Are Bitcoin Wallets Anonymous?-This is the Wrong Question.  

Are Bitcoin Wallets Anonymous
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Are Bitcoin wallets anonymous? No, they are not. No Bitcoin wallet can be claimed to be anonymous, but some can be considered to allow transactions to be more traceable than others. Indeed, the more appropriate question would be ‘are bitcoin wallets traceable?’

Bitcoin wallets are not anonymous because Bitcoin itself is not anonymous. 

But before we look at how different Bitcoin wallet applications might fair when it comes to traceability, and how your own actions is a factor, let’s first look at how and why Bitcoin and, therefore, Bitcoin wallets are not anonymous.

I know it might be confusing to hear that Bitcoin is not anonymous, especially if you are new to it and you’ve been told it is the digital currency of those who want to hide how they earn and spend their money.

In fact, the primary issue those who disapprove of Bitcoin have against it is that it can facilitate crime as users can easily hide their activities from law enforcement. That might be true, but it is not because Bitcoin is anonymous.

What does anonymity mean

The Google dictionary defines anonymity as the ‘lack of outstanding, individual, or unusual features; impersonality.’ This cannot be said of one’s presence and activity on the Bitcoin blockchain (the shared public ledger). 

You definitely have outstanding, individual and unusual features through your public address (public key) when you send and receive bitcoins. There are no two public addresses that are the same. Each address is unique and is like no other. I could extend it further and say that hardly any two Bitcoin transactions are the same, especially considering a bitcoin is divisible up to 8 decimal points. 

If Bitcoin were anonymous, you wouldn’t have a unique identifying piece of data (an address) you give those who need to send you bitcoins. 

Also, even in other aspects of the internet, achieving total anonymity is almost impossible. At any point, we seem to need some unique identifying tag. Even when you browse the net incognito, your IP address remains as a critical identifier. 

When you hear someone call Bitcoin anonymous what they really mean is that it is pseudo-anonymous. 

The difference is significant.

What is pseudo-anonymity? 

Pseudo-anonymity is a status achieved when you create a (mostly online) identity that is not linked directly to your real-world or legal identity. It is one way to preserve your privacy. 

For example, when one wants to use an email address that cannot be linked back to them (for whatever reason), they use made up names and place holder fake personal data to create one. What they end up having is a pseudo-anonymous email account.

They might use this identity to interact with others who they might not want to know who they indeed are or use it to create pseudo anonymous accounts on other online platforms.

That means they can send and receive messages without having to disclose their legal identity. True anonymity can only be achieved where you do not need to create any kind of profile (address) to use a service.

In the case of Bitcoin, and other cryptocurrencies, you use a pseudo-anonymous identity to send and receive digital currency. The idea is to get the experience of physical currency online. When you give out a $20 bill at the store, nothing on it indicates it came from you.

Meanwhile, if you make payment using PayPal, internet banking, or any other centralized digital payment method, there is always a trail leading to your doorstep. If their servers are hacked or they are under duress from the government to share data, your privacy regarding your finances is exposed to third parties.  

That is because you have to sign up for their services using your legal or real-world identity. The signup process often includes submitting a legal document to prove your identity. You may also have to share your postal and physical address.

Money spent on the Internet through centralized payment systems like PayPal or Internet banking lacks fungibility, an essential feature of money. One unit of the money might not be considered to be the same as another unit of the same amount or value.

That is because every piece of money is tainted by the path it takes and in particular the people who have owned it. Its history becomes a critical part of it. 

Pseudo-anonymity or anonymity, where it is achieved, attempts to delink digital money from its history, path, and the activities of those who have owned it in the past. Just like the physical cash is not necessarily tainted by the path it has taken and the hands it has gone through.

The reason why you cannot create a pseudo-anonymous account on PayPal or with your bank is that these are registered business entities that must abide by regulatory requirements.

In particular, they have to meet the Know Your Customer (KYC), Anti-Money Laundering (AML) and terrorist financing legal framework requirements. And these demands are typical in nearly every country on the globe.

Meanwhile, Bitcoin is a decentralized payment method. It is not in the control of a particular person or company. As the co-founder of asset management firm Morgan Creek Digital, Anthony Pompliano, stated in response to the infamous Trump tweet about not being a fan of Bitcoin, “With Bitcoin, there is no CEO. You can’t send a letter or send somebody in for a hearing.” 

In other words, there is no way to force Bitcoin to register its users using their legal or real-world identities. If that was the case, and it happened, centralized payment methods like PayPal would be way more private than Bitcoin because they do not publish the transaction ledgers for the public to see.

The identity you use on the Bitcoin ledger (blockchain) is a string of between 26 and 35 random letters and numbers. It is hard to memorize this identity (address). The Bitcoin protocol determines its shape and format. You have little say as what your public address should look like and the characters it should contain. The wallet application you are using randomly generates it for you. 

There is a push for human-readable public addresses though. Proponents of this feature believe it will make using Bitcoin easier, especially since you wouldn’t need only to copy paste or scan the address to share it. You will have the option to spell it like you do an email address. This has, however, only been tested on a few altcoins. 

A Bitcoin wallet address is normally known only to you until you share it with the person you want to send you bitcoins. And when they send the bitcoins, it will be published on the blockchain as a recipient of funds from the sender’s own public address.

The rest of the community will see on the addresses and the amount sent. However, it is only you and the sender who know the faces behind the addresses.

But that is not to say that attempts are not made to unmask those behind Bitcoin transactions. Some factors make it easy for transactions to be traceable, and one of those is the type of wallet application you use. 

That means third parties could find it easier to figure out the real-world identities of people involved in a transaction if the counterparties use particular wallet applications. This is especially the case if the sender fails to put in place necessary privacy safeguards.

It is important to emphasize that how you use any wallet application is an important factor as to whether your transactions can be linked back to you or not.

Delinking address and real-world identity.

