Automated Banking, With Bitcoin: PART FIVE

PART FIVE – UPGRADING BANKING, SENDING AND RECORDING BITCOIN MESSAGES

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The following is an ongoing series we are calling Automated Banking, With Bitcoin.

The aim of this series is to offer a clear and full picture of Bitcoin for all ages and levels of adoption from nocoiner, to precoiner, to remnant pleb, in the context of fiat, and with an eye towards the inevitable outcome currently in progress. We hope you take the time to share and discuss this series as it unfolds with family and friends.

Enjoy.

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RECAP

• PART ONE - BITCOINS THREE COMPONENTS, AND AUTOMATED FINANCIALS

• PART TWO - AN ERA OF FRAUD, IMMUTABLE LEDGERS WITH FIXED SUPPLIES

In Parts One and Two we compared Bitcoins singular, public, and immutable ledger system, with the current state of the art corporate, governmental, institutional, and banking systems multiplicative, private, and sometimes tragically fraudulent, ledger system(s).

• PART THREE - UNLIMITED TOKEN SUPPLY, AND FIXED TOKEN SUPPLY

• PART FOUR - BAD INCENTIVES, GOOD INCENTIVES, RANDOM NUMBERS

In Part Three and Four we looked at the noncustodial infinite supply of bank reserves and contrasted that with the self custodial fixed supply of Bitcoin tokens.

In this Part Five we take a closer look at the transactional mechanics of Bitcoin.

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PHYSICAL CASH (GOLD) TO ELECTRONIC CASH (BITCOIN)

For all its fraud waste and abuse, the modern banking system, and the bankers and governments that implemented it, in effectively every country on the planet, had the right idea.

Humanity badly needed an upgrade from the slow and expensive, to move yellow rocks we used as the basis for the modern banking system over the last 2,000 years, as the rest of societies technological growth began to outpace the antiquated system.

Gold became increasingly difficult to custody, prone to forgery, debasement, and impractical in everyday trade with its lack of divisibility.

Let’s listen in once again to another exceptional lesson from Darin Feinstein as he explains to Peter McCormack, host of the What Bitcoin Did podcast, explaining the development of modern banking, with his emphasis on its primary initial two functions; monetary transaction confirmations and monetary custodianship:

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With the help of his five sons, a Jewish banker from Frankfurt, Germany, Mayer Amschel Rothchild, established banks in Frankfurt, London, Paris, Vienna, and Naples, during the early 1800’s, that would serve as the steppingstone to the inevitable path forward, upgrading the world from the antiquated banking system based on physical gold money, into digital private ledgers without the need for slow and cumbersome physical money.

This upgrade concluded its first phase of implementation with the confiscation of the citizens of the worlds gold from all of these countries that founded a Rothchild bank including Germany, England, France, Austria, and Italy, by their local governments.

In fact most all modern societies in the first half of the 1900’s including the United States, Russia, and many others countries conducted a systematic confiscation of their citizens gold from the banking system. Surely in part an effort to line their pockets and fund their constituents, but also at a more practical level, it was an effort to move to a ledger based banking system, without the need to transfer or custody physical gold money, as it continued to grow increasingly more expensive to do so.

This was a painful step in the process towards Bitcoin, though it was a necessary step, to cement the reality that if money can be stolen, it will be, and when it is, World Wars, Great Depressions, and rampant inflation will ensue, and that therefore, what is needed is a money impervious to confiscation, easy to self-custody, with a fixed supply, that can be transacted peer to peer without trusted third parties.

The second phase of the antiquated banking upgrade was the conversion by the banks and their governments to move from physical gold to ledgers, for not only their citizens money, but also for all the governments of the world. This process concluded in 1971 when physical gold was completely eradicated from global trade, as the US unilaterally declared trade would be made in US dollars, using a credit based ledger system. This became the backbone of the modern global banking and monetary system.

Over the following decades, as computers became more ubiquitous, the physical private ledgers would reach full optimization as digital ledger systems, operating through electronic messaging networks, and digital private ledgers at each of the central banks, their member banks, and the local and regional banks that operated below them, completely detached from physical money, save for a small inconsequential percentage.

