The misunderstood cryptocurrency has a value, and I'll tell you why...

in Bitcoin

Why Is Bitcoin Valuable?

Bitcoin.  It’s everywhere in the news.  It was 2013’s best investment, and it’s taking the world by storm.

So why is it a big deal?  And why does it have value?  Well, this is my attempt of explaining one of the fundamental facets of currency: a proof of work.

Disclaimer: I am no economist.  There are other variables at play when valuing a currency.  Please bring these discrepancies and concerns to my attention in the comments.

Proof of Work

Proof of Work is arguably one of the biggest things that make a currency valuable.  The idea is that when we have something, and when we want to use that as currency, we need to know that it wasn’t produced trivially.

Traditionally, up until recently, we have used gold (or other precious metals) as proof of work.  We understand that gold (etc) is rare, and if someone is able to produce a quantity of gold, we know that they worked a specific, non-trivial amount to obtain that gold.  As a result, our currencies have been defined by precious assets.

Cool.  But what about Bitcoin?

Glad you asked!  Bitcoin derives its value from computation.  I.E., Bitcoin is valuable because we use computers to create it.  But how do we create a proof of work out of our computing power?  Easy.  We create problems that take computers a very long time to solve.  In the design of Bitcoin, this is achieved with hashing.

Okay… What’s hashing?

According to Wikipedia, hashes are defined as

[functions] primarily used to generate fixed-length output data that acts as a shortened reference to the original data. This is useful when the original data is too cumbersome to use in its entirety.

Consider a hash as a boiled-down version of its input.  The hash of a pot of soup would be some sort of reduction scraped off the bottom of a pan.

What is fascinating about hashes (and this is where the soup analogy stops working) is that hashes are one way.  In most cases, it is impossible to effectively reverse a hash without using trial and error.

In other words, there is no way to tell what a hash’s input was.

This is where Bitcoin’s value comes from.

Hashes and the Blockchain

Bitcoin transactions are recorded in a special, public data structure called a block chain.  Special programs called miners are used to add new blocks to the end of the block chain.

A miner’s task is to gather recent transaction metadata and a few other pieces of metadata, and find a random number that, when combined with the rest of the metadata, produces a hash that meets the difficulty requirement of the network.

For example, a recently mined block has the following hash

What’s worth note is that this block’s hash has 15 zeroes at the beginning.  This is evidence of the proof of work.  Finding a hash of the block is incredibly difficult right now, and as the Bitcoin network’s computing power increases, the required hashing difficulty increases accordingly.

How does a computer find a hash?

  1. Gather necessary metadata and structure it according to standard.
  2. Generate a random number and place it in the block.
  3. Hash the block.
    1. If the hash meets the network’s difficulty requirements the block is appended to the block chain, and the next block begins.
    2. If the hash doesn’t meet the network’s requirements, the computer is welcome to try again until it finds a valid hash.

At the moment, it would take one computer at least 98 years to hash a block by itselfThis is a proof of work.

Why are hashes good for this?

Again, good question!  Good hashes are full of entropy.  This is to say that minor changes in the input has a massive effect on the actual output of a hash.

The following inputs were hashed using MD5.  The passage on the right is missing the period at the end.  Otherwise, the passages are identical.

Input

Lorem ipsum dolor sit amet, consectetur adipiscing elit. Vivamus varius nulla mauris, ac ornare eros venenatis quis. Curabitur elementum risus vitae arcu mollis, vel accumsan nulla tincidunt. Cum sociis natoque penatibus et magnis dis parturient montes, nascetur ridiculus mus. Maecenas et condimentum lacus. Maecenas eu nisl ac arcu congue interdum. Sed risus elit, consectetur et venenatis eu, egestas eget nibh. Cum sociis natoque penatibus et magnis dis parturient montes, nascetur ridiculus mus. Donec a ligula purus. Vestibulum magna ligula, consequat sed varius sit amet, mollis sollicitudin lorem. Nulla et elit neque.

Lorem ipsum dolor sit amet, consectetur adipiscing elit. Vivamus varius nulla mauris, ac ornare eros venenatis quis. Curabitur elementum risus vitae arcu mollis, vel accumsan nulla tincidunt. Cum sociis natoque penatibus et magnis dis parturient montes, nascetur ridiculus mus. Maecenas et condimentum lacus. Maecenas eu nisl ac arcu congue interdum. Sed risus elit, consectetur et venenatis eu, egestas eget nibh. Cum sociis natoque penatibus et magnis dis parturient montes, nascetur ridiculus mus. Donec a ligula purus. Vestibulum magna ligula, consequat sed varius sit amet, mollis sollicitudin lorem. Nulla et elit neque
Output (md5) 35f45fa061f48a3d9cfc9ef3dee03aa1 313fb0e8e65bf7ac0a3f16f30f958e17

What’s interesting is that the hashes are dramatically different.  Consequently, it is nearly impossible to effectively game the inputs of a hash with an understanding of how it will affect the output.

Interestingly, these two hashes are such rare combinations of letters and numbers that performing a Google search for either hash will probably only lead to this article.

Most computers with a good graphics card are capable of computing around 30-50 million hashes per second.  That’s 30 to 50 million GUESSES per second.

The size of the entire network is at 17625 Thash/s.  In other words, the network is guessing 17,625 billion hashes per second attempting.

Hashes are relatively easy to calculate.  So once a random number is appended to the block and calculated to a valid hash, it can be recalculated instantly and reliability.  This verifies the proof of work.

The miner that successfully hashes the block is awarded an amount of Bitcoins for their work.  This is how Bitcoins are minted.The first miner to hash the block successfully gets the reward.  As a result, the network races to verify transactions.  Most Bitcoin transactions are committed to the blockchain within 10 minutes!

Safety.

This intensive hashing process also makes it virtually impossible to adjust the blockchain retroactively.  If an attacker wanted to undo or alter a transaction that happened in the past, the attacker would have to re-hash the block and every block after it since each block contains the hash of the block before it.  This is too much work for one adversary to achieve in a million lifetimes.

As a result, once a transaction has been committed to the blockchain, it is safe for eternity.  Bitcoin does not have refunds, or chargebacks for this reason.

Power.

Remember when I stated that one computer would take nearly 98 years to solve a block?  This leads to the exploitation of a very precious resource: our computing power.  At the moment, the Bitcoin network is capable of mining a block in about 10 minutes.

Mining is most commonly completed in pools that allow participants to solve hashes and share on the minted coins.  You are rewarded in proportion to the amount of work your computer completed.

Conclusion

Bitcoin is valuable, and we aren’t just pretending like it is for the sake of fantasy.  As with every other valuable currency, there is a proof of work involved in discovering new Bitcoins.

Rather than physically mining gold or precious metals, the Bitcoin network is seeking an answer (the hash) to a math problem that can only be found by trial and error.  The hash uses transaction metadata and a random number so that any changes in transactions would require rehashing each block of transactions.  As a result, it is impossible to retroactively adjust a transaction.

Try it!

Bitcoin is cool.  It makes it easy to send money avoiding restrictions regarding exchange rates and repatriation of money.

If you are looking to try Bitcoin, head to trybtc.com.  They’ll transfer a tiny amount of Bitcoin to a wallet of your choice.

Thanks for reading!  If you want to send me Bitcoin for any reason, my public address is 16sVVZiJuCUBpWhKRDse1AzSkNvxHNgceT

Write a Comment

Comment