Conversational Bitcoin: The Ebook

1. CONVERSATIONAL BITCOIN The Bitcoin basics you need to know Christopher Carfi Download this book for free at http://coindale.com/bitcoinbook Design by Michelle Senn

2. Conversational Bitcoin by Christopher Carfi is licensed under a Creative Commons Attribution-ShareAlike 4.0 International License. Download this book for free at http://coindale.com/bitcoinbook

3. Table of contents  What is Bitcoin? 04  Where can I spend bitcoins? 17  Why should I care about Bitcoin? 07  What else can Bitcoin be used for? 19  How do bitcoins get exchanged? 09  What does the government think about all this? 20  Are bitcoins money? 10  Where did Bitcoin come from? 21  Why should a business accept bitcoins? 12  What is Bitcoin mining? 23  Why should I personally use bitcoins? 15  What are the risks? Isn’t it a Ponzi scheme? 25  Isn’t Bitcoin just for drugs and porn? 16  Acknowledgements 27

4. What is Bitcoin? Bitcoin is a form of digital currency that has existed since insofar as the Bitcoin protocols are open standards that can 2009, and can be used to purchase goods and services at an be implemented by anyone. No organization “owns” Bitcoin, increasing number of locations worldwide (you can see some although there is a Bitcoin Foundation that is chartered of the merchants that accept bitcoins here). Bitcoins and with standardizing, protecting and promoting Bitcoin. the associated Bitcoin ecosystem have a number of different facets, all of which are important. The Bitcoin network performs a number of important tasks: trading digital assets (“bitcoins”) amongst the net- The Bitcoin ecosystem consists of a network of thousands of work members, confirming the validity of transactions that computers running the Bitcoin protocol that are connected have occurred on the network and collectively and predic- to the internet. The Bitcoin network is a true “peer-to-peer” tably managing the supply of bitcoins that are available to system, without a central set of servers; any computer run- be traded. Like the internet itself, the power of the Bitcoin ning Bitcoin software can connect (or disconnect) from network comes from the collective processing power of this network at will. This software is part of an open-source the thousands of individual machines connected to it. This project and anyone can inspect the code to understand its interplay between bitcoins (the medium of exchange) and inner workings. In some ways, it can be viewed in the same the Bitcoin ecosystem (the network and related its open- way one views the conventions that underpin internet email, source protocols) collectively provides a number of benefits: Download this book for free at http://coindale.com/bitcoinbook 4

5.  Bitcoins themselves can be used as a currency – one can  The Bitcoin network, at its core, contains a distributed buy goods or services using bitcoins if a merchant ledger of every Bitcoin transaction that has ever accepts them as a payment method. In this facet, Bitcoin taken place, and its protocols guard against “double is an alternative to Visa, MasterCard, American Express, spending” of bitcoins and other malicious activities. In this Discover, PayPal and cash. facet, the Bitcoin network itself can be used as a ledger that can illustrate ownership (and transfer of ownership)  One can perform instant, global transfers of bitcoins of digital assets. (For example, with a little bit of from one individual to another, with virtually no ingenuity, the Bitcoin network can act as an irrefutable transaction fees. In this facet, Bitcoin is an alternative timestamping service for all types of digital documents.) to international remittance services such as Western Union and MoneyGram.  Bitcoins themselves can, of course, also be used as a speculative commodity. In this facet, bitcoins have been  Since bitcoins are digital, fractions of a bitcoin can be called “digital gold” (as well as digital apples) and transferred in units as small as 0.00000001 bitcoin. In this can be traded on a number of international exchanges just facet, Bitcoin can act as a method for micropayments. like precious metals, pork bellies and frozen concentrated orange juice. Download this book for free at http://coindale.com/bitcoinbook 5