With all of the speed and divisibility solved, custody was still an issue. Even though the physicality of money no longer existed, the amount of units represented in the digital ledgers remained with trusted third parties, with the banking institutions.

Satoshi explained the limitations of this modern digital third party trust based system, we know as modern banking, in his 2008 whitepaper entitled “Bitcoin: A Peer-to-Peer Electronic Cash System”:

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 really 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.

The problem with this private digital ledger system is that there is no self custodial token, no “electronic cash” that all of the customers of the banks can utilize as a digital form of money. Digital ledger money solved the physical problems of gold money, but it introduced a new problem, the lack of self custody.

Bitcoins technological innovation is it’s self custodial monetary units that can be transacted without trusted third parties, and verified on an immutable digital public ledger.

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MODERN BANKING IS THE MYSPACE OF MONEY

In a way the modern banking system is like the Myspace version of a non physical digital ledger design, with Bitcoin being Facebook offering a more robust user experience with a fixed supply basis of units, and an ability to initiate bitcoin unit transfers without the need of a privileged bank or trusted third party intermediary. In time, the Myspace of banking will fade into a foggy memory for some and forgotten entirely by most, save for the node runners of the world whom will recite the history of the fiat standard on an annual basis, forever, so humanity never forgets from whence we came, to understand how far we can go.

Here is Saifedean Ammous, the Palestinian author of Principles of Economics, discussing Bitcoins innovation with the talented Polish host of Coin Stories, Natalie Brunell. I’ve purposefully gone out of the way to include their heritage here as it is relevant in this clip and the broader context of the necessary upgrade that is required of our money. Saif explains that Bitcoin is the new technology that protects humanity from well-intended socialist and Marxist Keynesian money printers:

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Satoshi has a succinct explanation in his whitepaper of the problem that Bitcoin solves:

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.

Prior to Bitcoin there was never a way to digitally send a payment peer to peer.

Historically, in order to send money over the internet, from one bank to another through a digital messaging system, the banking infrastructure, the government licensing, and the independent financial statement auditors provided the requisite trust in the system, acting as the gatekeepers, changing the balances in their private ledgers, representing the appropriate transactions of money.

The trouble with this modern banking system is that it does not not allow for it’s customers to send money peer to peer because there is no “money” in the system, there is simply ledger entries at each of the banks representing balances of “money.”

With Bitcoin the “money” is tethered to large random numbers that only the owners of the money control. In Bitcoin, the only way to send money from one person to another is peer to peer, to have the owner of the large random number with bitcoin assigned to it, write a message indicating how many units of his bitcoin he wants to send, to what other large random number he wants to send those units to, how much of a fee he wants to pay for someone to batch his message, and lastly a public signature on the message that is mathematically derived from his large random number proving that he is the owner of the units to be transferred.

In other words with Bitcoin, the transactions are mandatorily peer to peer. There is no other way to execute a transaction. This contrasts starkly with the modern banking system in which the “owners” of the money, the bank depositors do not have an ability to send their money directly. In the modern banking system, the owners of the money, the depositors, are reliant 100% on the bank to process their transfer of money to whom they want, when they want.

Satoshi offers more clarity for us. This is from a February 2009 post;

The root problem with conventional currency is all the trust that's required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.

Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.

We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. Their massive overhead costs make micropayments impossible.

The bank depositors are 100% reliant that the bank, a government, or a foreign actor does not change his number of units reported in the banks ledger, or the total number of units in the banking system, which indirectly reduces the purchasing power of the bank depositors number of units in the ledger.

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SENDING BITCOIN MESSAGES

In the previous Part Four we noted that bitcoins are assigned to large random numbers. And while that is effectively true, there is a little more nuance we should layer in here.

Once a large random number is created, the number must remain private. The creator should never share this number with anyone for it is the control mechanism to send bitcoin assigned to that number.

To keep this number private and utilize it, through some elegant mathematics the number is converted into a public number, or a public “address” which has special properties.

