The Basics of Bitcoins & Blockchains by Antony Lewis Book Summary Review

Rating: 7/10 Find it On Amazon

My Bottom Line Thoughts

I thought this was an excellent introduction to the world of cryptocurrency, bitcoins, and blockchains and the basics of how they work and what they are.

I’m new to understanding this industry and with all the hype and fortune made so far I figured it would be smart to at least understand the basics of what’s going on even if I don’t participate in any technically meaningful way or invest a lot into it.

I do think that the Web 3 space which is where cryptocurrencies, blockchain technology, Decentralized finance, NFTs, and more that we aren’t even aware of right now, are going to play a big role in the changing nature of the internet and how we use technology over the coming years.

Once you learn even a little bit about this space it opens your mind up to all the possibilities and shows you how it just makes sense that it’s the next version of the internet.

Summary Notes

Part 1: Money

Physical & Digital Money

• Cash is a form of physical money that you can use without any third party approving or censoring a transaction or taking a commission for processing it
• The biggest issue with physical cash is that it doesn’t work at a distance because unless you carry it with you you can’t transfer it to someone else farther away
• Digital money relies on bookkeepers who are trusted by their customers to keep accurate accounts of balances they hold
• In a simple way, you can’t own and directly control digital money yourself. It relies on the support of a third party to store and manage it for you
• Online card payments are known as card not present payments and in person card payments are known as card present payments 
• Merchants and users are always charged some amount of fees for transactions for security and business purposes 
• Cash payments have no identity linked to them while digital payments always have identity linked to them which is not necessary
• Is it a fundamental right to be able to make payments which are shielded from the eyes of the government? Should people be able to make anonymous digital payments like they do with cash?

Defining Money

• The generally accepted definition of money is that it needs to fulfill 3 main functions:
  • 1. Medium of Exchange
    • You can use it to pay someone for something
    • Doesn’t need to be universally accepted but it should be widely accepted in the context
  • 2. Store of Value
    • In the near term your money will be worth the same as it is today
    • Needs to buy you the same amount of good and services a month or year from today
    • When this breaks and the value is eroded it’s known as inflation and people develop alternative ways to undertake transactions
  • 3. Unit of Account
    • It’s something that you can use to compare the value of two items
    • If you record the value of all your possessions you need some unit to price them in
• Some believe that good money should fulfill all these functions while others think these functions can be fulfilled by different instruments
• The US dollar purchasing power has fallen 96% since the federal reserve system was created in 1913 so it is a poor store of value

How does bitcoin measure up against these definitions?

• As a medium of exchange bitcoin is the very first digital asset of value that can be transferred over the internet without any specific third party having to approve the transaction or being able to deny it as well as protecting your identity
• There is a small amount of merchant adoption
• It still is slower and more resource intensive than a traditional digital payment
• Bitcoin as a store of value has been extremely volatile but it has been an awesome investment
• That being said besides being a speculative investment it’s a pretty volatile and risky place to put your money for a store of value
• Bitcoin has a limited supply built into it so it seems it should hold it’s value but that’s only if the demand of bitcoin stays consistent over time
• As a unit of account bitcoin fails miserably due to its price volatility against the USD
• Almost no merchants are willing to price items in bitcoin because of the price volatility
• This is why there is a quest for stable coins or cryptocurrencies whose prices are relatively stable compared to the USD

Brief History of Money

• Forms of money
  • Barter (exchange valuable items)
  • Commodity money (money is the valuable thing)
  • Representative money (money is claim on valuable thing)
  • Fiat currency (money is de-linked from valuable thing)
• Gold Standards
  • 1. Gold specie standard: coins are made of gold and are a certain weight- this is commodity money
  • 2. Gold bullion standard: Notes or bits of paper are redeemable at the issuer (central bank) for gold- this is representative money
  • 3. Non convertible gold bullion standard: issuer declares that their currency is worth a certain amount of gold but doesn’t allow you to redeem your money for gold
• The US dollar peg to gold went through a number of different attempts but ultimately failed 
• The US gold standard failed in 1976 when the dollar became a pure fiat currency
• People talk about a gold standard but something is not a gold standard if you can’t redeem your dollars for gold or you keep changing the rate and implementing a gold standard is difficult

