A brief introduction to the concept of the bitcoin and similar cryptocurrency. Presentation made at CII CIO conference at Mumbai in December 2013

1. Currency
Commodity &
BitCoins
Prithwis Mukerjee, PhD
Praxis Business School, Calcutta
Prithwis Mukerjee, PhD

2. The barter market
1. Ram has excess salt, Shyam excess sugar
a.
b.
Ram exchanges excess salt for Shyam’s excess sugar
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 rice
a.
b.
Ram exchanges salt for Shyam’s sugar, then exchanges this sugar for
Jadu’s rice
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

3. Enter commodity
1. Ram has excess salt, Shyam excess sugar
and Jadu has excess rice
a.
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 rice
a.
and then in terms of products like sugar, oil, cloth, candle and services
like farming, body massage ...
Prithwis Mukerjee, PhD

4. Cowrie shells become “money”
Three functions
● Means of exchange
● Stores value
● Unit of account
Four properties
● Durability
● Fungibility
● Divisibility ?
● Verifiability ?
Prithwis Mukerjee, PhD

5. Cowrie Shells >>> Gold Coins
Durability
Fungibility
Divisibility
● 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

6. 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

7. 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

8. Currency can be issued by anyone
who is trusted by others
Traditional national
currency
● Indian Rupee
● US Dollar
Private 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

9. Trust can be Abused & Betrayed !
1980 : 1 ZWD = 1.5 USD
2009 : 1 ZWD had effectively Zero value or buying
power and was discontinued from circulation
Prithwis Mukerjee, PhD

10. 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

11. 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

12. Bitcoins : Two Mathematical Tricks
There are mathematical algorithms that
regulate
● the generation of bitcoins
● the transfer of bitcoins
and the regulation process is monitored and
have to be agreed to by ALL computers in the
bitcoin network
rules can be broken if and only if more than
50% computers collude with a violation
Prithwis Mukerjee, PhD

13. 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

14. Technology behind Bitcoins
Prithwis Mukerjee, PhD

15. Spend or Double Spend ?
Bank Ledger
RAM
SHYAM
60
MADHU
RAM pays 30 to SHYAM
50
70
BANK allows transfer
updates ledger
Bank Ledger
RAM
20
SHYAM
90
MADHU
70
Prithwis Mukerjee, PhD

16. Spend or Double Spend ?
Bank Ledger
RAM
SHYAM
90
MADHU
RAM pays 30 to MADHU
20
70
BANK BLOCKS transfer
Transaction fails
Bank Ledger
RAM
20
SHYAM
90
MADHU
70
Prithwis Mukerjee, PhD

17. Bitcoins The shared, synchronised ledger
Each person has a “wallet” and every “wallet is syncrhonised
with all other “wallets in the Bitcoin ecosystem
WalletID
X4
WalletID
Y9
WalletID
3T
WalletID
8R
X4
60
X4
60
X4
60
X4
60
Y9
50
Y9
50
Y9
50
Y9
50
3T
60
3T
60
3T
60
3T
60
8R
70
8R
70
8R
70
8R
70
Anonymous : Wallet ID is not linked to identity of owner
Prithwis Mukerjee, PhD

18. Every payment needs to be
confirmed by a majority of network
Wallet X4 transfers 20 to Wallet 3T
Transfer needs at least 10 or 15 confirmations
WalletID
X4
WalletID
Y9
WalletID
3T
WalletID
8R
X4
40
X4
40
X4
40
X4
40
Y9
50
Y9
50
Y9
50
Y9
50
3T
80
3T
80
3T
80
3T
80
8R
70
8R
70
8R
70
8R
70
TXN CONFIRM
TXN CONFIRM
TXN CONFIRM
Prithwis Mukerjee, PhD

19. Genuine payments are confirmed
within a short time
Wallet X4 transfers 20 to Wallet Y9
Transfer needs at least 10 or 15 confirmations
WalletID
X4
WalletID
Y9
WalletID
3T
WalletID
8R
X4
20
X4
20
X4
20
X4
20
Y9
70
Y9
70
Y9
70
Y9
70
3T
80
3T
80
3T
80
3T
80
8R
70
8R
70
8R
70
8R
70
TXN CONFIRM
TXN CONFIRM
TXN CONFIRM
Prithwis Mukerjee, PhD

