Bitcoin - digital gold


Published on

An overview of what Bitcoin is, how it works, and an analysis of problems with the currency.

Published in: Technology, Economy & Finance
1 Like
  • Be the first to comment

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Bitcoin - digital gold

  1. 1. Bitcoin – digital gold2013-06-19Lars Marius Garshol,,
  2. 2. Bitcoin?2• A digital currency– based on cryptography• Created by “Satoshi Nakamoto”– nobody knows who this really is• Basically a P2P crypto network– the network maintains the record of transactions– self-regulating through Bitcoin protocol• No central authority– no central bank– no central control of any kind• But it works...
  3. 3. 3If people will giveyou beer for it,it’s real money.
  4. 4. The promise of Bitcoin• Cheap transactions– fully digital in a decentralized P2P network– cost of transactions low, no privileged parties,should lead to low fees• No central control– no inflation– no single point of failure• Total freedom of use– no interfering governments– no party has the ability to block transactions• Secrecy– all transactions are pseudonymous– identity of account holders hidden4
  5. 5. Bitcoin as investment5Value of 1 Bitcoin in US dollars
  6. 6. 6Looking good, but does it live up to the promise?
  7. 7. The protocol7
  8. 8. Bitcoin• A bitcoin is a chain of digital signatures• To give a coin to you I sign– hash of previous transaction, plus your public key• Only I can do that– because only I have my private key• But anyone can check it– because my public key is inthe transaction• Secure because of howcryptography works8
  9. 9. The double-spending problem• Cryptography cannot prevent me fromspending the same coin twice– I buy a banana from you, and a newspaper fromsomeone else, using the same coin• The solution to this is to make everyoneaware of all transactions– that way, if I spend the coin twice, everyone willknow• However, we also need to know whichtransactions are accepted– a kind of ledger of transactions9
  10. 10. The block chain• Bitcoin clients collect new transactions– then issue a block containing the approvedtransactions– each block is cryptographically attached to the lastknown block• This chain of blocks is the ledger– once you have the entire block chain you know whoowns what bitcoins– only one transaction per bitcoin is accepted, thussolving the double-spending problem.10
  11. 11. A boot-strapping problem• But if anyone can create a block, why can’t Icreate one with my double-spending in it?– you can, but then others need to build on it– if others don’t extend the chain from your block,your block will be lost• But if anyone can create a block, whydoesn’t the chain fork into a billion strands?– because blocks are difficult to create– right now, you’d need roughly a year on a normallaptop to create a block– and only the block with the longest chain isaccepted11
  12. 12. Creating a difficulty• Each block contains a hash of its contents– that hash is computed cryptographically– that is, it’s deterministic but unpredictable– and Bitcoin requires that it start with a certainnumber of zeroes• Making the hash come out right is hard– let’s say the hash must begin with 20 zeroes– this means only one in a million blocks will beaccepted– clients must jiggle the nonce until the hash comesout right12
  13. 13. How difficult, exactly?• The protocol has rules for the difficulty– keeps the average block creation time at 10minutes– creation time goes up as computational resourcesimprove• Each block contains a “reward”– basically, some free bitcoin, as reward for creatingthe block• The 51% attack– the rules + difficulty ensure that an attacker needsmore than half the CPU power in the network tosucceed13
  14. 14. 51% attacks are real• There is a whole raft of digital currencies– not just Bitcoin• On June 8th and 10th Feathercoinsuccumbed to a 51% attack• The same thing is possible with Bitcoin– but far less likely14
  15. 15. Bitcoin mining rig15
  16. 16. The network• Bitcoin is basically a P2P network– computers speaking the protocol find each otherand connect to one another– transactions get distributed throughout the entirenetwork• All you need to join in is a Bitcoin client– Satoshi’s original client is still available– start it up, and it downloads the entire transactionhistory of all users16
  17. 17. The Satoshi client17
  18. 18. Exchanges• These are a kind of Bitcoin bank– basically, they allow you to use normal currency topurchase bitcoins– also allow you to keep accounts there– saves you having to run your own client• Other clients also exist– both desktop and web-based– usually called “e-wallet”18
  19. 19. A deeply elegant design• Just two concepts– bitcoins– blocks• Public keys double as– account numbers– access control to publicly held resources (bitcoin)• Blocks double as– official record of transaction– economic incentive to keep network running• The whole thing is self-sustaining19
  20. 20. 20But how can a digital signature on a digital signatureon a digital signature serve as money?
  21. 21. The nature of money21