Fiat Currency & Intrinsic Value

• People argue that bitcoin has no intrinsic value but this isn’t a good argument because fiat currency has no intrinsic value either
• Fiat currency has no intrinsic value as the paper used for banknotes is in principle worthless
• Fiat money is money that has no intrinsic value and does not represent an asset in a vault somewhere. It’s value comes from being declared legal tender by the government of the issuing country
• What matters is the utility in the asset and the ability to use it in your country to settle payments 
• It is just a form of accounting units for the value you produce and own in your economy 

Currency Pegs

• A currency peg is when someone in charge declares that one currency is worth a fixed amount of another currency and attempts to maintain that exchange rate by matching the supply of either currency with the demand

Quantitative Easing

• QE is a euphemism for an issuing authority (generally central bank) increasing the amount of fiat money in circulation in order to simulate a flagging economy
• The central bank buys assets, usually bonds, from the private sector (commercial banks, asset managers, hedge funds) in the secondary market

The history of money is characterized by its failures. Inflation, dilution, debasement, clipping, re-coining, and creation of new tokens worth less and less all appear frequently. The theme with money seems to be that whatever form it takes, it gets watered down either through debasement or by excessive creation until a certain limit, then there is a reform.

Part 2: Digital Money

How are Interbank Payments Made

• We easily understand physical cash payments when they are made but not digital bank payments…..physical cash payments are considered peer to peer
• The digital money world uses a bookkeeper who is an independent third party who because they are regulated can be trusted to maintain accurate books and records and bide by certain rules 
• We trust that when you instruct your bank to make a payment the amount of money leaving our account is the same as the amount that is entering the recipient’s account (less fees)
• With any digital asset we need a trusted bookkeeper to maintain a list of who owns what and who plays by some well understood rules

Same Bank Payments

• When someone makes a payment between the same bank that person instructs the bank to make the payment and the bank then adjusts their records by subtracting money from one account and adding to another
• This is called a book transfer in banking jargon and no money moves into or out of the bank
• We can imagine banking as a giant spreadsheet with a list of account holders
• Money in customers accounts at banks is a liability for the bank

Different Bank Payments

• There are 2 ways banks can digitally pay another bank
  • 1. Correspondent bank accounts 
  • 2. Using central bank payment system
• Correspondent bank account are bank accounts that banks open with other banks 
• The problem with correspondent bank accounts is that you would have to maintain accounts at every other bank your customers would want to transfer money to
• The purpose of a central bank account is to allow banks in each jurisdiction to pay each other electronically without each of them having to maintain account with one another
• The idea is that a central bank acts as a bank for the banks in its currency zone
• This allows payments to be made between any of the banks in the jurisdiction where each bank need to only maintain one account at the central bank instead of accounts with every bank
• So when dealing with a single currency:
  • If both customers bank with the same bank that bank clears the transaction
  • If two banks have a correspondent banking relationship then the receiving bank clears the transaction
  • If there is a central bank system- a RTGS or DNS- then the central bank clears the transaction

International payments

• There are payments of single currencies across borders and transfers of value across borders with foreign exchange where the sender and receive are working in different currencies
• Money in general does not leave its domestic currency zone
• There is no central bank of the world to clear international payments so we have to fall back to the less efficient correspondent banking systems
• In terms of foreign exchange, different currencies don’t simply become other currencies you have to find someone to exchange them with

Part 3: Cryptography

• Cryptography is about sending secret messages that can be read only by the intended recipient. It’s the stuff that spies use

Encryption & Decryption

• Encryption is the process of turning a plaintext or readable human message into cyphertext so that if the encrypted message is intercepted a snooper can’t understand it 
• Decryption is the process of turning the gobbledegook cyphertext back into readable plaintext
• Breaking the cyphertext means working out how to decrypt cyphertext without being given the key
• Nothing on the bitcoin network is encrypted by default. The whole point is that plain text transaction data is replicated across the network so that anyone can read and validate it
• Other cryptographic schemes such as public key schemes and cryptographic hashes are used extensively in Bitcoin 

