Technology

Bitcoin: everything you wanted to know

 By Luca Longo

Cryptocurrencies: everybody’s talking about them, many are buying them, but few know what they are, and very few realise how much energy they consume…

Hands up all those who have received dozens of emails from strangers keen to explain how rich they have become with bitcoins and – very generously – also offering us the possibility of becoming as filthy rich as them by buying cryptocurrencies. And raise the other hand if you have tried to understand what a cryptocurrency is, but quickly gave up trying to understand what it’s all about.

So, if you are now standing there with your hands in the air, don’t give up… read on.

What is a cryptocurrency?

After the financial crisis of 2008, many people have seen some of their savings of a lifetime vanish into thin air and have begun to be wary of banks and their role of mediation between those who lend and those who borrow money. Indeed the job of these institutions as guardians of the global financial infrastructure has been called into question.
2008 also saw the introduction of the first cryptocurrency – bitcoin – which continues to account for the overwhelming majority of the total capitalisation of the numerous cryptocurrencies (ethereum, litecoin, dash, monero…) launched in the following years. For simplicity, let’s focus for now on bitcoin.

Let’s take a step back…

Like all other currencies, paper or metal, bitcoin is nothing more than a payment system. When we buy goods or services we give an agreed quantity of some currency to the seller. It matters little whether we pay in cash or if we use a debit or credit card. In fact, we give up the right to own a certain amount of money in exchange for a certain good or service. In such transactions, however, there is always a bank or a state/country in the middle. The notes we give to the seller are not just pieces of paper (in fact they are largely made of of cotton, but never mind…) are documents guaranteed first by the bank and then by the state (and, if we pay in Euros, by the whole European Union). The seller accepts the notes because he knows that the state (or the EU) guarantees that at any time it can buy back those rectangular notes and give gold, or other precious goods of equivalent value, in exchange. If, for example, we were all to decide that the dollar no longer has any value, no one would accept payment in dollars anymore, and anyone who owned them could at best use their dollars as wallpaper and obviously the entire United States would find itself in an even worse situation than that which faced Greece just a few years ago.
But it is not any different if we pay with plastic rather than paper rectangles: if we use credit or debit cards there is no actual movement of money but only of bits. However, in the end, our online account will be lighter and that of the seller heavier by the same amount. and in the middle there is always the online interface of a bank and – behind which – a state that guarantees the safe care of the accounts of all those involved.
But what happens if we stop trusting the banks? This is what has given rise to cryptocurrencies. Like all online payments or using plastic, bitcoin transactions are completely digital. But unlike other currencies, bitcoins are not guaranteed by an intermediary recognised by those who sell and those who buy: they guarantee themselves.
Obviously it is necessary that each transaction is verified and that the ‘treasure’ in the electronic pockets of those who legitimately hold these currencies is in some way guaranteed.
In this case, it is not a physical institution but digital cryptography that assumes the role previously entrusted to the banks. We’ll look at this in more detail in a moment.

What is a Bitcoin register?

Bitcoin is nothing but a decentralised public register; a log that lists all bitcoin transactions (we use lowercase for the currency and uppercase for the register). Summing up all the bitcoin payments and receipts of a certain account holder we easily determine its current capital in bitcoins. The Bitcoin registry is public and anyone can, if they wish, download it from the Internet and keep it up-to-date. It is not centralised but distributed among those who wish to keep a copy. The owners of this register accept a series of rules on how to keep it up-to-date.
A bitcoin transaction, can not be invented, made to disappear or otherwise faked: anyone could trace it by comparing the fake register with the genuine ones spread throughout the rest of the world.
Easy, no? Actually, not at all. How can the global Bitcoin register understand if a new transaction corresponds to an actual and agreed bitcoin exchange between two subjects or if someone is trying to be smart?

Let’s try to understand with an example. Alessandro buys a cake from Gabriella. This physical transaction does not require an intermediary. The cake made by Gabriella is now in the hands of Alexander. Gabriella can not sell it to others because she does not own it anymore. Alessandro pays for the cake with a digital transaction and – from his computer – sends Gabriella a bitcoin: the price previously agreed between the two.
But who guarantees that Alexander does not try to be smart, making a copy of the bitcoin before sending it to Gabriella and then sending it also to Veronica in exchange for another cake baked by the latter? In the end, a bitcoin is nothing but a numeric code: a long string of 0s and 1s that anyone can copy. In this way Alexander would have uses only one bitcoin (one of the two is a duplicate) to have not one but two cakes. And, if he’s still hungry, he could go on like this. To infinity or until he can’t eat any more.
Gabriella decides to spend her legitimate bitcoin by buying some sweets from Veronica. OK. But who can tell if Gabriella, having received the bitcoin, that is the string, did not also make an identical copy before spending it with Veronica and then did not go also to Corrado to buy his cookies with the copy, i.e. with a fake currency (cryptocurrency)?
In other words, once Alessandro received Gabriella’s cake and paid for it in bitcoin, who legally owns the string of 0s and 1s that is the bitcoin itself?
A solution might be to use a register. We can’t give it to any of the parties involved in the exchanges, because there is the risk that someone will try to be smart and adjust the register. What we need is an entity deemed reliable by everyone – let’s say Marco – who will keep the register and verify that it is always kept up to date. When Gabriella passes the cake to Alessandro and receives a bitcoin in return, Marco will record the transaction and will score +1 on Gabriella’s account and -1 on Alessandro’s.
This is the traditional solution, and Marco is nothing other than a bank (and the state that guarantees the bank).
But what if Alessandro and Gabriella don’t trust Marco? If Marco decides that he is entitled to a percentage for the trouble of keeping the register? If Marco tried to be the smart one and marked -1 on the account of Alexander but +1 on his personal account leaving Gabriella empty-handed? In other words, what happens if Gabriella and Alessandro do not trust Marco or any other central authority?

