CRYPTO EBOOK

BITCOIN

Cryptocurrencies
Bitcoin
Written by
Andreas Thalassinos
(FXTM Head of Education)

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BITCOIN

Contents
Satoshi Nakamoto ........................................................................................... 3
Decentralisation & The Peer-to-Peer (P2P) Network ................................ 4
Public and Private Keys vs. Public Address ................................................ 5
Trust.................................................................................................................... 6
Proof-of-work.................................................................................................... 7
Financial Institutions ...................................................................................... 8
Blockchain technology .................................................................................. 9
Cryptography ................................................................................................... 10
Double spending.............................................................................................. 11
Bitcoin vs. bitcoin ............................................................................................ 12
Mining................................................................................................................. 13
Block Reward.................................................................................................... 14
Digital Signature............................................................................................... 15
Distributed System........................................................................................... 16
Byzantine Generals Problem.......................................................................... 17
The Future of Bitcoin....................................................................................... 18
Trading bitcoin ................................................................................................. 19
Altcoins............................................................................................................... 20
Regulation.......................................................................................................... 21
Transaction Fees .............................................................................................. 22
About the Author.............................................................................................. 23

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 Satoshi
Nakamoto
Emerging from the world of cryptography in the mid-2000s, the
mysterious Satoshi Nakamoto is credited as the mastermind creator
behind bitcoin the currency, and Bitcoin the network. Is that his real
name? Is he Japanese? American? Is he or she, in fact, a lot of people
merged under one pseudonym? To this day, no one knows.

As a direct response to the financial crisis of 2008, Satoshi Nakamoto envisioned

a new and decentralised digital currency system he called bitcoin. In October
2008, Nakamoto published a paper entitled “Bitcoin: A Peer-to-Peer Electronic
Cash System” which detailed a payment system based on chains of data blocks
(later to become known as blockchain) and the removal of third parties between
transactions. It came at a perfect time, of course, because a lot of people had lost
trust in traditional financial institutions due to the crisis.

Nakamoto’s proposal detailed how the new system would function without financial
institutions, how a peer-to-peer network would resolve the issue of double spending
and what this new system would mean for transactional privacy.

A few years after his proposal, Satoshi Nakamoto stopped being involved in the
development of bitcoin and completely disappeared from all public forums.

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Decentralisation &
The Peer-to-Peer (P2P) Network
The core principle of decentralisation is the removal of a central,
controlling body, whether that be an entity in the form of a financial
institution (i.e. a bank), a “trusted third party” in the form of a payment
provider, or an individual middle-man between the sender and the
receiver of a transaction.

One type of decentralised system like this has existed for many decades. Known
as peer-to-peer – P2P for short – this network consists of, in its most simplified
definition, two or more computers connected to one another and sharing all types of
data. Torrent file-sharing, which is widespread and allows users to download music,
movies, documents and other types of files, is based on a P2P network.

P2P technology has a long history. As a fault-tolerant network, P2P was initially
designed for the purpose of transmitting military messages without any vulnerability
to human fatality, natural phenomena or technical malfunction. Its primary feature
is its autonomy – in other words, its inherent decentralised nature.

A P2P network has no centralised authority or regulatory entity that monitors,

facilitates or controls any of the data that is shared between the two peers.

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Public and Private Keys

vs. Public Address
To understand bitcoin and its intricate structure, you need to know
the difference between three terms whose definitions are often, easily
(and mistakenly), interchanged.

Private Keys
In their purest form, private keys are 256-bit numbers that are generated randomly
and used to authorise the spending of bitcoins. ‘Bit’ is short for binary digit and
always represented by one of the two binary figures: a 0 or a 1.
Since the number of possible 256-bit combinations is extremely large, a simpler
system has been created to represent the private key. A 64-character hexadecimal
system using letters a-f and numbers 1-9, like so:
ef235aacf90d9f4aadd8c92e4b2562e1d9eb97f0df9ba3b508258739cb013db2
Public Keys
Derived from the mathematical theory of elliptic curve multiplication, public keys
are created from private keys. They are used to confirm that the data sent in the
blockchain is authentic; in other words that it comes from the owner of the specific
private key.
Thanks to the public key, the private key takes the shape of a digital signature,
without ever being publicly revealed. The receiver, or any peer in the network, will
only see the digital signature and public key.
Example of a Public Key:
030589ee559348bd6a7325994f9c8eff12bd5d73cc683142bd0dd1a17abc99b0dc
Public Address
Also known as the bitcoin address, the public address is also a major identifier for a
transaction and it’s derived from the public key. In fact, this is the information that
people need to input if they wish to send you bitcoin.
Each bitcoin transaction carries with it a unique public address, generated by
applying the public key into a cryptographic algorithm called Secure Hash Algorithm
(SHA).
Example of a Public Address: 1J7mdgA5rbQyUHE2NYd5x39WVBWK7AfsLpEo6XZy

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Trust
You’ve heard the term “trusted third party” before, right? Traditionally
speaking, this third party is the mediator between any customer and
any merchant. Banks and financial institutions or online payment
processors are conventional third parties that help facilitate
transactions.

