Bitcoin: Transaction block chains

The last really essential or salient piece for understanding the mechanics of how Bitcoins work is what we call the transaction block chain. So if you recall in the previous video, you had a motivating example of a user, Alice, who wanted to send some number of Bitcoins to another user, Bob, in the system. And what Alice has to do to initiate that transaction was to construct a transaction-- a record of sorts-- that contained information about the transaction and that was signed with Alice's signing key. And that actually contained Alice's public verification key and Bob's public verification key as well. And that transaction information was basically broadcast out, as we mentioned, to the entire Bitcoin ecosystem. To all the nodes on the Bitcoin peer-to-peer network. And the various nodes in the Bitcoin ecosystem are going to sit there. They're going to receive information about this transaction. But they're also going to be getting information about a lot of other transactions that are taking place around the same time. And what these notes are going to start doing is they're going to work on incorporating this transaction record into a ledger of all transactions that have ever taken place in the Bitcoin system. And so what happens is that each node basically starts off by taking all of the previously unincorporated transactions that they've ever received. So there's going to be all these transactions out there that have kind of happened within a given time window. And there's all these Bitcoin transactions kind of floating around. And these nodes-- these Bitcoin miners as they're called-- are going to receive information about all these different transactions and they're going to start working on incorporating those transactions. And their first goal is to collate these transactions into what's known as a transaction block. So if you recall our ledger analogy, a single Bitcoin transaction essentially corresponds to a proposed entry in a ledger. In that capacity, a transaction block would basically correspond to her page in a ledger where you have multiple transactions that are listed in that page of the ledger. And the goal-- the Bitcoin miner's goal-- is to really, essentially, to take that page and get it added to the global ledger book, the global comprehensive ledger book. Now to engage in this sort of work, what these nodes will basically do is they'll first take all the transactions that have been broadcast out. And let's say these four transactions have been broadcast out. And they're going to basically hash these transactions in pairs in basically a tree-like structure. They'll take these two transactions and they'll apply a [? graphic ?] hash function to those details. And we'll get a [? cars ?] flying digest, goes the same for these two, and then they'll take these two digests and hash them to get a single digest value. And this digest effectively encodes all of the transactions that were previously unincorporated and that were received by these individual nodes. And then this digest is basically going to be combined with the hash of the transaction block that was previously accepted by the network. So you can imagine if there is-- the network will have a series of transaction blocks that were previously accepted. And in fact, every transaction block as I mentioned just now incorporates the previous transaction lock. So this transaction block will incorporate the one that was used just before it, and this transaction block will incorporate the one that was used just for it. And it's going to go on literally until the beginning of Bitcoin times. So this is really where the Bitcoin-- the beginning of time for the Bitcoin system, this is just time equals zero for Bitcoin. And they're going to take this last block and they're going to, essentially now, take this last block and combine it with this most recent block. And so if you imagine that you have now, not just an individual block, because each individual block incorporates the block before it. We're not dealing anymore with an isolated or distinct block of transactions, but rather with a chain of blocks that starts literally at the beginning of the entire Bitcoin system. Now when you do all of this combination, at the end of the day, you're going to do some cryptographic hashing and you basically will end up with a sequence of numbers. And this sequence of numbers will be derived by incorporating all these blocks together. You'll get a sequence of numbers, and what we're going to basically do is take this sequence of numbers and convert that sequence of numbers into a challenge in a proof of work protocol. Now I did a separate video on proof of protocols, I would encourage you to watch that if you want to get a better sense for how they work. But the short of it is that what the Bitcoin mining node has to do at this point is he'll take that Bitcoin-- he'll take the challenge and he'll have to come up with a separate sequence of numbers-- which we typically termed the proof, or the proof of work-- and this proof of work has to have a very specific mathematical property. And what that property entails is that if you take the challenge numbers, and you take these proof numbers, and you concatenate them together, and you make them the input to a cryptographic hash function, the resulting output has to have a large prefix of zeroes And that doesn't have to be all zeroes, but a large portion of the beginning-- the prefix-- has to be all zeroes And if you think about for a moment, given that cryptographic hash functions, given that their output tends to look fairly random, it's unlikely in any given instance that you are going to see a proof. A proposed proof that provides you with a large