As we’ve seen, you need an address on the blockchain to use bitcoin. It is vital that this pseudo-anonymous identity is not linked to your legal or real-world identity.

Your privacy with using Bitcoin is guaranteed as long as third parties are not able to link your transactions to your name.

Delinkage of your bitcoin transactions from your real world is always under threat. There are those who are really interested in knowing who is behind a Bitcoin transaction, and for various reasons.

Government agencies might want to know as part of monitoring possible criminal activities such as money laundering and terrorist financing. The government is also interested in this data because it wants to see if you are paying due taxes.

On the other hand, criminals might also be interested in linking your blockchain address and your real world so that they can attempt to phish you and social engineer you so that they can collect your private keys to steal from you.  

Businesses might want to get hold of this data so that they can target you with ads and sales offers.

Things that make you vulnerable. 

There are several things you might do or fail to do that make you vulnerable. For example, if you create an account on an exchange and you are required to verify your identity, then the likelihood of someone attaching your name to the bitcoins you buy from that exchange is very high.

In fact, there are now for business entities engaged in doing surveillance and analysis of the transactions on the blockchain to determine the real world identities of senders and recipients.

One of those entities is Chainalysis, a company founded in 2014 to help law enforcement and companies track the movement of Bitcoin and highlight crime tainted transactions.

To counter-surveillance on the Bitcoin blockchain, users have access to a few tools. One of these is mixers, online pools where transactions are taken through and given new IDs so that they shake off any trail.

Unfortunately, many of these services are centralized, and therefore, they are vulnerable to being shut down. In fact, a few have been forced to shut down in the recent past. In late May 2019, Dutch Financial Criminal Investigative Service shut down BestMixer.io.   

Over time, since the launch of Bitcoin, we’ve seen the rise of cryptocurrencies that can be described as near anonymous. The most known of these is Monero and ZCash. 

The transactions of these decentralized currencies are not published on the shared ledger in a way that all details such as source and destination address, amount and time are visible to the public. The technology they use has allowed the networks to confirm the authenticity of transactions without accessing these details.

Now, how do wallets factor into this?

The question ‘can bitcoin wallets be traced?’ needs some unpacking because the answer has to be nuanced.

It is important to note that there tens of types of Bitcoin wallets that you can use. 

Each of these types of Bitcoin wallets is designed with unique features, capabilities, and architectures. These determine in a significant way whether that particular wallet makes your transactions easily traceable or not.

Also important is who designs and manages a wallet application. In particular, the control they have on how it works and their access to the data the wallet application generates.

Some wallet service platforms are offered and managed by for-profit centralized entities such as exchanges. For example, Coinbase, the largest crypto exchange in the US, provides a wallet service. Meaning you can create and run a Bitcoin wallet on their platform.

Some wallet applications are entirely open source community projects. Meaning no one entity is in charge or in control to harvest data.

The potential of traceability is high with Coinbase wallet, in particular, because they require users to verify their identities to use some of their services.

For example, using Electrum wallet on your desktop, an open source wallet application with no attached services that require you to identify yourself, has a lower potential of your transactions being traced.

Ideally, as a Bitcoin user, you should use a wallet that you have full control of. In particular, it should be a full-node wallet application installed and running on your local computer. 

A wallet you access through a browser or a mobile application is most likely relying on a service by a third party, a situation that increases the possibility of traceability.

Another factor that might make one wallet more traceable than another is the ability to generate new wallet addresses.

As a precaution, Bitcoin users are encouraged to use one address for a single transaction. That means for every payment you receive, you should create and provide a new address to whoever is sending you Bitcoins.

While possible, using a single address for multiple transactions makes it easier for whoever is trying to identify your activity on the blockchain to link them to you. And this situation doesn’t expose only you but also those who transact with you. 

Some wallet applications might have a robust mechanism for wallet address generation every time you want to receive bitcoins and others might be designed in a way that you will find yourself using the same address several times, thus increasing the chances of someone linking your transactions to your real life identity.

So, can bitcoin wallets be traced?

It depends on the following factors:

The type of wallet application

The exact kind of wallet you are using. Whether it is open source or offered by a third party. And whether it has inbuilt privacy features such as automated address generating system. You should use wallets from the list provided by the Bitcoin.org, the project’s official website. 

How you use the wallet application

The second factor is how you are using the wallet application.  Are you using it on a secure device? Do you use a new address for every transaction and do you adequately protect your private keys by keeping them in cold storage.

Where you use your wallet

The third factor is where you use your wallet. Do you use your wallet to get services that require you to identify yourself? Do you shop using your bitcoins on a site where you need to leave your identity or buy bitcoins from an exchange that requires you to verify your identity? 

 

You Can Buy Bitcoin on One Exchange and Sell on Another, But…

can I buy Bitcoin on one exchange and sell on another
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If you are like many people, you’ve probably sought to know how you can increase your value (or make money) with Bitcoin, and cryptocurrencies in general. 

And one of the questions you’ve probably asked yourself is ‘can I buy Bitcoin on one exchange and sell on another for a profit?

This is known as Bitcoin arbitrage, a concept borrowed from the stock markets, where investors can buy stock from an exchange with lower price offers and sell them on exchanges with higher price offers.

Before we dive in, an important disclaimer; this post should not be taken as professional investment advice. The content therein is for informational purposes only.

Now, can you arbitrage Bitcoin?

Yes, you can buy bitcoin on one exchange and sell on another and make some profit, but it is never as easy as it might seem. Many obstacles stand in your way, and you may need to do a lot more to succeed. 

In our last post, we looked at how Bitcoin exchanges work. It might be helpful to read it first before coming to this one. 

As pointed out in that post, there are about 250 crypto exchanges around the globe. Some are global, with a clientele from all over the place. Others cater to specific regions and countries. 

