BITCOIN: A SUSTAINABLE EXAMPLE OF CRYPTOGRAPHIC ...

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3 Δεκ 2013 (πριν από 3 χρόνια και 9 μήνες)

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B
ITCOIN
:


A

SUSTAINABLE EXAMPLE
OF
CRYPTOGRAPHIC
,

DECENTRALIZED
CURRENCY
?














Emmanuelle McCullough
-
Murray

100731457

Computer Science Honours Project

December 12
, 2011

Supervising Professor: Evangelos Kranakis

EMM
2


Abstract


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3


Table of Contents


Abstract

................................
................................
................................
................................
.........................

2

1.

Background:

................................
................................
................................
................................
..........

4

2.

Bitcoin

................................
................................
................................
................................
...................

8

2.1

How does it work?

................................
................................
................................
........................

9

2.2

The Bitcoin Network

................................
................................
................................
...................

12

2.3

Implementation

................................
................................
................................
..........................

14

2.4

Security

................................
................................
................................
................................
.......

17

2.4

The Bitcoin Ecosystem

................................
................................
................................
................

21

3.

Problems

................................
................................
................................
................................
.............

23

3.1

Anonymity

................................
................................
................................
................................
...

23

3.2

Security & Trust

................................
................................
................................
...........................

28

3.3

Hoarding and Deflation

................................
................................
................................
...............

30

3.4

Legality

................................
................................
................................
................................
........

31

3.5

Instability

................................
................................
................................
................................
.....

32

4.

The Future

................................
................................
................................
................................
...........

35

4.1

Will Bitcoin Succeed?

................................
................................
................................
..................

35

4.2

Potential Improvements

................................
................................
................................
.............

36

4.3

Concluding Thoughts

................................
................................
................................
..................

38

Bibliography

................................
................................
................................
................................
................

40

Appendix A

................................
................................
................................
................................
..................

43

Appendix B

................................
................................
................................
................................
..................

44

Appendix C

................................
................................
................................
................................
..................

45

Appendix D

................................
................................
................................
................................
..................

46


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4


1.

Background:



Since our ancient ancestors first started living together in communities, humans have realized
that more could be achieved through mutually beneficial trading than
by hunting and farming alone.
This exchange first took place in the form of bartering, with the exchange of tangible goods and services.
The Chinese were among the first to use items of symbolic value, like shells and subsequently silver
coins, with a set value in their trades. This ev
entually
led

to the creation of paper money, which was not
originally successful due to out of control inflation

(Parise 2011)
.


Many years later, the English established the gold standard, where the value of paper money
was t
ied to that of gold. As gold is a limited natural resource, this prevented the
problemati
c

mass
inflation.
The standard was eventually dropped in most of the world during the Great Depression,
though the United States retained it until it was abolished by
President Nixon.
The currency we now
recognize today is a fiat currency


it has value because it is backed by the government

(Parise 2011)
.
This means you can pay your taxes in it, and as a result it is accepted as payment for

most goods and
services.


The history of currency has not occurred in isolation however. It is closely tied to political beliefs
due to its
unavoidable link with centralized government. Many believe the government should not have
control of the money sys
tem, and one needs only look at the current recession to understand why.
Alternative currencies have therefore been proposed, usually by fringe groups with a focus on privacy. In
the 1990s, Julian Assange, current leader of the whistle

blowing organization

Wikileaks, was a member
of the cypherpunk
s mailing list. This group focused on the use of cryptography for achieving privacy and
libertarian ideals, and in 1998 anothe
r member proposed “b
-
money”; an

a
nonymous, digitally
distributed,

untraceable currency.
These ideals h
ave become more mainstream

as the flaws in
EMM
5


centralized ban
king

have

become difficult to ignore, and modern digital currencies focus on many of the
same concerns

(Grinberg 2011)
.

Before delving into modern currenc
ies, let us first look at what new currencies need to be able to
achieve in order to have any hope of success.
Good money must be easily divisible in order to
accommodate large and small transactions. It must be durable, so that it can circulate without de
caying
and retain its value. It must be
fungible;

for example a dollar is always
e
quivalent to another dollar.
It
must be relatively scar
c
e so as to be valu
abl
e

(Kevin 2011)
.
Fiat currencies respect all these rules, as did
the
gold standard. Digital currencies, generally, are easily divisible, as well as being durable and fungible.
Scarcity, as with paper money, becomes more problematic and can have
disastrous

inflationary results
when not handled correctly.

The creation of ele
ctronic currency is tied to the development of the internet and global networks
and so there is no single example of a successful
e
l
e
c
t
r
o
n
i
c

currency with any longevity.
Facebook
credits and Microsoft points
are two
d
i
g
i
t
a
l

examples which are tied to fiat
currencies;

users p
urchase
them and then are able to purchase products within the services

(Brito 2011)
.

