White Paper Introduction

The Bitcoin white paper’s introduction

To make it as effortless as possible for you to have access to the Bitcoin SV Academy’s educational material, we are publishing the entire Bitcoin Theory course over here on our blog.

The course goes through the Bitcoin white paper section by section elaborating on the concepts contained within each.

In the previous edition we covered the Bitcoin white paper’s abstract, and today we move on to the Bitcoin white paper’s introduction.

Stay tuned for a section-by-section release, and remember that you are still welcome to enrol in the BSV Academy to gain a certificate of completion to add to your resume!

Bitcoin white paper - Introduction

Commerce on the internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments. While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust-based model. Completely non-reversible transactions are not possible, since financial institutions cannot avoid mediating disputes.

The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for non-reversible services. With the possibility of reversal, the need for trust spreads. Merchants must be wary of their customers, hassling them for more information than they would otherwise need. A certain percentage of fraud is accepted as unavoidable. These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.

What is needed is 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. Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers. In this paper, 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. The system is secure as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes.

Commerce on the Internet
Commerce on the Internet

Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments. While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust-based model.
- Satoshi Nakamoto, Bitcoin white paper

At the time the white paper was published, internet commerce was a growing element of the economy with the rise of businesses such as eBay and Amazon proving that the internet could offer people business opportunities. The issue was that all transactions are routed through legacy payment systems to pay for goods or services via the internet and rely on trusted third parties to manage the payment process.

Most of these services tend to be credit card processors, banks, or payment processors such as PayPal. These systems work well for payments over an amount of several dollars, but when we look at smaller payments we see how the fees incurred by these third parties hinder profits for the business owner.

This is a significant burden on users and presents a barrier limiting the capabilities of services to implement systems using micropayments for $1 or less. By comparison, Bitcoin payments are received instantly and can be considered settled within just a few seconds, removing the lag that most payment systems insert in the process of commerce.

Non-reversible transactions
Non-reversible transactions

Completely non-reversible transactions are not possible, since financial institutions cannot avoid mediating disputes. The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for non-reversible services.
- Satoshi Nakamoto, Bitcoin white paper

As financial institutions are required to be part of each transaction that uses legacy payment systems when there is mediation they are forced to intervene. This is a time-consuming and costly process for merchants and represents a drain on commerce, where depending on the industry, as much as 3% of all credit card transactions are contested, costing the merchants fees, the cost of the goods charged back, and time, stress and effort.

In turn, these costs are passed onto the consumer who pays an invisible margin on top of all goods and services to cover not just the cost of their transaction, but the cost of mediating the transactions that malicious actors make using stolen cards or through fraudulent back charging.

In these systems, there is no ability for a merchant selling a non-returnable good or service to receive a non-reversible payment for that good or service which is a missing link in the chain of commerce.

Privacy in commerce
Privacy in commerce

With the possibility of reversal, the need for trust spreads. Merchants must be wary of their customers, hassling them for more information than they would otherwise need.
- Satoshi Nakamoto, Bitcoin white paper

Due to the need to track customers to prosecute fraudulent behaviour, merchants who use legacy payment systems are forced to request details from customers that don’t relate to the nature of the commerce and serve no purpose other than to back-stop the merchant’s liability in the case of fraudulent actions. Despite this, the cost of prosecuting fraudsters who abuse the payment system is prohibitive for smaller transactions, and merchants' only recourse is to keep records of bad actors so that they can decline their business in future.

This represents a huge problem for the privacy of good actors within the system, as their identity details often end up being stored in large merchant databases with their corresponding payment details. Merchants often do not spend the time or money needed to adequately secure this information and breaches in customer privacy have created situations where thousands or millions of customer details have been leaked onto the dark web, causing financial and identity theft all over the world.

The Paradigm of fraud acceptance
The Paradigm of fraud acceptance

A certain percentage of fraud is accepted as unavoidable. These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.
- Satoshi Nakamoto, Bitcoin white paper

Due to how payment services by trusted third parties operate, for merchants operating both online and in physical locations, it is almost impossible for them to avoid coming into contact with bad actors who use fraudulent practices to obtain goods without paying.