6. Download this book for free at http://coindale.com/bitcoinbook

7. Why should I care about Bitcoin? Above and beyond the hype in the news about the financial vely that it only takes 10% of a population to hold an unsha- impact and speculation around Bitcoin, the long-term rea- keable belief for that belief to then accelerate and become son to pay attention is that the Bitcoin network is, in some the dominant idea. If Bitcoin gains a 10% foothold in a geo- ways, a new layer of the internet. In the same way that the graphy, demographic, industry or application, then it is quite creation of the web browser in 1994 launched a new wave of likely the network effects will accelerate and drive Bitcoin to innovation that continues today, the development of the Bit- become a notable component of the way things get done for coin network creates a new set of possibilities for electronic that group. commerce and services. A few of these types of examples are included in the “what else can Bitcoin be used for” section The approach used for the Bitcoin network itself is an elegant of this ebook. solution to a class of difficult problems. As such, in addition to bitcoins themselves being used as currency, the most interes- More pragmatically, it is quite conceivable that Bitcoin will ting reason to care about Bitcoin is that we are just beginning be continue to grow until it hits a tipping point of adoption, to explore the types of solutions that can be built using the at which point it may accelerate to ubiquity in the same way Bitcoin network. As more entrepreneurs and investors begin the internet, smartphones and tablets have. A 2011 study by to explore the space, it is certain that interesting solutions to the Rensselaer Polytechnic Institute (RPI) showed conclusi- previously intractable problems will be created. Download this book for free at http://coindale.com/bitcoinbook 7

9. How do bitcoins get exchanged? To exchange bitcoins on the network, one needs to have a Bitcoin wallets are integrated with QR code scanners. Just bitcoin wallet. A Bitcoin wallet is a file that can live on your like email addresses, you can have as many Bitcoin addresses computer or smartphone, or it can be hosted on a trusted as you want, and a Bitcoin wallet can contain any number of service on the network. A wallet contains a record of credits addresses. To send bitcoins to someone, you instruct your and debits of bitcoins into and out of it. Sum up all those wallet to send bitcoins from one or more of your Bitcoin transactions and you can see how many bitcoins that wallet addresses to someone else’s Bitcoin address. The number of contains. bitcoins in your wallet is reduced by the number of bitcoins The credits and debits in a Bitcoin wallet are associated with you’ve sent, the number of bitcoins in the recipient’s wallet is one or more “addresses.” Bitcoin addresses can be thought of increased by that same number, and the network verifies the analogously to email addresses, and take the form of a long transaction to ensure that the sender doesn’t try to “double number such as 1Fm8XdPvGzKbfuHrBrsK8d7ZDLvCCM1WWc spend” those bitcoins. The transfer process occurs nearly (that’s the Bitcoin address of a Bitcoin wallet currently taking instantaneously, and the verification of the transaction by the donations for the Philippine Red Cross for typhoon relief, network takes place within minutes. and if you were to send bitcoins to that address, you’d be making a donation). Sometimes people choose to translate Perhaps most importantly, there is no middleman to the their Bitcoin addresses into QR codes in order to make it easier transaction. In this way, transferring bitcoins it like using cash, to use smartphones to send bitcoins, as many mobile-based in that it is a direct transaction between two parties. Download this book for free at http://coindale.com/bitcoinbook 9

10. Are bitcoins money? Over the centuries, many things have been used as “money,” including cowry shells, peppercorns, gold, silver and, of  It needs to be a store of value, and can be saved and stored for later use. course, modern currencies such as dollars and euros. Since bitcoins can be used to obtain goods or services in some cases, are they also money? According to the International Monetary Fund, for something to act as “money,” it needs to have three traits:  It needs to be a unit of account, and can be a base for prices.  It needs to be a medium of exchange, and can be used to buy and sell goods and services between parties. Download this book for free at http://coindale.com/bitcoinbook 10

11. That’s the textbook definition of “money.” For a further read At the current time, there are businesses and individuals on nine other ways bitcoins stack up against other currency who will trade bitcoins for goods and services, and there types, a great read is the article “The Nine Characteristics are a number of exchanges where bitcoins can be traded for That Make Bitcoin Money” from The Genesis Block. dollars, euros and other traditional currencies. More realistically, however, perhaps we should talk about So, are bitcoins “money?” Practically speaking, as long as “currency,” which is described as “a system of money in there are individuals who are willing to trade with bitcoins, general use” as a medium of exchange within a particular the textbook definition is less relevant. If two individuals group of individuals. On this point, the Financial Times are willing to exchange bitcoins for other goods, services or gives a much more pragmatic and accessible definition. other currencies, it’s money to them. According to the Financial Times, “a currency is anything that two people agree is a currency.” Download this book for free at http://coindale.com/bitcoinbook 11

