It is time to start getting a handle on how Bitcoin works. In this blogpost lesson, we will read the introduction of the Bitcoin whitepaper together and understand it line by line, just like we did with Satoshi Nakamoto’s abstract. Take a couple of minutes to carefully read the introduction:
Satoshi prefaces the introduction by stating the problem:
“Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments.”
While this system works, he believes that it has one big weakness. Can you guess what that might be? It’s somewhat obvious: it requires us to trust the financial institutions that facilitate these financial transactions. Makes sense, right? You have to trust the people and/or institutions you’re entrusting with your hard-earned money and personal information.
Satoshi states it clearly,
“…it still suffers from the inherent weaknesses of the trust based model.”
We cannot transact on the internet without banks and credit card companies because we need these entities to settle digital transactions and protect us from fraudulent transactions.
But per Satoshi,
“Completely non-reversible transactions are not really possible.”
Financial institutions further protect us by helping mediate disputes. For example, if you accept payment for a service on PayPal, PayPal will eat the cost of a fraudulent transaction. The cost for mediating those disputes is mitigated via a fee that consumers have to pay for each transaction.
“The cost of mediation increases transaction costs.”
Given that there is a cost for every transaction on the internet, micro-payments are not really possible.
“…cutting off the possibility for small casual transactions”
I cannot casually send you $0.28 cents because the transaction cost is usually higher than that (e.g., on PayPal, the credit card processing fee is 2.9% + $0.30).
Moreover, since fraudulent transactions are an inherent risk with internet payments, merchants collect customer information in order to protect themselves against losses. Satoshi acknowledges this by saying,
“Merchants must be wary of their customers, hassling them for more information than they would otherwise need.”
If there was a way to make non-reversible transactions, then we would no longer need these trusted financial institutions or have to turn over our consumer information to them.
Satoshi then proposes his solution:
“an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”
The system Satoshi envisioned, Bitcoin, is peer-to-peer, with users directly transacting with one another.
Moreover, transactions are impossible to reverse, eliminating the possibility of fraud altogether. In other words, Satoshi proposes that he has a solution to the thorny “double spend” problem.
“We propose a solution to the double-spending problem using a peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions.”
Satoshi’s proposed system works so long as the majority of compute power in the network is held by honest peers (rather than malicious peers who want to take down the network).
“The system is secure as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes.”
In the following blogpost lessons, we will start to break down what exactly Satoshi means by “peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions.” It is a mouthful, but that’s okay, because we will slowly chew into it.
See you then!