Cryptography Basics Notes: Cryptocurrency - Bitcoin
This article is sourced from: Talking about Li and the DAO
## 1. About Bitcoin
(1) Basic Introduction
Bitcoin is a digital currency that operates on the basis of blockchain technology. This article mainly provides a detailed overview of the knowledge related to the cryptocurrency Bitcoin.
It was first published by Satoshi Nakamoto on October 31, 2008, on the P2P foundation website in the paper titled "Bitcoin: A Peer-to-Peer Electronic Cash System." It has been 16 years since then, and Bitcoin's maximum increase has exceeded 96 million times, as shown in the figure below.
(The above figure is based on data up to August 2024)
Bitcoin is equivalent to a decentralized ledger with no independent manager; anyone can keep records. Each block is a page in this ledger, and the system automatically generates Bitcoin as a reward. This process is what we commonly refer to as mining.
Every ten minutes, all miners simultaneously solve the same problem. The first miner to find the answer gains the right to record a page in the ledger and will receive a certain amount of Bitcoin upon completion. This is the process of Bitcoin issuance.
In the Bitcoin network, the production speed of new coins is predetermined, with the generation time for each transaction block maintained at around 10 minutes. Initially, the reward for successfully mining a block was 50 Bitcoins.
(2) Bitcoin Halving
Every time the blockchain reaches an integer multiple of 210,000 (which occurs every four years), the reward for successfully mining a block is halved: first from 50 Bitcoins to 25, then from 25 to 12.5, and so on. By around the year 2140, the entire system will produce 21 million Bitcoins, reaching the predetermined total cap. After that, no more Bitcoins will be generated, and Bitcoin miners' earnings will come from transaction fees.
The so-called Bitcoin halving does not refer to the value of the coin but rather to the reward for recording transactions (mining).
So, what is this reward specifically?
For blocks 1 to 210,000, the reward for each block is 50 Bitcoins.
For blocks 210,001 to 420,000, the reward per block decreases to 25.
And so on, in summary, every time 210,000 blocks are completed, the reward is halved.
Bitcoin averages one block every ten minutes, so it takes about four years to complete 210,000 blocks, meaning the reward is halved every four years.
(3) Bitcoin Halving Market Trends
Here is the price trend chart before and after the first halving:
As we can see, on November 28, 2012, nothing happened, and the price only began to rise in March of the following year (more than three months later), reaching 266 before starting to fall again, and then it surged again in November 2013, a full year after the halving.
Here is the price trend chart before and after the second halving:
It can be seen that before the halving on July 10, 2016, there was already a price increase, and after the halving, the price actually dropped, only to start rising again in early 2017.
Here is the price trend chart before and after the third halving:
Everyone knows that halving occurs every four years, so you cannot use this information for speculation.
(4) Major Events in Bitcoin Development
2008: A person using the pseudonym Satoshi Nakamoto published a white paper outlining a plan for a "new electronic cash system that is completely peer-to-peer, without the need for a trusted third party."
2009: The first Bitcoin was mined.
2010: A programmer named Laszlo Hanyecz made the first Bitcoin transaction, purchasing two pizzas from Papa John's for 10,000 Bitcoins.
On November 1, 2010, the Bitcoin logo was born: created by an unknown artist under the name "Bitboy," whose identity remains unknown to this day.
On December 12, 2010, Satoshi Nakamoto published his last article: he added some DoS restrictions and removed the previously introduced alert system safety mode on bitcointalk.org.
In June 2011, the first Bitcoin bubble occurred: although Bitcoin was created in 2008, its price only began to soar in 2011. In early 2011, the trading price of Bitcoin was below $1, but by June 2011, the price had risen to over $31. However, due to a massive hack at the Mt. Gox exchange, 25,000 Bitcoins were stolen, and by November 2011, the price had dropped to $2.
On November 18, 2012, Bitcoin experienced its first halving: the first halving event occurred at block height 210,000, reducing the block reward from 50 Bitcoins to 25 Bitcoins.
On March 18, 2013, Bitcoin's market capitalization first surpassed $1 billion.
On July 9, 2016, Bitcoin experienced its second halving: the second halving occurred at block height 420,000, reducing the block reward from 25 Bitcoins to 12.5 BTC.
In November 2017, the Chicago Mercantile Exchange officially launched Bitcoin futures trading, and Bitcoin surged to a high of $19,000.