12. Why should a business accept bitcoins? While it’s true that there are thousands of businesses “handing 2.5% to banks to move bits around the Internet is around the world that accept Bitcoin today, the real question the worst possible choice.” In a situation such as this, where is does it make sense for all businesses? The answer is, of transaction fees are high relative to the profit margin of the course, “it depends.” business, accepting Bitcoin may be an attractive option. A primary benefit of accepting Bitcoin is that it eliminates Another benefit from the merchant’s perspective is that once network transaction fees. Since the distributed Bitcoin net- a Bitcoin transaction is done, it’s done. With Bitcoin, there work is handling the task of securely transferring bitcoins is no concept of a “chargeback” (a word that strikes fear between buyer and seller, there is not a central toll-taker into the hearts of many a merchant). In a chargeback, also sitting between the parties. In a prototypical example, if sometimes called a reversal, a customer contacts a credit the profit of a business in a competitive industry is only 5 %, card company to initiate an investigation into a transaction. eliminating the typical transaction fee that accompanies If the bank finds in favor of the customer, the funds from the credit card purchases can significantly improve the out- transaction can be clawed back from the merchant. Bitcoin look for that organization. In his post “Why I Am Interested transactions are more like cash. When the deal is completed, In Bitcoin,” investor Chris Dixon appropriately notes that it is irreversible.1 1 Naturally, caveat emptor plays strongly in this situation. If a buyer is for some reason unsure of the trustworthiness of a merchant, a Bitcoin transaction should be thought of in the same way as a cash transaction. A buyer would be ill-advised to send bitcoins to a merchant if there was an expectation that the merchant wouldn’t deliver on the promise of an agreement. Download this book for free at http://coindale.com/bitcoinbook 12

13. In the short term, another strong positive benefit to businesses in accepting bitcoins is that Bitcoin is a currently a hot topic, and that a business can get a sizable amount of marketing buzz in announcing its support for Bitcoin. One of the primary areas areas of concern that businesses mention with respect to accepting Bitcoin is that they are worried about volatility risk, since bitcoins have fluctuated wildly in value over the past year. Except in extreme cases, this is less of a practical issue since infrastructure providers such as Coinbase and BitPay provide instant exchange services to immediately convert Bitcoin purchases into dollars. Download this book for free at http://coindale.com/bitcoinbook 13

15. Why should I personally use Bitcoin? As an individual, there may be a number of places where it On the other hand, there are other types of transactions for makes sense to use bitcoins. As a payment method for goods which bitcoins are an extremely attractive mechanism. The and services from established businesses (e.g. Overstock.com), most talked about example of this type is using bitcoins for the reasons to use bitcoins are likely more philosophical than international money transfers. Currently, existing money practical at the current time. If one is aligned with the ethos transfer networks (e.g. Western Union, MoneyGram, etc.) of Bitcoin, using bitcoins to pay for your next laptop or latte charge fees that are often 8% –12% of the amount transferred. is an action that shows your support for a decentralized In contrast, person-to-person Bitcoin transfers have no sig- monetary system. That said, it probably won’t cost less, or give nificant transaction fees. In other words, the next time you you a significantly different experience than paying with an want to send someone money, you can just do it, fee-free and existing bank card or cash. You’ll pay, and you’ll get your item in without a middleman. exchange for that payment. (Do note that once you make a payment with Bitcoin, that transaction is effectively irreversible. Up-and-coming money transfer networks such as BitPesa are Bitcoins do not have the same type of consumer protections exploring using bitcoins as a remittance mechanism to take that one typically gets with credit cards, for example.) advantage of the benefits of the Bitcoin network. These services have the potential to greatly improve the remittance process to Africa, Central America, South America and other locales where remittances from overseas are a significant part of the economy. Download this book for free at http://coindale.com/bitcoinbook 15

16. Isn’t Bitcoin just for drugs and porn? A lot of the early stories in the media focused around Bitcoin it is more akin to a Twitter handle pseudonym rather than a being used for illicit purchases, most notably through an completely anonymous moniker. online marketplace called The Silk Road, upon which many purchases of controlled substances allegedly took place. Having moved past the rebellious adolescent stage, Bitcoin is The Silk Road was taken down by the FBI in October 2013 now used for all sorts of transactions, including automobiles, which, incidentally, was when the trading value of bitcoins houses, electronics, content and services. began its most recent climb. Perhaps shutting down The Silk Road contributed to the legitimacy of Bitcoin. There is a common misperception that purchases with bitcoins are completely anonymous, which may contribute to the perception that Bitcoin is aligned with illicit activity. However, Bitcoin is more appropriately a pseudonymous system, rather than an anonymous one. While a Bitcoin wallet address is a long string of numbers and characters, Download this book for free at http://coindale.com/bitcoinbook 16

