currency, commodity and bitcoins

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Prithwis Mukerjee, PhD Currency Commodity & Coins Prithwis Mukerjee, PhD Praxis Business School, Calcutta Bit

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A brief introduction to the concept of the bitcoin and similar cryptocurrency. Presentation made at CII CIO conference at Mumbai in December 2013

TRANSCRIPT

Page 1: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

CurrencyCommodity &Coins

Prithwis Mukerjee, PhDPraxis Business School, Calcutta

Bit

Page 2: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

The barter market

1. Ram has excess salt, Shyam excess sugara. Ram exchanges excess salt for Shyam’s excess sugarb. What if Ram does not need sugar at the moment ? but needs rice

instead ?

2. Ram has excess salt, Shyam excess sugar, Jadu has excess ricea. Ram exchanges salt for Shyam’s sugar, then exchanges this sugar for

Jadu’s riceb. And it is obvious that this process can become very tricky and

unworkable if number of participants and products in the market becomes very large

Page 3: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Enter commodity

1. Ram has excess salt, Shyam excess sugar and Jadu has excess ricea. Every body has “cowrie” shells as well

2. Ram sells excess salt to Shyam and gets cowrie shells

3. Rams uses some cowrie shells to buy rice from Jadu, keeps rest for future use

4. Cowrie shells, otherwise useless, acquires a value in terms of a salt and ricea. and then in terms of products like sugar, oil, cloth, candle and services

like farming, body massage ...

Page 4: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Cowrie shells become “money”

Three functions● Means of exchange● Stores value● Unit of account

Four properties● Durability● Fungibility● Divisibility ?● Verifiability ?

Page 5: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Cowrie Shells >>> Gold Coins

DurabilityFungibilityDivisibility

● a fraction of a gold coin has a proportional fractional value

Verifiability

Verifiability● A central authority,

the “king” or the government, certifies and authenticates the genuineness of the gold coin

Page 6: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Gold Coins >>> Currency Notes

Verifiability >> Trust● Monetary authority

issues “representative” currency or paper that is backed by an equivalent quantity of gold

Only Trust, no verification● Monetary authority

acknowledges that there is no gold behind the currency

● The credibility of the monetary authority sustains value

Page 7: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Currency Notes >> Ledger Entries

Currency notes can be deposited in a bank and “dematerialised”● converted into a ledger entry ● sent, received or otherwise exchanged

through debit or credit operations caused by instructions ○ physical - cheques○ digital - EFT

Banks work as trusted middlemen to facilitate the transfer of money

Page 8: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Currency can be issued by anyone who is trusted by others

Traditional national currency● Indian Rupee● US DollarPrivate national currency● HK Dollar issued by

○ HSBC○ Standard Chartered○ Bank of China

Game currency● Linden Dollars in

Second Life● “Gold”, “Silver”,

“Copper” in World of Warcraft

Coupons that we use in daily life● Sodexho coupons

Page 9: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Trust can be Abused & Betrayed !

1980 : 1 ZWD = 1.5 USD2009 : 1 ZWD had effectively Zero value or buying power and was discontinued from circulation

Page 10: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Bitcoins

● No physical artifact, a digital currency● No central monetary authority to issue

currency○ Managed by a network of computers operating a

peer-to-peer software● Protected by the laws of mathematics and

cryptography○ Just as the laws of mechanics ensures that planets

revolve round the sun without the intervention of any central air traffic control mechanism

Page 11: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

StupidCoin --an innocently simplistic currency

Let us assume …● A monetary

authority creates 1000 jpeg image files (SCdollars)

● Gives 10 SC$ to 100 people ( “the market”) and asks them to use it for purchases.

Problems● Each person can

make any number of copies of the files and increase his wealth

● Anyone, including the central authority, can create any number of new coins

Page 12: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Bitcoins : Two Mathematical Tricks

There are mathematical algorithms that regulate● the generation of bitcoins● the transfer of bitcoinsand the regulation process is monitored and have to be agreed to by ALL computers in the bitcoin networkrules can be broken if and only if more than 50% computers collude with a violation

Page 13: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Two Mathematical Processes

To generate a Bitcoin you must prove that you ● have consumed a

certain amount of CPU cycles and

● solved a mathematical “puzzle” before anyone else has

To transfer a Bitcoin you must prove that you● have received an

equivalent or higher amount of bitcoins from somewhere and

● have not spent it anywhere else

Page 14: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Technology behind Bitcoins

Page 15: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Spend or Double Spend ?