In January 2018, the legendary figure Lazlo Hanyecz successfully purchased pizza again via the Lightning Network.
On May 25, 2020, Bitcoin experienced its third halving: the third halving event occurred at block height 630,000, reducing the block reward from 12.5 Bitcoins to 6.25 Bitcoins.
On February 8, 2021, Tesla announced it would accept Bitcoin payments.
On February 19, 2021, Bitcoin's market capitalization surpassed $1 trillion.
In April 2021, Bitcoin's price reached $65,000.
In June 2021, China banned Bitcoin mining, causing Bitcoin to briefly drop below $30,000, and Bitcoin mining power migrated to the United States.
On September 7, 2021, Bitcoin became legal tender in El Salvador.
In November 2021, Bitcoin's price reached the previous all-time high of $69,000.
In 2023, it was a significant year for Bitcoin's ecosystem development: new concepts such as Ordinals, Inscriptions, BRC20, Atomical, ARC20, Bitstamp, SRC20, Rune, Taproot Assets, RGB, etc., emerged one after another, with the development in 2023 surpassing that of the previous several years combined.
In January 2024, the U.S. SEC approved 11 Bitcoin spot ETFs for listing.
In March 2024, stimulated by Bitcoin spot ETFs, the price of Bitcoin rose to $73,000, breaking the previous high before the halving for the first time.
In April 2024, Bitcoin experienced its fourth halving.
From 2024 to now, the rise of Bitcoin Layer 2.
## 2. Lightning Network
(1) Basic Introduction
The Lightning Network is a Bitcoin Layer 2 protocol that enhances the transaction speed and privacy of Bitcoin by establishing payment channels between two parties. The main idea of the Lightning Network is to conduct a large number of transactions off the Bitcoin blockchain, only placing key steps on-chain for confirmation.
This design was first proposed in February 2015 in the paper "The Bitcoin Lightning Network: Scalable Off-Chain Instant Payments." The Lightning Network mainly improves off-chain transaction channels by introducing the concept of smart contracts. The core concepts include RSMC (Recoverable Sequence Maturity Contract) and HTLC (Hashed Timelock Contract). The former addresses the confirmation issue of off-chain transactions, while the latter addresses the payment channel issue.
In the Lightning Network, a payment channel can be established between two users. This is typically achieved by creating a special transaction on the Bitcoin blockchain that "locks" a certain amount of Bitcoin in a multi-signature wallet. This transaction is called a "funding transaction," marking the opening of the payment channel.
In traditional blockchain networks, each node processes each transaction as a whole after broadcasting it to the network. As a result, when the network becomes busier, transactions may be processed slowly and incur high fees. The Lightning Network allows for instant completion of off-chain transactions by establishing a network of payment channels between users, eliminating the need to wait for confirmations from the underlying blockchain network.
(2) How the Lightning Network Operates
Channel Opening: Two users can jointly create a Lightning Network channel, with each locking a portion of Bitcoin on the blockchain as the initial funding for the channel. These funds will be used for off-chain transactions within the channel.
Off-Chain Transactions: Once the channel is open, the two users can conduct multiple off-chain transactions within the channel, which are not actually submitted to the main blockchain but are settled internally within the channel.
Channel Closing: When users wish to end the channel and submit the final transaction results to the main blockchain, they can close the channel. This will record the final transaction state on the blockchain, completing the settlement.
## 3. Bitcoin UTXO Model
Bitcoin transactions require specifying inputs and outputs, where inputs are the UTXOs (Unspent Transaction Outputs) that the payer will use, and outputs are the UTXOs paid to the payee.
How to understand UTXO? Here’s an example:
Suppose A and B both have $10 in their wallets, and now A wants to transfer $5 to B. If we use Ethereum's method (which employs an account balance model) for the transfer, we would simply modify A's wallet balance to $5 and B's wallet balance to $15, completing the transaction.
However, if we use the UTXO model for the transaction, it is entirely different. A needs to spend the entire $10 as a whole, and this $10 will be split into two $5 UTXOs in the Bitcoin network, with one transferred to B and the other returned to A. This process is akin to B's wallet receiving a new $5, while A's wallet receives $4 in change (assuming a miner fee of $1), which is somewhat similar to using cash in a physical store.