Public Key Cryptography

• In public key cryptography the key used to decrypt a message is different than the key used to encrypt the message which is known as asymmetric scheme making it more secure
• In asymmetric cryptography if you want to receive encrypted messages you create two mathematically linked keys: a public key and a private key
• You can share your public key and anyone can use it to encrypt messages for you
• You use your private key known only to you to decrypt those messages 
• Bitcoin uses a scheme called ECDSA- elliptic curve digital signature algorithm where it picks a random number between 0 and 2^256-1 which when written out has 78 digits which is your private key
• Then it does some ECDSA math on it to generate a public key

Hashes

• A hash function is a series of mathematical steps or algorithms that you can perform on some input data, resulting in a fingerprint, or digest, or simply a hash
• There are basic hash functions not used in blockchains and cryptographic hash functions used in blockchains
• Basic hash functions could be “use the first character of the input” of Hash(what time is it) =W
• W is the hash value
• Cryptographic hash functions have 5 main properties
  • 1. It is deterministic so the same message always results in the same hash
  • 2. It is quick to compute the hash value for any given message
  • 3. It is not feasible to generate a message from its hash value except by trying all possible messages
  • 4. A small change to a message should change the hash value so extensively that the new has value appears appears uncorrelated with old value
  • 5. It is not feasible to find two different messages with the same hash value
• This process where you can easily go forward but you can’t go backwards from the hash value makes them more secure and like a trapdoor function
• Cryptographic hashes are used in bitcoin in a number of places
  • Mining process
  • Identifiers for transactions
  • Identifiers for blocks in order to link them in a chain
  • Ensuring that data tampering is immediately evident

Digital Signatures

• Used extensively in bitcoin and blockchains for creating valid transactions by signing messages to move coins from your account to someone elses
• A digital signature is created by taking the message you want to sign and applying a mathematical formula with you private key….anyone who knows your public key can mathematically verify that this signature was indeed created by the holder of the associated private key
• Wet ink on paper signatures are problematic because there is no way of knowing if a document has been tampered after your signature is applied and your signature can easily be copied

Why Alice and Bob

• In cryptography alice and bob are often used because they are the first characters used by Ron Rivest, Adi Shamir, and Leonard Adleman in their 1978 paper

Part 4: Cryptocurrencies

• There are tons of different cryptocurrencies each working differently with different rules  and mechanisms that’s you can’t really make generalizations

Bitcoin

• It may be better to refer to bitcoin as an electronic asset instead of a cryptocurrency or digital currency
• Bitcoins are digital assets (coins) whose ownership is recorded on an electronic ledger that is updated on about 10,000 independently operated computers around the world that connect and gossip with each other
• The ledger is called bitcoins blockchain
• Transactions that record transfer of ownership of those coins are created and validated according to a protocol which is implemented by software that participants run on their computers 
• The machines running the apps are called nodes of the network
• Specialist nodes called miners bundle together valid transactions into blocks and distribute those blocks to nodes across the network
• Anyone can buy and own bitcoins and every transaction is recorded and shared publicly in plain text on bitcoin’s blockchain

The Point of Bitcoin

• To create a peer to peer version of electronic cash that would allow online payments to be sent directly from one party to another without going through a financial institution

How Bitcoin Works

• Transactions are payment instructions of specific amounts of bitcoin from one user generated account to another
• Transactions are created using wallet software, authenticated with unique digital signatures, then sent to bookkeepers (nodes) who individually validate them according to some well known business and technical rules
• Bookkeepers then add valid transactions to their mempool and distribute them to other bookkeepers that they are connected to
• Miners gather these transactions into blocks and compete with each other to mine their blocks by tweaking the block contents,  specifically the nonce field, until the hash of the block is smaller than some target number
• Target number is based on the difficulty setting at the time which is derived from the time taken to mine the previous set of blocks to achieve a network wide target frequency of one new mined block every 10 minutes
• MIners receive financial incentive in the form of new BTC and transaction fees which they may credit themselves to compensate for spending resources to perform the competitive  hashing needed to create valid blocks
• Blocks link to each other in a unique sequence to form a ledger, the bitcoin blockchain, that is recorded identically almost simultaneously on thousands of computers around the world that run bitcoin software
• If a bitcoin transaction is not recorded on this blockchain it is not a bitcoin transaction 
• There is no central authority who controls the ledger or who can censor specific transactions
• DIfferent blockchain platforms work differently

