Bitcoin: The Cryptoanarchists’ Answer to Cash

[Eugen Leitl]

http://spectrum.ieee.org/computing/software/bitcoin-the-cryptoanarchists-answer-to-cash/0

FEATURE

Bitcoin: The Cryptoanarchistsb Answer to Cash

How Bitcoin brought privacy to electronic transactions

By Morgen E. Peck  /  June 2012

Bitcoin Opener

Illustration: Harry Campbell

There's nothing like a dollar bill for paying a stripper. Anonymous, yet
highly personalbwherever you use it, that dollar will fit the occasion.
Purveyors of Internet smut, after years of hiding charges on credit cards, or
just giving it away for free, recently found their own version of the
dollarba new digital currency called Bitcoin. b)

Youbll know it when you see it (strippers who accept tips in bitcoins
advertise their account addresses right on their bodies). And more important,
if you pay with it, no one needs to know. Bitcoin balances can flow between
accounts without a bank, credit card company, or any other central authority
knowing who is paying whom. Instead, Bitcoin relies on a peer-to-peer
network, and it doesnbt care who you are or what youbre buying. b)

In the long run, a system like this, which restores privacy to electronic
payments, could do more than just put the sneak back into the peek. If enough
people take part, Bitcoin or another system like it will give political
dissidents a new way to collect donations and criminals a new way to launder
their moneybwhile causing headaches for traditional financial gatekeepers.b)
graphic link to future of money landing page

You may have heard about Bitcoin last year, when the digital currency was
briefly a major media story and speculators rushed to cash in on the rising
value of bitcoins. Or perhaps you heard about hackers raiding the coffers of
the largest online bitcoin exchanges, which coincided with the price of
bitcoins plunging. Since January Bitcoin has stabilized. Itbs been holding an
exchange rate of about US $5. b)

The dream of an anonymous, independent digital currencybone where privacy is
maintained for buyers and sellersblong predates Bitcoin. Despite obituaries
in magazine articles from Forbes, Wired, and The Atlantic, the dream is far
from dead.b)

The pursuit of an independent digital currency really got started in 1992,
when Timothy May, a retired Intel physicist, invited a group of friends over
to his house outside Santa Cruz, Calif., to discuss privacy and the nascent
Internet. In the prior decade, cryptographic tools, like Whitfield Diffiebs
public-key encryption and Phil Zimmermannbs Pretty Good Privacy, had proven
useful for controlling who could access digital messages. Fearing a sudden
shift in power and information control, governments around the world had
begun threatening to restrict access to such cryptographic protocols.b)

May and his guests looked forward to everything those governments feared.
bJust as the technology of printing altered and reduced the power of medieval
guilds and the social power structure, so too will cryptologic methods
fundamentally alter the nature of corporations and of government interference
in economic transactions,b he said. By the end of the meeting, the group had
given themselves a namebbcypherpunksbband the superhero-like task of
defending privacy across the digital world. In just a week, cofounder Eric
Hughes wrote a program that could receive encrypted e-mails, scrub away all
identifying marks, and send them back out to a list of subscribers. When you
signed up, you got a message from Hughes: b)

    Cypherpunks assume privacy is a good thing and wish there were more of
it. Cypherpunks acknowledge that those who want privacy must create it for
themselves and not expect governments, corporations, or other large, faceless
organizations to grant them privacy out of beneficence.b)

Hughes and May were deeply aware that financial behavior communicates as much
about you as words canbif not more. But outside of cash transactions or
barter, therebs no such thing as a private transaction. We rely on banks,
credit card companies, and other intermediaries to keep our financial system
running. Will those corporations save and even share a dossier of your
spending habits? Even using cash requires trust that the bill will maintain
its worth. Will governments print too much currency or too little? Many
cypherpunks would say that the only way to answer these questions is to build
an entirely new system.b)

Gradually, their mistrust germinated into an anarchist philosophy. Most
simply wanted to be able to buy things without someone looking over their
shoulders. But others on the mailing list imagined liberating currency from
governmental control and then using it to lash back at their perceived
oppressors. b)

Jim Bell, a onetime Intel engineer, took these fancies further than anyone,
introducing the world to an odious thought experiment called an assassination
market. Citizens needed an effective way to punish politicians who acted
against the wishes of their constituents, he reasoned, and what better
punishment than murder? With an anonymous digital coin, argued Bell, you
could pool donations from disgruntled citizens into what amounts to bounties.
If a politician made enough people angry, it would only be a matter of time
before the price pushed him out of office or cost him his life. Bellbs essay,
bAssassination Politics,b eventually attracted the attention of federal
agents. His spiral through the U.S. court system started with an IRS raid in
1997 and ended this March with his release from prison. b)