Now, back to inscriptions. If you withdrew 0.1 BTC from an exchange to your wallet to create an inscription (meaning you currently hold a 0.1 BTC UTXO), when you go to mint (trade) the inscription, this single UTXO will be spent during the "submission phase." If the corresponding inscription requires 0.05 BTC, theoretically, the excess Bitcoin would return to your address. However, since your address currently has only one UTXO and it coincides with Bitcoin's block time of 10 minutes (assuming it is 10 minutes, it could be longer), during these 10 minutes, your address's UTXO is effectively 0 (because the UTXO being spent cannot be spent again), meaning you cannot create a new UTXO, resulting in the failure of the inscription. This is the underlying reason why it shows insufficient balance.
## 4. Overview of Bitcoin's Major Ecosystem Developments
(Bitcoin Ecosystem Map)
What is Bitcoin Layer 2?
Layer 2 is an independent blockchain network built on top of Layer 1, aimed at packaging most transactions from Layer 1 to alleviate pressure and expand capacity.
Note: Bitcoin ecosystem knowledge system mind map (reply "Bitcoin Mind Map" in the public account to obtain the high-definition original image)
Knowledge Index
Brief History of Bitcoin Layer 2 Development
SegWit (Segregated Witness): A Bitcoin scalability improvement proposal proposed in December 2015 by Bitcoin Core developers Eric Lombrozo, Johnson Lau, and BlockStream co-founder Pieter Wuille.
SegWit (BIP141) was implemented in 2017. The most significant advantage brought by the SegWit upgrade was the increase in block capacity, laying the foundation for Layer 2 development.
Taproot: The Taproot proposal, released by Bitcoin Core developer Greg Maxwell in January 2018, was officially implemented in 2021. Taproot is a major upgrade since SegWit, aimed at enhancing privacy, simplifying transaction verification, improving efficiency, and enabling more complex smart contract processing capabilities.
These upgrades have paved the way for the development of Bitcoin Layer 2. Mainstream Layer 2 solutions include:
State Channels: Allow participants to conduct multiple transactions without needing to record all transactions on the blockchain.
Sidechains: Blockchains that operate independently of the main chain, allowing assets to be transferred between the main chain and sidechains.
Rollup: Provides an efficient scaling solution by bundling a large number of transactions and submitting them to the main chain.
PoS Scaling: A scaling solution based on Proof of Stake (PoS) that further enhances the network's scalability and efficiency.
## 5. Bitcoin ETF
(1) What is an ETF (Exchange-Traded Fund)?
An Exchange-Traded Fund (ETF) is an investment fund traded on stock exchanges, similar to stocks. ETFs hold assets such as stocks, commodities, or bonds and typically operate with an arbitrage mechanism designed to keep their trading price close to their net asset value.
A Bitcoin ETF is an investment fund that allows people to indirectly invest in Bitcoin without actually owning the cryptocurrency. Since ETFs exist within the traditional financial system, Bitcoin ETFs open the door for a broader range of investors.
In January 2024, the U.S. Securities and Exchange Commission approved 11 Bitcoin spot ETFs for listing.
(2) What is the difference between spot and futures cryptocurrency ETFs?
Underlying Assets: Spot Bitcoin ETFs directly hold Bitcoin as the underlying asset. This means the fund owns and manages actual Bitcoins. The price of the ETF tracks the price movements of Bitcoin and has various embedded mechanisms to ensure price relevance. In contrast, futures Bitcoin ETFs hold futures contracts that are typically based on Bitcoin as the underlying asset. These contracts represent agreements to buy or sell Bitcoin at a predetermined price on a future date.
Trading Mechanism: Spot Bitcoin ETFs track the real-time price of Bitcoin. When traders purchase shares of a spot Bitcoin ETF, the fund buys and holds an equivalent amount of Bitcoin. Futures Bitcoin ETFs hold and thus track the prices of Bitcoin futures contracts, which are traded on regulated futures exchanges and have expiration dates. The performance of the ETF is related to the performance of these futures contracts rather than the spot price of Bitcoin.
Risk Profile: Spot Bitcoin ETFs carry risks associated with owning and managing Bitcoin, and the value of the ETF may fluctuate based on Bitcoin's price movements. Futures Bitcoin ETFs introduce additional risks, such as the risk of futures contracts expiring and potential price discrepancies between Bitcoin futures and spot prices. These ETFs also carry market and liquidity risks associated with futures trading.
This section concludes here. This is the second part of the "Cryptocurrency Basics Notes" series. We will continue to share more content from the knowledge framework map. The complete "Cryptocurrency Basics Notes" will be compiled into a PDF for download and reading after the series is fully updated.
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