Categories
Cryptocurrency Basics

Bitcoin Blockchain Software – Understanding Wallets

Editor’s Note
The following transcript was taken from one of Kelly’s live classes for tax professionals.

SLIDE 55

There are multiple ways of getting a wallet. The main way I suggest is you just go and create an account somewhere, were somebody can send you bitcoin. You can create an account at Coinbases, but Coinbase is in exchange. What did I say about exchanges? They are not a place to store your money because exchanges use hot wallets. Exchanges also control the private key. I can’t stress this enough. People lose their private keys and are in a panic on all these discussion boards. How do we get our money back? You’re toast if you lose them and it’s your responsibility to save them. There’s a phrase that we use “you don’t got your keys, you don’t got your money.” When you create an account or your clients go to Coinbase and set up an account, they take $100 from a bank account and go buy a hundred dollars worth of bitcoin. They now have a wallet on that exchange in their name. They have an address. The process of buying a crypto generated an address in their wallet. Now they can see that they have it. They can click on the transaction ID, go to the Block Explorer and see it. What they don’t have is the private key. It’s controlled by Coinbase. This is why Coinbase is being called the “new bank”. You do not control your money if you don’t have the private key.

Public key cryptography is what trips up a lot of people from wanting to actually get in charge of their own money. They think it’s just too hard and it’s not exactly easy. It’s getting easier and easier. The user interfaces are getting better and better. Be aware there are lots of services popping up on the Internet that are saying I can help you manager your crypto currencies easily. They’re doing the same thing Coinbase is doing. They have a beautiful interface, they’ll let you put your different cryptocurrencies in and they make it easy for you to spend them, collect them and keep them in one place. They control your private keys.

You want a wallet where you control the private keys. That also means you control the security for that wallet. You’re not paying the bank to make sure they have security to control your money. You have to figure out redundancy. You have to figure out paper wallets versus digital wallet versus the computer wallet. It’s not as hard as it sounds once you’ve done it a few times.

SLIDE: screen grab of the Exodus wallet

I love to send people to the Exodus wallet because I think it’s easy, it’s beautiful and I can get access to my private keys and save them. You can go to Exodus.io <I checked this domain) to learn about this wallet. It’s a piece of software that lives on a computer. You can use it on your laptop or your desktop. It’s a place to track your money. Exodus has a mobile phone version <yes, I checked this) but I haven’t used it on purpose because it’s a hot wallet. I have a laptop that I use just for my crypto currencies. That laptop is off-line until I go to use it. That makes it not as hot of a wallet.

I’m about to confuse you with the next sentence I’m about to say: some wallets allow you to exchange the coins right inside the wallet. I told you this technology is moving at the speed of fire on a grassy plain. They’re constantly making it better and easier. It also makes it more difficult to keep track of the transactions and put them on a tax return. I use Exodus and I’ve traded some of my bitcoin for some cryptocurrencies that aren’t on the exchanges that I like to use. They might not be on an exchange, but I can get that currency inside Exodus. I usually trade bitcoin or ether to get another currency that I can’t spend my US dollars on. Remember, most of cryptocurrencies are not convertible virtual currencies. I have to buy them with other virtual currencies. I can use bitcoin and buy something else. I can do that inside Exodus because they have a relationship with an exchange called Shapeshift.

Slide: Tax organizer graphic

This is very complicated and it’s hard to keep track of, which is why I have a beautiful Crypto Tax Organizer that I put together just for my tax professionals to help you understand all the different questions you might want to ask your client during the interview. If you have questions on some of the wording on the organizer, just Google it.

SLIDE: Paper Wallet

This is a picture of a paper wallet. I had a client come to my office and said: I bought a bunch a Litecoin because this guy on YouTube said I should. I am not tech savvy in the slightest and he said I want a paper wallet. Can you make me a paper wallet? I said sure, let me figure it out, and I generated a Litecoin paper wallet. I went to a site, moved my mouse around the screen, it popped up and said here’s your paper wallet. The paper wallet generates a private key and a public address. You’ll see the smaller number with the fewer digits in the red square on the slide, that’s the public address. The one with more numbers is the private key. That’s what they look like.

SLIDE 53

Part two is about proof of work, the consensus algorithm. This algorithm confirms transactions and produces new blocks. Each mining node collects transactions sent over the network and bundles them into a temporary block. Every 10 minutes all the mining nodes simultaneously race to solve a complex computer puzzle to decide which miner’s temporary block will be permanently added to the blockchain, then miners get rewarded. Once a block is chosen, all other mining nodes must verify that selected block. That shouldn’t be too difficult.