While cypherpunks like Bell were dreaming up potential uses for digital
currencies, others were more focused on working out the technical problems.
Wei Dai had just graduated from the University of Washington with a degree in
computer science when he created b-money in 1998. bMy motivation for b-money
was to enable online economies that are purely voluntary,b says Dai, bones
that couldnbt be taxed or regulated through the threat of force.b But b-money
was a purely personal project, more conceptual than practical.b)

Around the same time, Nick Szabo, a computer scientist who now blogs about
law and the history of money, was one of the first to imagine a new digital
currency from the ground up. Although many consider his scheme, which he
calls bbit gold,b to be a precursor to Bitcoin, privacy was not foremost on
his mind. His primary goal was to turn ones and zeros into something people
valued. bI started thinking about the analogy between difficult-to-solve
problems and the difficulty of mining gold,b he says. If a puzzle took time
and energy to solve, then it could be considered to have value, reasoned
Szabo. The solution could then be given to someone as a digital coin. b)

In Szabobs bit gold scheme, a participant would dedicate computer power to
solving cryptographic equations assigned by the system. bAnything that works
well as a proof-of-work function, producing a specific binary string such
that it can be proved that generating that string was computationally costly,
will work,b says Szabo. In a bit gold network, solved equations would be sent
to the community, and if accepted, the work would be credited to the person
who had done it. Each solution would become part of the next challenge,
creating a growing chain of new property. This aspect of the system provided
a clever way for the network to verify and time-stamp new coins, because
unless a majority of the parties agreed to accept new solutions, they
couldnbt start on the next equation. b)

When attempting to design transactions with a digital coin, you run into the
bdouble-spending problem.b Once data have been created, reproducing them is a
simple matter of copying and pasting. Most e-cash scenarios solve the problem
by relinquishing some control to a central authority, which keeps track of
each accountbs balance. DigiCash, an early form of digital money based on the
pioneering cryptography of David Chaum, handed this oversight to banks. This
was an unacceptable solution for Szabo. bI was trying to mimic as closely as
possible in cyberspace the security and trust characteristics of gold, and
chief among those is that it doesnbt depend on a trusted central authority,b
he says. b)

Bit gold proved that it was possible to turn solutions to difficult
computations into property in a decentralized fashion. But property is not
quite cash, and the proposal left many problems unsolved. How do you assign
proper value to different strings of data if they are not equally difficult
to make? How do you encourage people to recognize this value and adopt the
currency? And what system controls the transfer of currency between people?b)

After b-money and bit gold failed to garner widespread support, the e-money
scene got pretty quiet. And then, in 2008, along came a mysterious figure who
wrote under the name bSatoshi Nakamoto,b with a proposal for something called
Bitcoin. As is fitting for the creator of a private digital currency,
Nakamotobs true identity remains a secret. bIbve never heard of anybody who
knew about that name earlier,b says Szabo. bAnd Ibm not going to speculate on
who he may or may not be.bb)

To create a working system, Nakamoto started with the idea of a chain of
data, similar to bit gold. But rather than creating a chain of digital
property, Bitcoin records a chain of transactions. b)

The simplest way to understand Bitcoin is to think of it as a digital ledger
book. Imagine a bunch of people at a table who all have real-time access to
the same financial ledger on laptops in front of them. The ledger records how
many bitcoins each person at the table has at a given time. By necessity, the
balance of each account is public information, and if one person wants to
transfer funds to the person sitting across from him, he has to announce that
transaction to everyone at the table. The entire group then appends the
transaction to the ledger, which they all need to agree on. In a system like
this, money never has to exist in a physical form, and yet it canbt be spent
twice. b)

This is basically how Bitcoin works, except that the participants are spread
across a global peer-to-peer network, and all transactions take place between
addresses on the network rather than individuals. Address ownership is
verified through public-key cryptography, without revealing who the owner is.
b)

The system turns traditional banking privacy on its head: All transactions
are made in public, but theybre difficult to link up with a human identity.
Maintaining the dissociation takes vigilance on the part of the Bitcoin user
and careful decisions about which outside applications and exchange methods
to use, but it can be done. bAnonymity is typically compromised by means
outside of Bitcoinbs control, in other words,b says Jeff Garzik, who is on
the team of programmers now responsible for developing the Bitcoin software.
Bitcoin is often described as providing pseudoanonymity, by creating enough
obfuscation to provide users with plausible deniability.b)

People who own bitcoins have a programbcalled the Bitcoin clientbinstalled on
their computers to manage their accounts. When they want to access their
funds, they use the client to send a transaction request. The innovation of
Bitcoin is to use the processing of these transaction requests as the
mechanism for creating new currency.b)

As requests pile up in the system, individual computers, running bminingb
programs, bundle them into chunks called transaction blocks. Before each
block of transactions becomes part of the accepted Bitcoin ledger, or block
chain, the mining software must transform the data using cryptographic hash
equations. The Bitcoin client accepts the resulting hash values only if they
meet strict criteria, so miners typically need to compute many hash values
before stumbling upon one that meets the requirements. That process costs a
lot of computing powerbso much that it would be prohibitively difficult for
anyone to come along and redo the work. Each new block that gets added and
sealed strengthens all the previous blocks on the chain. b)

