Bitcoin and Blockchain Technology : An Introduction

Opening of the 2016-2015 Academic Year
Scuola di Economia e Statistica, Milano Bicocca University

An introduction to the bitcoin disruptive innovation and its underlying technology

Transcript

1. Bitcoin and Blockchain Technology An Introduction ferdinando@ametrano.net https://twitter.com/Ferdinando1970 https://speakerdeck.com/nando1970 https://it.linkedin.com/in/ferdinandoametrano
2. What is Bitcoin? https://www.youtube.com/watch?v=Gc2en3nHxA4&hl=it&fs=1 Alla scoperta del Bitcoin https://www.youtube.com/watch?v=3UzHB8EfqWk&list=PLrVvuryXHYTfX6dg884fSGYLbLJgX6vAQ&index=1 © Ferdinando Ametrano 2016 2/51
3. Understanding Lags Well Behind The Hype Understanding of the technology however lags well behind the hype, amongst practitioners, policy makers and industry commentators alike. ‘Blockchain’ technology seems to promise major change for capital markets and other financial services – some say it may ultimately prove to be as important an innovation as the internet itself – but few can say exactly how or why. Michael Mainelli, Alistair Milne (2016) The Impact and Potential of Blockchain on the Securities Transaction Lifecycle http://ssrn.com/abstract=2777404 © Ferdinando Ametrano 2016 3/51
4. Why Bitcoin Is Hard To Understand At the crossroad of: 1. Game theory 2. Cryptography 3. Computer networking and data transmission 4. Economic and monetary theory Mainly not a technology, a cultural paradigm shift instead © Ferdinando Ametrano 2016 4/51
5. • Decentralized digital currency • Not backed by any government or organization • Instantaneous peer-to-peer transactions • No need for trusted third party • Cryptographic security • Low-cost banking for everybody everywhere https://bitcoin.org/en/faq http://www.coindesk.com/information/ © Ferdinando Ametrano 2016 5/51
6. The Information Economy • Data is transferred with zero marginal cost • Why pay a fee to move bytes representing wealth? • Why only 9-5, Monday-Friday? • Who (and when) will gift humanity with a global instantaneous free p2p payment network? BANK © Ferdinando Ametrano 2016 6/51
7. Bitcoin: Money For The Information Economy • Decentralized: no authority • Permissionless: no regulator • Censorship resistant: no frozen funds • Open-access: no discrimination, no amount limits, 24/7, 365 days • Free: negligible transaction costs • Borderless: no geographic limits • Transnational: no specific jurisdiction applies • Secure: non falsifiable, non repudiable transactions • Resilient: nothing has been able to stop it or break it © Ferdinando Ametrano 2016 7/51
8. Investment Landscape © Ferdinando Ametrano 2016 8/51
9. A Blockchain Transaction https://blockchain.info/tx/8f1d3a8ef6b2d4a25d2f499279e01518b4770819ccbc39a765c4c326170c61b3 About $83M transacted with $0.04 fee © Ferdinando Ametrano 2016 9/51
10. Bitcoin Economy http://bitcoincharts.com/charts/bitstampUSD#tgWzm1g10zm2g25zv • Total number of BTC is about 14M • BTC Market Cap: about $3-14B (USD M0 is about $1,200B) © Ferdinando Ametrano 2016 10/51
11. December 2013: China crackdown • People’s Bank of China crackdown: – prohibits financial institutions from trading, underwriting, or offering insurance in bitcoins or any other digital currency – Bitcoin is not to be considered a currency – owning bitcoins is not outlawed or prohibited • As of December 2013 BTC China was world's largest Bitcoin exchange by volume • Alibaba, China's top Internet retailer, stopped using bitcoins as of January 19 2014 © Ferdinando Ametrano 2016 11/51
12. February 2014: Mt Gox bankruptcy • As of January 2014 Mt Gox was world's largest Bitcoin exchange by volume • In February 2014 it filed for bankruptcy protection from creditors • It announced that around 850,000 bitcoins belonging to customers and the company were missing and likely stolen, an amount valued at more than $450 million at the time • Fraud or theft? © Ferdinando Ametrano 2016 12/51
