Bitcoin part 2: Coins

(Warning: I have had a couple glasses of wine.)

(Related video)

To my knowledge, there are only two kinds of money: token-based and ledger-based.

Scenario #1. You go to Starbucks, hand them a $10 bill, and they give you a latte. (I did say “Starbucks”.) That’s token-based money, with the bill functioning as the token. Many things have served as such tokens at various places and times, ranging from pieces of paper to little chunks of precious metal to cigarettes.

Scenario #2. You go to Starbucks, hand them your Starbucks Card™ with $20 on it, and they give you a latte and hand back your Starbucks Card™ with $10 on it.

Clearly, you spent money; after all, you got a latte. Of course, that money is not literally “on your card”. What is on your card is a unique ID number that got sent to the Starbucks Great Central Computer that initially recorded “$20” next to your ID number. The computer then recorded your transaction on a ledger that says you spent $10 and have $10 left “on your card”. Thus this money is ledger-based.

Ledger-based money generally has the problem — or advantage, depending on your point of view — that a central authority (a) knows who you are and (b) controls the ledger and therefore the money.

Suppose all of Starbucks’s (or is that “Starbucks'”?) customers were revolting (participle, not adjective) and demanding a card that acted more like cash. Could Starbucks simply record “$20” on the magnetic strip on the card itself, overwrite the strip to change that value as you spent the “money”, and not even have a Central Computer?

No, because even if the magnetic strip were encrypted somehow, you — or someone more clever but not too much more clever than you — would find a way to copy the strip onto another card. (This is a very important concept that we will revisit later.)

Now, in point of fact, Starbucks could mostly solve this with an active card. Tamper-resistant (and non-copyable) “smart cards” do exist, and they could be programmed to respond only to commands originating from the Starbucks Central Computer. Then there would be no ledger, and nobody would have to know who you are! But somebody would still be in charge of the Computer.

Anyway, Bitcoin does not work like that.

Enough rambling. Here is the punchline: Bitcoin is ledger-based. But the ledger is unlike anything you have ever seen. Well, unless you have already seen it. To understand Bitcoin, it is necessary and sufficient to understand its ledger: The nature of the entries, how they are made, who gets to make them, and so forth.

Bitcoin’s ledger is called the block chain, and I will get to all of that. Eventually. But first I think I want to take a couple of detours through cryptography and number theory.