How to make a cryptocurrency safe?

Gabriella and Alessandro find a solution: they distribute the register to all their trusted friends, not just Marco. In this way they decentralize the control of the register. The register is digital: you can easily create an application that keeps every copy synchronized with all the others. If most of the custodians of the decentralized registry agree on the validity of a transaction – for example, that Alexander has sold a bitcoin to Gabriella in exchange for his cake – then that transaction is added to the list of transactions logged on the register.
In this way it is more difficult to cheat: if Alessandro or Gabriella wanted to fake the register, they would have to involve most of the custodians of the copies of the register.
If Gabriella claimed that she had received two bitcoins from Alessandro, or if Alessandro claimed that he had never given one to Gabriella, their register would no longer be synchronized with that of all the others and the fraud would be evident. And even if one of the two also convinced Marco to manipulate his copy, their copies would be clearly different from those of the majority of custodians.
It is obvious that the more custodians there are, the more difficult it is to organize a conspiracy involving the majority of them.
This is how a currency transaction can take place without a central authority guaranteeing it. The virtual transfer of a string of 0s and 1s – while remaining a digital procedure – assumes the same physical value of the cake that Gabriella sold to Alessandro. There is only one cake and it is always clear who owns it (ok, the cake – unlike the bitcoin – will soon be eaten, but that’s another matter).
In this way, not only the transaction, but also the currency itself, are guaranteed by the users themselves who take the place of the central authority.
And this is exactly how the Bitcoin register works, with the difference that it is not only distributed to a small circle of trusted friends but is public and accessible to anyone. Also… to the bad guys.

Ok, but who keeps the Bitcoin registry up to date?

It is clear that the number of custodians of the register is itself a guarantee, but someone has to take the trouble to keep the register up to date. Bitcoin offers a solution by rewarding the most willing custodians and at the same time keeping out those who want to be smart.

Who are the miners and what is a blockchain?

If they want, the custodians of the register can not only exchange currencies but also become miners. These collect the last transactions in a block and add this block to the chain of previous blocks that makes up the register. This register is called a Blockchain precisely because, literally, it is nothing more than a chain of blocks, each in turn made up of an ordered set of records of individual transactions.
To add a new block to the chain, the miners must solve a complicated mathematical puzzle that requires a huge amount of computational work to work. The first miner who can solve the puzzle is rewarded with… some bitcoins (for sure not with cakes!). They are called miners because, armed with powerful systems of calculation, they look for the solution to the mathematical puzzle as gold diggers went foraging for nuggets. With a bitcoin today valued at around €15,000 euros, it is obvious that the effort is rewarded so well that it encourages more and more miners to create large computer systems dedicated to this in order to be the first find the solution to the puzzle and to bring home the bitcoins.
If you want to know the current value of bitcoin and the exchange rate in various conventional currencies, you can find it here. If you want to see a real time graphic representation of bitcoin traffic – and the corresponding periodic construction of blocks to add to the Blockchain – you can find it here.

How the miners keep a check on each other

Obviously, before logging the new block just made to the Blockchain, the other custodians of a copy of the Blockchian analyse the validity of the new package by making sure that it is genuine. When the majority of users have approved it, the new block is attached to the Blockchain which is then is distributed to all the custodians who then replace the previous one. This whole process takes place automatically. Only at the conclusion of this process is the winning miner is rewarded with his sum. From now on, all the transactions contained in that last block are public and therefore those who paid using bitcoins no longer own them while those who were paid in them have them physically.
To those who wondered why Alessandro was willing to pay around €15,000 for a single cake by Gabriella, all I can say is: taste it and you will understand. I’m talking about the cake. But let’s not get distracted and go back to the Blockchain.
We have seen how miners are incentivized, but the same system also serves to discourage the bad guys.
To fake a block with false transactions to your advantage and pass it off as good, you would have to frequently win the race with those trying to solve the puzzle. It would require immense banks of dedicated computers, and you would run the risk of losing everything in a flash if the custodian community discovered the rotten apple. Finally, hacking of this kind would still lead to a decline in collective trust and the price of bitcoins would collapse, leaving even the bad guys in the dirt.

