Welcome to Bitcoin Island

Forget currencies and commodities… perhaps the right analogy for Bitcoin is LAND!

Oleg Andreev posted an insightful tweet the other day:

You could argue this is a trivial observation: how else could it work?!  But thinking in terms of ownership and protocols for transfer of ownership is a surprisingly helpful way to think about how the system works.  And that’s because the “protocol of ownership” insight means there is a whole other world of history, tradition and precedent to learn from: land!

Here are some observations to motivate the thought:

  • In the end-state the quantity of Bitcoin will be fixed, just like land.
  • Bitcoin is not perfectly fungible and neither is land
  • Bitcoin is not “consumed” through use – just transformed and transferred. This is similar to land and dissimilar to many commodities, which are consumed (or at least degraded) through use.

OK – not a perfect parallel but let’s go with it for now…. What happens if we think about Bitcoin through the lens of land?

Well, first, it allows us to think about coins that haven’t been mined yet… we can think of them as parcels of land on “Bitcoin Island” that haven’t been released yet:

Image

The “Land Interpretation” of Bitcoin. Think “Bitcoin Island”

Second, it helps us put some intuition behind the concept of the “unspent transaction output”.  These are Bitcoins that have been sent somewhere but not yet themselves been spent.  So the set of all unspent transaction outputs (UTXOs) can be thought of as the latest state of every Bitcoin that has ever been mined.

The UTXO is absolutely crucial to everything in Bitcoin and yet very few people think in these terms, talking instead about misleading terms like “address balances” and so forth.

But the interesting thing is: if we take a “land interpretation” of Bitcoin, then UTXOs have a really simple explanation: they are plots of land! And Bitcoin transactions are simply actions that merge or split these plots of land.

Imagine I own twenty Bitcoins. My Bitcoin wallet software will show a “balance” of twenty. But it’s likely that this balance actually consists of multiple unspent-transaction outputs. Even if I had bought all twenty Bitcoins in one go, it’s likely that the seller merged several smaller UTXOs that added up in total to twenty Bitcoins.    So perhaps I received three plots of “land”: 7 Bitcoins in one, 7 in another and 6 in the third.  My total “holdings” are 20 – but it is formed from three “UTXOs”.

Perhaps my holdings on Bitcoin Island look like this:

Image

We can think of Unspent Transaction Outputs as plots of land on “Bitcoin Island”. Plots A, B, C represent three unspent transaction outputs controlling 20 Bitcoins

And now it’s possible to teach people about Bitcoin transactions without completely confusing them!

Imagine I wanted to buy a second-hand car for 11 of my Bitcoins.  Let’s also imagine that I pay a transaction fee of 1 BTC to keep things simple (a HUGE over-estimate, of course)

I need to do a few things:

  • Step One: I need to prove ownership of the coins I’m trying to spend
  • Step Two: I need to say how the coins are going to be allocated – how many am I sending and to where? 11 to the seller, 8 back to me and 1 for the miner in this case.
  • Step Three: I need to specify what the new “owners” will need to do to prove they do indeed own the coins. In other words, I need to specify what they will need to do in their Step one when they try to spend their coins in the future.

I do this in Bitcoin by issuing a transaction that accomplishes all three steps in one.  Here’s what it might say:

“I own three unspent transaction outputs: A, B and C. In total they represent twenty Bitcoins. Here is my proof I am entitled to spend A.  Here is my proof I am entitled to spend B.  Here is my proof I am entitled to spend C. I hereby reshape my plot into two new plots: one plot 8 units in size, which I call X and a second plot 11 units in size, which I call Y. Whoever mines this transaction can claim the remaining 1 BTC. If you can satisfy the following conditions then you will be considered to own X: … . If you can satisfy the following conditions then you will be considered to own Y: …”

I will set the conditions so that only the seller of the car could satisfy the Y condition and so that only I could satisfy the X condition (that’s my change and I don’t want anybody else spending it!)

The end result is that I have simply rearranged the land holdings:

Image

Transaction outputs A, B, C are now spent, replaced by two new unspent transaction outputs: X and Y.  X is my change, Y now belongs to the car dealer and F goes to the miner.  

 

But we can go further… we can now have an informed discussion about what “ownership” means in Bitcoin.  When I “send” Bitcoins to somebody, I’m not assigning ownership to an individual.  What I’m actually doing is laying down a condition – and anybody who can satisfy that condition will be considered the owner.

Now, normally, the condition is very simple.  It says something like:

“To spend this output you must prove you know the public key that hashes to the following address: …   And you must prove you own the corresponding private key by issuing a digital signature”.  