Bank Ledger

RAM 50

SHYAM 60

MADHU 70

Bank Ledger

RAM 20

SHYAM 90

MADHU 70

RAM pays 30 to SHYAMBANK allows transferupdates ledger

Page 16: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Spend or Double Spend ?

Bank Ledger

RAM 20

SHYAM 90

MADHU 70

Bank Ledger

RAM 20

SHYAM 90

MADHU 70

RAM pays 30 to MADHU BANK BLOCKS transfer

Transaction fails

Page 17: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Bitcoins -The shared, synchronised ledger

WalletID X4

X4 60

Y9 50

3T 60

8R 70

WalletID Y9

X4 60

Y9 50

3T 60

8R 70

WalletID 3T

X4 60

Y9 50

3T 60

8R 70

WalletID 8R

X4 60

Y9 50

3T 60

8R 70

Each person has a “wallet” and every “wallet is syncrhonised with all other “wallets in the Bitcoin ecosystem

Anonymous : Wallet ID is not linked to identity of owner

Page 18: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Every payment needs to be confirmed by a majority of network

WalletID X4

X4 40

Y9 50

3T 80

8R 70

WalletID Y9

X4 40

Y9 50

3T 80

8R 70

WalletID 3T

X4 40

Y9 50

3T 80

8R 70

WalletID 8R

X4 40

Y9 50

3T 80

8R 70

Wallet X4 transfers 20 to Wallet 3TTransfer needs at least 10 or 15 confirmations

TXN CONFIRM TXN CONFIRM TXN CONFIRM

Page 19: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Genuine payments are confirmed within a short time

WalletID X4

X4 20

Y9 70

3T 80

8R 70

WalletID Y9

X4 20

Y9 70

3T 80

8R 70

WalletID 3T

X4 20

Y9 70

3T 80

8R 70

WalletID 8R

X4 20

Y9 70

3T 80

8R 70

Wallet X4 transfers 20 to Wallet Y9Transfer needs at least 10 or 15 confirmations

TXN CONFIRM TXN CONFIRM TXN CONFIRM

Page 20: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Double payments are denied by network

WalletID X4

X4 20

Y9 70

3T 80

8R 70

WalletID Y9

X4 20

Y9 70

3T 80

8R 70

WalletID 3T

X4 20

Y9 70

3T 80

8R 70

WalletID 8R

X4 20

Y9 70

3T 80

8R 70

Wallet X4 transfers 30 to Wallet 8RTransfer needs at least 10 or 15 confirmations

TXN REJECT TXN REJECT TXN REJECT

Page 21: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

My personal wallet : hosted on web

Page 22: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Wallet : After logging in

Page 23: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

In reality, the situation is slightly different

The wallet does not contain the balance in each walletIt carries a series of debit and credit transactions pertaining to every transaction that is happening

0:00 X4 +60

0:01 Y9 +50

0:02 3T +60

0:03 8R +70

Page 24: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Transaction # 1 : Successful

X4 pays 20 to 3T● one input

transaction is marked used

● change is sent back to itself

● one input transaction is marked used

0:00 X4 +60 used

0:01 Y9 +50

0:02 3T +60

0:03 8R +70

1:00 X4 -60

1:01 X4 +40

1:02 3T +20

Page 25: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Transaction # 2 - successful

X4 pays 20 to Y9● one input

transaction is marked used

● change is sent back to itself

● one input transaction is marked used

0:00 X4 +60 used

0:01 Y9 +50

0:02 3T +60

0:03 8R +70

1:00 X4 -60

1:01 X4 +40 used

1:02 3T +20

2:00 X4 -40

2:01 X4 +20

2:02 Y9 +20

Page 26: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Transaction # 3 : rejected