The basis of the question of whether you can buy bitcoin on one exchange and sell on another is the fact that prices on these exchanges are not exactly the same. If you did a spot check at precisely the same time, some would be showing rates that are a little higher than those on others. At times we have witnessed a price difference that is as high as 40%.

That was the gap that was witnessed between South Korean crypto exchanges and those in other countries in January 2018. 

Now and then huge differences in Bitcoin price have also occurred between exchanges in countries like Zimbabwe and Venezuela and those in the rest of the globe. 

In 2017, exchanges operating in Zimbabwe were selling Bitcoin at a premium price that exceeded the global rate by over 10%.

In January 2019, we saw the price of Bitcoin and other cryptos in Venezuela exceed the global prices by a premium of about 40%.

But why is Bitcoin price different on exchanges?

The price of bitcoin like that of any asset in a free market is determined by supply and demand. In particular, the variation in demand for bitcoin in different parts of the globe is the primary cause of the difference in exchange prices. 

Some factors influencing the price of bitcoin are global. For example, when the block reward halves after every four years, the supply shrinks for the entire global market and that pushes up the price for all the exchanges in the same way.

However, many local factors could drive the price higher for one exchange and not others. A good example is high inflation and the failure of economic policies in a particular country that an exchange has as a primary market.

Zimbabwe is a good example where inflation has gone really high. At some point the country’s currency became worthless, and people had to look for alternatives. Bitcoin has been one of the other options, and that saw its price in the country has been higher than the global average.

Venezuela has seen poor economic policies by the government coupled by sanctions from the US and others result in high inflation making cryptocurrencies attractive to the population, and that made the price higher in the country than what was available in other countries.

The other factor that influences different bitcoin prices on different exchanges is regulation. Exchanges face different demands, including taxation by various jurisdictions. These translate to different user experiences, fees, demand and ultimately the price.

So, in short, local economic trends, political stability and regulatory policies play a significant role in making exchanges have different Bitcoin and crypto prices. 

It is also important to point out that Bitcoin exchanges are independent entities with different business models, fee structures and strategies. In fact, they are mostly silo-ed except for customers who use multiple of them. 

Moreover, they have different volumes and trade activity. All these contribute to each having slightly different pricing from the next.

Is bitcoin arbitrage legal?

To some, stock arbitrage may seem unethical. Indeed, it is common for some to ask ‘is arbitrage illegal?’

It could be if someone uses internal information or shares it to those who could use it to their advantage. In other words, if someone leaks information about actions about to be taken, which could affect the stock price, then we are likely looking at illegal activities.

 However, if an investor is taking advantage and exploiting the difference in price on two exchanges to make a profit, then there is nothing illegal about it. The same view can be taken on Bitcoin arbitrage.

Challenges to arbitrage Bitcoin

While it is possible to buy bitcoins on one exchange and sell on another, it is not easy. You have to overcome the following challenges to be successful:

High volatility of the bitcoin price

The bitcoin price often changes fast. It is usual for the cryptocurrency gain and loses value in a matter of seconds. And the price change doesn’t always move in the same direction on all exchanges, at least not in the short term (say seconds, minutes and hours).

That means you may see an arbitrage opportunity between two exchanges, but within a few minutes, it gets erased. These fast price changes might require you to act fast; otherwise, a profit opportunity could quickly turn into a massive loss by the time you sell on the other exchange. 

Slow fiat payment (depositing) options

On many exchanges, you need to deposit the fiat currency on an account on their platform before you can buy cryptos. You can make a deposit using a bank transfer, debit card or even a service like PayPal. 

It turns out, however, that many times it takes a very long time before the money is received on the exchange. With bank transfer, it could take as long as seven days. Considering the volatility of the bitcoin price, waiting that long to exploit price difference on two exchanges is not practical.

 Speed is of the essence in Bitcoin arbitrage.

Different requirements by different exchanges to use their service

Huge Bitcoin price gaps usually occur between exchanges in different countries. The requirements to join these exchanges and trade are not the same. Indeed, some are closed off to people in some regions.

For example, someone in America you might struggle to get approval to trade on Chinese exchanges. That means you might miss very lucrative opportunities simply because you couldn’t get a working account on one of the exchanges you eyed for arbitrage. This is mostly the case, especially if you seek to trade large amounts.

The whole situation is complicated by how difficult it is at times to move fiat currency between countries.

The hidden cost of transacting

The Bitcoin prices indicated on exchanges do not include the fees you will have to pay to make a purchase or a sale. These fees are usually added at the point of transferring funds to a buyer or from a buyer. And therefore you may end up learning about them when it is too late to do anything.

It may turn out that the exchange that indicates a lower price charges a lot more fees, which would cancel whatever profit you thought you were going to make. 

You will pay fees to sell and buy. You may also pay fees to deposit and withdraw from the exchange. 

The fees you may incur extend beyond those charged by the exchange. You also have to pay fees to move funds from your bank account to the exchange account. Also, you may be charged to convert your funds from one fiat currency to the one used on the exchange, and back when you make withdrawals.

When you add all these fees and cost, the total is likely to erase any profit you make from the arbitrage.

What you may do to increase your success with Bitcoin arbitrage.

The first thing you should do is to study the exchanges between which you want to trade and make sure you know how they work. In particular, you should be aware of all the fees you would incur when you buy from one and sell on another. Consider if the cost would eat too much into the price difference.

The second thing to do is to register and get approval on the exchanges you want to trade beforehand. This is part of being prepared so that you are able to act quickly when arbitrage opportunities come.  

Given that speed is critical, you always need to have funds ready on exchanges as you wait for an opportunity to act. That means no time is lost. You may need to have both fiat and crypto funds on all exchanges you intend to trade on.

That means if the price is lower on exchange A than on exchange B, you buy on A using fiat already there. You then head offer to B and sell the corresponding amount of cryptocurrency you already have on your wallet there.

 All in all, you need to do a lot of learning as well as research before you start doing Bitcoin arbitrage on various exchanges.