Zynga, t
he

creator of the

massively popular Farmville game which
is

typically played from

within Facebook
,

generate
d $597.5
million in
r
evenue

last year

through microtransactions, with
F
acebook taking

a

30% cut of purchases
made using
F
acebook credits

(Ivan 2011)
.
Similar system
s exist for many digital worlds, including

second
life which saw
USD
1.5

million in
transactions in 2007 using its virtual currency Linden Dollars.
This
demonstrates the high level of activity online, and opens the door for other electronic currencies. What
if there was a single, unifying digital currency that all these virtual worlds acc
epted? The currency would
have a high chance of success, as there would be a pre
-
existing market of people ready to use it, and
with the support of the game or community creators, user confidence would be easier to obtain.
This
would not

be

possible in som
e markets however, where the quantity of virtual currency you have is
EMM
6


dependent on skill or effort.
In the massively multiplayer online game World of Warcraft, players earn
in
-
game gold based on the amount of time they invest in the game.

Gold farming
, the

practise of
accumulating in
-
game gold in order to sell it for real currency, does happen but is

forbidden and
accounts found to be participating in it are banned.

This
virtual currency
represents a type of escapism,
and would not benefit from being linked

to a real world currency

(Grinberg 2011)
.

The current e
-
commerce market is dominated by PayPal,
which

ha
s

gain
ed

consumer trust by
guaranteeing against fraud and dealing with familiar currencies. Numerous attempts at digital
currencies
have failed for a variety of reasons. Services like Gold Money and Pecunix were based on the gold
standard rather than USD or another fiat currency, which was unpopular with consumers as they
couldn’t tell easily what the value corresponded to.
Other services like Digicash put too much emphasis
on anonymity, which was a low priority for most consumers who generally had no qualms about
entering their credit card information online

(Grinberg 2011)
.

Most consumers still
feel this way, though
there has been a small shift in thinking in some markets as a result of the large number of high profile
hacks in recent years.

What is the appeal of the decentralized approach to banking? It would remove the middle man from
transact
ions, which would reduce or remove fees associated with using the system.
The government
would no longer be able manipulate the money supply to achieve macroeconomic goals, which many
believe they should not be trusted to do.

Why then the move to digital
currency?
Fiat

c
u
r
r
e
n
c
y

i
s

notoriously lacking in security.
It is

frequently counterfeited, and easily manipulated by the government and financial markets.
It can be
politicized, as in the recent Wikileaks scandal, when financial institutions like Visa
and Mastercard
refused to allow donations to be made.
Many argue that only the individual should be able to decide
where their money goes

(Parise 2011)
.
As we perform more and more of our daily tasks online, it seems
EMM
7


only logic
al that our currency should also evolve to better suit the way we are doing business.
Digital
currency would also be a theoretical
benefit

to international business, as it would not neces
sarily be
linked to one country’
s government.

This paper will examin
e Bitcoin as an example of a modern digital currency. Bitcoin is apolitical
and unregulated, with no trusted third party and no possibility of tampering to affect its supply.
It is
managed by a network with public records to prevent fraud and double spendi
ng, and
exists outside of
country boundaries.
It is impossible to tax and, if it were to become popular, it could be used a
s a

single
currency for the world.
Bitcoins have no inherent worth, much in the same way as paper money, and
therefore
rely

on wide a
cc
eptance by users to maintain their

worth

(Parise 2011)
.

As this paper will
show, Bitcoin is a revolutionary idea which, though it may not succeed, presents a radical departure
from our current economic system.




EMM
8


2.

Bitcoin

Bitc
oin is a pseudonymous, decentralized, cryptographic currency designed by Satoshi
Nakamoto. It allows for transactions to be made without any centralized control by banks or
governments. Instead, it relies on strong cryptography to prevent fraud and double
spending. All
transactions are pseudonymous, meaning they are not tied to a real identity. This does not mean that
they are fully anonymous

though
, as will be discussed later.


Cryptographic currencies face the issue that they are digital products, and th
erefore naturally
nonriv
a
lrous, meaning that possessing it does not decrease the supply for other users on the network.
Currency relies on the idea of limited supply however in order to retain its worth, and so Bitcoin uses a
predetermined rate of release
and a maximum quantity of Bitcoins in order to prevent massive inflation.
Another issue specific to cryptographic currencies is that of double
-
spending, meaning spending money
that you have already spent, which is usually handled by a trusted intermediary.

In lieu of this, Bitcoin
uses strong cryptography to create verifiable transactions records. The transaction list is distributed
peer to peer,
so each user is able to insure the bitcoins they are receiving have not already been traded
to someone else

(Lowenthal 2011)
.


One of the major boons of Bitcoins is its presumed anonymity. Generally, this anonymity
prevents any regulation, as the government is unable to identify end users. Even if the government were
to take down the Bit
coin site and project, it would not affect the currency in any way, as there is no
central choke point as in traditional transactions.
This can be a force of good, with the Electronic
Frontier Foundation calling Bitcoin a “censorship
-
resistant digital curr
ency”
(Brito 2011)

but also evil, as
anonymity facilitates illicit activities.
These activities, like ordering drugs or gambling illegally, create
opposition for Bitcoin, and will be discussed
in more detail later.

EMM
9


2
.
1

How do
es it work?