SLIDE: MAP

Here’s a map that gives you a rough idea of where bitcoin mining node operations are around the planet. Some of the biggest nodes are in China. You’ll notice that they tend to congregate up north. Mining operations use a lot of electricity, which makes them hot places. I’ve heard Jamie Diamond and others on the news complain that bitcoin is bad because it uses so much electricity. I have some slides from a different training on my site called Fundamentals of Virtual Currency. It shows a study a woman did to debunk that the banking industry uses way more electricity then the bitcoin blockchain does. (<-should it be the other way around?) The two together use a lot of electricity. If we were to get rid of one or the other, we’d use less electricity. I vote we get rid of the financial system that is currently not trustworthy. it’s expensive and it’s not working anymore as is. This is potentially a new system. The proof of work consensus algorithm is what is going on in the mining part and is what is doing all the validating of the transactions and then generating that new bitcoin when a block gets added.

Part three is the public distributed ledger, which we call the blockchain. You’ll notice that some corporations and institutions don’t like to use the word blockchain. They like to use a fancy word. They call it distributed ledger technology. Beware. Let’s take a short trip back in time to when the Internet was born. When the Internet was born nobody knew that it would be worth anything. Then Google came out with their search engine and all of a sudden I could see some use for it. Then suddenly it seems like every business on the planet wanted a website that was on the Internet, one that everybody could see. During that time what were corporations trying to do? They were creating these things called intranets. They were trying to harness this new technology to use on their own, but separate. They didn’t want to use the Internet, they wanted to create their own intranet that would just have their information. How’s that going for them?

We never hear about intranets anymore. Occasionally you’ll see a big corporation with an intranet. That’s just for their employees to get information about the company and whatnot. They’re not all that popular. This is what I see going on in the corporate world that is wanting to capture the technology called blockchain. They want to disconnect it from the technology called blockchain, because blockchains involve cryptocurrencies and for the corporate world, that is very messy. We don’t want to create new currencies. We just want to use the technology called blockchain and not pay attention to those things called cryptocurrencies that get generated from the blockchain. This is why you’ll see places call them distributed ledger technology. Don’t be fooled, it’s just a blockchain. If it doesn’t generate a cryptocurrency, it’s not a blockchain. As far as I am concerned and what all the developers I talk to, if it does not generate a cryptocurrency, it’s not a block chain. It’s a fancy database that they’re calling a distributed ledger technology.

Audience member question: isn’t it the encryption that they’re so interested in and why they’re looking at it? Answer: yes, but it’s more than just encryption. It’s how data is tracked. One of the best early use cases of distributed ledger technology, also known as blockchain, is on supply chain management. They can track the supply chains from the United States to China as there’s so much that has to happen in between. The paperwork is just unreal with what these guys have to go through to move stuff from one place to another. If all that information was put into a blockchain, it would be easier to manage. I don’t think they’re trying to call that a DLT (distributor ledger technology), but what that kind of blockchain would be, is a private blockchain. They wouldn’t want everybody in the world see what’s going on in their shipping practice. They would make a blockchain and you would only be able to see it if you were invited to it. I can’t think of all that the DLT’s right now because that’s all going on behind the scenes. Any company that’s building out their own DLT is not really got to tell you all about it. It’s not only a private blockchain and I don’t know how they’re taking the cryptocurrency out of the equation, because that’s what keeps track of double spend. If they don’t care about spending the cryptocurrency that is generated in the blockchain then maybe they can use a DLT not caring about the currency. They’re not trying to do a currency.

Audience member comment: the (who? At the 15:20 mark) are trying to keep the transactions private. They also keep track of the entire history of those transactions.

SLIDE 55

Here are some images I put together to try to give you a visual of what’s going on. The blockchain is a shared digital ledger of transaction blocks. This is a representation of what it looks like. This is the entire block. When this block got generated and got added to the blockchain, it would’ve been added to a connected to a block over here. When that got created, somebody earned some bitcoins. This is just an example. There’s lots of transactions that will be in here. The amount varies from block to block. They never have the exact same quantity of transactions in them. Then the next block got created. Whoever generated that block got paid in bitcoin. How does this block connect to the former block? It’s called a hash. There was a hash made of this entire block, that is this number right here on top… This is the number they got when the puzzle was solved. This is the number that got generated. That number is also the number that’s put in the next block, and this is what tells the next block how to stay connected to the one before it and so on and so forth. Hashes are not easy to break.