X4 pays 30 to 8R● there are no

unused input transactions to cover this output transaction

● transaction cannot be confirmed

0:00 X4 +60 used

0:01 Y9 +50

0:02 3T +60

0:03 8R +70

1:00 X4 -60

1:01 X4 +40 used

1:02 3T +20

2:00 X4 -40

2:01 X4 +20

2:02 Y9 +20

3:00 X4 -30

Page 27: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Public-private key encryption is used to ensure authenticity

0:00 X4 +60 used

0:01 Y9 +50

0:02 3T +60

0:03 8R +70

1:00 X4 -60

1:01 X4 +40 used

1:02 3T +20

2:00 X4 -40

2:01 X4 +20

2:02 Y9 +20

3:00 X4 -30

Encrypted by X4 private key for transmission to 3T

Encrypted by X4 private key for transmission to Y9

Opened by 3Tby X4 publickey and loaded into 3T’s walletwith 3T’s private key

Opened by Y9by X4 publickey and loaded into Y9’s walletwith Y9’s private key

Wallet consists of the set of all previous transactions plus a set of public and private keys and the ability to send and receive encoded transaction information

Page 28: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Confirmations areCrucial & Expensive operation

Confirming a transactions means looking through an immense pile of earlier unused transactions and determining whether a new transactions is valid or invalid

This needs a lot of computing power● why would anyone do it ?● what is the incentive ?The reward is that you get NEW BITCOINs

Page 29: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

“Miner” adds a BLOCK to the CHAIN

The BLOCK CHAIN consists of blocks of already confirmed transactions.Lying outside this chain is a pool of unconfirmed transactions.

Miner must collect a set of unconfirmed transactions from the pool, confirm them and consolidate them into a new block that is added to the block chain.

Page 30: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Whose block gets added ?Yours ? or Mine ? Solve a puzzle !

Input :● Address of last

block of current chain

● Set of confirmed transactions

● Guess a numberOutput is a mathematical hash function

If the output meets a certain criteria then your block is accepted into the chain

Every else has to start afresh because address of last block has changed !

Page 31: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Mining Bitcoins --Difficulty and Rewards

Why difficult ?● Because the hash

function must contain a number of leading zeroes and be below a certain threshold value

What is the reward ?● Today, the reward is

25 coins / block● This reward is

halved as the number of bitcoins increases

● Total cap would be 21 million around year 2150

Page 32: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Bitcoin Technology

What has been covered so far ?● How are Bitcoins created

or generated in a controlled manner

● How are Bitcoins transferred without the danger of double spending

Other technical issues ● How do we ensure the

authenticity of a bitcoin transaction ?

● What happens if a rival group starts another branch of the BLOCK chain

Mathematically correct answers exist

Page 33: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Comparison : Gold and Bitcoin

● A finite amount of gold is available in the world. Quantity not known.

● Digging gold out of the ground is complex and expensive exercise.

● Instead of mining gold you can also buy gold from a bullion dealer at a commodity exchange

● There will be a finite amount of bitcoins. Quantity is 21 million

● Creating new bitcoins is expensive in terms of computing power, electricity consumption

● Instead of “mining” bitcoins you can always buy bitcoins at a bitcoin exchange

Page 34: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

The Economics of Bitcoins

Page 35: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Bitcoins can be used as

Currency● to make payments

by sending coins from one wallet to another

Commodity● that can be bought

as investments and subsequently sold at profit ( or loss !)

Page 37: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

New Vendors are appearing ...

Page 38: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Exchange : From Virtual to Real

Page 39: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Bitcoin : A tradeable commodity

Page 40: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Add and Withdraw Real Money

Page 41: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Are Bitcoins Legal ?

● Bitcoins are as legal as any other commodity like gold.

● Taxable when converted into recognised currency

● Bitcoins, like cash, can be exchanged anonymously○ Can be used for

payment of illegitimate activity

● Reputable exchanges ask for KYC documents○ passport○ phone bill

Page 42: Currency, Commodity and Bitcoins

Prithwis Mukerjee, PhD

Thank You

Prithwis Mukerjeehttp://blog.yantrajaal.comtwitter: @prithwis

this presentation available at http://bit.ly/pmbitcoin1