13. Silk Road • Online market, operated as a Tor hidden service • Online users were able to buy illicit goodies using bitcoins, while browsing it anonymously and securely without potential traffic monitoring • Launched in February 2011, shut down in October 2013 • Ross William Ulbricht, alleged to be the owner of Silk Road, arrested in San Francisco, sentenced to life in prison • Other black markets have filled in as successors © Ferdinando Ametrano 2016 13/51
14. Bitcoin resilience • Is there anything else in financial world: • Just 7 years old • Without government or corporation backing • That can lose its main (China) market • With fraud/theft at its main reference exchange (Mt Gox) • With such a bad reputation (Silk Road) • That could be still alive and kicking? © Ferdinando Ametrano 2016 14/51
15. Bitcoin used by terrorists Europol: • Despite third party reporting suggesting the use of anonymous currencies like Bitcoin by terrorists to finance their activities, this has not been confirmed by law enforcement https://www.europol.europa.eu/sites/default/files/publications/changes_in_modus_operandi_of_is_in_terrorist_attacks.pdf © Ferdinando Ametrano 2016 15/51
16. Bitcoin for Money Laundering UK HM Treasury: The money laundering risk associated with digital currencies is low, though if the use of digital currencies was to become more prevalent in the UK this risk could rise https://www.gov.uk/government/publications/uk- national-risk-assessment-of-money-laundering-and- terrorist-financing 3 4 5 2 1 © Ferdinando Ametrano 2016 16/51
17. Cryptolockers • CryptoLocker is a ransomware propagated via infected email attachments and botnets; when activated, it encrypts files stored on local and mounted network drives • The malware then displays a message which offers to decrypt the data if a bitcoin payment is made © Ferdinando Ametrano 2016 17/51
18. Private Monies • A widely accepted medium of exchange or payment – issued by a non-governmental body – without legal privileges • Private monies do not have to be generally acceptable; they merely have to be widely accepted • Public demand for private currencies: – hold them in the expectation that they will not diminish in purchasing power as state money has – conduct illegal activity – wish to be part of a movement against increasing state control of economic and personal behavior – just want better money © Ferdinando Ametrano 2016 18/51
19. Liberty Dollar: 1998-2009 • Private mint that issued gold and silver coins; also issued notes redeemable in precious metals • Periodically revalued against USD: the value of the latter fell over time against precious metals • Specifically designed to function in parallel with and in competition to USD • Never marketed or represented as official US currency • Highly successful: it became the second most popular currency in the US • Its use declared a federal crime by the US government • Its founders convicted for counterfeiting, fraud and conspiracy against the United States © Ferdinando Ametrano 2016 19/51
20. E-gold: 1996-2007 • Digital payment system with gold as unit of account • User accounts backed by gold reserves • By 2005, e-gold had grown to be second only to PayPal in the online payments industry: 1.2M accounts and $1.5B transactions • Indicted in April 2007 by US law enforcement services • Charges: unlicensed money-transmitting entity and a means of moving the proceeds of illegal activities • Never proven and even the judge expressed major doubts • ‘Offshore’ payment system rather than a money transmitter or bank as defined under then-existing regulations, not least because gold was not legally ‘money’ © Ferdinando Ametrano 2016 20/51
21. Digital Transfer of Value • To securely (cryptographically) transfer value digitally has been possible for decades • However it had always required the creation of a centralized trusted party to prevent double spending • Bitcoin – does not require a central trusted party – is designed to resist attacks of malicious agents, as long as they do not control network majority © Ferdinando Ametrano 2016 21/51