Bitcoins Ecosystem

• Bitcoins ecosystem consists of parties who perform different functions
• Miners and bookkeepers focus on building and maintaining the blockchain
• Wallets make it easy for people to use cryptocurrencies
• Exchanges and crypto payments processors bridge between the fiat and crypto worlds
• It’s also important to note that bitcoin is not as decentralized as people believe it to be….around 80% of the hash power is controlled by Chinese entities, most bitcoin nodes are running the same software which is written and controlled by a small number of people, the mining hardware is also mainly produced by Bitmain a chinese company, and bitcoin ownership shows a concentration in a small number of people

Other Bitcoin Notes

• Bitcoins are not stored in wallets your private keys are which enable you to see your ownership and to make payments
• Ownership of bitcoins is recorded on bitcoins blockchain so you can look at that database and see that at this time a specific address has a specific number of bitcoins associated with it
• Bitcoin wallets are apps that 
  • Create new bitcoin addresses and store the corresponding private keys
  • Display your addresses to someone who wants to send you a payment
  • Display how many bitcoins are in your addresses
  • Make bitcoin payments
• There are also hardware wallets like trezor or ledger nano
• You buy and sell bitcoins and other crypto on crypto exchanges 
• Satoshi Nakamoto was the author of the bitcoin whitepaper and creator of Bitcoin who  has kept his real identity anonymous …..he owns a significant portion of bitcoin around 1 million so he is super rich

Ethereum 

What is Ethereum

• The vision of ethereum is to create an unstoppable, censorship resistant, self-sustaining, decentralized world computer
• Ethereum is trustless validation and distributed storage and processing of data and logic
• In contrast to bitcoin ethereum transactions can contain more than just payment data and the nodes in ethereum are capable of validating and processing much more than simple payments
• On ethereum you can submit transactions that create smart contracts -small bits of general purpose logic that are stored on ethereum blockchain
• Smart contracts can be invoked by sending ether to them a bit like a juke machine
• To participate in the ethereum network you can download some software called an ethereum client where you can then perform functions

Ethereum is similar to bitcoin because

• It has an inbuilt cryptocurrency
• Has a blockchain
• It’s public and permissionless
• Has proof of work mining 

Ethereum is different from bitcoin because

• The ethereum virtual machine can run smart contracts 
• It has gas fees which are used to support more complex computations kinda like a price chart for what you want to do
• Gas price is the amount of ETH you are prepared to pay per unit of gas for the transaction to be processed
• You can set a gas limit 
• ETH has wei units where one ETH can be split into smaller amounts like BTC
• Ethereum block time is shorter at 14 seconds compared to 10 minutes for bitcoin
• Ethereum has smaller blocks
• Ethereum uses the word account instead of addresses that bitcoin uses
• Issuance of ETH tokens is more complicated than BTC
• Ethereum has an active leader Vitalik Buterin while bitcoin does not

Smart Contracts 

• Short computer programs that are stored on ethereum’s blockchain, replicated across all nodes, and available for anyone to inspect
• There are 2 steps performed separately 
  • 1. Uploading the smart contract to ethereums blockchain
  • 2. Making the smart contract run

Cryptocurrency Forks

• A crypto fork is either a fork of a codebase or a fork of a live blockchain (chainsplit)
• You either create an entirely new ledger which is achieved by forking a codebase
• Or you create a new coin that has a shared history with an existing coin by forking a blockchain