That’s what the “OP_DUP OP_HASH160 …” stuff you sometimes see is usually saying.

But the conditions can be far more complex than that…. It’s all down to how you write your transaction.

Where is this going?

OK – so thinking of Bitcoin in terms of land helps us build some intuition around UTXOs, which we can think of as “parcels of land on Bitcoin Island” and we see that Bitcoin transactions are really just a way to merge or split these parcels of land and impose conditions that allow people to assert ownership.

And now things get really interesting.  Because there are all sorts of interesting phenomena that happen with land transactions that we can use to think about Bitcoin problems.

Fungibility

The land analogy works because Bitcoins are not perfectly fungible. Sure – there are projects trying to overcome this but this feels like an arms race between developers and law-enforcement agencies. To the extent that fungibility remains imperfect, what drivers could force different “land parcels” to have different values?

For me, the biggest topic on the horizon for fungibility is “coin tainting”, “whitelisting” and the other schemes intended to “tag” Bitcoin addresses or UTXOs.

I see these schemes as directly analogous to concepts like land “blight” on the one hand and maybe “planning gain” on the other.  For example, if you own a “plot of Bitcoin land” that has been “whitelisted” by an exchange or finance firm such that you can access their services, presumably your “plot” would be worth more than one that didn’t have that property?

It is perhaps no surprise that the fungibility issue is so hot right now.

Mineral Rights and Colored Coins

Two pieces of seemingly identical land can be worth vastly different sums: if one is sitting on oil and the owner has mineral rights, a purchaser will be willing to pay them more for their land than if it didn’t! Perhaps this is a useful analogy for colored coins: two identical Bitcoins can trade for different prices if one of them has been “colored” by a trusted issuer. What are the taxation implications? What happens when projects trying to add coin coloration to Bitcoin conflict with projects trying to create fungibility?

Alt coins

Perhaps Altcoins are just different islands! If there is a Bitcoin Island, then presumably Litecoin has Litecoin Island and Dogecoin has Dogecoin Island?

This interpretation now helps us think more clearly about the role and value of altcoins.   Perhaps the innate characteristic of a currency (faster confirmation? Use of scrypt?) makes the island a more attractive place to live. But if all the infrastructure and population is on Bitcoin Island then these features may not be enough.  Who knows.

Charges and Liens

It is possible to impose conditions on land parcels in many jurisdictions. A mortgage company can prevent sale of land unless the debt is settled and some landowners in the UK have been dismayed to discover that their land ownership came with an expensive obligation to pay for the upkeep of a local church.

In some cases, the obligation is short-lived (e.g. the mortgage charge) but in others, it persists across transactions (e.g. chancel repair liability).    A question I don’t know the answer to is: can you write a Bitcoin transaction that imposes conditions on a UTXO that propagate?  That is: can you write a transaction such that whoever spends the UTXO must impose the same condition on their transaction output?

Conclusion

Of course, the land analogy is imperfect but I do think there is something to it.  If nothing else, the mental image of “Bitcoin Island” with UTXOs being the plots of land feels like a really useful one… it has certainly helped my understanding…

 

 

23 thoughts on “Welcome to Bitcoin Island

  1. This is a great piece, probably the best explanation I have seen showing how the underlying protocol works. I will definitely be stealing this analogy when I talk to people about Bitcoin.

    To answer your question: no, you can’t write a transaction such that whoever spends the UTXO must impose the same condition on their transaction output (but you might be able to in future). Bitcoin scripting currently doesn’t allow any reference to anything except the data contained in the script. You can’t reference any other data about the transaction itself or any other transaction.

    There are some discussions in the development community about how to add smarter functions into scripting which will allow these sort of smart contracts/transactions. The problem is that adding these functions while maintaining security, backwards and forwards compatibility is very difficult. We will see alt-coins adding this functionality, most notably Ethereum which aims to allow the creation of extremely complex contracts.

  2. @Albert…. I would argue the opposite… changing the 21M cap would be *extremely* difficult…. you would need to gain support of over 50% of hashing power *AND* convince everybody else that the change didn’t fundamentally undermine the system (or else risk a mass exodus of users/consumers). i.e. you’d need both to gain the support of a diverse group of miners *and* win a war of hearts-and-minds with the extended community. Anybody with a vested interest in the status quo would be lined up against you.

    Not easy at all.

  3. Do you really need to convince 50% of the mining power, or just fork the software? Also I bet the miners would go for it as it would mean more coins for them. Who is in charge of the software? People. I would not underestimate the power of greed.🙂
    I forgot to mention, if the limit can be modified, then we cannot use the land analogy.