Naturally, any transactions that involve people’s money must be built on trust. After
the 2008 financial crisis, this core principle was shaken as the concepts of fraud and
disputes became more prominent.

Traditional trust constitutes good faith towards the middle man; should any disputes
or claims of fraud arise, it is up to this intermediary to settle them. The system works
relatively well, but merchants end up incurring costs, customers are asked for more
information, and transactional fees increase.

Coupled with the fact that the traditional trust system took a hit after 2008, Satoshi
Nakamoto came up with the Bitcoin Network as a new kind of trust system, based on
the P2P network.

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Proof-of-work
Integral to the mechanics of Bitcoin, proof-of-work (or POW) is
Satoshi Nakamoto’s ingenious workaround for confirming the blocks
of transactions. The trust that is traditionally extended to financial
institutions is transferred to the decentralised nodes (or computers)
on the P2P Bitcoin network.

These nodes validate and group transactions into blocks. In order to include the
block in the ledger (blockchain), these nodes need to solve a “cryptographic puzzle”.
This is done by hashing the information in the block to satisfy specific conditions.
For example, one such condition is that the resulting cryptographic hash has to be
less than a specified number. Since this type of proof-of-work involves a lot of trial
and error, the approach is called bruteforce - meaning all possible solutions are
exhausted until the correct one is found.

The idea behind POW first emerged in the early 90s. By 1999, the first appearance of
the official term was documented, and while appearing in various forms, it became
increasingly popular when Satoshi Nakamoto integrated it into Bitcoin, amending it
to include the decentralised node verification system.

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Financial Institutions
Financial Institutions, in the context of Bitcoin, are the conventional or
traditional entities or companies that deal with monetary transactions
within the overall sphere of financial services.

Banks, for example, are the most readily recognisable and referred-to financial
institutions. They store clients’ financial data and records, apply their own fees for
various transactions, and generally act as the middle man (or “trusted third party”)
between a buyer and a seller or, indeed, any two parties (whether individual or group)
who enter into some form of financial agreement between each other.

After the 2008 financial crisis, terms like “bail-in” and “bailout” became popular
and threw a very negative light on all standard and regulated financial institutions,
especially banks. A popular investment bank famously collapsed in September 2008,
prompting a massive banking crisis. With the enactment of the Emergency Economic
Stabilization Act of 2008, it has been reported that the US government supplied up to
$700 billion to banks in order to bail them out of the crisis.

Nakamoto developed bitcoin as an “antidote” to this loss of collective trust in

financial institutions.

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Blockchain technology
Blockchain technology is at the centre of what makes the entire
cryptocurrency system function, including, of course, bitcoin.

As the name suggests, a blockchain is essentially a chain of blocks that contain

transactions and other data. In the case of bitcoin, this data is an encrypted form
of digital currency. However, the blocks contain more than just the transactions
themselves.

Besides the transactions (i.e. the amount for transfer), the blocks also contain the
following information:

• A timestamp indicating when the block was created

• A digital signature that is unique to its contents
• A code that links it to the previous block.

To get more detailed, the block header – which is the key identifier of any given block
within the blockchain – contains even more data. This includes, but is not limited to,
the version of the blockchain, an encrypted summary of transactions, and a number
that correctly calculates the digital signature of the block header.

Once a block is included in the blockchain, it becomes permanent and irreversible.

Looked at in its entirety, a blockchain consists of every transaction that occurred
since the beginning of bitcoin, starting with the very first block known as Genesis.

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Cryptography
Cryptography has a long history, dating back thousands of years. At
its heart, the principle definition has remained the same even while
technological advances have radically modernised cryptography.

It is the discipline or science of keeping data and messages secure (or secret) while
communicating and/or transmitting them over an insecure route or through a
vulnerable medium.

Historically speaking, the use of cryptography heavily influenced the course of

action in both World War I and World War II. Since then, cryptography has made
huge advances into the digital space. The Bitcoin network uses cryptography as its
primary security measure.