22. Precursors • Ecash, David Chaum, 1982 (blind signature) • Hashcash, Adam Back, 1997 (Proof-of-Work) • B-money, Wei Dau, 1988 (distributed database) • Bit gold, Nick Szabo, 1998 (distributed database, sequential money creation) • Anonymous Electronic Cash, Tomas Sander and Amnon Ta-Shma, 1999 (anonymity) • Reusable P-o-W, Hal Finney, 2004 © Ferdinando Ametrano 2016 22/51
23. The announcement From: Satoshi Nakamoto <satoshi <at> vistomail.com> Subject: Bitcoin P2P e-cash paper Newsgroups: gmane.comp.encryption.general Date: 2008-10-31 18:10:00 GMT I've been working on a new electronic cash system that's fully peer-to-peer, with no trusted third party. The paper is available at: http://www.bitcoin.org/bitcoin.pdf The main properties: Double-spending is prevented with a peer-to-peer network. No mint or other trusted parties. Participants can be anonymous. New coins are made from Hashcash style proof-of-work. The proof-of-work for new coin generation also powers the network to prevent double-spending. Bitcoin: A Peer-to-Peer Electronic Cash System Abstract. A purely peer-to-peer version of electronic cash […] Satoshi Nakamoto --------------------------------------- The Cryptography Mailing List © Ferdinando Ametrano 2016 23/51
24. Satoshi Nakamoto • Unknown identity: pseudonymous person or group? • Worked on Bitcoin since probably 2007 • Published the paper in 2008 • Released the code in January 2009 • Stopped involvement mid-2010 • Entrusted the project and a copy of the alert key to Gavin Andresen, effectively his successor • He owns about 1M bitcoins, never spent http://mag.newsweek.com/2014/03/14/bitcoin-satoshi-nakamoto.html https://www.wired.com/2016/05/craig-wright-privately-proved-hes-bitcoins-creator/ http://www.bbc.com/news/technology-36168863 © Ferdinando Ametrano 2016 24/51
25. Nakamoto's political motivations • "Yes, [we will not find a solution to political problems in cryptography,] but we can win a major battle in the arms race and gain a new territory of freedom for several years. Governments are good at cutting off the heads of a centrally controlled networks like Napster, but pure P2P networks like Gnutella and Tor seem to be holding their own." • "[Bitcoin is] very attractive to the libertarian viewpoint if we can explain it properly. I'm better with code than with words though." • In the Bitcoin's transaction database, the first entry has a note by Nakamoto: "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks" © Ferdinando Ametrano 2016 25/51
26. Source Code License Bitcoin was released under the MIT license, so it is: • open source; cryptographic software’s source code must be available to allows public inspection (absence of backdoor and security vulnerabilities) • free software; the user the right to use, copy, modify, and redistribute the software • Instead, proprietary software is often close source and it only grants the right to use © Ferdinando Ametrano 2016 26/51
27. Bitcoin: a currency and a protocol • Bitcoin: protocol, software, and community • bitcoins: units of the currency bitcoins are sent using Bitcoin • bitcoins are the first powerful protocol application: a digital property created inside the Bitcoin protocol © Ferdinando Ametrano 2016 27/51
28. Bitcoin the protocol • Distributed public ledger of transactions: • shared with peer-to-peer technology • allows to transfer a unique digital token • the token can be exchanged, but not duplicated • keeps records of each and every transaction forever • It can replace any processing central authority • with decentralized peer-to-peer cryptographically secure equivalent © Ferdinando Ametrano 2016 28/51
29. The bitcoin currency • Not to be found anywhere, they only exist as public ledger documented transactions • A bitcoin wallet is a public address • 1FEz167JCVgBvhJBahpzmrsTNewhiwgWVG • the bitcoin public ledger (aka blockchain) certifies for everybody how many bitcoins are associated to the wallet http://blockexplorer.com/address/1FEz167JCVgBvhJBahpzmrsTNewhiwgWVG It is mine; you are REALLY encouraged to tip © Ferdinando Ametrano 2016 29/51
