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Introduction

There are no conditions of life to which a man cannot get accustomed, especially if he sees them accepted by everyone about him.

—Leo Tolstoy

Several years ago I was fascinated by an experiment I did. I was trying to live cashless, paying only with plastic cards, either debit or credit. My attempt was pretty successful until I went on a business trip abroad. My first (but not last!) failure was in a restaurant, when I received a check without a placeholder for a tip amount. There were no problems paying with a credit card, but there was no way to add a tip to the bill. So I had to ask my friend (who was not participating in my experiment) to pay a cash tip. The payment system, even though it was “aware” of electronic payments, was not fully integrated into the world of plastic money. Such a situation is still common in many places, especially outside North America and Europe.

I would face similar challenges today if suddenly I decided to do the same experiment with bitcoin, but this time the limitations would be different. Instead of geographical borders that divide the world into cash and cashless zones, there is an invisible Rubicon between the offline and online worlds. In this new version of my experiment, I could live a sustainable life without cash (or plastic) if I didn’t leave my house. I could shop online and even order food from local restaurants. Whenever I needed to make a transfer of traditional money, for example, to pay the commodity bills (still virtual but counted in dollars rather bitcoins), I could exchange my bitcoins online and convert them to dollar transfer. I could even earn a living by mining the cryptocurrencies at home. However, this pattern breaks very quickly when you go offline and enter traditional brick-and-mortar stores. Few retailers today accept bitcoin or any other cryptocurrency, despite the obvious benefits: convenience, security, lower transaction fees, and attracting new generation of customers.

One of the most important goals of this book is to help people who are not closely familiar with math and cryptography to understand crypto payments. In order to do it smoothly and wisely, we need to understand several things, the first being the place cryptocurrency has in the modern payment ecosystem.

Don’t let the fact that this book is technical scare you if you are not a programmer. This book can still be read by anyone who wants to get paid or pay with cryptocurrency, and the first several chapters will prove it by answering very basic questions, such as what are the players in the existing electronic payments game, and whether it is possible to integrate bitcoin into it painlessly without breaking the major rules.

While I realize that the readers of this book might be in a sense obsessed with crypto payments, we should stay calm and remember that there were (and in fact still are!) other types of currencies and methods of payment. Although bitcoin enthusiasts often use the term “revolution,” from many perspectives, especially from the merchants’ point of view, creation of cryptocurrency is just an evolution of a payment system that was made possible by modern science and technology, namely cryptography and the Internet.

If you ask how to characterize bitcoin in a single word, many would answer “cryptography.” Although I agree with this answer, it is too generic, so my answer would be more specific (but contain more words): “public-key encryption and hash function.” Here is why.

If we analyze existing payment systems—predecessors of bitcoin—there are two main problems in their design: security and centralization. Security flaws in the design of payment cards resulted in the creation of PCI data security standards, which forced merchants, service providers, banks, and payment brands to invest billions of dollars into security controls, which eventually failed to protect them from data breaches. On the other hand, as you will see in part I of this book, centralized management of the first virtual currencies was the main reason for fiasco.

Bitcoin design provides solutions to both the security and centralization problems: digital signature and proof of work. A digital signature is based on public-key cryptography, while a cryptographic hash function is the essential part of both a digital signature and a proof-of-work implementation.

Before the invention of digital signatures, it was impossible to broadcast the message throughout a public channel such as the Internet and verify through multiple recipients that this message was unchanged since its creation by the original sender. Along with public-key encryption, the cryptographic hash function made creation of a digital signature possible, which protects the integrity of crypto transactions—a solution for security problems.

At the same time, a cryptographic one-way hash function, besides its participation in digital signature design, made proof-of-work implementation possible, which is a solution for centralization problems.

So it’s safe to say that if you understand the cryptography behind bitcoin, then you know how bitcoin and other cryptocurrencies work, so you can trust them.