While transacting bitcoin, cryptography comes into play when describing the role
of the Secure Hash Algorithm (SHA). This is a cryptographic algorithm designed by
the National Security Agency (NSA). In order for a user to obtain his or her public
keys, the corresponding private key is fed into SHA-256. This generates the public
key, which is then fed back into the SHA-256 to generate the public address. The SHA-
256 algorithm takes a string of data of any length and transforms it into exactly 256
bits – that is, a series of 256 1s and 0s.

Another innovation of Satoshi Nakamoto is the digital signature, which is actually

not only unique to every block but also contains links to the previous blocks that
make its transactions irreversible. Digital signatures are another example of the kind
of cryptography used in the Bitcoin network.

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Double spending
Even though a form of P2P technology has been available since the
1960s, it has proven very difficult for an independent online payment
system such as bitcoin to appear. The reason for this can be summed
up in two words: double spending.

The best way to explain what double spending is to imagine a bitcoin transaction as
a text file:
Imagine that each text file represents €10.
A customer only has €10 to his name and needs to buy a product online that is worth
€20.
If he takes the text file, and copies it 10 times, all of a sudden he has €100.
If the customer buys 5 products with these €100, he would be double spending.
In the bitcoin world, if someone were to copy a digital file that represents €10, and
send €10 to two different merchants at the same time, this would be an act of double
spending.
Nakamoto figured out a workaround for double spending, by registering each bitcoin
in a public ledger (i.e. the blockchain) and ensuring that once a bitcoin is spent, it
would be marked as spent, and would not be usable for more spending.

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Bitcoin vs. bitcoin

One of the most common misconceptions when talking about the
most popular digital cryptocurrency is the differentiation between
Bitcoin and bitcoin.

Bitcoin (written with a capital B) defines the entire network upon which the
cryptocurrency system is built. When referring to Bitcoin, it’s the blockchain
technology that is being referenced, the system that makes use of all of the necessary
confirmations needed for new blocks to be added to the chain (i.e. the public ledger).
The other bitcoin (always written with a lower-case ‘b’) refers to the actual currency,
which runs on the Bitcoin network.

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Mining
To mine bitcoin you need software and a computer built for the specific
purpose of mining. The goal of the miner is to figure out a hash of the
block that is equal to or less than a specific target. If all information in
the block header remains constant, the result of SHA-256 will always
be the same – see the section on Cryptography to get a refresher on
the SHA.

In cryptography, a nonce is an arbitrary number that can only be used once. That’s
why it is included in the header – every time the calculated hash of the block header
fails to meet the targeted range, the nonce is increased and the hash is re-calculated
until it ultimately reaches its target.

Miners with the most powerful computing devices will have an advantage – the
total number of possible answers is close to 1077, which requires a lot of power and
speed. Since there is no logic when calculating the winning hash, bruteforce should
be followed.

Once the winning targeted hash is calculated, the block is included in the blockchain
and the reward is granted to the victorious miner. Currently, a block is included in
the blockchain every 10 or so minutes and a single block may contain approximately
1,000 transactions.

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Block Reward
As nodes need to solve cryptographic puzzles on a P2P network
through the use of bruteforce, and the number of possible
combinations is about 1077, Satoshi Nakamoto decided to include an
incentive in the Bitcoin system to make up for all these great efforts.

The first node to solve the puzzle will be awarded with a reward, which is known as
the “block reward”. The first ever reward was set at 50 bitcoins. In reality, every time
a new block is included in the blockchain, it generates a corresponding reward anew.

Nakamoto also figured out a way to control the creation of new bitcoins, by setting
a limit of up to around 10 minutes between new blocks being included in the
blockchain. Looking at it this way, you can say a cryptographic puzzle is solved every
10 or so minutes. That means 144 blocks per day or 52560 per year. As more nodes
and more powerful computers join the network, puzzles will be solved much faster.

To avoid any inflationary trends, Nakamoto also included a parameter called

‘Difficulty’ in the protocol. This increases the number of leading zeros in the resulting
hash when a node tries to solve the puzzle. In addition to this, the block reward is
halved every 210,000 blocks (which is approximately every 4 years). The last reward
will be awarded in the year 2140.

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Digital Signature
The digital signature is the result of a mathematical formula
(or, cryptographic hash algorithm), known as SHA-256 (refer to
‘Cryptography’ for more information on the SHA).

A file of data is accepted and scanned through this cryptographic algorithm,

generating an output of 64 alphanumeric characters. This output is known as the
digital signature. Keep in mind that the length of this alphanumeric code will always
be 64 characters, regardless of the length of the received data file, and that every
digital signature always begins with 4 zeroes.