Bitcoin works using a public transaction record. Whenever the user spends a bitcoin, they
cryptographically sign a statement of transfer to the new owner, who is identified by their public
cryptography key.
As soon as the transaction occurs, th
e recipient publishes it to the global Bitcoin
network, providing
undeniable
evidence that the coin has been spent, and other users will now only
accept those
b
itcoins from the new owner

(Lowenthal 2011)
.

The electronic coins ar
e therefore a chain
of digital signature
s
. Specifically, the transactions contain a hash of

the

previous transaction and the
new owner

s public key, which the current owner signs
and adds to the end of the coin, as in
Diagram 1

below.
The payee can verify
each of the signatures to ensure the chain of ownership

(Nakamoto 2009)
.


Diagram
1

-

A chain of transactions

(Nakamoto 2009)

Appendix
B contains

the raw data for a single transaction.

From it, we c
an discern the hash of the
transaction as well as the size in kb. The transaction also records the number of inputs and
outputs

EMM
10


(vin_sz and vout_sz) as any transaction can have bitcoins coming from one or more sources, and being
given to one or more recipi
ents.
We see at the bottom of the transaction the public key th
at

corresponds with ‘User 1’s Public Key’ in the diagram above. The user must have the corresponding
private key or they will not be able to add the transaction to the chain.
The value of the t
ransaction is
also stored in the value field
;

in this case it is 50.014000

BTC
.
We can also see the value of the nonce,
stored as ‘n’.
This particular transaction is a user receiving
bitcoins for having generated the block, so
when we look at the ‘in’ port
ion, we can see the hash and ‘coinbase’, which is the signature equivalent
to ‘User 0’s Signature’
for

a generation input

(Bitcoin Wiki 2011)
.

This mechanism on its own does not prevent double spending however. Typically, a
trusted central
authority would verify the transactions, but this invalidates the goal of Bitcoin, as it puts one authority in
control of the entire network.
The task of verification must be distributed therefore, which is achieved
through the public trans
action record.
It is important that there
be

only one transaction record, which is
shared among all the nodes on a network. The majority of users must agree on the validity of the
history, in order to provide sufficient proof to the payee that the
b
itcoin
has not been previously traded

(Nakamoto 2009)
.


A block resembles the diagram below. It

is made up of two portions, the block header and the
body of the block which contains the

transactions. These transactions

(Tx in the dia
gram below)

are
stored in a hash tree, which will be explained later in this paper.
The header of the block contains the
block version number, the hash of the previous block, the Merkle root for the transactions, the
timestamp, the current target and the n
once.
Let us examine each of these
, beginning with the block
version number.
This is modified if the software upgrades.
The Merkle root is a 256
-
bit hash based on all
transactions which is modified when a new transaction is accepted. The target and the no
nce are both
important for the proof of work that bitcoins requires. The target is value which is modified when the
EMM
11


difficulty is adjusted. To control the creation of new bitcoins, the difficulty is either increased or
decreased. Difficulty changes ever
y

2016 blocks and is a measure of how difficult it is to find a new block
compared with the easiest it can ever be.
It is calculated
by dividing the maximum target by the current
target.
A target is a 256 bit number that the SHA
-
257 hash of a block’s header
must be lower than or
equal to in order to be accepted by the network

(Bitcoin Wiki 2011)
. The lower this target, the more
difficult it is to generate a block.
If your block has is successfully below the target, you
have foun
d the
proof of work
, if not you must increment the nonce and try again.
The nonce is a 32
-
bit field which is the
only modifiable part of the block header.
Incrementing the nonce will completely modify the hash
. This
system means that progress cannot be mad
e towards reaching a target, the user can only try again with
the same chance of success.
The maximum target is as follows:

0x00000000ffff0000000000000000000000000000000000000000000000000000
. Since a lower target is
more difficult to achieve, this maximum

represents the lowest possible difficulty

(Bitcoin Wiki 2011)
.


Diagram
2

-

A chain of blocks

(Nakamoto 2009)

Appendix C contains sample block data for

a block containing a single transaction
.

You

can clearly
see the hash of the previous block (prev_block) as well as the Merkle root (mrkl_root)
. The number of
transactions(n_tx) is 1, the target (bits) is 428215665 and the nonce is 3223544391.

The body of the
block is the Merkle tree (mrkl_tree) at

the bottom, which will store the transactions.


This brings up the remaining major issue

for a digital currency
:

how to ensure there is no fraud in
the generation of the currency. Bitcoin utilizes a proof of work similar to Hashcash
, a denial
-
of
-
servic
e
EMM
12


counter measure tool. A hashcash stamp represents a proof
-
of
-
work which takes a parameterizable
amount of work for the sender to compute, but can
be easily

verified by the recipient

(hashcash.org
2011)
. In Bitcoin’s case,
t
he

proof of work involves
attempting to reach a value below the target
described above, by
incrementing

the nonce of the block header.