17. Where can I spend bitcoins? As of this writing, there are thousands of businesses listed Additionally, companies such as Coinbase and BitPay enable on coindale.com and other Bitcoin directories. A few notable merchants to accept payment in bitcoins with the addition brands that accept bitcoins are shown below. of a simple payment button, similar in the way they can accept payment through other services such as PayPal. Download this book for free at http://coindale.com/bitcoinbook 17

19. What else can Bitcoin be used for? While the speculative, transactional and funds-transfer to itself as “Trusted Timestamping on the Bitcoin Blockchain,” aspects of Bitcoin have received the most press to date, it is uses the underlying shared ledger of the Bitcoin network to the underlying foundation of the Bitcoin network that perhaps unimpeachably store timestamps of when documents were holds the most long-term promise. Lightspeed Venture created. What are the types of industries that could be disrupted Partners India states that “the underlying Bitcoin protocol by an application like this? Any service or situation where ab- makes itself applicable beyond the use cases of ‘store of solute proof of a document is required is a potential candidate. value’ and ‘payments.’ The Bitcoin Foundation took a huge This means everything from notaries to documenting prior art in step in allowing meta data to be included in the blockchain. the patent process, and from transferring auto titles to real esta- This will unlock a lot of innovation.” Venture capitalist Fred te could potentially be affected. And this is just one example. Wilson of Union Square Ventures, an early investor in Coinbase, agrees and is looking forward to opportunities that address Just as the first television shows were merely individuals on “Bitcoin as infrastructure.” Similarly, Chris Dixon of Andreessen stage reading scripts (since that what was done using the pre- Horowitz, another significant investor in the space, sees decessor technology, radio), the first applications of the Bit- many aspects of Bitcoin being very interesting. coin network will likely mirror existing processes. That said, the most interesting aspects will likely take a few years to So, what does a service on top of the Bitcoin infrastructure come to light and will use this new infrastructure in ways we look like? Once initial example is BTProof. BTProof, which refers haven’t yet imagined. Download this book for free at http://coindale.com/bitcoinbook 19

20. What does the government think about all this? What does the government think about a financial infra- The bottom line is that government regulation of Bitcoin is structure that doesn’t have a sovereign nation backing it? a rapidly evolving area. A site called BitLegal is tracking Bit- The answer is...it depends on which government you are coin’s status in many countries around the globe. As this talking about. Certain countries, such as Thailand and Iceland, is a fast-moving area, it is recommended that you do your historically have been hostile toward Bitcoin. Others, own investigation into any particular government’s positi- including the United States, have taken a more tempered on with respect to Bitcoin. approach. One of the biggest areas of concern and interest in the United States has been in the area of how Bitcoin activities will be taxed. At the current time, the IRS has not given any formal guidance in this area, although individuals on sites like Forbes and representatives from the HR Block Tax Institute have offered their speculation. Download this book for free at http://coindale.com/bitcoinbook 20

21. Where did Bitcoin come from? A whitepaper outlining the fundamentals of Bitcoin was Although journalists from The New Yorker, Fast Company published in 2008 by Satoshi Nakamoto, and the first open and other publications have spent an impressive amount of source code based on the whitepaper was released in 2009. effort attempting to determine the true identify of Satoshi, the fact that Satoshi’s identity is unknown is less important In the ensuing years, it has come to light that “Satoshi Na- than the system itself. Since the system is transparent, it kamoto” is itself a pseudonym for the developer (or group matters little who created it. of developers) who created Bitcoin. While the true identity of Satoshi is unknown, there is negligible impact to Bitcoin itself as a result of this “mystery.” Since Bitcoin is an open source protocol, any developer can examine firsthand the code that underpins the system. In fact, thousands of individuals have done so over the ensuing years. In this fashion, the Bitcoin system is no different than other open internet standards such as HTTP and SMTP (the protocol that underpins internet email). Download this book for free at http://coindale.com/bitcoinbook 21