  22. 22. A potted history of money22• The beginning: gold coins– gold has intrinsic value1– coins therefore valuable not just as money, but also inthemselves• The next stage: symbolic money– paper notes, and coins in cheap metals– backed by the promise of free exchange against gold atany time• Fiat money– paper notes and coins, backed by nothing– nothing, that is, except legal requirements• Digital money– today, most money is bits– that is, numbers in relational databases– specifically, the account databases of banks1Ok, not really, but it’s what people thought
  23. 23. What can be used as money?23• Basically anything• Provided it is rare
  24. 24. An example of fail"How can you have money," demanded Ford, "if none of you actually produces anything? Itdoesnt grow on trees you know.""If you would allow me to continue ..."Ford nodded dejectedly."Thank you. Since we decided a few weeks ago to adopt the leaf as legal tender, we have, ofcourse, all become immensely rich."Ford stared in disbelief at the crowd who were murmuring appreciatively at this andgreedily fingering the wads of leaves with which their track suits were stuffed."But we have also," continued the management consultant, "run into a small inflationproblem on account of the high level of leaf availability, which means that, I gather, thecurrent going rate has something like three deciduous forests buying one ships peanut."Murmurs of alarm came from the crowd.The management consultant waved them down."So in order to obviate this problem," he continued, "and effectively revalue the leaf, we areabout to embark on a massive defoliation campaign, and ... er, burn down all the forests. Ithink youll all agree thats a sensible move under the circumstances.”24 The Restaurant at the End of the Universe, Douglas Adams, chapter 32
  25. 25. Stone money25 Yap islanders carrying a coin to a festival, 1964
  26. 26. Money without banks26Following an industrial dispute, [Ireland]’sbanking system shut down for nearly sevenmonths, with customers unable to withdraw ordeposit money.Yet instead of the countrygrinding to a halt as anticipated, people beganaccepting cheques or IOUs based on their ownassessments of risk. So in a rich and developedeconomy, albeit one with strong communallinks, institutionalised banking was replaced by apersonalised credit system – proving, he says,“the official paraphernalia” of banks, credit cardsand notes, can disappear “and yet money stillremains”.
  27. 27. The functions of money27• A medium of exchange– that is, you can use it to buy things– instead of having to barter• A unit of account– it’s the unit in which you do book-keeping– a unit of measurement of economic value• A store of value– you can use it to store value for when you need it– an alternative to a hoard of gold
  28. 28. Scorecard28Currency Exchange Account Store ScarcityLeaves Yes Yes Kind of FailYap stones Yes Yes Yes YesIrish IOUs Yes Kind of WithinreasonYesGold coins Yes Yes Yes YesPaper notes Yes Yes Yes YesBank acc’t Yes Yes Yes YesBitcoin Yes Yes Yes Yes
  29. 29. Promises andproblems29
  30. 30. Bitcoin usage30• Total size of the economy– 11,282,525 BTC– 1,218,749,633 USD ≈ 1.2 billion USD• Transactions last 24 hours– 43,331– volume: 60,034,876 USD– (unknown % of this transfers between differentaccounts with same owner)• Effective GDP of Bitcoinia1– 21,912,729,783 USD ≈ 22 billion USD– 0.01% of United States GDP– 4.5% of Norway GDP– roughly same as EstoniaAs of 2013-06-13, source: by multiplying last 24hby 365, then converting withUSD exchange rate. EffectivelynominalGDP, without accountingfor self-to-self transfers.
  31. 31. Could Bitcoin replace nationalcurrencies?31• In a word, no– in most countries, the law requires the nationalcurrency to be accepted “as payment for any debt”– in many countries, the legal tender must beaccepted as payment for goods1• Governments require insight intotransactions– for purposes of taxation– income tax, sales tax, ...• National currencies are key to regulatingthe national economy– we will return to this, but basically it is not a rightthat the state is going to let go of1 In Norway: §14 of Sentralbankloven
  32. 32. Anonymity• Bitcoin is pseudonymous, not anonymous– basically, everyone knows which public keys holdwhat bitcoins– but not everyone knows who holds which keys• Knowledge of all public key owners implies– total awareness of all transactions• In short, breaches of anonymity canpotentially be extremely embarassing– may even cause legal difficulties32
  33. 33. How secret are pseudonyms?33• Most e-wallets automatically create lots ofkeys– making it easier to hide your identity• Researchers have shown that networkanalysis can be surprisingly effective1– for example establishing which keys have the sameowners• Researchers have earlier shown thatanonymized data can be reversed– revealing the identities of accounts• Remedies have been proposed– but not implemented• Essentially, you can not rely on secrecy intoday’s Bitcoin1
  34. 34. Speed of transactions34• Having your transaction accepted into ablock is not enough– because the block chain forks all the time• Need to wait until 5 more blocks added tothe chain– since the longest chain is the one that’s used• Average block time = 10 minutes– secure transaction time = 1 hour• Not so good for ATMs or physical stores
  35. 35. Fast transactions are not secure35