The average work required to
complete this is exponential in the number of zero bits required, but can be verified by execu
ting a
single hash. Once the CPU cycles have been expended to make it satisfy the proof of work the block
cannot be changed without redoing the work. Future blocks are also chained onto it, meaning that to
change the block you would have to redo all the bl
ocks after it. Diagram 2 shows
h
o
w

t
h
e

b
l
o
c
k
s

c
h
a
i
n

t
o
g
e
t
h
e
r
, each containing the nonce and the hash of the previous block. This makes fraudulent activity
unlikely as the attacking nodes would have to catch up with and then surpass the work being done by
the honest
nodes. The proof of work difficulty is variable and is determined by a moving target of an
average number of locks per hours. If blocks are being generated too fast, the difficulty of the problem
increases, allowing the system to compensate for increasing
hardware speeds and variations in interest
over time

(Nakamoto 2009)
.

This proof of work solves the problem of determining representation in majority decision making.
If
the majority w
as

base
d

on a one to one relationship betw
een IP addresses and votes, the system could
be successfully attacked by anyone with the ability to allocate many IPs. This proof of work however
gives one vote per CPU.
The majority decision is represented by the longest chain, which logically has
the gre
ate
st

proof of work effort invested in it.
If the majority of CPU power is controlled by honest
nodes, the honest chain will grow the fastest and outpac
e

all competing chains.
The minority attacker
will not be able to reproduce the block it wishes to chang
e, and then catch up to the honest chain

(Nakamoto 2009)
.

2
.
2

The Bitcoin Network

Let us examine the specific steps that creator Satoshi Nakamoto outlines for the Bitcoin network:

EMM
13


1.

New transactions are broadcast
to all nodes


if
the transaction is

only received by most nodes

it
will still become part of a block eventually

2.

Each node collects new transactions into a block

3.

Each node works on finding a difficult proof
-
of
-
work for its block


4.


When a node finds a proof
-
of
-
work
, meaning

the hash of its block header is below the target
, it
broadcasts the block to all nodes


if a node does not receive a block it will realize when it
receives the next block, and can request the one
that’s

missing


5.

Nodes accept the blocks only if all trans
actions in it are valid and not already spent

6.

Nodes express their acceptance of the block by working on creating the next block in the chain,
using the hash of the accepted block as the previous hash.

Nodes in this network will always consider the longes
t chain to be the correct one
, as this is the chain
that the most nodes have
accepted
and are contributing to,

and will keep working to extend it. If two
nodes broadcast different versions of the next block simultaneously,
some nodes may receive one or the

other first, and will work from the one they first receive.
The nodes store the other branch they received
in case it becomes longer

after the next proof of work is found. The nodes will t
h
en switch to the longer
one and continue their work
there

(Nakamoto 2009)
.

Future coins cannot be created in advance, as the blocks require the chain of previous blocks and
the history of transactions to produce.
The number of new coins per block changes in relation to a
specific algorithm,
meaning that though it began at 50 BTC initially, it will eventually reach 0 when all
21,000,000 BTC have been created.
Reaching the maximum number of bitcoins will not
affect

the
potential number of users the network can support however. Bitcoins can be d
ivided down to the eighth
decimal place by default, and even further with small software modifications

(Lowenthal 2011)
.


EMM
14


Bitcoin is currently in its inflationary phase, as new bitcoins are still being created.
The first
transac
tion of each block is a special transaction which starts a new coin owned by the creator of the
block.
This has encouraged Bitcoin mining, where users harness large amounts of CPU power in order to
produce blocks and earn Bitcoins.

Providing a reward for p
roducing blocks incentivizes nodes to support
the network as w
ell as
provides

a way for the b
itcoins to be distributed initially.

The algorithm ensures
that a steady amount of Bitcoins are created, so eventually the effort required to produce bitcoins wil
l
outweigh the benefits of creating them.
At that point, the network will be supported by transaction fees,
which will be very low as anyone can run a node contrary to the large amount of overhead

accrued by
a
central authority

(Kevin 2011)
.
Prohibitive transaction fees have been a barrier for micropayments in the
past, and Bitcoin could be one way of addressing this issue.
This incentivizing ideally encourages the
nodes to stay honest, as an attacker would have to as
s
emble more

CPU power than all honest nodes,
and then choose between using that power to defr
aud people by modifying payment,

or

mak
ing

new
coins. It should be more profitable to obtain more new coin
s

than any other user on the network, than
to undermine the system b
y stealing back his payments.
If the attacker overwhelms the system, it would
very negatively impact consumer confidence, which remains of crucial importance for the fledgling
currency, and they would diminish the value of their own
b
itcoins

(Nakamoto 2009)
.

2
.
3

Implementation

From an implementation perspective, let us look at the way transactions are stored on disk. As all
users require information on transactions for the purpose of verifying th
at the

bitcoins they are
receiving ha
ve not been previously spent, there needs to be some
optimization

of storage to not waste
disk space.
Bitcoin handles this by discarding transactions which are buried under enough blocks. In
order to not break the block’s hash however the transactions are
stored in a Merkle Tree
, a type of hash
tree
.