Often these private and public numbers are referred to as “keys” like a private key that unlocks information associated with the public “key.”

The public address (or key) is mathematically derived from the large random private number (or private key), but the math works in such a way that it is impossible to derive the large random private number from the public number (or address). This is the basis of “cryptographic” math and where the “crypto” in cryptocurrency gets its name from.

In order to send bitcoin as stated above, four pieces of information are included in a message;

1. The sender needs to first have some bitcoin assigned to a public address that he derived from his large random private number and indicate how many units he is sending (or assigning) to the intended recipient.

2. He then needs an address from the recipient of whom he is sending the bitcoin. Again, the recipients public address is also derived from some other large random private number that only the recipient knows.

3. The sender also needs to include the amount of fees he is paying the miner (or message batcher) as we will learn of momentarily,

4. And lastly the sender needs to include one more special number in his message that is referred to as a signature, which is once again mathematically derived from, you guessed it, the senders large random private number. This signature is special not only because it is one way math like the public address, but also because it is what the network perceives as authorization to reassign the bitcoin units indicated in the message from the previous public addresses currently assigned to the bitcoin to the new public address of the recipient. The signature has the same properties of the address in that it is not possible to derive the large random number from the signature, and it has another property in that it is easy to mathematically verify with certainty that the signature was derived from the large random private number associated with the current public address currently associated with the bitcoin units prior to the transfer.

To have these units of bitcoin transferred, this “signed” message can be simply broadcast through the internet where it will be received by any thousands of listening nodes in every country of the world, waiting to receive such a message.

The cryptography in this private number, public number, or private key, public key system is not limited to “cryptocurrency” it is in fact used all over the place, including at your local bank, and most anywhere you make a payment or send a message over the internet.

Here is a great clip from James D’Angelo explaining the cryptography if you want some more details on the cryptography used in Bitcoin, and most everything else on the internet.

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RECORDING BITCOIN MESSAGES

Once a signed bitcoin message is sent, listening nodes, the same nodes that house and maintain the ledger discussed in Parts One and Two, store the signed message for miners, in a temporary pool along with other recently broadcasted signed messages also in the process of transferring or assigning bitcoin to different public addresses. You can think of this node pool (often referred to as a memory pool, or mempool) like a lounge at a nice resort where the messages are just chilling, totally relaxed sipping on pina colada, hanging out and waiting to be batched.

Eventually, the miners (or batchers as they may more aptly be referred to after their bitcoin creation foray ends in 2140) will select as many messages as possible with the highest amount of fees possible, to collect as payment, for their service of batching this next set of messages.

Generally the signed messages are chillin’ in their node pool for about ten minutes as the miners gather as many messages as they can fit into one bundle referred to as a block and then broadcast the batched messages to the network of nodes as a new block of work completed.

For their work, batching the messages, provided the miners follow the rules enforced by the nodes, the nodes will accept the block of messages as final, the bitcoin transferred and assigned to new large random numbers seen to the public as public addresses is thus then recorded to the public immutable ledger that each node maintains a copy of. And the successful miner collects the fees from each of the messages for his service of batching the messages into the most recent block recorded to the public ledger.

Through this messaging process, neither the nodes nor the miners care to know or could even figure out, who is associated with the creation of the messages, with the previous owner of the bitcoin and with the subsequent owner of the bitcoin. Bitcoin operates without discrimination to whom is sending or who is receiving monetary units.

This is once again in stark contrast to the modern banking system. Sending a payment via bank, can take days, not minutes, can cost a very large amount relative to the amount sent, may not be sent at all depending upon who the recipient is, what the reason for the transaction is, whether the bank is open to process the transaction, whether the recipients bank is open to process the transaction, whether the senders government wants to freeze or confiscate his funds for any particular reason, etc.

The nondiscriminatory trustless nature of Bitcoin is a tremendous advancement in the technology of money.

We’ll learn in Part Six more about the elusive miners that batch these bitcoin messages and why the modern world is going to be entirely turned on its head in the coming decades. Something about cheap abundant energy for everyone...

Until next time, amigos. Cheers!