30. Bitcoins Are Scriptural Asset • Bitcoins only exist as validated transactions • Bitcoins are not liabilities • Bearer instruments © Ferdinando Ametrano 2016 30/51
31. Asymmetric Cryptography: Public/Private Key Pair • mathematically linked, perform opposite digital signature functions: – private (secret) key used to generate the signature – public key used by anyone to verify the signature • The bitcoin wallet address is (derived from) the public key • The private key allows spending from the wallet • Try at https://www.bitaddress.org © Ferdinando Ametrano 2016 31/51
32. A bitcoin transaction: from public key to public key • Transaction: amount + receiver’s public key • The sender’s private key signs the transaction • With sender’s public key anyone can verify that: – The private key has been used, non-forged signature – The transaction has not been tampered or modified – The amount is at sender’s public key disposal • The transaction is published to the public ledger • Everybody knows that the receiver’s public key has received the transacted amount © Ferdinando Ametrano 2016 32/51
33. Bitcoin wallet security • Bitcoins are effectively owned by whoever can spend them • Securing a wallet: private key safe storage • PC client: Bitcoin Core, Armory, Electrum • Web client: greenaddress.it, blockchain.info • Cold storage: never exposed to Internet, stored away © Ferdinando Ametrano 2016 33/51
34. Pseudonymity, Anonymity • Bitcoin is really pseudonymous, not anonymous: • The public key does not provide direct information about the private key owner • All transactions are transparent to everybody’s inspection. • Perfect persistent public account history: the public ledger is forever https://blockchain.info/ http://blockexplorer.com/ © Ferdinando Ametrano 2016 34/51
35. Bitcoin’s public ledger: the block chain • Transactions are bundled in blocks, sequentially chained, about one block every 10 minutes • The block chain is a history of transactions resilient to network attackers • The cryptographic link between blocks requires large amount of computing power, so the block chain cannot be altered without huge resources • Computing power is measured in hash/s, hash being the basic operation needed for validation © Ferdinando Ametrano 2016 35/51
36. Network hash rate Specialized non-generic hardware, with hashing capacity thousands times that of the combined 500 largest supercomputers © Ferdinando Ametrano 2016 36/51
37. Mining • Miners are the nodes of the network providing the computing power for: – processing and validating transactions (avoiding double spending) – securing the network – synchronizing the nodes • Miners compete to process a new block of transactions. The winner provides a proof-of-work and is rewarded with the issue of new bitcoins. • Seigniorage revenues subsidize the network, making transaction almost free © Ferdinando Ametrano 2016 37/51
38. The Byzantine Generals' Problem • Generals can communicate using messengers, cannot have a summit • There are traitors amongst them • Must decide unanimously whether to attack • Success (i.e. fault tolerance) is achieved if the loyal generals can agree on their strategy, whatever it might be © Ferdinando Ametrano 2016 38/51
39. Hash Function • Any algorithm that maps data of arbitrary length to data of a fixed length (called the hash value) in a non-invertible way • Bitcoin uses the (Secure Hash Algorithm) SHA- 256 algorithm that generates a fixed size 256- bit (32-byte) output © Ferdinando Ametrano 2016 39/51
40. SHA-256(“Hello, world!”) SHA-256(“Hello, world!”) = 315f5bdb76d078c43b8ac0064e4a0164612b1fce77c869345bfc94c75894edd3 SHA-256(“Hello, world!0”) = 1312af178c253f84028d480a6adc1e25e81caa44c749ec81976192e2ec934c64 SHA-256(“Hello, world!1”) = e9afc424b79e4f6ab42d99c81156d3a17228d6e1eef4139be78e948a9332a7d8 …… SHA-256(“Hello, world!4249”) = c004190b822f1669cac8dc37e761cb73652e7832fb814565702245cf26ebb9e6 SHA-256(“Hello, world!4250”) = 0000c3af42fc31103f1fdc0151fa747ff87349a4714df7cc52ea464e12dcd4e9 © Ferdinando Ametrano 2016 40/51