20. Double payments are denied by
network
Wallet X4 transfers 30 to Wallet 8R
Transfer needs at least 10 or 15 confirmations
WalletID
X4
WalletID
Y9
WalletID
3T
WalletID
8R
X4
20
X4
20
X4
20
X4
20
Y9
70
Y9
70
Y9
70
Y9
70
3T
80
3T
80
3T
80
3T
80
8R
70
8R
70
8R
70
8R
70
TXN REJECT
TXN REJECT
TXN REJECT
Prithwis Mukerjee, PhD

21. My personal wallet : hosted on web
Prithwis Mukerjee, PhD

22. Wallet : After logging in
Prithwis Mukerjee, PhD

23. In reality, the situation is slightly
different
The wallet does not
contain the balance in
each wallet
It 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

24. 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
0:01
Y9
+50
0:02
3T
+60
0:03
8R
+70
1:00
X4
-60
1:01
X4
+40
1:02
3T
used
+20
Prithwis Mukerjee, PhD

25. 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
0:01
Y9
+50
0:02
3T
+60
0:03
8R
+70
1:00
X4
-60
1:01
X4
+40
1:02
3T
+20
2:00
X4
-40
2:01
X4
+20
2:02
Y9
used
+20
used
Prithwis Mukerjee, PhD

26. 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
0:01
Y9
+50
0:02
3T
+60
0:03
8R
+70
1:00
X4
-60
1:01
X4
+40
1:02
3T
+20
2:00
X4
-40
2:01
X4
+20
2:02
Y9
+20
3:00
X4
used
-30
used
Prithwis Mukerjee, PhD

27. Public-private key encryption is
used to ensure authenticity
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
0:00
X4
+60
0:01
Y9
+50
0:02
3T
+60
0:03
8R
+70
1:00
Encrypted by X4
private key for
transmission to Y9
-60
1:01
X4
+40
1:02
3T
+20
2:00
Encrypted by X4
private key for
transmission to 3T
X4
X4
X4
+20
2:02
Y9
+20
3:00
X4
-30
Opened by 3T
by X4 public
key and loaded
into 3T’s wallet
with 3T’s
private key
-40
2:01
used
used
Opened by Y9
by X4 public
key and loaded
into Y9’s wallet
with Y9’s
private key
Prithwis Mukerjee, PhD

28. Confirmations are
Crucial & 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

29. “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

30. Whose block gets added ?
Yours ? or Mine ? Solve a puzzle !
Input :
● Address of last
block of current
chain
● Set of confirmed
transactions
● Guess a number
Output 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

31. 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

32. Bitcoin Technology
What has been
covered so far ?
Other technical issues
● How do we ensure the
authenticity of a bitcoin
● How are Bitcoins created
transaction ?
or generated in a
● What happens if a rival
controlled manner
group starts another branch
● How are Bitcoins
of the BLOCK chain
transferred without the
danger of double
Mathematically correct
spending
answers exist
Prithwis Mukerjee, PhD

33. Comparison : Gold and Bitcoin
● A finite amount of gold is
available in the world.
Quantity not known.
● There will be a finite
amount of bitcoins. Quantity
is 21 million
● Digging gold out of the
ground is complex and
expensive exercise.
● Creating new bitcoins is
expensive in terms of
computing power, electricity
consumption
● Instead of mining gold
you can also buy gold
from a bullion dealer at a
commodity exchange
● Instead of “mining” bitcoins
you can always buy bitcoins
at a bitcoin exchange
Prithwis Mukerjee, PhD

34. The Economics of Bitcoins
Prithwis Mukerjee, PhD

35. 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

36. Who will accept Bitcoins ?
Prithwis Mukerjee, PhD

37. New Vendors are appearing ...
Prithwis Mukerjee, PhD

38. Exchange : From Virtual to Real
Prithwis Mukerjee, PhD

39. Bitcoin : A tradeable commodity
Prithwis Mukerjee, PhD

40. Add and Withdraw Real Money
Prithwis Mukerjee, PhD

41. 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

42. Thank You
Prithwis Mukerjee
http://blog.yantrajaal.com
twitter: @prithwis
this presentation available at http:
//bit.ly/pmbitcoin1
Prithwis Mukerjee, PhD