  36. 36. But what about that pub?36• They accept fast payments• So, basically, they’re takingthe chance that a customerwill double-spend– probably this is fairly safe at themoment– and if they ever get scammed,they only lose a few pounds– the publicity is probably worthmore than that, anyway• The customer is safe– once the pubco’s servers see thetransaction, they get their beer– double-spending attacks affectthe seller, not the buyer"By not waiting for a block, we arevulnerable. On the other hand, myattitude is if they do, theyre standingright here.Theyve got a pint in front ofthem.You can go and take it off them.People [in pubs] hang around after apurchase, rather than walking out, so Ithink the risk of a double spend isminimal.” --Stephen Early, owner“So far, his pubs have takenaround £750 in Bitcoinpayments in the few weekshes been accepting them.”
  37. 37. Immature infrastructure37• Stories of users losing bitcoin managed ontheir desktops appear all the time– generally, their machines are compromised– attackers then steal public keys, abscond with BTC• Not all exchanges are trustworthy– or, they are honest, but run into problems– see stories of people having problems withexchanges again and again• The protocol is secure, but theinfrastructure is not
  38. 38. Bitcoin is not alone• Ripple ?• Litecoin 40 million USD• Feathercoin 1 million USD• Namecoin 5 million USD• PPcoin 4 million USD• Terracoin 1 million USD• Novacoin 1 million USD• Ven 2 million USD• Bitcoin 1.2 billion USD38It’s not a given thatBitcoin will be the oneto succeed, but it is thebiggest, by a goodmargin.
  39. 39. Outcompeted via mining?• Will people abandon Bitcoin for othercurrencies because mining other currenciesbecomes more attractive?• The bigger Bitcoin gets, the harder miningbecomes• Mining a smaller currency might be morecost-effective– even if it’s smaller, and the currency of lower value39
  40. 40. Currency stability40• The value of Bitcoin has been fluctuatingwildly• Not ideal when combined with slowtransactions– value of the currency may change before thetransaction has completed• Caused by two issues– small size of Bitcoin economy,– no central bank to adjust currency value• One of those issues may go away
  41. 41. No government control at all41• Is that really likely?– governments can certainly control money flows inand out– perhaps they can control even more, if they want• Does allow money to “escape”– think of Cyprus– Turks protesting by taking money out of banks– ...• But are major money flows outside gov’tcontrol really a desirable thing?– can it be stopped simply because it’s not desirable?
  42. 42. No central bank• Bitcoin has a fixed total size of the currency– the fee for new blocks decreases over time,eventually to zero– after that time (2021) there will be no new bitcoins• This follows from the design of the protocol– having a totally decentralized system was a keydesign principle– this does not allow for any central bank• Libertarians love this aspect– means “no Fed” (which they hate)– also “no debasing the coinage” (ditto)• But...42
  43. 43. A little economictheory43
  44. 44. The economy grows faster than themonetary base44Value of 1 Bitcoin in US dollarsThis is deflation!
  45. 45. Inflating and deflating45• Inflation– when the value of money decreases over time– when 1 XXX buys less next year than this year• Deflation– the opposite– your money grows more valuable as it sits in yourpocket• Sounds like “inflation good, deflation bad”– but it’s not that simple
  46. 46. Hyperinflation = disaster46The cost of one beer in Harare, Zimbabwe,November 24, 2007
  47. 47. The effect of inflation• Inflation erodes the value of savings– savings in cash, that is• Encourages spending– investment in real estate, business etc is safer– or just buying anything at all• Economic growth is measured in GDP– falling GDP is bad for everyone– GDP is essentially a measure of the velocity ofmoney– because my spending is your income, and yourspending is my income• Deflation has the opposite effect– why buy a new whatever now, when the samemoney will buy more tomorrow?47
  48. 48. 48
  49. 49. A little inflation is a good thing• Central banks generally aim for ~2%– for a healthy balance between spending and saving• Most of theWestern world now runs belowthat– a consequence of the economic crisis• Japan has run below for two decades– essentially fell into a hole because a real estatebubble burst (sound familiar?)• Massive money-printing has not solved theproblem– Japan has tripled its monetary base, to no effect– the US has doubled its mb, with same result49
  50. 50. Life in Bitcoinia• Basically, Bitcoin is designed for a stagnanteconomy– one where people sit on their bitcoins• A national economy based on Bitcoin istherefore a horrible idea– it would, in effect, be like going back to the goldstandard– or adopting the Euro• But could it work as a “side currency”?– a kind of alternative Paypal?– yes, probably– if they fix the problems with it50
  51. 51. Bitcoin as “side currency”• Doesn’t this make Bitcoin simply acompetitor to Paypal?• If so, does it need to be a currency at all?• What about a Paypal with non-reversabletransactions?– might be just as cheap and attractive?• To be decided by competition, perhaps...?51
  52. 52. 52Conclusion?I don’t have one yet.