Cryptography Project

David B. Robins

March 2011

Digital Currency

What are some desirable qualities? What should be used?

1. Portability

2. Durability

3. Fungibility/homogeneity

4. Divisibility

5. Anonymity

6. Rarity

7. Recognition

Facilitates trade between people: eliminates barter.

Store of durable value.

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.

What is currency?

Governments decreed that only their notes be accepted as money

Then they decided to stop redeeming them for silver or gold

What is currency?

http://www.schizoidboy.com/us-dollar-purchasing-power.html

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

Why digital currency?

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

Early attempts

(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)

Why they failed

Bitcoin• Developed by Satoshi Nakamoto in 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

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.

How do they work?

Transactions chained in the block chain:

How do they work?

(From “Bitcoin: A Peer-to-Peer Electronic Cash System”)

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

How do they work?

How do they work?

Multiplatform client: connects to network, finds (“mines”) coins

“Cryptocurrency” – store of value on its own

How does it fit our requirements for currency?

1. Portability – carry on a USB key, phone, etc.

2. Durability – make all the backups you want; encrypt

3. Fungibility/homogeneity – one coin spends like any other

4. Divisibility – down to 8 decimal digits (currently 2 used)

5. Anonymity – create as many identities as you want

6. Rarity – hard to “mine” due to computational difficulty, which can be adjusted as necessary

7. Recognition – cryptographic verification using hashes and public keys

It is “backed” by those willing to accept it, like fiat currencies.

Bitcoin

And adds:

8. Decentralized – less susceptible to political whim or turmoil

9. 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 gonna die.” —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

Bitcoin

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)

Why digital currency?

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

The market

Confidence and use increasing

Settling at almost par with USD

The market

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”?

The future