Only the root of the transaction tree is included in the blocks hash, meaning old blocks can then be
compacted by
pruning

the branches of the tree.

This adds up to about 4.2MB a year, which is
a
EMM
15


negligible amou
nt of space considering most personal computers now have upwards of 500GB in
storage

(Nakamoto 2009)
.

Merkle trees are

b
i
n
a
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y

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h
i
l
d

n
o
d
e
s
.


Merkle trees in bitcoin use
Double

SHA
-
256, and are
built up
according

to the following protocol
:

hash(a) = sha256(sha256(a))


hash(a) hash(b) hash(c)

hash(hash(a)+hash(b)) hash(hash(c)+hash(c))

hash(hash(hash(a)+hash(b))+hash(hash(c)+hash(c)))



A

M
e
r
k
l
e

b
r
a
n
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h

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s

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e

t
r
e
e

w
h
i
c
h

a
l
l
o
w
s

y
o
u

t
o

cryptographically

p
r
o
v
e

t
h
a
t

t
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e

o
b
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e
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t

y
o
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r
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3
.

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h
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f

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w
i
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a
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2

t
o

p
r
o
d
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c
e

H
a
s
h
2
3

(Bitcoin Wiki
2011)
.


EMM
16



Diagram
3

A Merkle Tree in a block

(Nakamoto 2009)

Now, when the user wants to verify payment, he queries network nodes to get a copy of
the block
headers for the longest proof
-
of
-
work chain, and then obtain
s

the Merkle branch which links the
transaction

to the block
in which
it’s timestamped.
Though the user is unable to verify the transaction
himself, he can link it to a place in the chai
n and observe whether or not network nodes accept it.
Blocks
added after it further confirm the network’s acceptance.
This method of verification is reliable as long as
honest nodes control the network
, but becomes vulnerable if the network is overpowered
by an
attacker.

Nakamoto proposes the solution that network nodes send out alerts when invalid blocks are
detected, prompting the user’s software to download the full block to confirm the inconsistent
transactions. The potential insecurity here means that
businesses receiving frequent payments would
probably want to run their own nodes in order to improve security and verify transactions more quickly

(Nakamoto 2009)
.



EMM
17


2
.
4

Security

Bitcoin utilizes a different
privacy model than
traditional

transactions. In the traditional privacy
model, the user performs transactions through a trusted third party, and all members of the transaction
are aware of the other’s identities. This information is kept from the public ho
wever.
Bitcoin works very
differently
,

with hidden identities, no trusted third
party, and public transactions. Keeping the public
keys used in transactions anonymous allows for good, though not perfect, privacy.
Since the
transactions are not secret, it i
s essential that people not be linked to their transactions.
This is
comparable to the stock exchanges, where the time and size of trades is made public, but the involved
parties are not iden
ti
fied.

Using different key pairs prevents transactions from bein
g linked to a common
owner, as if the owner of a key
wa
s revealed

such linking could expose

their

other transactions as well.

This model can

be

shown to be theoretically sound with the following example.
Consider a scenario
where an attacker is attempting

to generate an alternate chain faster than an honest chain.
If the
attacker succeeds, he will still not be able to create value out of nothing or to take mone
y which does
not belong to him, as the nodes will not accept an invalid transaction as payment an
d honest nodes will
not accept blocks containing them.
The attacker can only try to reverse
his

own transactions to regain
previously spent Bitcoins.

The race between the attacker’s chain and the honest chain is characte
rized
as a Binomial Random Walk. The

success event is the honest chain being extended by one block and
increasing its lead by +1.
The failure event is the attacker’s chain being extended by one block
, reducing
the gap by
-
1.
Nakamot
o suggests this problem is
analogous

to the Gambler’s Ruin p
roblem which is
defined as such
: suppose a gambler with unlimited credit starts at a deficit and plays a potentially
infinite number of trials to try and breakeven.
The probability that he ever reaches breakeven (or in our
case that

an attacker ever catche
s up with an honest chain) can be modeled as follows:





EMM
18































































































































Given the assumption that p > q, which is the case when the majority of th
e network is controlled by
honest nodes,
the probability drops
exponentially

as the number of blocks the attacker has to catch up
with increases.
Without early advances, chances become increasingly small that he will be able to
succeed.
(Nakamoto 2009)


Now consider the problem of how long the recipient of a new transaction must wait to be sure
the sender cannot modify the transaction.
Let us assume a malicious sender wishes to make the
recipient believe he has been paid, then r
everse payment back to himself after some time.
The receiver
will be alerted to the reversal of payment, but the malicious sender hopes this will occur too late for
anything to be done about it.
The receiver generates a new key pair and gives the public ke
y to the
sender just before signing in order to prevent the sender from
preparing

a chain of blocks ahead of time.

