The Rise Of Bitcoin

An example of a cryptocurrency is bitcoins. Satoshi Nakamoto published a paper on the

Web in 2008 for a peer-to-peer electronic cash system. Despite many efforts, the identity

of Satoshi remains unknown to the public and it is not known whether Satoshi is a group

or a person.

The cryptocurrency invented by Satoshi Nakamoto, called bitcoins, is run using

open-source software. It can be downloaded by anyone, and the system runs on a decen￾tralized peer-to-peer network. It is not only decentralized but also supposedly fully

Satoshi in Japanese means “wise” and someone has suggested that the name might be a portmanteau of four

technology companies: SAmsung, TOSHIba, NAKAmichi, and MOTOrola. Others have noted that it

could be a team from the National Security Agency (NSA) or an e-commerce firm (Wallace, 2011).

Other suggestions are David Chaum, the late Hal Finney, Nick Szabo, Wei Dai, Gavin Andresen, and

the Japanese living in the neighborhood of Finney by the same surname Dorian Nakamoto. There are

other suggestions such as Vili Lehdonvirta, Michael Clear, Neal King, Vladimir Oksman, Charles Bry,

Shinichi Mochizuki, Jed McCaleb, and Dustin Trammell, but most have publicly denied that they are

Satoshi distributed. That means that every node or computer terminal is connected to each other.

Every node can leave and rejoin the network at will and will later accept the longest proof

of work known as the blockchain as the authoritative record.

This longest blockchain is proof of what has happened while these nodes were gone.

Cryptocurrency is mysterious and misunderstood for a few reasons.

First, no one knows who is really behind some of these cryptocurrency systems. It was

designed so that third-party trust is not needed and sometimes there is no legal entity

behind it but open-source software.

Second, many have jokingly remarked that Bitcoin sounded more like “big con”

especially after the collapse of Mt. Gox. But it is important to note that Mt. Gox was

merely a financial intermediary, being just one of many unregulated exchanges that trade

in Bitcoins. Mt. Gox was not part the Bitcoin system itself. It is a complex currency sys￾tem to the men in the street and therein lies the confusion.

Third, cryptocurrency involves mining or proof of work. There are rewards for

mining and the reward is given to the first who can solve a cryptography problem.

The degree of difficulty of the problem will ensure that the timing to solve the prob￾lem is approximately 10 min for Bitcoin. Cryptocurrency cleverly solves the double￾spending problem so that every cryptocurrency can be spent only once. It is a financial

technology and it involves financial regulation but therein lies the difficulty in execu￾tion and understanding even for the professionals. That is why it is an area of great

interest to researchers, regulators, investors, and merchants and it is hitting the head￾lines regularly.

The general arguments for a successful distributed cryptocurrency are as follows:

1. Open-source software: A core and trusted group of developers is essential to verify the

code and possible changes for adoption by the network.

2. Decentralized: Even if it is not fully distributed, it is essential that it is not controlled by

a single group of person or entity.

3. Peer-to-peer: While the idea is not to have intermediaries, there is a possibility of pools

of subnetworks forming.

4. Global: The currency is global and this is a very positive point and workable for

financial integration with or without smart contracts among the parties.

5. Fast: The speed of transaction can be faster and confirmation time can be shortened.

6. Reliability: The advantage is that there is no settlement risk and it is nonrepudiable.

The savings in cost of a large settlement team for financial activities can be

potentially huge.

7. Secure: Privacy architecture can be better designed incorporating proof of identity with

encryption. If that is done, the issues surrounding Know Your Customer/Client

(KYC) and anti-money laundering and terrorist financing (AML/TF) will be resolved.

8. Sophisticated and flexible: The system will be able to cater to and support all types of

assets, financial instruments, and markets.

9. Automated: Algorithm execution for payments and contracts can be easily

incorporated.

10. Scalable: The system can be used by millions of users.

11. Platform for integration: It can be designed to integrate digital finance and digital law

with an ecosystem to support smart contracts with financial transactions. Custom￾ized agreements can be between multiple parties, containing user-defined scripted

clauses, hooks, and variables.

The possible applications will be wide-ranging and include global payment and remit￾tance systems, decentralized exchanges, merchant solutions, online gaming, and digital

contracting systems. Each cryptocurrency is a great and an interesting experiment. No

one knows where these cryptocurrency experiments are heading but the experiments

are interesting because of the technology that is developed along with them.

The technology disrupts the payment system as we know it because it costs almost

nothing to transfer payments. Cryptocurrency technology will allow us to reach out

to the unbanked and underbanked. It presents the opportunity to function as a conduit

for payments and funds. It will transform the way business is being done by diminishing

the role of the middleman, whether it is smart accounting or smart contract.

It will also change the way financial world operates especially in fund raising and lend￾ing. Basically, it is possible to do an Initial Crowd Offering or crowd lending, all in the

peer-to-peer framework, eliminating the middleman.

However, there are downsides or potential risks for cryptocurrency too. Cryptocur￾rency like Bitcoin depends on mining, and once the incentives for mining disappear, no

one knows if the cryptocurrency in question will continue to have consensus on the dig￾ital register. They are over 400 cryptocurrencies and the number is increasing on a daily

basis. But many of them are in the graveyard.

So, as they say, “let the buyer beware,” because what you own may just be worthless

once there are doubts about the blockchain. It seems that if the cryptocurrency exhausts

most of their coin supply too fast and too early, the probability of the coins dying is

higher. For some coins, it is difficult to know who is behind them and whether there

could be a backdoor that allows someone to control the system. Cryptocurrency with

unknown developers has a higher probability of being buried in the graveyard.

The blockchain may come under attack as well. The blockchain serves as a proof of

the sequence of events as well as proof that it came from the largest pool of computing

power. As soon as the computing power is controlled by nodes that are cooperating to

attack the network, they may produce the longest chain of their choice creating doubts

about the validity of the blockchain. This can easily happen once the interest on a par￾ticular currency wanes and the number of miners shrinks, which opens up the possibility

of having a few blockchains in concurrent existence. Once there is any doubt of the accu￾racy of the blockchain, even if it was subsequently corrected, the coin will be heading for

the graveyard.

When there are no new coins to reward the miners, the system is unlikely to continue.

Once no new coins are issued as the mining reward, then the miners are expected to be

rewarded purely by transaction fees. This can be a problem. On the other hand, if the fees

are increased too quickly or to an unreasonable level, interest on the coins will wane as well.

With higher mining cost due to expensive equipment, mining pools will be formed. This is

because miners prefer higher probability of success in cracking the code. However, this will

lead to an undesirable outcome of mining pools exceeding 30% or even 50% of the net￾work, thus exposing the cryptocurrency to attack. This was indeed the case for Bitcoin

when the mining pool accounted for over 50% in the middle of 2014. This is one serious

problem that needs to be solved sooner rather than later and consensus ledger or digital

register without mining may be one solution.

Written by David Lee Kuo Chuen

Stanford University

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