To make things even more secure, the system is designed so that if just one character
is changed in the data, the SHA-256 algorithm will generate an entirely different
signature.

If a user was attempting to trick the system by changing the amount of bitcoins
he received from the sender, the corresponding digital signature would change as
well, including all the previous signatures since the beginning of time. This makes it
impossible for users to trick the system, which creates another layer of security.

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Distributed System
In computer networks there are mainly two architectures:
client server and peer-to-peer.

We have already covered P2P, which is the main foundation for Nakamoto’s Bitcoin
network – and it was clear from the start that Bitcoin will not be based on a client-
server protocol, as that is a centralised environment where the applications, files and
other resources are stored on a central computer, the server. So, what did Nakamoto
do to replace the second main architect model? He came up with a relatively
innovative alternative: the distributed system.

The Bitcoin network follows this distributed application model, wherein the work
load is spread among the participated nodes (or computers) – without a central
server. In order to maintain reliability in the network, a consensus must be reached
among the participating computers. Although 100% consensus is ideal, it is not
feasible every time.

When “digging” into computer networks, one will come across the Byzantine
Generals Problem – the subject of our next topic.

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Byzantine Generals Problem

A group of generals have surrounded an enemy city. They have to attack or
retreat, but must wait to see what their commanding officer will order them
to do.

In order for the mission to succeed, it is imperative that a consensus exists among all the
generals. Correspondence between the commanding officer and the generals is done
through insecure and vulnerable mediums. What’s more, a number of generals or perhaps
even the commanding officer could turn out to be traitors.

As long as the commander remains loyal, and the number of traitors is less than 1/3 of all the
generals, then consensus may be reached to attack or retreat.

Naturally, a loyal general would receive contradictory messages from the commander and
from a general who happens to be a traitor. In this scenario, it is not possible to achieve more
than 50% consensus.

The reason it’s important to understand the Byzantine Generals Problem is because the
Bitcoin system faces a similar issue as it also transmits information through an insecure
medium (i.e. the internet). This is why Nakamoto introduced the proof-of-work concept,
in order to bypass it. When sending a message, the message is hashed and a nonce is sent
to all nodes to verify the proof-of-work. Unlike the Byzantine example, the transmission of
transactions or blocks (i.e. the “correspondence”) is therefore done through more secure
and near-invulnerable methods. Every message (that is, every block) is chained; as a result it
is almost impossible to tamper with it.

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The Future of Bitcoin

The current situation of bitcoin is that a number of countries still
prohibit the buying, selling and trading of it. In other countries the
use of bitcoin is still disputed and under very careful scrutiny by their
respective governments.

The reason for this fragile state of the bitcoin is that governments fear losing
control. This creates a panic that in the future, this lack of control may open doors to
unforeseen problems where governments and regulatory bodies will not be able to
step in and draft, plan and execute monetary policies that can fix the problem.

With that said, however, many countries have adopted bitcoin as a legitimate form of
currency and have accepted that it’s here to stay in some shape or form. While some
may have a more conservative approach with regards to the new digital currency, it
is clear that Bitcoin technology has already taken root.

Even if bitcoin the currency loses all of its value one day – depending on market
action and how future regulations treat it – it is clear that the Bitcoin network and
the technology that the currency was built on will have a long life.

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Trading bitcoin
A lot has been said about bitcoin lacking intrinsic value, hence not
having any real value in the currency markets. However, taking the
intrinsic value of an asset into consideration when trading is only one
approach to the markets.

Another approach focuses more on the price chart, demand and supply, and the
crowd’s psychology in order to make informed decisions – usually by traders who
prefer technical analysis over fundamental analysis while trading.

Price patterns and popular indicators may be used to deduce a lot of information
from a price chart. Don’t forget that it is not only the financial headlines that move
the markets, but the traders’ psychology as well. With the right indicators and tools,
you will realise that traders’ psychology is also present on the price charts. Therefore,
CFDs on bitcoins and other cryptocurrencies (i.e. speculation on cryptocurrency price
movements without owning the actual cryptocurrency) are usually traded against
the US Dollar, and may be treated and traded just like any other financial instrument
if you apply disciplined technical analysis to your trading.

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Altcoins
Bitcoin constitutes the basis of many other decentralised currencies
that have appeared since 2009.

These are referred to as alternative coins, or altcoins for short. While they have many
similarities to the Bitcoin network, altcoins use different variations of blockchains and
proof-or-work algorithms for their foundation – many claiming to be an improvement
on Bitcoin.