The dishonest sender begins working in secret on a parallel chain with his alternate version o
f

the
transaction after the transaction is com
pleted.
Th
e

recipient now waits until the tr
a
n
s
action has been
added to a block and z blocks have been linked after it.
The attacker

s potential progress can be
modelled as a Poisson distribution with
the expected value
:







A
s

a

P
o
i
ss
on

r
a
n
d
o
m

v
a
r
i
a
b
l
e

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e
p
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t

f
o
r

t
h
e

t
o
t
a
l

n
u
m
b
e
r

o
f

occurrences

i
n

a

g
i
v
e
n

t
i
m
e

p
e
r
i
o
d
,

i
t

i
s

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u
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e
d

t
o

a
p
p
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i
t

t
o

B
i
t
c
o
i
n
.

T
h
e

B
i
t
c
o
i
n

s
y
s
t
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m

c
o
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t
r
o
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s

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o
w

m
a
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y

b
i
t
c
o
i
n
s

a
r
e

c
r
e
a
t
e
d

b
y

EMM
19


h
a
v
i
n
g

a

v
a
r
i
a
b
l
e

d
i
f
f
i
c
u
l
t
y

l
e
v
e
l
.

T
h
e

m
o
v
i
n
g

t
a
r
g
e
t

i
s

t
h
e
r
e
f
o
r
e

t
h
e

r
a
n
d
o
m

v
a
r
i
a
b
l
e
,

m
e
a
n
i
n
g

t
h
a
t

t
h
e

d
i
s
t
r
i
b
u
t
i
o
n

i
t

p
r
o
d
u
c
e
s

w
i
l
l

b
e

a

P
o
i
s
s
o
n

d
i
s
t
r
i
b
u
t
i
o
n

(Neal 2011)
.

To get the probability
that
the attacker could still catch up now, we multiply the Poisson density for each
amount of progress he could have made

by the probability he could catch up from that point to get
:





























































This can be rearranged as follows to avoid summing the infinite tail of the distribution
:





























This is modelled as a
P
ython program in Appendix A which produces the output below:


For

probability that attacker finds next block

(
q
)

= 0.1

z = 0

Prob

=1.0000
00000000

z = 1

Prob

=0.204587273942

z = 2

Prob =0.050977892839

z = 3

Prob =0.013172241678

z = 4

Prob =0.003455243466

z = 5

Prob =0.000913682187

z = 6

Prob =0.000242802745

z = 7

Prob =0.000064735316

z = 8

Prob =0.000017299804

z = 9

Prob =0
.000004631163

z = 10 Prob =0.000001241402


EMM
20



Graph
1



Probability a
n

attacker will succeed

when probabili
ty of finding next block is 0.1



Graph
2

-

Probability an attacker will succeed when the probability of finding the next block is 0.3

0

0.2

0.4

0.6

0.8

1

1.2

0

5

10

15

Probability

Number of blocks behind (z)

0

0.2

0.4

0.6

0.8

1

1.2

0

10

20

30

40

50

60

Probability

Number of blocks behind (z)

For

probability that attacker finds next block

(
q
)

= 0.
3

z = 0 Prob =1.000000000000

z = 5 Prob =0.177352311360

z = 10 Prob =0.041660479968

z = 15 Prob =0.010100762173

z = 20 Prob =0.002480398178

z = 25 P
rob =0.000613228391

z = 30 Prob =0.000152233942

z = 35 Prob =0.000037895767

z = 40 Prob =0.000009451722

z = 45 Prob =0.000002360764

z = 50
Prob
=5.90295E
-
7

EMM
21


From these two examples we can see that the probability of success d
rops off exponentially very
quickly.
The attacker therefore has little time to gain headway before he loses his chance of ever
catching up.

2
.
4

The Bitcoin Ecosystem

Naturally, Bitcoins are only valuable if a large enough group of people accept them as being
valuable. This is a hurdle that all currencies must overcome, but fiat currencies have a much easier time
due to government support. The Bitcoin ecosystem is not large by any means, but does have a variety of
users and services. There currently exist excha
nges for many fiat currencies into Bitcoins, with Mt. Gox
being the most popular. This service had USD 10,000 in trading for a typical day in March of 2011, and
will handle running the Bitcoin client for you. There are joint mining operations

as previously

mentioned,
and
several types of merchants, though by no means enough to allow someone to subsist solely based
on purchases made in
b
itcoins. Examples include web hosts, online casinos, auction sites, adult
media/toy merchants and most infamously, the illi
cit drug marketplace Silkroad. Bitcoins can also be
used to make donations to nonprofits, like the Electronic Frontier Foundation or Wikileaks. Notably
absent is any type of futures trading, with many users treating Bitcoins themselves as an investment

(Grinberg 2011)
.

Due to the philosophy of decentralization and anonymity behind Bitcoin, it has been linked to
political ideology.
A
fter the release of state department cables by Wikileaks, the banks and Paypal froze
their accoun
ts preventing any donations from being made.

This

has

led to a temporary shutdown of
the
site, which claims donations were its main source of income. In a post made on their website, Wikileaks
explicitly states, “We
cannot

allow giant US finance companies

to decide how the whole world votes
with its pocket

(IDG News Service 2011)
.”

