We define an electronic coin as a chain of digital signatures.
Each owner transfers the coin to the next by digitally signing a hash of the previous transaction and the public key of the next owner
and adding these to the end of the coin.
A payee can verify the signatures to verify the chain of ownership.
The problem of course is the payee can't verify that one of the owners did not double-spend the coin.
A common solution is to introduce a trusted central authority, or mint, that checks every transaction for double spending. After each transaction, the coin must be returned to the mint to issue a new coin, and only coins issued directly from the mint are trusted not to be double-spent. The problem with this solution is that the fate of the entire money system depends on the company running the mint, with every transaction having to go through them, just like a bank. We need a way for the payee to know that the previous owners did not sign any earlier transactions.
For our purposes, the earliest transaction is the one that counts, so we don't care about later attempts to double-spend. The only way to confirm the absence of a transaction is to be aware of all transactions. In the mint based model, the mint was aware of all transactions and decided which arrived first. To accomplish this without a trusted party, transactions must be publicly announced , and we need a system for participants to agree on a single history of the order in which they were received. The payee needs proof that at the time of each transaction, the majority of nodes agreed it was the first received.
The solution we propose begins with a timestamp server
A timestamp server works by taking a hash of a block of items to be timestamped
and widely publishing the hash, such as in a newspaper or Usenet post [2-5]. The timestamp proves that the data must have existed at the time, obviously, in order to get into the hash.
Each timestamp includes the previous timestamp in its hash, forming a chain, with each additional timestamp reinforcing the ones before it.
To implement a distributed timestamp server on a peer-to-peer basis, we will need to use a proof of-work system similar to Adam Back's Hashcash , rather than newspaper or Usenet posts.
The proof-of-work involves scanning for a value that when hashed, such as with SHA-256, the
hash begins with a number of zero bits. The average work required is exponential in the number of zero bits required and can be verified by executing a single hash.
For our timestamp network, we implement the proof-of-work by incrementing a nonce in the
block until a value is found that gives the block's hash the required zero bits.
Once the CPU
effort has been expended to make it satisfy the proof-of-work, the block cannot be changed
without redoing the work.
As later blocks are chained after it, the work to change the block
would include redoing all the blocks after it.
The proof-of-work also solves the problem of determining representation in majority decision making.
If the majority were based on one-IP-address-one-vote,
it could be subverted by anyone
able to allocate many IPs.
Proof-of-work is essentially one-CPU-one-vote.
The majority decision is represented by the longest chain, which has the greatest proof-of-work effort invested in it.
If a majority of CPU power is controlled by honest nodes, the honest chain will grow the fastest and outpace any competing chains.
To modify a past block, an attacker would have to redo the proof-of-work of the block and all blocks after it
and then catch up with and surpass the work of the honest nodes.
We will show later that the probability of a slower attacker catching up diminishes exponentially as subsequent blocks are added.
To compensate for increasing hardware speed and varying interest in running nodes over time, the proof-of-work difficulty is determined by a moving average targeting an average number of blocks per hour. If they're generated too fast, the difficulty increases.
The steps to run the network are as follows:
1) New transactions are broadcast to all new nodes.
2) Each node collects new transactions into a block
3) Each node works on finding a difficult proof-of-work for its block.
4) When a node finds a proof-of-work, it broadcasts the block to all nodes.
5) Nodes accept the block only if all transactions in it are valid and not already spent.
6) Nodes express their acceptance of the block by working on creating the next block in the
chain, using the hash of the accepted block as the previous hash.