Can the Bitcoin Network be Shut Down? Why it’s not Done.

On July 12, 2019, President Donald Trump tweeted about Bitcoin. 

He is the highest ranking US politician who has publicly registered dislike or disapproval of Bitcoin. He joins a growing list of politicians hostile to Bitcoin. 

In May, the Nobel peace winning economist Joseph Stiglitz added his voice to the debate of whether Bitcoin and other cryptocurrency have a place in the global economy. He thinks the US dollar is the best currency society can ever have, and cryptocurrencies should be shut down.

In November 2015, JPMorgan Chase CEO Jimmie Dimon was quoted stating:

 “Virtual currency, where it’s called a bitcoin vs a U.S. dollar, that’s going to be stopped. No government will ever support a virtual currency that goes around borders and doesn’t have the same controls. It’s not going to happen.”

Many more attacks on Bitcoin have come from Jimmie Dimon since then, even though JPMorgan does offer customers ways to invest in the cryptocurrency.

If you are planning to buy some bitcoins or invest in any asset it backs or a company that offers bitcoin-related services, then such verbal attacks, and in particular calls for it to be stopped, from high ranking politicians, award-winning academics and banking executives would most likely make you wonder ‘can the Bitcoin network be shut down?

What is at stake

The Bitcoin network is the peer-to-peer network of independent computers that participate in maintaining the Bitcoin shared ledger (or blockchain) through mining. 

The Bitcoin network serves as the cryptocurrency’s backend server. It stores all transaction data and executes all the necessary operation code to make bitcoin payments possible. 

Shutting it down could have worse results than shutting down the servers of a major global commercial bank. 

The Bitcoin network holds a lot of value, both directly and indirectly. For starters, the market capitalization of its native currency (bitcoin) is above US$200 billion, and it is highly likely to double in the next few years, especially with the upcoming reward having in 2020 (reduces supply) and the general growing interest around the world (increases demand). 

Also, there are Bitcoin derivatives that more investors are increasingly buying. This includes the likes of bitcoin futures and Bitcoin Exchange Traded Funds (ETFs.) 

And, there are hundreds, if not thousands, of Bitcoin-related companies around the world. These entities have their own investors and, also important, employees who depend on them for a living. 

Then there are other networks and decentralized applications that operate on top of the bitcoin network such as smart contract platform RSK, the Microsoft identity tool ION and the blockchain data provenance framework Factom.

Not to mention the fact that if the bitcoin network, which is the most secure of all blockchain network owing to its hashing rate, is shut down then there will be little faith in the other blockchain networks and most of them could most likely be abandoned by users in droves.

In short, a lot is at stake. If the bitcoin network was to be shut down, many people would count huge losses, and entire industries will be wiped out. 

But why shut down the Bitcoin network? 

And who has the motivation to shut down the Bitcoin network?

Bitcoin is not short of enemies who will rejoice if it ceased to exist. Of course, top on the list is governments. It has always been taken for granted that governments, through their agencies, have the monopoly on creating and determining how money is used in society.

Trump passes this exact message in his tweet about cryptocurrencies. 

Bitcoin threatens this monopoly as it takes the responsibility of issuing money from the hands of probably self-seeking entities into the hands of maths, cryptography and computer protocol, which reduces errors and manipulation.

The power to issue and manage money is one of the most powerful tools the government has. Therefore it will not take losing it kindly.

US Congressman Brad Sherman has alluded to this fact. In May 2019, he urged his colleagues to nip it in the bud (shut the Bitcoin network down.)

“An awful lot of our international power comes from the fact that the U.S. dollar is the standard unit of international finance and transactions….It is the announced purpose of the supporters of cryptocurrency to take that power away from us.”

The second category of those who most likely want the bitcoin network shut down are the banks and in particular the central banks. With permission from governments, banks create money through the fractional reserve system. They lend this money out and make huge profits.

In the last few years, many in the banking sector have registered their dislike and disapproval of bitcoin, and cryptocurrencies in general. Jimmie Dimon mentioned above is the most brazen.

Bitcoin enables people to be their own bank. The wallet you need to receive, hold and send bitcoins are open source applications that no one owns or controls. In addition, other applications that Bitcoin has made possible such as smart contracts provide the necessary tools for P2P financial services such as P2P  credit.

The banking industry is worth trillions of dollars and those in charge of it will not cede part of their market and power without a fight.

Others who might have the reason and motivation to take the bitcoin network down are hackers. They might do it just for the fun of it or to prove that they can do it.

But can the bitcoin network be shut down?

As the technology stands now, it is not possible to shut down the bitcoin network. If it was, then it could have already been done.

The architecture of the Bitcoin network makes it impossible. The bitcoin network is decentralized. It doesn’t have a controlling center or a heart that can be taken out to paralyze it.

It is made of independent computers that communicate and form a consensus on transactions through a protocol implemented using open source software.

Can the bitcoin network be shut down using hash rate takeover?

The most promising way to attack the bitcoin network, and potentially shut it down, is to try to take control of more than 51% of the hashing power. 

To understand how hashing power works on the Bitcoin network, read a post we published here.

If a single entity can accumulate 51% of the bitcoin network hash rate, it can then override the decision of other miners on the network. That includes influencing critical processes, in particular, the addition of new transactions. This entity can also afford to censor users of the network’s shared ledger.

An entity with 51% of the hash rate might even go back in history and make changes to the ledger (the blockchain), thus taking away its immutability. And that is not a good thing because one of the main strengths of Bitcoin is that its ledger is immutable. Once a record is made, it can’t be changed.

But how realistic is a 51% attack?

It is possible to accumulate enough computer power to have the majority of the hashing rate. In fact, a few times in the life of Bitcoin, some mining pools have come close to controlling 51% of the bitcoin network hash rate.

However, using it to shut down the bitcoin network is highly unlikely to succeed for the following reasons;

First, it costs a lot of resources to acquire bitcoin mining hash rate in terms of high power expensive mining rigs as well as electric power consumption. 