The bminerb whose computer first finds an acceptable hash value is rewarded
with newly minted bitcoins. The Bitcoin system adjusts the difficulty of the
hashing requirements to control the minting rate. To its proponents, this is
one of Bitcoinbs biggest attractions: Unlike the printing of bfiatb currency,
which can be done on demand, the creation of Bitcoins will gradually taper
until it reaches a limit of 21 million coins. b)

As more and more miners compete to process transactions, mining requires more
computing power. Brock Tice, who mines bitcoins in St. Paul, Minn., has a
whole room stuffed full of enough mining computers to heat his office in the
winter. But Tice first became interested in the network for a different
reason. He thought it would be a better way to accept money from customers
online. b)

In 2009, he began selling little blue canary-shaped night-lights from his
home in New Mexico. He quickly lost patience with all the standard payment
options. bI had been thinking for a while that something like Bitcoin was
needed,b he says. bI run a couple of small businesses, and taking or making
payments is just such a huge pain.b Every time a customer pays with PayPal,
for instance, Tice hands over 2.9 percent of what he charges plus a small
fee. For international sales, he pays even more. The rates for Google
Checkout and credit cards are about the same, and for each one he has to open
an account with the company processing the transaction, and then trust that
it will eventually hand over the money. After reading about how Bitcoin
works, Tice decided to include it as a payment method on his website.b)

For merchants like Tice, the benefits are obvious. In addition to relieving
him of fees (at least for nowbBitcoin has an optional mechanism in place for
miners to collect fees in the future), Bitcoin transactions wonbt open him up
to claims of credit card fraud. In Bitcoin, all transactions are
irreversible.

On the other hand, unlike credit card users, consumers paying with bitcoins
have no way to get their money back if Tice never ships the item. But as with
any financial transaction, some level of trust is still required. And some
customers would prefer to trust a merchant to make good on a sale than trust
them to protect sensitive data. Last spring, hackers broke into the Sony
PlayStation Network and swiped a trove of private account detailsbcredit card
numbers, birthdays, log-ins, passwords, home addresses, and all the names
associated with them. Just days later, it happened again, and within a week
the security of more than 100 million Sony accounts was at risk. bI think
Bitcoin really has the potential to change our expectations about what
information we give merchants,b says Gavin Andresen, Bitcoinbs project
leader.

The Bitcoin system has had its own hacking problems. Other than a few
die-hard miners, most people buy bitcoins at an exchange where you pay
dollars, euros, or whatever and get bitcoins in return. These exchanges also
allow merchants to convert their bitcoin collections into other currencies.
Unfortunately, the security of the exchanges hasnbt been as good as the
Bitcoin client itself. The largest online exchange, Mt. Gox, lost 500 000
bitcoins to hackers in June 2011, which sent the price barreling down. Anyone
who invests in a bitcoin better understand that itbs going to be more
volatile than the dollar, says Michael Kagan, the managing director at
ClearBridge Advisors, an investment firm in New York City.b)

Even with the ups and downs, many of Bitcoinbs early adopters amassed their
virtual fortunes when mining was easy, so they have an incentive to keep the
system going (assuming they didnbt cash out at the peak of the bubble). Itbs
possible they are hoarding the currency, as the economist Paul Krugman
speculated they would, waiting for the price to rise again as mining becomes
more competitive and expensive. And while Bitcoinbs fixed minting rate helped
attract its most fervent early adopters, it also made the barrier to entry
much higher for people who want to join now. bIf anything is the Achillesb
heel of Bitcoin, that probably is it,b Szabo says.b)

If Bitcoin does fail, it may die in an act of cannibalism. Nakamoto
introduced the block chain, but cryptographers are now already working on
improvements. The minting rate is only one of many things that could be
tweaked. bBitcoin is the first of a new breed,b says Garzik. bPeople will
learn from Bitcoin and build something better, or Bitcoinbs critical mass
will force it to evolve and learn from its own mistakes.bb)

This article originally appeared in print as "The Cryptoanarchists Answer to
Cash."

About the Author

Morgen E. Peck never saw the point in writing about money or finance. Then
she attended a conference on the cryptocurrency Bitcoin and talked to
anarchists, programmers, bankers, cryptographers, libertarians, finance
lawyers, and a game show host. From this crucible of ideas, she emerged quite
altered. bIbd like to personally thank Satoshi Nakamoto [Bitcoinbs supposed
creator] for finally making money interesting enough to write about,b she
says.

TAGS: Bitcoin // Internet // cryptocurrency // cryptography // encryption //
hash functions // peer-to-peer networks // privacy