For example, Litecoin is one of the first altcoins to use Scrypt as the proof-of work
algorithm – this results in much faster confirmations than Bitcoin has, making it a
very attractive alternative for retailers and investors.

Scrypt was designed to be bruteforce-tolerant, which implies much higher security.

Within the Litecoin system, a new block is added in the chain every 2 and a half
minutes (compared to Bitcoin’s 10 minutes).

To date, 84 million litecoins are scheduled to be put into circulation.

Other popular altcoins include Ethereum, Ripple, IOTA and ADA.

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Regulation
A key feature of bitcoin is its independence from financial institutions
and central banks, and – as a direct result – the monetary policy of
any country and government.

This was, of course, a very attractive feature to many people when Nakamoto’s
invention came to life, especially after the financial crisis that affected so many
people.

During bitcoin’s short life so far, many have seen how high the volatility has been
for the cryptocurrency. A result – at least partially – of different government policy
makers not allowing their constituents to invest in the new form of currency. Volatility
is a result of uncertainty, fear and panic – and it grows rapidly around an asset that is
not regulated by any central authority.

Some countries are looking into the feasibility of regulating the cryptocurrency.
Perhaps some regulation really is needed for this decentralised currency, in order to
ensure more stable growth and wider acceptance.

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Transaction Fees
It is no secret that miners invest in fast computing devices to be able
to compute as many hashes as possible.

A lot has also been said and written about the high electricity bills that individuals or
pools of miners have to pay in order to run their computers. The incentive, of course,
is the block reward! As mentioned previously, this is a number of bitcoins starting
from 50 and halving every four years until the last year of 2140, when all 21 million
bitcoins will have been mined. But, if the block reward is low and doesn’t cover all
of the expenses, what then? How will the bitcoin network operate and run without
the incentive to reimburse the miners’ expenses fully? The answer is transaction
fees. There is also incentive with transaction fees, which may see a substantial rise
through time.

It is logically deduced that even though the bitcoin cash system attempted to remove
the fees imposed by the financial institutions to the merchants (who consequently
passed them on to the consumers), transaction fees in the bitcoin world will
eventually increase to cover the mining expenses. Keeping in mind that the bitcoin
reward is halved every four years, only the rise of bitcoin’s price will keep transaction
fees low. Time will tell!

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About the Author

FXTM’s Head of Education, Andreas Thalassinos, is a respected FX educator and Certified
Technical Analyst. He is a recognised authority in the forex industry, and renowned for
his expertise in algorithmic trading. After years of consulting with FXTM on a number
of key projects, Andreas officially joined the company in June 2016 and is the principal
driver and architect of FXTM’s extensive educational programme. His department’s
international seminars and workshops provide clients across the world with on-
location support, while his webinars, Ebooks, educational articles and videos form
the cornerstone of FXTM’s multilingual, open access training resources. The training is
tailored to traders’ needs by region and experience level.

Thalassinos has played a key role in the development of forex education within the
industry, training tens of thousands of traders and forex professionals around the world.
Traders of all levels value his seminars and workshops for both content and his passionate
and lively presentations. As Head of Education, Thalassinos also plays a pivotal role in
FXTM’s research and development team. In this capacity, he led the development of the
FXTM Trading Signals and FXTM Pivot Points Strategy tools, which are designed to help
traders spot potential trading opportunities across various trading instruments.

Thalassinos has been awarded a number of international professional certificates

including: MSTA by the Society of Technical Analysts (UK) and CFTe and MFTA by the
International Federation of Technical Analysts (USA) – the highest qualifications in the
technical analysis community. He also holds a BSc and MSc in Computer Science from
University of Louisiana at Lafayette and Bowie State University, respectively.

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NOTES TO EDITORS
The FXTM brand provides international brokerage services and gives access to the global currency markets, offering trading in forex, precious metals, Share CFDs, and CFDs on Commodity
Futures. Trading is available via the MT4 and MT5 platforms with spreads starting from just 1.3 on Standard trading accounts and from 0.1 on ECN trading accounts. Trading on the
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regulated by the Financial Services Commission of the Republic of Mauritius with an Investment Dealer License bearing license number C113012295.

DISCLAIMER: This written/visual material is comprised of personal opinions and ideas. The content should not be construed as containing any type of investment advice and/or a
solicitation for any transactions. It does not imply an obligation to purchase investment services, nor does it guarantee or predict future performance. FXTM, its affiliates, agents,
directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness of any information or data made available and assume no liability for any loss
arising from any investment based on the same.

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