The blockade

was problematic for many people, who had
laboured under the misimpression that their money could freely flow where they wanted it to. I
t made
all too clear the position of third party intermediaries as choke points for the financial system. A piece of
EMM
22


legislation known as the Combating Online Infringement and Counterf
ei
ts Act (COICA), which is currently
being

debated in the United States
senate would allow the Department of Justice to require payment
processors to block transactions to blacklisted sites, allowing the government to restrict even further
where money is allowed to go

(Brito 2011)
. Many feel v
ery strongly that this represents a violation of
personal freedoms. Rick Falkvinge, the founder of the Swedish Pirate Party, has gone so far as to convert
all his savings into Bitcoins. He justified this by saying that the value of bitcoins has risen a
tho
usand fold

against the U.S. dollar in

the previous 14 months, an inadvisable investment as past gains do not
necessarily engender future success

(Surowiecki 2011)
.


EMM
23


3.


Problems

3
.
1

Anonymity



There are many appealing features to Bi
tcoin on the surface, but does it really
provide the
anonymity it claims to?
It can, but the number of caveats means that for most users it will not.
Since
every transaction is logged publicly, you can easily see the flow of bitcoins from one address to an
other.
Though the addresses themselves do not necessarily

reveal

the identity behind them
,

network anal
y
sis,
surveillance or just googling the address can provide valuable information.
If any of the addresses can be
tied to an identity, the
se

known identit
ies can be used to determine the identities of those they traded
with, eventually revealing the whole network.
Network analysis can identify the exchange service that
bitcoins were purchased from as Bitcoins carry traces of the original transaction no matt
er how many
purchases are made. Users would typically have to use their money in fiat currency to purchase bitcoins,
which means providing some form of banking information, which naturally re
veals the identity of the
user. There are a few solutions for thi
s, but all require additional effort from the user, and are not part
of a
normal
Bitcoin transaction.

In order to disguise their movements online, the user must use TOR. TOR provides access to
.onion, the part of the internet which is anonymous, untraceab
le, and unknown to most users.
TOR uses
onion routing which makes it impossible to discern the sender or recipient of data.

A more detailed
explanation of how TOR and onion routing work will be presented later in this paper.

Using a TOR
browser bundle lik
e Truecrypt, and an anonymous mail account like Safemail, a user can browse the
internet in complete anonymity. To try and anonymi
z
e
b
itcoins that were purchased using a bank
account, users can try mixing services such as Bitcoin Laundry. This service requ
ires you to already have
bitcoins, which it combines with other user’s bitcoins, and then it returns a different set of bitcoins to
you (minus a commission fee). This theoretically breaks the connection between you and your
purchased bitcoins.
This idea wo
rks in theory but falls apart in practise if there are not many other
EMM
24


people using the service, as this increases the likelihood that you will just receive the same coins back
that you put in.

Another service is Bitlaunder, which is only accessible throug
h TOR. This services works
in a slightly different way, taking bitcoins and selling them for another currency. They then use this
currency to buy a different set of bitcoins, and send them to you. This can be risky depending on
fluctuations in exchange rat
es
, and since many users do not typically use TOR, is unlikely to be adopted
by the majority of people

(Vince 2011)
.

The point of failure seems here to be the initial purchase of the bitcoins, which requires banking
infor
mation.
Cash is therefore the only
truly

anonymous way to purchase Bitcoins, and so there are
several services to facilitate this, though none are ideal.
Bitcoin 4 cash is an in
-
and
-
out exchange,
meaning that they buy bitcoins in exchange for pre
-
loaded vi
rtual credit cards, and sell the bitcoins for
cash.
Exchange rates are a major factor for this service, with a locked exchange rate
for

a 10% deposit,
or the going rate with increased risk.
With a locked in rate, Bitcoin values could skyrocket between the
time you make the purchase and

the time

your cash is received by Bitcoin 4 cash, meaning you would
have gotten less bitcoins for your money. On the other hand, if the exchange rate plummets and you
have chosen to go with the going rate, your cash could be
worth fewer bitcoins by the time it arrives

(Vince 2011)
.


Another similarly named service is Bitcoin 2 cash, which matches buyers and sellers. You do not
purchase bitcoins from this service, you just fund an account that

you then use to buy from another
account holder who is selling.
This service has the advantage that you can choose the optimal time to
execute your exchange, without the
uncertainty

of
fluctuating

exchange rates while your cash is being
delivered.
Finally
, services exist to facilitate in person exchanges, which naturally carry the risk of
meeting an unknown person, but also require trust that the seller will actually transfer the bitcoins after
EMM
25


you have paid them.
These services include Ubitex, BTC near me

and Bitcoin.local
, and only work in large
urban areas where there are many people using bitcoins

(Vince 2011)
.



The risk for anonymity posed by the exchanges was brought to the forefront in June, when Mt.
Gox, the most
popular exchange, complied with requests from the DEA for user information.
This stance
is not
surprising
, given that many services are subject to local laws, and in order to continue operating
they must comply with these laws.
A statement given by Mark Ka
rpeles, the chief executive of Tibanne
Co which
operates

Mt Gox, makes this very clear,
“We

are not here to flip the economic system on its
head, nor do we believe it is necessary for that to happen in order for Bitcoin to be a player in world
markets. We
have to exist and exercise our right to do business f
r
om within the confines of the system.”

