Bitcoin: The Blockchain is Coming
During my university studies late in 2015 I turned in a short paper with the title Bitcoin: The Blockchain is Coming Your Way. Given the current news of the rise of Bitcoin's value, it looks like this is an interesting topic. Here is my whole paper:
The digital cryptocurrency Bitcoin was named once or twice in the news as a channel for the culprits of international terrorism to receive payments while giving it a bad name as in the FoxNews article by Heather Nauert “ISIS parks its cash in Bitcoin, experts say” (Nauert, 2015). In this case, if the news say A, that yes, it is true, criminals are using Bitcoin to some limited extent, then the news should also say B, that given the properties of Bitcoin’s underlying technology, the criminals may get and should get caught easier since all its transactions are public and transparent (McCallum, 2015). However, Bitcoin is still a security concern primarily because the technology itself can’t get the criminals caught. The authorities must learn how to use Bitcoin’s properties to derive new law enforcement methods and that is one reason why Bitcoin deserves a closer look. The other and main reason is that lately it is becoming a serious candidate as an alternate currency for certain types of payment methods such as cross border remittances and for micropayments in amounts of a tiny fraction of its value because the minimal or no transaction cost (McCallum, 2015).
The most serious concern for Bitcoin’s adoption is its seemingly fragile security and history of exchange failures and notorious hacking during 2013 and 2014 headed by the Mt. Gox collapse in April 2014, during which several hundred million of US$ in bitcoins was lost. Perhaps because of these concerns, Bitcoin’s value against traditional currencies is still very volatile. Despite all of the negative events in recent history, Bitcoin is not only surviving, it is noticeably expanding.
One of the reasons for Bitcoin’s ability to survive is its innovative technology. It uses peer-to-peer connection between two parties enabling them to make payments without any oversight by any government, any bank, or any similar entity and almost for free or with a very little cost. It implements three concepts that can be broken into three categories: blockchain as an electronic version of a public transactions ledger, secure electronic wallet to store individual bitcoins, and the third would be the approval process via so called “miners”, entities involved in mining for bitcoins as a reward for approving and recording transactions. To support these three concepts Bitcoin implements a unique protocol that so far has not been broken and appears to be technologically sustainable for times to come.
The most important and innovative component of Bitcoin system is its electronic ledger called Blockchain, in which it is not possible to double-spend, or in other words, to use the same funds to purchase multiple products. Each of the blocks in the blockchain represents a transaction that fits exactly into the current jigsaw puzzle of transactions forming one solid block. The piece of the puzzle, i.e. a block, is fully transparent and anyone can find out which addresses transacted with each other, when, and for how much (Bradbury, 2015). One block, or a transaction, can contain multiple inputs and outputs allowing multiple payments in one go. In order a transaction to be valid and approved, every input has to be an unspent output of previous transactions (Wikipedia, 2015). To add a block to the Blockchain, i.e. approve a transaction, the block has to go through a deliberate approval process, in which number of “miners”, or nodes on bitcoin network, are using consensus algorithm checking every newly generated block and when the block can be attached to its predecessors by verifying the entire blockchain, the transaction is then added to the puzzle. The transaction block, a key component of the Blockchain, contains a cryptographic hash using SHA-256 hashing algorithm code that it is created by using a solution to a computationally hard problem called “proof-of-work” (Zohar, 2015). Thus, it is not easy to create a block that fits into the blockchain while making it more profitable for the nodes (or “miners”) approving a block to comply with the rules rather than violating them to create and approve a fraudulent transaction. The approval process is called “mining” since the “miners” are being rewarded by bitcoins.
Because creation and approval of an additional block is a difficult problem, there are rarely conflicts arising from multiple unapproved blocks in the system and if they are, the conflicting block is simply rejected and then a new block must be created. As the entire Blockchain is growing by the mining process, it is becoming more and more difficult and expensive with time. In recent years miners have been using specialized ASIC (Application-Specific Integrated Circuit) computer systems that consume remarkable amount of power. For example, in April 2014 to calculate a single bitcoin proof-of-work costs equivalent of 16 gallons of fuel (Bradbury, 2015).
As far as the security and trustworthiness of Blockchain including the approval process of adding of new blocks or “mining” are concerned, it can be concluded that these major Bitcoin components have solid foundation for its intended purpose. The other critical component is the bitcoin container, otherwise called a bitcoin wallet. The notion that a wallet is a bitcoin storage container is actually not correct, because all the bitcoins are stored in the Blockchain, the transaction ledger. Wallets would then be better described as digital credentials for individual bitcoin holdings (Wikipedia, 2015). Bitcoin wallets use public key cryptography consisting of one public key and one private key. There are several types of bitcoin wallets, such as mobile, desktop, hardware and web wallets on remote servers. The most interesting and secure brand of bitcoin wallet appears to be the combination of a desktop wallet Electrum having a built in support for hardware wallet Trezor with an option storing an encrypted version in a public cloud making it harder for users to lose their wallets (SatoshiLabs, 2015). Electrum is considered one of the most trusted wallets out there especially since it is in use since 2011, far oldest out of all bitcoin wallets available today. The bitcoin wallets are generally considered to be secure under most of conditions with possibly two types of credible threats: a case in which a wallet could be potentially stolen if stored on a remote server or a in a case where a wallet owner would lose his or her private key. However, it must be noted that the Bitcoin exchange Coinbase offering online bitcoin wallets is FDIC insured and therefore its customers are insured up to $100,000 worth of their bitcoins.
Today, during the remaining days of the year 2015, Bitcoin’s technology and security appears to be rock solid and its only notable disadvantage to be accepted by higher number of potential users is its volatility, but this can be minimized by exchanging the bitcoins with one of the traditional currencies soon before and after each transaction.
Bitcoin’s significant contribution to the financial world is its innovative technology of the blockchain database that is being seriously looked at by major banking institutions. The main reason for this is that the banking crisis in 2008 happened largely due to lack of transparency and due to very high complexity of transactions. The implementation of blockchain database in financial industry has potential to eliminate such pricey mistakes and make fund transfers much more effective, transparent and less expensive. However, there is still one problem in the way of mass implementation of blockchain databases and that is to have the blockchain started. “How does the zero looks like?”, asks Leda Glyptis, head of Europe, Middle East and Africa innovation center at Bank of New York Mellon (ComputerWeekly.com, 2015). While financial institutions are still scratching their heads how to implement the blockchain technology, Bitcoin has a big time head start, but be assured, Blockchain is coming one day to your bank for sure.
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