Bitcoin

Richard Farr

What is Bitcoin?

Bitcoin Clients

• Multiple Bitcoin clients available
• Standard client for Win/Mac/Linux available from bitcoin.org
• Simply download and run, wait several hours for full sync to the network
• Mobile wallet for Android: 'Bitcoin Wallet' app
• Third party wallet services such as coinbase.com

Receiving Bitcoins

Bitcoin Addresses

Bitcoin Addresses

• In order to send and recieve bitcoins your client generates a random public/private ECDSA keypair
• The public key is hashed into a human readable format and becomes your 'receiving address'
  • for example '18rCHnjG8W4gBoGhFPNmgt18ckFjuwG4d7'
• If you want someone to send you BTC you send them your receiving address
• Receiving addresses are psuedo-anonymous, by themselves they say nothing about who the receiver is

Bitcoin Addresses

• The private key is kept secret to only the BTC wallet holder
• The private key is used when you want to 'send' BTC
• Your BTC client creates a new transaction, signs it with the private key, and publishes it to the network
• The network verifies that the private key matches the expected public key so that only the holder of the private key can spend the coins associated with the receive address

Blockchain

• All transactions in the Bitcoin network are published publicly in a ledger known as the blockchain
• The blockchain is a hash or 'Merkle' tree where each 'block' contains the hashed value of all previous blocks
• Allows the authenticity of the entire blockchain to be validated easily
• New blocks are added to the chain with an expected frequency of once every ten minutes
• Blocks details which transactions were made, what addresses sent and received a certain amount of BTC

Blockchain

Proof of Work

Proof of Work

• What keeps people honest? How to prevent double spending or rewriting the block chain history?
• Bitcoin requires that each block of transactions be 'solved' before it is accepted into the network
• The problem to solve is to find a random nonce, that when combined with the contents of the current block and the hash of the previous block will hash to a value that is smaller than the difficulty setting
• The difficulty of solving a block can be calibrated by requiring a larger or smaller value of the resultant hash

Proof of Work

• Some nodes of the bitcoin network dedicate large amounts of computing power in order to solve a block
• These nodes are colliquially known as bitcoin miners
• The network calibrates difficulty dynamically in order to produce one solved block on average every 10 minutes
• Rewriting the block chain after a solution has already been found is computationally difficult as you would need to rewrite all blocks after as well

Confirmations

• Once a new transaction is published it can be seen immediately on the network
• At this point the transaction is not yet in a found block and could conceivable be reversed or lost
• This is known as 0 confirmations
• As time passes and the blockchain is extended, each block increases the number of confirmations
• Merchants can choose the number of confirmations that they wait to manage their risk. Generally the most conservative merchants wait for 6 confirmations, approx 1 hr

Buying and Selling Bitcoin

Exchanges

• Many bitcoin exchanges have sprung up in order to allow the buying and selling of BTC over the internet
• Mt. Gox is the largest exchange and is based out of Japan. They are currently in the process of opening a presence in the United States
• caVirtex is a Canadian exchange based in Alberta. Allows direct deposit and withdrawal from a Canadian bank account
• Most exchanges are generally not market makers and charge a fee for conversion

Local bitcoins

• Find someone else who will exchange bitcoins for physical cash or other goods
• LocalBitcoins.com allows you to find classified ads for buyers and sellers in your neighbourhood to do in person exchanges
• BTC ATMs are currently under development and being deployed to allow convenient and fast conversion of cash into BTC
• Paper Bitbills are bills with the public/private key printed right on them. The private key is covered such that once exposed the bill can not be passed off as unspent

Functions of Money

• Medium of exchange
• Store of value
• Unit of account

Medium of Exchange - Advantages

• No third party intermediary is required to send or receive BTC
• Low transaction fees
• Can send BTC anywhere in the world, within minutes - only internet connection and client software required
• No identy information needs to be divulged in order to send or receive BTC

Medium of exchange - Advantages

• No chargebacks for transactions, BTC is as good as cash
• Bitcoin accounts can not be frozen or confiscated unless the private key is known
• Private keys can be stored encrypted and backed up in the cloud and do not need to be online to receive BTC

Medium of exchange - Disadvantages

• Bitcoin transaction confirmations generally take several minutes to an hour to become confirmed by the network
• No chargebacks means that buyers are taking on more risk when dealing with merchants
• Requires large computing network and internet access to function
• Wallet theft is problematic and some new malware specifically searches for bitcoin wallets to steal

Store of value - Advantages

• Money supply of Bitcoin is fixed at ~ 21 million
• In theory the value of Bitcoin relative to the economy should increase in proportion to economic growth
• Bitcoin combines the scarcity of precious metals with the convertability of cash
• Access to the account is possible from anywhere in the world instantly
• Bitcoin accounts cannot be frozen or tampered with without access to the private key

Store of value - Disadvantages

• System relies on electricity and computing power for infrastructure
• Wild price flucuations of Bitcoin are likely as the market cap is still very small (~400 million)
• Easy to lose the private key and thus the balance associated with it unless safeguards are taken
• Bitcoin still relatively new, protocol may have as yet undiscovered flaws

Unit of account

• Bitcoins are subdividable to 8 decimal places, worth about 0.00005 cents at current market prices
• This unit is known as a Satoshi, named after the creator of Bitcoin
• Other units include mBTC and µBTC
• If 8 decimal places turn out to not be enough the precision can be expanded if most nodes on the network agree

Mining Bitcoins

Mining Bitcoins

• Anyone can become a bitcoin miner
• When a block is 'mined' the miner is paid both Seignorage (currently 25BTC) as well as transction fees
• Seignorage will decrease geometrically over several years as the number of Bitcoins in circulation approaches 21 million
• After that point transaction fees will be the sole reward for miners
• Market incentive for miners to minimize overhead and maximize output

Mining Bitcoins

• Progression of more efficient and powerful methods of mining
  • CPU ( ~30 MHash/s @ 65 watts)
  • GPU ( ~1000 MHash/s @ 700 watts )
  • FPGA ( ~1000 MHash/s @ 40 watts)
  • ASIC ( ~60,000 MHash/s @ 60 watts)
• Newer hardware is faster and uses less electricity
• As more computational power is added the Bitcoin network adjusts diffcult upwards
• Mining equilibrium depends on price of bitcoin, fee amount, electricity cost, difficulty level, and hardware acquisition costs

Transaction Fees

• When sending a BTC payment the user can optionally attach a fee amount
• This fee amount is paid to the miner who solves the block first
• Miners have full discretion over which transactions they will accept and process
• While it is optional, if no fee is attached the transaction may never get processed

Predictions

• Bitcoin has a promising future and could potentially revolutionize our idea of electronic payments
• Low cost, fast method to send money anywhere in the world
• Innovative properties such as pseudo-anonymity, decentralized trust model, inflation resistance
• Bitcoin ultimately will complement, not replace existing monetary systems

Questions?