41. Proof-of-Work • A new block is added with a mathematical proof-of-work based on SHA-256 hashing. Find a nonce for a given block such that: • SHA-256(previous block hash, transactions, nonce) <= target • The longer chain (actually the one with higher difficulty) is the consensus © Ferdinando Ametrano 2016 41/51
42. Validation Process: Block Generation The proof-of-work difficulty is adapted to the overall available computing power to ensure an average of one block every ten minutes © Ferdinando Ametrano 2016 42/51
43. ASIC Mining • Application-Specific Integrated Circuit • Designed and manufactured for a specific purpose • Introduced in 2013 for Bitcoin mining • Less power consumption, higher hashing power. Outpaced CPU and GPU mining © Ferdinando Ametrano 2016 43/51
44. Bitcoin Monetary Rule • 2009: 50BTC every 10 minutes – halving every 4Y • This is the only way new bitcoins are released • It is called mining because of its similarity with the progressive scarcity of gold extraction digital cash supply free of discretionary intervention © Ferdinando Ametrano 2016 44/51
45. Inelastic Money Supply Deterministic Decreasing Rate 2029: issued 96.88% of all BTC 2141: issued last 0.00000001 BTC © Ferdinando Ametrano 2016 45/51
46. Friedrich August von Hayek - Denationalisation of Money • history of coinage is an almost uninterrupted story of debasements; history is largely a history of inflation engineered by governments for their gain • why government monopoly of the provision of money is regarded as indispensable? It deprived public of the opportunity to discover and use a better reliable money Blessed will be the day when it will no longer be from the benevolence of the government that we expect good money but from the regard of the banks for their own interest A Free-Market Monetary System, Gold and Monetary Conference, New Orleans, Nov. 1977, https://mises.org/daily/3204 Hayek, F. A., Denationalisation of Money, The Institute of Economic Affairs,http://www.mises.org/books/denationalisation.pdf © Ferdinando Ametrano 2016 46/51
47. Bitcoin as (Digital) Gold in the History of (Crypto)Money gold • Its adoption was not centrally planned • For centuries it has been the most successful form of money • It has bootstrapped all monetary systems we know of • It has been surpassed by other kind of money without becoming obsolete bitcoin • Its adoption has not been centrally planned • It is the most successful form of cryptocurrency • It will bootstrap new monetary systems • It might be surpassed by more advanced type of cryptocurrencies without becoming obsolete © Ferdinando Ametrano 2016 47
48. “Blockchain – not bitcoin – will prove revolutionary in banking” http://www.economist.com/news/leaders/21677198-technology-behind-bitcoin-could-transform-how-economy-works-trust-machine © Ferdinando Ametrano 2016 48/51
49. Bitcoin in 2014 Is Like Internet in 1994: Weird and Scary Marc Andreessen: American entrepreneur, investor, and software engineer. Coauthor of Mosaic, cofounder of Netscape https://twitter.com/pmarca/status/677658844504436737 3 4 5 2 1 © Ferdinando Ametrano 2016 49/51
50. The Walled Garden Model • Controlled access to web content and services • Offered in the late ‘90s and early ‘00s by Compuserve, AOL (and to some extent MSN) • Corporates wanted to go online, but not in the wild unregulated internet, populated by anonymous agents • They eventually realized that perceived risks, which are real, are outweighed by benefits © Ferdinando Ametrano 2016 50/51
51. Bibliography • Satoshi Nakamoto, “Bitcoin: A Peer-to-Peer Electronic Cash System” (2008). https://bitcoin.org/bitcoin.pdf • Ferdinando M. Ametrano, “Hayek Money: The Cryptocurrency Price Stability Solution” (2014). Chapters 1, 2, and 3. http://ssrn.com/abstract=2425270 © Ferdinando Ametrano 2016 51/51