This cost of entry provides the first layer of protection against this attack. For most people to invest in Bitcoin mining, there must be an ROI.

But that means a determined entity like government, whose ROI doesn’t have to be financial and that also has access to an enormous amount of funds it can use to acquire hash rate; this attack is doable.

But can bitcoin be stopped this way?

No. First, the entity, say government, should be willing and ready to compete with honest players, many of which are enthusiastic enough about the cryptocurrency to invest resources in hardware and software that supports it.

Most importantly, in the event they manage to gain 51% of the hashing power, the rest of the miners and the community can simply fork the blockchain to create a new branch and ignore the chain the attacker took over.

The attacker is then left with a branch that has no users, and that is after spending an enormous amount of resources without a return on investment as the rest of the network ignores them. Meanwhile, honest miners will hardly lose anything and will continue receiving the mining reward to cover their costs.

The Bitcoin community can keep forking as long as the attacker has resources to burn in pursuit of shutting down the Bitcoin network.

It is important to point out that the Bitcoin protocol is designed in a way that it pays to play by the rules. Breaking the rules in the consensus process leads only to losses.

What about quantum computing?

Can a quantum computer hack bitcoin?

There is a lot of concern that quantum computers are a threat to Bitcoin. The particular area of concern that quantum computers can hack bitcoin is in the cryptography that secures bitcoins in wallets. It is thought by many that the computer can do calculations fast enough to figure out a private key.

However, experts in the area have indicated that this is not a severe threat. In particular, because the exposure period is minimal and, more importantly, there are solutions to fix that. 

Scientists from New Zealand’s Victoria University of Wellington have proposed making the blockchain have properties of a time machine using the concept of entanglement, first described by Einstein.

The other concern regarding quantum computers and the Bitcoin network is the possibility of it being used to produce a hash rate enough to launch a 51% attack. That it could calculate fast enough to change data on the shared ledger to the Genesis block.

This is hypothetical, of course. But it is essential to consider that quantum computers will be available to the rest of the bitcoin mining community. Therefore the only clear impact possible, in this case, is likely to be an increase in the mining difficulty.

Can the Bitcoin network be shut down by shutting down the Internet?

Shutting down the entire Internet itself seems like the surest way to shut down the Bitcoin network. Let’s imagine for a moment that the entire internet could be switched off, something totally impossible. Even that will not work as an infrastructure that makes the Bitcoin network use other channels such as radio waves to propagating data are being put in place.

In late 2017, blockstream, a blockchain solutions company, launched a satellite connection for the Bitcoin network. The company has formed partnerships that make it possible to use Bitcoin without the Internet.

But even with that safeguard, it is highly likely that the entire internet could be shut down just to kill Bitcoin. So it is safe to say bitcoin can’t be stopped this way. Even if two-thirds of the Internet is shut down maybe through a natural disaster like a massive asteroid hitting the earth, the part that will survive will have all the network memory intact.

Last but not least, it is counterproductive to shut down the Bitcoin network while over 2000 alternative cryptocurrencies (altcoins) exist. Some of the altcoins have even more robust privacy features. An excellent example of such kind of cryptocurrency is Monero. In fact, as more cryptocurrency are coming into the picture, Bitcoin is turning out to be the least dangerous to the old systems.  

How Bitcoin Uses Blockchain, a Basic Guide

How Bitcoin Uses Blockchain
Image by Pete Linforth from Pixabay

Before we look at how bitcoin uses blockchain, we need to answer this basic question; is Bitcoin the same as Blockchain?

Bitcoin and blockchain do not refer to the same thing. However, the two are closely interlinked. We can say they have a symbiotic relationship.

Bitcoin is a unit of digital currency—categorized as a cryptocurrency because of its use of cryptography for security and user labels (addresses). It exists only as bits and bytes on computers. 

And like with any other digital currency, its transactions have to be published on a ledger. 

It is the ledger on which Bitcoin transactions are published that is known as a blockchain. There is no bitcoin without blockchain. Bitcoins are just units written on the shared ledger and never independent pieces of data. 

Blockchain is a unique digital ledger. 

Before Bitcoin, nothing like a shared ledger (blockchain) had ever existed. The world had never seen a decentralized digital ledger whose content’s credibility was never in question. To appreciate the uniqueness of the blockchain as a digital ledger, you need to understand:

  1. How it is stored and 
  2. How it is updated. 

Indeed how these two functions are carried out is what makes blockchain revolutionary. 

It is easier to understand everything about blockchain, including where it resides and how it is updated when you compare it with what it seeks to replace.

Centralized digital ledgers

Bitcoin was the first cryptocurrency, but not the first digital (or electronic) currency. Ledgers that track and facilitate ownership and use of digital currencies have been around close to as long as computers have existed.

Financial institutions in particular banks were among the first entities to embrace computers, and the primary use they found for them is storing and updating customer transactions on dynamic ledgers.

It is now estimated that the bulk of the money in circulation exists only as electronic money on digital ledgers that banks and other financial institutions maintain. Countries like Sweden have seen digital currency adoption go up to 85% in recent years. The digital ledger, therefore, has turned out to be a central pillar and an asset in global finance. 

It is important to note that this type of digital ledger is stored on servers that the bank owns and controls. Also, all the edits are primarily done by the bank’s agents (tellers—human and machine).

The ledger is described as centralized, and that is because an authority in the form of the bank or a financial institution exists to oversee its use. The institution has full ownership and control of the ledger. It manages all its aspects, including access to it, data that can be added and its use by third parties.

A critical feature of a centralized ledger is that any edit can be done if one has the necessary access privileges. The records are not immutable. And this is why a lot of resources are put into preventing unauthorized access by hackers and other third parties.