The ledger permanently records bitcoin transactions between peers on the network in a sequential chain of cryptographically hash linked blocks, called the blockchain.

The image on the bottom left part of the slide shows you what the wallet does. This picture shows a wallet on the left and a wallet on the right. One is a sender, one is a receiver. The transactions of sending something from the sender to the receiver is tracked inside the blockchain.

I’ll show you a video that will explain what a blockchain is. What I want to point out is that these are real people. This is the Yapese video. Did you know there are real Yapese people on the planet? They live in Micronesia. What this video is about to depict to you is real. I thought that somebody made this up as a great way to describe the blockchain. This is exactly how the Yapese people use to keep track of their money. I actually have a picture I found of their physical coin, you’re going to see what that is. It’s about 10 feet tall and weighs a few kilos. <- a few kilos is just 4.5 lbs, maybe say it weighs a few tons) This was their money.

Do you have a link to the video we can post here?
Video transcription
To understand blockchain let’s go back to 500 A.D. on the island of Yap, located in what is now Micronesia. The Yapese people had stones like this everywhere. This is a Yapese coin. It was their money! It’s about 200 kilos. Suspending these like modern coins? That posed a bit of a problem. Well, the Yapese solved this by not ever physically moving the coins. The coins were placed in very visible locations on their tiny island. Every adult Yapese knew who the owner of each coin was by memory. When two people wanted to transact, they would announce the change in ownership to the other Yapese who would all update their knowledge of who the coin belonged to. Voila, the coin was exchanged. The Yapese were using what we would call a distributed ledger. It’s a ledger in that each Yapese had a mental record of the ownership of all coins and they would mentally update that ledger anytime there is a transaction. It’s distributed in that the ledger wasn’t just known by one person, it was known by all people. Now, the Yapese could have asked one person to keep track of the mental ledger and coins. That person would have to be really trustworthy in terms of both honesty and administration skills. The monopoly that person would have on transaction activity might lead them to charge a fee, or make rules for who and when one can transact, and problems would arise if that person fell ill, decided to leave or their integrity was compromised in some way. That central person would be a bank. Distributed ledgers perform many bank-like functions without requiring trust in a central entity. In the Yapese example, a person can’t tamper with the ledger, claim ownership of the stone that doesn’t belong to him, or all the Yapese will come forward and contradict his claim based on their knowledge of the ledger. So fraudulent transactions aren’t likely. Also if one particular member of the tribe isn’t available or moves away, thereby losing a copy of the ledger, transactions can still be validated by the other Yapese. So the system is fault resistant.

The video stops there midstream because the original goes on for a while and gets much more into detail about how the blockchain works. I felt like that was enough to help you understand the basics.

SLIDE that shows the graph of bitcoin rewards SLIDE#?

The next slide shows some statistics. I’ve been mentioning several of them as we go but here they are consolidated. This graph shows you the existence of bitcoin over time, when it’s going to be halved and at what point in time it will go to 21 million. We’re about here, (pointing to 12.5) right now and we’re about to go to 6.25. Block rewards started at 50 bitcoins. They’re cut in half every four years. Only 21 million bitcoins will ever be mined. They’re expected to all be mined by 2140. Sometimes blockchains fork. It’s a whole other topic. In 2017 the blockchain forked into two blockchains and created what’s called Bitcoin Cash. It’s very controversial. I owned bitcoin when that happened and when the fork happened, I suddenly had some coins in my Coinbase account called Bitcoin Cash. I was so confused, I didn’t know what to do with it. I immediately sold it. I’m stupid, which is why I am an educator. I’m teaching myself along the way. I had nobody in my life telling me what to do. Sometimes I didn’t make the best decisions. You have the benefit of my experience and knowledge, so you can help your clients not make the same mistakes.

The total bitcoins in circulation right now is approximately 18 million. 144 blocks are mined per day on average. It takes about 10 minutes to mine each block. One Satoshi is the smallest division of a bitcoin. That’s eight digits and we call that one Satoshi. The total rewards today is 12.5. The next halving occurs May 2020. <- do you want to do a 2020 update for timing relevance in the text version?) We’re expecting the price of bitcoin to go up after that halving. You should see a lot more people showing up at your office going “I’m getting into this, its price is going up! I’m buying it, I’m selling it!” It’s the law of supply and demand. The bitcoins are going to get cut in half in May 2020. There will be less coming into the system. Most of them are already there and quite a few of them have been lost. I don’t know how many.