Part 5: Digital Tokens

• Tokens can mean different things depending on the context
• A token is essentially something that is issued by an issuer which can be used in a specific context or marketplace
• The token has value because the context gives it value 
• If you take the token outside the context the value drops to zero
• To owner a token in the crypto asset context you need to be the person who has the private key that corresponds to the address with which the token is associated
• Types of tokens
  • Native blockchain tokens: usually the incentive for block creators to work and cryptocurrencies are usually these tokens
  • Platform tokens: required to use general purpose decentralized networks that support a wide variety of applications….same as native tokens 
  • Asset backed tokens: represent title or ownership to some real world asset held in trust by a custodian
  • Utility tokens: represent a claim on a service provided by the issuer of the token

Notable Cryptocurrencies and Tokens

Currency tokens (used as money or store of value)

• Bitcoin
• Ripple 
• Litecoin
• Zcash
• Dash
• Monero

Platform Tokens (used as gas to power smart contracts)

• Ethereum
• Ethereum classic
• New economy movement
• EOS

Utility Tokens

• Augur
• Siacoin
• Golem
• Gnosis

Brand Tokens

• Basic attention token
• Civic
• steem

Part 6: Blockchain Technology

• Blockchains can be categorized as distributed ledgers 
• Blockchain technologies are the rules or standards for how a ledger is created and maintained and different technologies have different rules for participation, network rules, specifications for how to create transactions, methods of storing data, and consensus mechanisms
• Public permissionless blockchains are usually used by cryptocurrencies
• Private permissioned blockchains are designed to allow groups of participants to create their own blockchains in a private context which a lot of private companies are using
• Private blockchains don’t need their own token or need to incentivize block creators

What is Common to Blockchain Technologies?

1. A database that records changes in data
2. Replication of the data store across a number of systems in real time
3. Peer to peer rather than client server network architecture
4. Cryptographic methods such as digital signatures to prove ownership and authenticity and hashes for references and sometimes to manage write access

What are Blockchains Good For?

Public blockchains are good for:

1. Speculation
2. Darknet markets 
3. Cross border payments
4. Initial coin offerings

Part 7: Initial Coin Offerings ICO’s

• ICOs are sometimes called token sales or token generation events and are a new way for companies to raise money without diluting ownership of the company or having to pay investors back
• Other traditional ways companies raise money is by equity, debt, or pre-ordering used often in crowdfunding
• ICOs work when a company describes a particular product or service in a document called a whitepaper and announces their ICO. Investors send funds usually cryptocurrencies to the company in return for tokens or a promise of tokens in the future
• The tokens can represent anything but usually represent either financial securities linked to the success of the project or access to a product or service created by the venture

Part 8: Investing

• People have made and lost fortunes in the crypto markets 

Pricing

• For tokens that are a claim on an underlying asset like 1 oz of gold the price of the token should more or less track the price of the underlying asset but cryptocurrencies are not like that
• Cryptocurrencies are not a claim on any asset nor are they backed by an entity so how do you calculate a fair price?
  • 1. What is the current price of the crypoasset?
  • 2. What causes prices to change?
  • 3. What should the price be?
• The current price of any asset is determined by the market
• The prices of cryptocurrencies and tokens behave like any other financial asset, driven by buyers and sellers who make trading decisions based on various factors:
  • 1. Sentiment (how traders feel about the asset)
  • 2. Gossip and chatter on forums and social media sites
  • 3. Technical successes
  • 4. Technical failures 
  • 5. Celebrity endorsements 
  • 6. Founders getting arrested
  • 7. Orchestrated pump and dumps where people coordinate to all buy a coin together to make the price go up then sell
  • 8. Manipulation by large holders of any particular token

Risks and Mitigations

• Crypto asset prices are very volatile and a lot of them have fallen to zero
• Liquidity risk is the risk that the market cannot support your transaction at the price you expect
• Exchanges also sometimes have issues keeping customers assets secure
• Wallets often have security risks involved with them if they are stored online when your private keys are stored online on the internet
• Hardware wallets are the best compromise between security and convenience
• There are also plenty of regulatory risks and scams in the crypto world

Conclusion

The two most important things that have been created in the crypto industry are:

1. New censorship resistant financial assets, methods of value transfer, and transparent automation
2. New technologies for business to business data and asset transfer