According to a report by the global accounting firm Deloitte, banks spend as much as US$3000 per employee annually to prevent cyberhacking. That translates to hundreds of millions for a large bank. But still, billions are lost annually to cybercriminals who manage to access centralized ledgers and make unauthorized changes (transactions) on the digital ledger.

Decentralized digital ledger

On its part, the blockchain is a ledger that is stored on multiple computers that form a peer-to-peer network. All the nodes on the network keep identical copies of the ledger.

When a computer joins the Bitcoin network, one of the first things it has to do, especially if it needs to be a full node is to download the entire blockchain, right from the first transaction in January 2009. The size of the Bitcoin shared ledger is close to 250GB (by publishing time of this post) and increases at a monthly rate of about 5GB. 

But how the ledger is stored is not where the magic happens. The real magic happens when these multiple copies on different and independent computers on the network are updated. 

It is vital that all copies remain synchronized at all times. However, there is no authority to oversee the process and in particular, the addition of new transactions to the shared ledger. Instead, all the nodes have to form a consensus on the latest additions as well as the general status.

And that is where mining comes in. To understand how mining takes place, read an earlier blog post published here.

Those who help maintain the ledger need to be incentivized. And they are incentivized by being rewarded by the newly released bitcoins. Without bitcoin, it will be challenging for the public peer-to-peer network to maintain the ledger. 

Indeed, even blockchains whose primary application is not a digital currency have had to resort to having a native coin that miners receive as a reward for making their computer resources available for use to maintain a decentralized ledger.

How does Bitcoin work with Blockchain?

Indeed, the blockchain is used in more ways than just a ledger on which transactions are recorded and tracked. In addition to being a ledger on which data is stored, it is also used as a virtual machine that can execute code and thus run numerous applications.

Blockchain technology applications are referred to as decentralized applications (dApps). They range from digital assets, simple websites to complex information systems.

A blockchain is what its application makes it be. If it is used to keep and track ownership of a digital currency like Bitcoin, then it is a ledger. But if it is used to run an app and store its data, then it is a virtual machine on a peer-to-peer network.

Many of the blockchains that have been launched after that of Bitcoin have many capabilities that go beyond supporting the use of digital currency. The Ethereum blockchain, in particular, can support multiple applications, the most revolutionary of which being smart contracts, agreements written in code that self execute once specific predefined conditions are met.

So how does bitcoin use blockchain?

Bitcoin is the first ever blockchain application (or dApp). While bitcoin without blockchain is not possible, the blockchain can, and has, existed without the bitcoin. And this is proven by the thousands of other blockchains that have been created.

Bitcoin, as a digital currency, uses blockchain in the following 5 ways:

  1. As a ledger on which Bitcoin spends and receipts are recorded.

The blockchain is the reference point when there is the need to prove who owns what bitcoin and at what time. 

It is the shared truth of all those who use Bitcoin, and in case of any dispute, the blockchain is consulted as the final arbiter.

The blockchain is the ledger on which ownership of bitcoin units is recorded but, more importantly, tracked. When Jane sends Bob bitcoins, the ledger has to reflect this transaction as well as their new balances.

When Jane sends a Bitcoin to Bob, the Bitcoin peer-to-peer network of independent computers through consensus (mining) reduces the amount attached to her address on the blockchain by that amount and increases what is written next to Bob’s address by the same margin. 

Of course, how the system works is more complex than this description.

2. As a source of security for transactions

By its design, blockchain secures digital records in a way others systems do not. Unlike digital ledgers in centralized systems, blockchain doesn’t rely on controlling access for security. The Bitcoin blockchain is public, and everyone is welcome to help maintain it through mining.

Each transaction on the bitcoin blockchain is time-stamped. This makes it immutable, meaning no one can arbitrarily change it or erase it from the records.

Given that all participants have to agree at every point the status of the ledger, it is almost impossible for an individual or single entity to make changes on the ledger. Also, the transactions are stored in batches known as blocks, which are interlinked through hashed IDs.

This makes the blockchain an immutable ledger. Once a record is made, it can not be altered. An attempt to change records requires one to change the ID of every block on every copy of the shared ledger. This is impossible as it requires non-existent computer power, and even if it was possible, the rest of the network could easily ignore the altered copy.

It is the reason why bitcoin transactions are irreversible. Immutability of the blockchain makes the transactions it carries credible.

Besides, the public-private key cryptography used on the blockchain ensures that everyone’s private funds are adequately protected. Every user can generate a private key known only to them, and through it, they can spend what is sent to them.

3. As an address system

The first step for anyone who wants to use the cryptocurrency is to create a public key (an address) on the blockchain. This is a pseudonym identity through which others can send you bitcoins and from which you send others bitcoins. 

Indeed, an address system is fundamental to any blockchain app.

It is the basis on which others interact with you on the blockchain. The address is created using a wallet application on your mobile phone or desktop.

Every public key has a corresponding private key through which one can control ownership of bitcoins. A public key could be thought of like an email address and a private key a corresponding password. 

To receive email messages, you share the address with others. To read messages sent to you, the password gives you access. To receive bitcoins, you share your public key. To spend those bitcoins, you need the corresponding private key.

The public key address on the blockchain is a genius use of the public-private key cryptography, whose primary function is the security of user funds on the shared ledger.

The blockchain system is robust enough that there is no risk that two users can generate an identical address for receiving bitcoins. And one can create as many addresses as they want. Indeed, it is advisable to use a new address for every single transaction. 

Meaning, you should share a new address every time you need to receive bitcoins from someone. That secures your privacy as well as that of the sender. It makes it a little harder for a third party to track and figure out identities and their spending habits.

4. The blockchain offers privacy to bitcoin users

The blockchain creates the possibility that someone can create an account they control to which they receive and send funds without the need for them to share personally identifying information. 

Before Bitcoin, it was almost always necessary for one to give their real-world identity to use a digital or electronic currency. This was primarily necessary to ensure the money went to the right person.