Commonly this is done through the acquisition of compromised credit card numbers and details, or by the true owner of the credit card reversing the charges made by the merchant through their financial institution.

These problems can be mostly avoided by accepting physical currency however this is becoming less desirable to both consumers and merchants due to the overheads involved for both parties in handling banknotes and coins.

There are no methods of transacting electronically available to users of legacy money systems that do not require the use of trusted third parties in the transaction.

What is needed...
What is needed...

What is needed is 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.
- Satoshi Nakamoto, Bitcoin white paper

Due to the reasons outlined in the previous section, what is needed is a system that uses cryptographic knowledge proofs to allow the purchasing party (customer) to establish a firm basis of custody over the money being used in a transaction. Bitcoin achieves this by using digital signatures and a simple but fully featured scripting language.

Bitcoin signatures are simple for the receiving party to validate and can be stored on the public ledger with efficiency and very low overheads. Because the sending party can establish control over the tokens themselves without using a third party to hold funds and manage the transfer, transactions are very fast and simple.

By using Bitcoin, receivers can quickly and simply validate that funds were indeed controlled by the sending party and that the transaction correctly allocates the correct amount to their control without requiring additional validation by third parties.

Learn more about Bitcoin Script here.

Protecting sellers from fraud
Protecting sellers from fraud

Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers.
- Satoshi Nakamoto, Bitcoin white paper

Thanks to the practically irreversible nature of the Elliptic Curve Digital Signature Algorithm (ECDSA) sellers who receive payments over the Bitcoin network can simply and quickly verify the authenticity of the funds received without needing to revert to a trusted third party.

Where the payment involves the delivery of goods or services, payments can be locked using simple scripting functions that require proof of delivery before the release of funds, with simple conditional clauses allowing for funds to be returned to the payer in the event of non-delivery. These features can be implemented using features native to the Bitcoin protocol drastically reducing the incentive or possibility to commit fraud.

Learn more about Elliptic Curve Digital Signature Algorithms here.

Proposed solution
Proposed solution

In this paper, 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 Nakamoto, Bitcoin white paper

One of the core innovations of the Bitcoin system is how it prevents users from taking digital coins which have been used in a transaction and double-spending them to a different party as a means to commit fraud. Transactions are recorded as plaintext on the ledger and are readable by all parties.

As transactions are created, network nodes assemble them into block templates against which they perform proof-of-work computations. When a valid proof-of-work solution is found, the block becomes a proof of existence timestamp for all of the transactions it includes whilst establishing which, of any pair of conflicting (double-spending) transactions, is accepted as first-seen and valid. Nodes append transactions to a block template in an order that closely matches the chronological order in which they were received.

This means each valid block represents a consensus-driven agreement on the order in which events were recorded by the network. Blocks are added in chronological order and as more work is added to the chain of blocks, this serves as proof that transactions in a given block were validated and accepted by the network participants collectively before the time indicated in the block header.

Learn more about proof-of-work here.

Security and Honesty
Security and Honesty

The system is secure as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes.
- Satoshi Nakamoto, Bitcoin white paper

As long as there is a pool of nodes who are competing to collect and add new transactions to the longest chain of proof-of-work, the system’s security is maintained. This system works against fraudulent actors both in the payments system and at the node level by allowing honest systems to reject blocks which include transactions that double-spend inputs they have already seen used in validated transactions or which violate the established rules of the network.

This enforcement is achieved through the accumulation of work by honest nodes within the system and creates a situation where attackers must overpower the network for an indefinite amount of time to maintain a chain of work that includes a fraudulent activity. In this way, the hashpower that performs the work on blocks acts as an enforcement system, allowing the honest actors within the network to collectively expend enough energy to outpace the attacking systems over time.

Time in this scenario is open-ended and attacking chains can emerge which retain an appearance of legitimacy and viability for extended periods. Thankfully, due to the high cost of performing proof-of-work, the dishonest nodes are forced to spend large sums of money to maintain the fraud. This expenditure is financially nonviable to maintain, eventually leading to the re-emergence of the honest chain as the legitimate record of activity on the ledger.

Brendan Lee

Training and Development Manager - Bitcoin Association