Nick Neuman

Nick Neuman on Bitcoin Security and Self Custody | The Investor’s Podcast

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Key Takeaways

  • Contrary to the marketing hype, blockchains have narrow use cases and that is to have a decentralized ledger outside of anyone’s control.
    • By contrast, central bank digital currencies exist on a centralized ledger that allows granular control of money. This works fine on a well-maintained database.
  • By committing resources, each miner has the same ability to influence a proof of work network and dedicating more energy to the network ultimately secures it.
    • Whereas in Proof of Stake, larger holders can stake coins and earn more, compared to smaller holders who may not even have the ability to stake
    • Additionally, PoW encourages innovation because miners have to pursue superior equipment and cheaper energy.
  • To control a private key is to own a bitcoin. Multi-sig involves having multiple keys protecting your bitcoins. Thus, you can lose a key or more and still not lose access.
    • Bitcoin brings back convenient digital self-custody, a huge improvement over any form of money in history
  • Square recently announced developing an open-source Hardware (HW) wallet to increase global adoption. Self-custody allows Square to enter new markets internationally without friction
  • The Bitcoin network recently signaled approval for the Taproot upgrade which improves bitcoin’s scripting and privacy features

Intro

Bitcoin, not Blockchain

  • Contrary to the marketing hype, blockchains have narrow use cases and that is to have a decentralized ledger outside of anyone’s control.
    • By contrast, central bank digital currencies exist on a centralized ledger that allows granular control of money. This works fine on a well-maintained database.
  • Bitcoin has tens of thousands of nodes around the world that maintain and verify a copy of bitcoin’s ledger. No one can influence bitcoin including its founder.
    • On the other hand, altcoins are subject to centralization issues. For instance, Ethereum nodes must trust Infura with their data and nodes.
  • Resiliency is a key feature in the network that holds your wealth. Bitcoin wins that use case beyond any competition

Proof of Work vs Proof of Stake

  • By committing resources, each miner has the same ability to influence a proof of work network and dedicating more energy to the network ultimately secures it.
    • By contrast, larger holders in a Proof of Stake system can stake coins and earn more, whereas smaller holders may not even have the ability to stake
      • PoS is still an unproven technology at scale when the incentives are much higher to attack the network
  • PoW encourages innovation, miners have to pursue superior equipment and cheaper energy.
    • On the other hand, PoS has a squatters advantage; stakers benefit the longer they stake
      • For instance, startups today can use flared gas to mine bitcoins while In PoS, all you can do is stake coins
    • The argument around energy consumption comes from an uninformed point of view. Bitcoin incentivizes green energy and more efficient usage of our current grid.

 Public and Private Keys

  • Every bitcoin wallet has a private and public key pair. Private keys allow you to spend bitcoins and thus should always be kept a secret.
    • A private key is a randomly selected 256-bit string of data. Private keys are un-replicable, un-guessable, and unforgeable.
      • The randomness can be generated by software or manually (e.g. rolling a dice 256 times)
    • Private keys can be encoded in 24 human-readable words called a mnemonic seed phrase for easier management, akin to how domain names are easier than IPs
  • A public key is created from a private key and it lets a user create addresses to receive bitcoin, those bitcoins are then tied to the origin private key.
    • Elliptic curve multiplication is a one-way cryptographic mathematical formula that converts private into a public key. Said differently, it’s trivial to calculate a public key from a private key, but the reverse is impossible
  • Extended Public Addresses (XPub) is a form of a public key that allows one to derive an unlimited amount of bitcoin addresses
    • Bitcoin is layers of cryptography built on top of each other used by everyone, allowing it to be trust-less and decentralized

Hardware Wallets

  • HW Wallets are dedicated devices with highly secure chips that hold private keys safely, even on infected computers. The most popular include ColdCard, Trezor, and Ledger
    • Additionally, HW wallets have a screen to verify transactions without the keys ever touching the internet
    • Most HW wallets use a pin to secure data against physical access
  • Keep in mind, purchase hardware wallets from the manufacturer itself or authorized resellers, not third party or bigger stores
    • Additionally, always make sure to download firmware updates from the manufacturer itself and to back up before updating.

The Future is Multi-Signature

  • To control a private key is to own bitcoin. However, fear of losing keys leads users to trust custodial third parties and, in essence, replace their bitcoins with a bitcoin IOU
  • Multi-sig involves having multiple keys protecting your bitcoins. Thus, you can lose a key or more and still not lose access.
    • For instance, in a 3 of 5 scheme, 5 keys protect your coins and 3 of those are required to spend.
    • Additionally, a successful theft requires access to multiple keys, exponentially harder if keys are geographically dispersed
  • Storing your seed words on paper makes them vulnerable to fire and flood and damage. One solution is to store them on metal wallets that protect against damage
    • Multi-sig provides a superior alternative by allowing a lost key to be replaced, negating the need to restore from backups
      • “We [Casa] really think that seed phrases, in 10 years, will not be used by the majority of people owning bitcoin” – Nick Neuman

Future of Self-Banking

  • Some institutions have multi-sig custodial schemes that provide users additional backup without giving up custodial control.
    • Even more, multiple institutions can hold keys, making it harder to collude and seize your coins
    • Users are free to choose different key combinations based on their security models
  • Simple mobile wallets with a single key will be more suitable for daily transactions whereas larger net worth can be controlled by multi-sig schemes.
    • People will be their own banks, and they will have different levels of bank security, similar to today
      • Think, 2 of 3 multi-sig with a key on your phone, another on your HW wallet, and the third with an institution
  • The convenience of paper receipts leads people to trust warehouses and banks with the custody of their gold. Eventually, this trust was broken and we arrived at paper money and fractional reserve banking.
    • Bitcoin brings back convenient digital self-custody, a huge improvement over any form of money in history

Impact on Banks

  • Banks focus on securing dollars, and they still lack the expertise to secure bitcoins. Thus, they subcontract bitcoin companies
    • Banks’ business model will change when self-custody disintermediates them
  • Square and CashApp are restricted to a few countries, self-custody allows Square to enter new markets internationally without friction
    • Remarkably, Square recently announced developing an open-source HW wallet to increase global adoption
  • El Salvador recent announcement of Bitcoin as legal tender marks the start of bitcoin adoption game theory on country level

Taproot

  • The Bitcoin network recently signaled approval for the Taproot upgrade which improves bitcoin’s scripting and privacy features
    • Currently, spending from a multi-sig wallet reveals the multi-sig scheme to the network and allows attackers to estimate the value stored under the scheme
      • Schnorr signatures, part of the taproot, can collapse signatures to look the same as a single signature.
    • Taproot also enables advanced scripting. An example: If a user doesn’t move the coins for 5 years, change the multi-sign from a 3 of 5 to a 2 of 5, then to a 1 of 5 in another 5 years
      • Schnorr hides the scripting abilities from the network as well

Miscellaneous

  • CoinJoin involves mixing your coins with other users to make it harder to trace a coin’s history
    • This could be outlawed in the future. However, long term bans are unsustainable, especially with features being built into everyday wallets and solutions
    • Keep in mind, monitoring entry/exit points is still a viable way of tracking coin owners
  • Bitcoin enables people to easier move towards more favorable tax jurisdictions
  • Running a full node is a critical part of the network, the more nodes the more resilient the network is
    • It requires some setup, but then you participate in the bitcoin network
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Notes By Mostafa Khaled

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