On the blockchain, users generate their own addresses and share them with others. This removes the responsibility of making sure money is sent to the right person from a third person. There is no need to verify identities. 

Through pseudo-anonymous identities ( in the form of public addresses) bitcoin affords users a cash experience on the Internet. That means, one can spend money on the internet without necessarily leaving a trail that leads to their doorstep.

5. Blockchain is a source of sustainability for the currency.

Users are assured that as long as the Internet exists in some corner of the globe, bitcoin will continue to exist given that the blockchain exists in multiple copies on thousands of nodes around the world.

Due to the nature of blockchain’s decentralization, Bitcoin can survive all kinds of attacks including censorship, internet failure, hacking attempts and even major natural disasters.

In short, Bitcoin relies on blockchain to give its users all the benefits that matter to them, including security, privacy and reliability. It also relies on the blockchain for its existence and long term survival.

 

How Does a Bitcoin Exchange Work? In More Ways than One

How Does a Bitcoin Exchange Work?
Courtesy of PXHere.

First things first, what is a bitcoin exchange?

A bitcoin exchange is an online platform or a physical establishment where one can buy and sell bitcoins, as well as other cryptocurrencies. 

Most exchanges support the buying and selling using fiat currencies like the US dollar. But a growing number of exchanges now support only conversions between cryptocurrencies. That means you can only use a cryptocurrency to buy another — for example, bitcoins to buy ethers.

Something to clarify at this point is that increasingly people use the term ‘crypto exchange’ instead of ‘bitcoin exchange. And that is because the term bitcoin exchange was more appropriate when bitcoin was the only cryptocurrency.

Now a crypto exchange may support up to hundreds of cryptocurrencies and blockchain assets.  Poloniex, for example, supports 80 crypto assets and Shapeshift close to 100.

According to CoinMarketCap, an online crypto market tracker, there are close to 3000 blockchain digital assets that exchanges can list.

With that said, people still refer them loosely as bitcoin exchanges. So if you’ve wondered what the difference is between a bitcoin exchange and a crypto exchange, it comes down to whether it supports only Bitcoin or along with other blockchain assets.

Why are crypto exchanges critical?

The rise of crypto exchanges was occasioned by the need to convert between bitcoin and fiat currencies. In particular, a crypto exchange is the easiest way to acquire cryptos. The other ways, such as mining and selling goods and services for them, are a bit more complicated.

And what is the history of crypto exchanges?

In February 2010, having recognized the difficulty new users were having when trying to buy bitcoins, a user on the forum Bitcointalk going by the username dwdollar set up BitcoinMarket. That was the first ever Bitcoin exchange where one could buy and sell bitcoin using, among others, PayPal.

However, the most well-known early bitcoin exchange was Mt Gox. The exchange, which had grown to be the largest, lost about 850,000 bitcoins belonging to its customers in unclear circumstances and filed for bankruptcy in early 2014. 

Crypto exchanges have remained a critical component in the crypto eco-space. As a crypto user, it is hard to imagine life without exchanges.

The number of crypto exchanges has grown to hundreds. Some are global, while some cater to specific countries or regions. CoinMarketCap lists slightly over 250 crypto exchanges.

But how does a Bitcoin exchange work?

It is important to note that all exchanges do not work in the same way. While they basically serve the same purpose, they have different designs and architectures that result in different benefits and user experience.

Broadly, and based on how they work, crypto exchanges can be grouped into two; centralized exchanges and decentralized exchanges (DEXs).

Centralized exchanges

These are exchanges run by registered business entities and, most importantly, from central points. They are companies with investors, offices and staff.

It is essential to point out that an exchange is considered centralized because it has a responsible team that makes and acts on critical business, legal and technical decisions. 

This team determines who accesses the service, what amounts they can transact and what fees they need to pay. It has the technical ability to bar (or censor) a user from the platform. The ability to censor, lack of privacy and high costs are some of the disadvantages of centralized exchanges.

Some of the benefits of centralized exchanges include speed, excellent user interfaces and responsive support to help solve issues users face. 

Centralized crypto exchanges can further be subdivided into the following three categories:

1. Those that buy and sell on their own behalf

These exchanges are those that buy and sell for a profit margin. If you want cryptos, you buy from the company and if you need to sell, the company buys from you. As a buyer or seller, you never interact or transact with other users on the platform.

Also, as a user, all you need is a profile on the exchange through which you make orders. You may not maintain a money account or a crypto wallet on their platform. When buying cryptos, the fiat money you send them goes directly from your bank account or PayPal to their account.

When selling cryptos to them, the coins come from a wallet you control to their hot wallet. Some exchanges in this category, however, do provide wallet services. Meaning you can generate a wallet you manage on their platform and use it to hold your coins. The wallet is completely yours and only you can transact through it.

An example of an exchange in this category is Coinbase. The US-based exchange does provide crypto wallet service. You can sell the coins in your wallet to them and you can also receive the coins they sell you into that wallet. 

To start using an exchange like Coinbase all you need to do is to visit their official website and sign up like you would a social media site. The signup part is always simple and straightforward. 

However, you may be required to provide valid personally identifying information, in particular, a government-issued ID and a physical address to access most of the services available on the site. This is a requirement based on the Know Your Customer (KYC) and anti-terrorist financing regulation by government agencies.

The primary source of revenue for an exchange in this category is the difference between the cost of buying and the selling price of the currencies they support.    

2. Those that buy and sell on behalf of third parties

These are exchanges that allow users to advertize what they want to buy or sell and at what price. Other users will go through these offers and when they find what they like, they authorize the exchange to buy or sell on their behalf. In other words, the exchange is a go-between and a facilitator of a transaction involving individuals who have agreed to trade.

In other words, the exchange matches buyers and sellers by directly helping users find the kind of deals they are looking for. When a match is achieved, the exchange goes ahead and executes the transaction for the parties involved.