  4. @Albert, you are correct, it is not set in stone. Unfortunately you can only mine less than the amount you are allowed to, like in this block. If you mine any more than the amount you are allowed to, the rest of the network will reject your mined block. The rewards can be changed (as we saw with Dogecoin which went from providing random rewards to providing fixed rewards) but as Richard says this requires the agreement of most participants which is very difficult to achieve.

  5. I would suggest a better analogy would be Virtual Real Estate being the Domain names. They are unique and have little impact in carrying or holding costs until demand and development occurs. Value can be transferred to the acquiring party along with each unique identity and the Domain name remains the same.

  6. Richard, the land analogy is a fruitful aid to concept development in BitThink. The blockchain and its associated miners takes on the role of the title registrar in a Torrens land registry. The elimination of the double-spend problem is equivalent to the Torrens attribute of indefeasibility of title or ownership. Since the spread of this idea from the state of South Australia in 1858 to Western Canada in 1861, the adoption of this method of land registry has been most rapid in land rush and gold rush jurisdictions. Bitcoin only recently emerged from its own land rush stage with Laszlo Hanyecz’s historic 10 May 2010 purchase of the 10 000 BTC Father John’s pizza. The blockchain is our title registry. The parallels are rich and in need further thought mining…

  7. @eric – thanks for the comment. I’m not sure your analogy works, however: the important piece (for me) is inspiring a mental model that brings the UTXO concept to life. So you need some idea of consuming one or more inputs, producing one or more outputs and in so doing reallocating the satoshis/bitcoins. As other commenters have said, it’s not possible to trace from input to output with certainty so my analogy doesn’t work perfectly. But I think you do need some idea of merging/splitting. Or perhaps I misunderstood your point?

    @canadense1 – agree land registry is a very useful parallel…. But perhaps Torrens is only part of the story? i.e. you can look at the blockchain to see which “address” currently owns a UTXO… but you can also see the full chain of title going back to one or more coinbase transactions…. so it’s a bit like *both* land registration systems at the same time!

    Btw… @laurentMT proposed an alternative analogy based on “flows” here: http://laurentmt.blogspot.fr/2014/03/about-nature-of-cryptocurrencies.html

  8. Richard, in the Bitcoin protocol there is no need to trace the chain of ownership, although it is certainly feasible to do so. The innovations of the Torrens asset registry are the “mirror” principal and the “curtain” principle, meaning that indefeasible title is established without the necessity of tracing the chain of prior ownership, although one can readily do so.

    A large part of the expense, and risk, in the present funds transfer system is the necessity of maintaining the chain of transfer for liability reasons and AML risks not to mention forensic accounting for taxation and fraud risk. Bitcoin’s chain certainly can be employed in this manner, but the critical insight comes to us in recognizing that the transfer and its attendant costs do not require that the chain be traced after it is secured in the blockchain.

    This is the critical feature that also distinguishes a Torrens registry from the older costly and cumbersome chain-of-deeds asset registry. The insight here, which I shall not further dwell upon, is that both Bitcoin and Torrens solve the double-spend problem in a profoundly transformative manner, quite apart from surface appearances.

  9. I would argue regarding the 21M BTC cap, that based on it’s design there is no need to add to that number, and create an inflationary environment. Why is this even brought up? We need to focus on (and I’m certain it is) a universal automated accounting solution, at least for Americans still here, to handle the capital gains tax so it’s not a deterrent to continued wide acceptance. I’ve heard blockchain.info and some wallets are able to easily make the calculations, but I haven’t heard for sure.

  10. @canadense1 – thanks for the extra information. What’s your view on “coin tainting” and/or “whitelisting/redlisting” projects? It strikes me that, at heart, they’re all about trying to defeat the curtaining principle, as you call it…. i.e. they seek to look “beyond” the last transaction and impute properties to UTXOs/coins today based on something that happened in the past. Did I get that right?

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  12. Hi Richard. I realise this was written some time ago. This is an interesting analogy to help understand Bitcoin. I just want to point out that your example involving the 20 received bitcoin may be misunderstood. Some readers may be led to believe that the 20 bitcoin you bought “in one go” actually exist as three separate UTXOs in your wallet when in fact we know that it will really be just one UTXO of 20 bitcoin.

  13. @klmoney – thanks for the comment. You’re right… I didn’t distinguish clearly between the two cases… thanks for clarifying.

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  19. Nice article, that cleared out a lot of questions I had about the Bitcoin protocol.

    Now, if Bitcoin is an island and altcoins are other islands… Sidechains would definitely be a way to build bridges, right?🙂

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