation is to wait for transactions
20:07to make it into at least one block,
20:09or get one confirmation, before considering it final. And for larger
20:12transactions, wait for at least six blocks.
20:14In light of BTC guild's ability to solve six blocks in a row,
20:18you might want to wait even longer. By design,
20:21each block takes about 10 minutes to solve, so waiting for six blocks would
20:24take about an hour.
20:26Compared to the several seconds a credit card transaction takes, waiting this long
20:29for confirmations may seem burdensome,
20:32but keep in mind that credit card customers can claim a stolen card
20:35months later to have charges reversed from merchants (card chargebacks),
20:39so Bitcoin is actually much faster from a merchant's perspective.
20:42The particular choice of 10 minutes was somewhat arbitrary, but extremely short
20:46times could lead to instability,
20:48and longer ones would delay confirmations. As more computers join
20:51the network,
20:52and specialized hardware is designed specifically for mining,
20:55the block solution time would get very small. To compensate, every two weeks
20:59all the Bitcoin software recalibrates the difficulty of the math problem to
21:03target 10 minutes.
21:04For comparison, a similar digital currency called Litecoin has been able
21:08to operate with a two-and-a-half minute block time.
21:12In summary, Bitcoin is a mathematically protected digital currency that is
21:15maintained by a network of peers.
21:17Digital signatures authorize individual transactions,
21:21ownership is passed via transaction chains, and the ordering at those
21:24transactions is protected in the block chain.
21:26By requiring difficult math problems to be solved with each block,
21:30would-be attackers are pitted against the entire rest to the network in a
21:33computational race they're unlikely to win.
21:35Bitcoin promises many interesting ideas,
21:39such as insulation from government meddling, anonymity,
21:42and potentially lower transaction fees. It also has many challenges,
21:45as it is currently very difficult to exchange Bitcoins for other currencies,
21:49and has been cited as a haven for illegal activity and tax evasion,
21:53so governments might try to ban it. Also the mathematical race that protects the block
21:57chain uses a substantial amount of electricity.
21:59If you'd like to view a written version of this video
22:03you can find one on my personal blog: imponderablethings.com
22:06The blog also has some additional explanations of the math behind the
22:10digital signatures and cryptographic hashes that underlie the system.

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