The buyer and seller will have accounts with the exchange and the exchange will credit and debit these accounts accordingly. If you need to buy bitcoins, for example, you will first need to transfer the fiat currency from your bank account to an account you have on the exchange. Likewise, if you are selling bitcoins, you need to transfer them to a wallet on the exchange.

An example of an exchange in this category is Binance. The sign up is simple and straightforward. For security purposes, you are asked to set up 2-factor authentication in the form of Google Auth, SMS or email. You may be asked to provide identification information, in particular, a government-issued ID and physical address before you can access all services on the platform.

After signup, you can then deposit from your bank account or your crypto wallet. With funds on the platform, you can then go through what offers others have made or you can make your own orders. When you make a sale or buy offer on the platform, you are a ‘Maker,’ and when you take a buy or sell orders by others, you are a ‘Taker.’

This primary source of revenue for an exchange in this category are the fees they charge every transaction.  

3. P2P crypto exchanges 

What is a P2P Bitcoin exchange?

A P2P crypto exchange is an online platform that allows traders to transact with one another directly. The platform doesn’t get hold of the funds involved and does not move the funds between the traders or on their behalf. Each counterparty is in the control of their funds and they exchange simultaneously with each other.

How does P2P Bitcoin exchange work?

The first step to using a P2P crypto exchange is to create an account or profile. You do this by signing up with your email address. On almost all of the P2P crypto exchanges, you are prompted to set up 2-Factor authentication for security reasons. 

With an account, you can access and read ads that other users have posted on the platform. The ads are in two categories; those by sellers and those by buyers. If you do not find offers that you like, you are free to set up and publish your own ads, of course, subject to terms and conditions. You are free to offer competitive prices. 

The P2P exchanges provide the necessary tools to make the transaction between individuals possible. The tools include an escrow service, which means during the transaction period funds are moved to a wallet with multiple keys with the platform support having access to one. In the event of a dispute, they can step in and transfer the funds to the deserving user.

On some of the P2P exchanges, traders can meet in person to complete transactions. That means you look for offers on the platform by people living near you then set a meeting to trade, which includes using physical cash. 

The crypto exchanges in this category include Localbitcoins, Paxful, Remitano and CoinCola. The primary source of income for the exchanges are the fees they charge for one to put up a sell or buy an ad. 

Often people confuse P2P exchanges with decentralized exchanges. They are not the same and, indeed, their architectures are very different.

The next section is about decentralized exchanges but it is important to state at this point that the difference between P2P exchanges and decentralized exchanges lies in how they are run and managed. 

P2P exchanges are centralized businesses with investors, offices and staff. They have full control of how the platform works. They can arbitrarily change the rules, deny services to some and even shut down accounts.

Meanwhile, decentralized exchanges are not companies or centralized business entities. They are open source protocols that provide the necessary tools for people to transact. No one has the power to arbitrarily change the rules, censor others or shut down accounts (wallets). Any change to how the platform works is done through consensus and collaboration by independent developers. 

Decentralized exchanges (DEXs)

Bitcoin and other cryptocurrencies are decentralized, and protects users from censorship, breach of user privacy and high costs.

Exchanges are critical components of the crypto ecosystem, but they have turned into single points of failure (SPOF). Due to them being controllable, they expose users to the same issues they are probably trying to avoid by choosing cryptocurrencies over the centralized payment methods.

By having to use a centralized exchange, one is at the risk of being censored, especially given that the company running it could be pressured by an outside authority such as a government. For exchanges to operate in many countries, they are expected to follow laws and regulations on money business services. 

That also includes collecting personally identifying data for KYC compliance, which exposes users to breach of privacy. Indeed, centralized exchanges go against most of the things that cryptocurrencies are about; free from censorship, anonymous and cheap to use.

It is for these reasons that decentralized exchanges have been developed.

But what is a decentralized exchange?  

Decentralized exchanges (DEXs) are protocols (set of rules) that allow users to convert between currencies without having to go through a third party. For a long time, what stood in the way of implementing decentralized exchanges was what is known as the atomic swap problem

If Alice and Bob are exchanging digital assets, one of them has to go first. If Alice sent first, Bob might decide not to keep his side of the bargain and therefore defraud Alice. This problem has been solved through the application of smart contracts, self-executing agreements written in code. 

But how do decentralized exchange work?

Most of the DEX projects are in the early stages. But those that have gone through the tesnet phase work with an implementation of the protocol through open source software or application that a computer runs to join networks. That means for one to trade with others, they need to either download and run the application.

The DEX protocols software acts as the interface between payment platforms. For example, the protocol could arbitrate with a smart contract between users on two blockchains. With that said, the detail implementation is different for each DEX project.  

Bitcoin ATMs

Bitcoin ATMs are machines put at strategic locations like shopping malls, bars and coffee shops. These machines are technically Bitcoin or crypto exchanges. You can buy bitcoins from them as well as sell to them if you need to. 

The essential advantage of using a Bitcoin ATM over other types of exchanges is that you do need to share your personally identifying data to use the service. All you need to do to buy bitcoins, for example, is to share your bitcoin address with the machine through a QR scanner and to insert bills into a slot.

You can find a Bitcoin ATM near you by using Bitcoin ATM tracking maps such as CoinATMRadar. 

Physical agents

Another form of crypto exchanges that you might have to use are agents in stores and malls. These are mostly cashiers who can help you convert between Bitcoin in particular and fiat. 

LibertyX is a US firm that has partnered with cashiers and small businesses across the country to make this service possible.

How does this type of crypto exchange work?

You sign up on the official site, and also down their app to your phone. With your account, find an agent near you and when you find one, initiate a buying transaction, indicate the amount you want to transact and share the address to which the bitcoins should be sent. 

LibertyX will display a one-time use code that you should copy and carry to a local agent in the store, coffee shop or bar. Once the agent sees the code, they will receive your payment and your cryptos will be sent to you. 

So, how does a bitcoin exchange work? There is evidently more than one way.

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