Digital Currency

1. Digital Currency Cryptography Project David B. Robins March 2011

2. What is currency? • What are some desirable qualities? What should be used? • Portability • Durability • Fungibility/homogeneity • Divisibility • Anonymity • Rarity • Recognition • Facilitates trade between people: eliminates barter. • Store of durable value.

3. What is currency? • Rare metals, minted into coins, fit the requirements • But people don’t want to carry them around: paper notes invented • Precious metals and commodities stored in vaults; bearer certificates • Japanese stock trading starts with rice coupons • Unfortunately, that’s not quite the end of the story.

4. What is currency? • Governments decreed that only their notes be accepted as money • Then they decided to stop redeeming them for silver or gold http://www.schizoidboy.com/us-dollar-purchasing-power.html

5. Why digital currency? • Cost of physical cash: $60 billion/year in the US to move it • Credit/debit cards lack anonymity • Desire for a lack of central control – distributed system • Protects against political turmoil • Inflation Confiscation

6. Early attempts • DigiCash • Founded by Chaum in 1980; emphasis on privacy • Sold the system to several businesses and agencies in Netherlands • CyberCash • Founded by creators of Verifone credit card transaction system • Claimed cracked by Russian hacker; Y2K bug; bankrupt 2001 • Peppercoin • Developed by Micali and Rivest • Saw modest adoption; some technology found its way to PayPal • Digital stores for and methods for trading existing state currencies • Transferred existing currency; not new currencies in their own right

7. Why they failed • (Or saw limited success.) • People weren’t as concerned with security as digital currency folk thought • They give their card to a waiter to take away; why not over the Internet? • Not worried who has their card number in a database, just use • Credit card companies’ chargebacks alleviate most concerns (social)

8. Bitcoin • Developed by Satoshi Nakamotoin 2009 • “Bitcoin: A Peer-to-Peer Electronic Cash System” • How does it work? • What are the cryptographic protocols used? • How do they secure it? • Does it meet the requirements for currency? • Recall the 7 listed earlier • Why use it – does it add anything over existing forms? • What’s the market like? • Liquidity • Volume

9. How do they work? • Definitions: • Coin: a Bitcoin, worth approximately 1 USD lately. Abbreviated BTC or bc, e.g., 50 bc, 200 BTC. • Identity: public and private key (ECDSA) used by owner to sign transactions. A single person may have multiple sets of these – one for each coin if they like. There is no link back to a name or other personally identifiable information (PII), although someone could use a digital signature to verify ownership of a particular Bitcoins (e.g., to show assets if requesting a loan). • Transaction: transfer of one or more coins or parts thereof between identities using the Bitcoin protocol. • Block: a series of transactions (not necessarily involving the same coins), verified with a hash that combines the block’s transactions and the previous block to create a chain.

10. How do they work? • Transactions chained in the block chain: (From “Bitcoin: A Peer-to-Peer Electronic Cash System”)

11. How do they work? • A “full” block must be hashed to add it to the shared chain (SHA-256) • The hash must have a certain number of leading zero bits • Accomplished by varying a nonce, a large integer within the block • Believed to be computationally difficult • Difficulty can be varied with computing power by increasing # of zeroes • First successful user to find this value receives 50 bc • Created by first transaction in the block being hashed • This value is halved every 210,000 bc • Referred to as “mining” Bitcoins: proof of work, like mining gold • If there’s a tie, “longest chain wins” • Nodes hold both; the chain the next block is added to becomes primary • Space isn’t a problem: block chain grows by ~4.2M/year

12. How do they work? • Multiplatform client: connects to network, finds (“mines”) coins

13. Bitcoin • “Cryptocurrency” – store of value on its own • How does it fit our requirements for currency? • Portability – carry on a USB key, phone, etc. • Durability – make all the backups you want; encrypt • Fungibility/homogeneity – one coin spends like any other • Divisibility – down to 8 decimal digits (currently 2 used) • Anonymity – create as many identities as you want • Rarity – hard to “mine” due to computational difficulty, which can be adjusted as necessary • Recognition – cryptographic verification using hashes and public keys • It is “backed” by those willing to accept it, like fiat currencies.

14. Bitcoin • And adds: • Decentralized – less susceptible to political whim or turmoil • Secure – hide private keys and even owner can’t give it up • But requires some computational ability and (eventual, at least) network access. • This access could be blocked – if the network is not public, its purpose is weakened • How is double-spending countered? • “A computer is a machine for copying bits; if your business model depends on preventing bits from being copied, you’re gonnadie.” —Cory Doctorow/Kevin Carson • Fortunately, it doesn’t: low-hashed block chain and signed transactions • Paper demonstrates that the probability of being able to create a false block chain to double-spend becomes infinitesimal with only a few more blocks added

15. Why digital currency? • Easier to carry than Less inflationary than • “You only really own those things you can carry under both arms at a dead run.” • —Robert A. Heinlein • Since inception, they’ve gone from around $0.05 to about $1 (USD) • Number of Bitcoins will be limited to close to 21 million • Creation is at a known and steady rate (6 blocks/hour = 300 bc/hour)

16. The market • At time of writing: • 113655 blocks • 5.68 million BTC (worth ~$5M) • Volume around 10k BTCs daily, some spikes around 60k (i.e., ~$10k/day) • This is relatively illiquid: • Compare: MSFT typically trades few 100k shares/day or ~$4M/day • And the state currency market is huge • About 10 places to trade Bitcoins for USD now • Maybe 200 places that take them directly, and more will take donations

17. The market • Confidence and use increasing • Settling at almost par with USD

18. The future • Definitely a consideration for diversifying a portfolio • But don’t expect you can be paid in Bitcoins just yet • … Or use them at the supermarket • Cryptographically, the protocol is future-proof: • Allows for changing hash algorithm (e.g., if SHA-256 was broken) • The author did consider it and build it in • But may require network freeze and software upgrade • Number of zeroes in required hash increased with processing power • Increased adoption and use; eventual “critical mass”?