string of zeroes at the beginning. And so what the Bitcoin miner will have to do is on average, he'll have to try out many possible choices for these proof numbers until he finally gets lucky and he stumbles upon one that has this kind of off-beat or strange statistical property. And the actual difficulty of finding these proof numbers, as you can tell, is dependent on exactly how many leading zeroes are required. The more leading zeroes you require in this proof, the longer it takes to actually solve a problem. The longer it takes to actually come up with a proof that works with respect to a given challenge. The fewer zeroes that you require, the less time it will take. Now the exact number of bits of zero bits required in the Bitcoin protocol actually does change over time. It gets calibrated. And it's designed to not, on average, the average time taken across the whole system should be about 10 minutes. So you want to take about 10 minutes for at least one node to come up with a valid proof, but keep in mind that a lot of nodes are working on this proof concurrently. All right, now once this proof of work is found, let's say that the proof of work is eventually found. The Bitcoin miner will announce the results to the overall peer-to-peer network. He's going to take this proof and really all the challenge, and so on, and he's going to announce it to all the notes. And they're now going to see that, hey, there's this proof out there, somebody found it. Let's drop the other stuff we were doing and we're going to now start to work and build on top of this new proof. Remember, this new proof of this new challenge, these all incorporate all the previous transaction blocks. Really, what they're starting to do is starting to work off of a new, updated transaction block chain. And they're going to incorporate any new unincorporated transactions into that new transaction blocking. Now there are a couple of points I want to make here. So first of all, as part of constructing these transactions blocks, and really as part of incorporating them into a transaction block chain, Bitcoin miners are actually allowed-- one little special treat-- they are allowed to include in that transaction block-- a special node for themselves. And this node will basically be a little reward if they can get-- and let me use the greenish color for that reward-- they could take the first block, the first transaction item, the first transaction record, and they can put in that transaction record-- they can assign a reward to themselves. Now the amount of that reward will change over time. But I do want to point out what this transaction is typically called is called a coin-based transaction, or a generation transaction. This is how new coins get included in the Bitcoin system. So whenever a minor succeeds in coming up with a proof as part of that he'll have been allowed to come up with his own transaction to reward himself, a special little reward, for extending the effort necessary to come up with this proof and for doing all this work associated with adding a new transaction block to the existing transaction block chain for Bitcoin. And I think that's reasonable. After all these notes are using a lot of computational power to come up with these proofs and if they're using computational power that must mean that somewhere along the line, somebody is spending money on electricity and so on. Now, I also want to point out that in addition to this coin-base award, the nodes who're doing the Bitcoin mining, the ones who succeed. Also get to collect the transaction fees that were specified in the transaction records. If you recall, a person issuing a transaction in Bitcoin can allocate or set aside a certain amount of money-- maybe it can be a Bitcoin or a fractional Bitcoin-- for the node who succeeds in coming up with the actual proof of working, and effectively the node that succeeds in being able to add that transaction to the overall bitcoin transaction block chain. And so that node that does the work succeeds, gets a reward, another transaction fee. Now this could actually become quite large because the node will not only get the transaction fee before one transaction. You'll get the transaction fee for all the transactions that appeared in the current block. It's going to give the aggregate over all these different transactions. Now the second point I want to make is that it might be possible for two nodes to solve the proof of work independently of each other. And somehow, they both end up trying to add to that existing chain in some ways. You make get some weird chain forking happening. If that happens, the peers in the Bitcoin network will basically break a tie by sticking with the longest chain. And by longest, I don't mean the one that has to be the most transactions in it. I really need the one that has the highest aggregate difficulty associated with that underlying proof of work protocol in each of the transaction blocks. And we'll basically look at the total amount of effort that was required to generate that chain with regard to that proof of work. And whichever chain has the most work associated with it is a chain that's sacrosanct, it's a chain that everybody will accept. Now you may get some word discrepancies because of network latency issues and so on. But the idea is that after maybe a couple of rounds when there are ties, they'll quickly resolve themselves as long as most of the nodes are being honest and really stick to the implementation of the protocol. Now since Bitcoin miners are generating bitcoins, I think there's an interesting question that comes up here which is, how is the Bitcoin money supply, controlled, and how is it managed? And I'm going to talk about that concept in a subsequent video.