Is bitcoin a bubble?

Certainly the price of a bitcoin has risen at an incredible speed.
Created on 1 September 2009, in 2010 it was worth 6 cents, in 2015 around $100, in 2016 around $500, but in 2017 it soared from $985.56 on 2 January to a maximum of $17,549.67 on 11 December!
The real value of bitcoins is subject to exactly the same laws of supply and demand that govern the value of cakes, antique stamps, companies, and entire currencies. If investors attribute to any of these various subjects a higher value than that which is currently accepted, their value will rise. If there is a loss of interest, the value will go down. But it can also precipitate if, for some reason, investors and savers were disappointed by news about the poor quality of Gabriella’s cakes, the discovery of fake old stamps, or the lack of solidity of a company or an entire country and its corresponding national currency.
When a country finds itself in financial difficulty, it is tempting to print new paper money in order to repay its debts. However, this means overestimating the value of that country because all of the new currency put into circulation would only be guaranteed by the same gold reserves held by the state which already guaranteed previously issued money. If the state issues only a little at a time, then the purchasing power of that single currency will drop slowly. A phenomenon more commonly known as inflation.
But if the government gets carried away and gets the mint to go on printing money ad libitum, we’re in trouble. In this way citizens and foreign investors lose confidence in that country and the value of its currency will fall and maybe even collapse.
In order to avoid inflation, the mysterious creator of the algorithm behind bitcoins came up with two solutions.
The algorithm itself was constructed so as not to be able to generate more than 21 million bitcoins. Until now miners have “discovered” around 17 million bitcoins. Only 4 million still remain to be created (always as a bonus for adding blocks to the blockchain). Once the cap is reached, the mathematical algorithm will not be able to generate even one more. It would be like asking your home gas meter to indicate one cubic meter more when all the dials have reached at 9. Or like measuring with a fraction of a degree more when the thermometer has already reached its maximum.
In addition, the algorithm is constructed in such a way as to make the mathematical puzzle necessary to generate bitcoins increasingly more difficult to solve. In this way, the more bitcoins that are created the more complex it is to create new ones and inflation is kept under control.

The real weak point

We have talked about the many advantages of bitcoins. But we must also look at the other side of this virtual currency. The Achilles’ heel of bitcoin – and all other cryptocurrencies that work in this way – is in the very mechanism that creates and guarantees them mentioned above.
Each miner, to be able to solve the puzzle before other miners and win the bitcoin, must have access to a greater computing power than that of the others. So don’t not imagine pimply nerds armed with PCs locked in a garage: the battle is now between big companies specialized in bitcoin and equipped with huge computer centres administered by first-class systems engineers and computer technicians.
It is not a hobby! The total global revenues produced by hunting for new bitcoins in the last year was $18 billion. The estimated global cost to create them was less than $2 billion. So, on average, these companies have earned more than $9 for every dollar invested. So far it has been a phenomenal business!

Genesis Mining's cryptocurrency mining farm in Iceland (Marco Krohn, Wikimedia)

Energy

But all these computer centres require a huge amount of energy in order to function. Worse, with the progressive complication of the puzzle to be solved to add a block to the blockchain and generate new bitcoins, the computing power needs to increase. And therefore also the energy requirement increases.
To give you an idea, every day 100 million KWh are consumed just to produce bitcoins, this corresponds to an annual consumption of 36.32 TWh. If we compare global energy needs, we see that as many as 152 countries consume less than what is consumed by the bitcoin miners. Currently, finding bitcoins uses more energy than that used by the whole of Bulgaria (which has a population of over seven million).
To be precise, in the national consumption tables produced by the International Energy Agency, the miners are in 37th place in the world after Algeria, Vietnam e Sweden ma prima di Qatar, Uzbekistan e Norway.
But consumption is growing so rapidly that this data will soon be obsolete. In any case, you can still find them updated in real time here.

Is this sustainable?

If the increase in energy consumption required for each new bitcoin remains constant, the search for bitcoins would consume all of the world’s energy by February 2020.

Do we want to make things worse? Yes: let’s!

The worst problem with bitcoins is not just the total energy consumption, but the fact that the miners’ infrastructures are mainly located in China and are mainly fed by coal-fired power stations. The electricity generated from coal is available at very low prices; so for this reason, entire industrial blocks in China are filled with computers exclusively dedicated to this traffic. Virtual traffic but, as we have seen, potentially able to generate average earnings of 900%.
Every single bitcoin transaction produces as many as 123.31 kilograms of carbon dioxide (yes, that’s right: kilograms). That is the equivalent of a footprint of just under 18 million tonnes of CO2 per year.
And we are only talking about bitcoins and not the other cryptocurrencies that have arisen in their wake.
This is significant data for the environment and faced with which we can not remain indifferent…

READ MORE: Blockchains to democratize the energy market? by Chris Dalby

about the author
Luca Longo