Currency, Commodity and Bitcoins
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Transcript of Currency, Commodity and Bitcoins
Prithwis Mukerjee, PhD
CurrencyCommodity &Coins
Prithwis Mukerjee, PhDPraxis Business School, Calcutta
Bit
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
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 ...
Prithwis Mukerjee, PhD
Cowrie shells become “money”
Three functions● Means of exchange● Stores value● Unit of account
Four properties● Durability● Fungibility● Divisibility ?● Verifiability ?
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
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
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
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
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
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
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
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
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
Prithwis Mukerjee, PhD
Technology behind 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
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
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
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
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
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
Prithwis Mukerjee, PhD
My personal wallet : hosted on web
Prithwis Mukerjee, PhD
Wallet : After logging in
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
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
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
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
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
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
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.
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 !
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
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
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
Prithwis Mukerjee, PhD
The Economics of 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 !)
Prithwis Mukerjee, PhD
Who will accept Bitcoins ?
Prithwis Mukerjee, PhD
New Vendors are appearing ...
Prithwis Mukerjee, PhD
Exchange : From Virtual to Real
Prithwis Mukerjee, PhD
Bitcoin : A tradeable commodity
Prithwis Mukerjee, PhD
Add and Withdraw Real Money
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
Prithwis Mukerjee, PhD
Thank You
Prithwis Mukerjeehttp://blog.yantrajaal.comtwitter: @prithwis
this presentation available at http://bit.ly/pmbitcoin1