22. What is Bitcoin mining? One of the interesting aspects of the Bitcoin network is that on the network to validate the current set of transactions there is a predictable, consistent approach to the number (called a “block”) and solve an intensive cryptographic of bitcoins that are in circulation. New bitcoins are added puzzle is rewarded with a bounty of bitcoins. At the current to the economy on a regular schedule by way of a process time, the reward is the sum of 25 bitcoins, which is about called mining. There are currently approximately 12 million USD$25,000 at current exchange rates. In other words, bitcoins in circulation, a number that will rise to 21 million about once every ten minutes, a miner on the network is by about the year 2140. reaping a fairly sizable reward. When someone sends bitcoins to another individual on the This mining reward is one of the keys to the growth of the network, that transaction needs to be verified by the mem- Bitcoin network. In the early days of Bitcoin, the crypto- bers of the network in order to prevent individuals from graphic puzzles were comparatively easy. However, the attempting to “double spend” those bitcoins. All of the creators of the Bitcoin protocol anticipated the fact that computers attached to the Bitcoin network are engaged in there may be an explosion of interest in the system, and the process of verifying those transactions. The incenti- built in a number of thoughtful mechanisms. For example, ve to keep one’s computer attached to the network is that mining of bitcoins gets more difficult if there are many once every ten minutes or so, the first computer (miner) computers connected to the network, and the bounties get Download this book for free at http://coindale.com/bitcoinbook 23

23. smaller over time as well. Both these factors contribute to predictability in the number of bitcoins that are created. In the early days of Bitcoin, mining was often done on a home computer. However, as the cryptographic puzzles have become more complex, the computing power required to solve the current block has outstripped the capabilities of most home miners, and is now performed almost exclusively on purpose-built, high-performance hardware that is specifically built for mining bitcoins. Download this book for free at http://coindale.com/bitcoinbook 24

24. What are the risks? Isn’t it a Ponzi scheme? Bitcoin is only beginning to move past the earliest adop- investments in mining hardware will become obsolete at ters and be noticed by the mainstream. As such, much of an ever-increasing rate. Alternative cryptocurrencies (e.g. the true “risk” around solutions and companies being crea- Litecoin) could come into vogue and reduce the interest in ted using the Bitcoin network is due to market acceptance Bitcoin. In classic early-market fashion, there are many un- and timing, rather than technical uncertainties in the uncertainties. derlying Bitcoin protocol itself. As has been noted, the Bitcoin network itself is built using open source code, which is A lesser-discussed, but notable risk in any system with limi- available for inspection by anyone. ted resources is the “power law” problem. Simply put, many systems, and especially financial systems, have a tendency There are definitely risks in the overall Bitcoin ecosystem. to concentrate wealth. Bitcoin seems to be no exception, Speculation on the value of bitcoins themselves is currently with some estimates stating that half of all bitcoins are an extremely volatile proposition. The exchange rate bet- owned by only 927 people. This makes the concentration of ween bitcoins and other currencies fluctuates wildly. Ra- wealth in bitcoins slightly worse than the concentration of pid advances in mining technology based on ASIC (appli- wealth in the United States, where the top 1% of individuals cation-specific integrated circuit) technology means that hold on the order of 40% of the national wealth. Download this book for free at http://coindale.com/bitcoinbook 25

25. A commonly-asked question is “is Bitcoin a Ponzi scheme?” In a Ponzi scheme, later investors are the source of cash for the early investors, and the entire scheme is built on that pyramid structure. Bitcoin does not have these traits. Yes, there are aspects of risks, but, no, Bitcoin is not a Ponzi scheme. Download this book for free at http://coindale.com/bitcoinbook 26

26. Acknowledgements The ecosystem around Bitcoin is evolving rapidly, and this document is a snapshot in time as this market begins to evolve. A special thank you to Steve Alter, Jay Baer, Micah Baldwin, Sean Bohan, Rick Calvert, Zachary Chastaine, Virginia DeBolt, Julie Schwab Delgado, Chris Eldridge, Susan Etlinger, Jonathan Faustine, Tom Foremski, Janet Fouts, Tom Gebarowski, Heather Gold, John C. Havens, Kevin Jones, Douglas Karr, Eric Kaun, David Kay, Ellen Petry Leanse, Mark Nelson, Lizanne Ray, John Scholvin, Marla Schulman, Susan Scrupski, Ted Shelton, Marty Thompson, Kelly Galvin Tirman, Robert Tolmach, Josh Weinberger, Joel Winter and most importantly Lisa Stone for their questions, input and support.

27. http://coindale.com/bitcoinbook Download this book for free at http://coindale.com/bitcoinbook