As the exchanges must deal with the banks in order to perform currency exchanges, and receive money
from its
user’s

bank account, it cannot operate outside the law
. Karpeles also said, “I think it is safe to
say that we do not intend to enable illegal
activities

or have blood on our hands by association.”

The
specific activity that led to these DEA requests were purchases made from Silkroad, an online market
place
for purchasing and selling illegal substances.
As Silkroad operates through TOR, authorities had no
way to identify those running the site, and with Bitcoins being used for the purchases, no way to identify
the customers or the sellers.
The only point wher
e they could ident
ify those making the purchases wa
s
from their initial purchase of the Bitcoins, information that is fairly easy to come by as the exchanges
“need to stay within the boundaries the regulatory bodies have set.”

The exchanges are, and need t
o be,
legitimate businesses for Bitcoin to be appealing to more than just a fringe group

(Vince 2011)
.

It would
be detrimental for Bitcoin to only be associated with illicit activities, as it furthers the incorrect premis
e
that the only reason anyone would seek anonymity is if they have something illegal to hide.


There are a few other methods to break the anonymity of Bitcoin
.
Most users have software
created and compiled by Bitcoin.org.
If this software was to become co
mpromised with backdoor
EMM
26


functionality, authorities or attackers would be able to access an
individual’s

computer and wallet
details, including the crucial
Bitcoin

key file.
The backdoor would provide a transparent, undeniable link
between the user and the
originating wallet, removing the key benefit of Bitcoin.
There is currently no
evidence that this has happened, but it represents the point of failure with highest reward and the
lowest risk

(Bitcoin Exchange Scam
-

Bitcoins are now Worthless 2011)
.
Though the underlying code for
Bitcoin is completely
open source
, very few users compile the program from source on their own, and
tiny percentage of those will read through the code base.
This could already be in place, and though i
t
smacks of paranoia, has already been found to happen in other open source projects, including BSD,
where it was alleged that ex
-
developers had accepted money from the American government to put
backdoors in the IPSEC stack in 2001

(de Raadt and Perry 2010)
.





Another point of risk is the network trail that is established whenever bitcoins are transferred
between two wallets.
The sending computer must connect to the
Bitcoin

network at some point to
complete the transfer, and

at the point the data sent will eventually have to pass through an external
server unconnected to their
Bitcoin

activity, like an ISP node.
Deep Packet
Inspection (DPI)
can then be
used to identify the recipient wallet.

DPI differs from traditional packet

forwarding as it can also scan the
payload of IP packe
t
s, rather than just the header.
It allows network operators to identify the sender
and content of each packet as it passes through network nodes.
It is capable of examining all traffic from
a specific

IP address, and can even reassemble e
-
mails as they are written.
It was originally intended for
network management, but is now primarily used in surveillance and to identify copyright infringement

(Telecommunication Engineering Centres n.d.)
.

Since all nodes on the
B
itcoin network must be able to
understand the message,
packet

analysis

will always be viable to identify the trail connecting two
wallets.
The analysis can be targeted by identifying high value targets within the ne
twork. All
transactions details are public, and so creating a network graph is simple and will clearly display
important nodes.

EMM
27



There is one final threat to

the

Bitcoin
user’s

anonymity, which is tied to its success or failure.
For Bitcoin to thrive as a
currency, its users must be making purchases. All purchases of tangible goods
made online however require an address be given so that the product can be delivered. Even a post
office box requires some sort of identification in order to reserve.
The governm
ent could easily require
businesses accepting Bitcoins to collect identification information from customers,
as financial
institutions are already required to do, and then request that information when illicit activity is
suspected, as they did with Mt. Go
x.
This will identify a large portion of the network, which the
government can use together with the public transaction record to deduce the identities of the other
users.
For a given address it will immediately become apparent where money
i
s being sent to

and
received from.
This problem is only avoidable if purchases are not made, but for Bitcoin to succeed
people need to be using it.

And if many people are using it, the government will monitor it heavily.

So
for the user who requires anonymity, cash rema
ins the most anonymous way to make purchases

(T. B.
Lee 2011)
.


To illustrate the simplicity of analysing the Bitcoin network, a Python program has been included
with this paper called ‘Block Analyser’, sample output for whic
h is in Appendix

D. This program takes in
formatted block data as a CSV, and outputs information
about transactions
.

It can process many blocks
and provide data for the
in
dividual block
s
, as well as summary of all blocks.

It provides the address of
the us
er (or users)
that

generated the block, as well as how much they earned for doing so. It also
output
s

the us
er
s who are sending and receiving the most bitcoins, as well as the addresses of those
they were trading with. Using this information, the governmen
t or other entities could easily determine
who to focus on
within the bitcoin community, and if the identity behind any address is revealed,
addresses they are linked with could also be at risk.

For example, using Wikileak’s bitcoin address
(
1HB5XMLmzFVj8A
Lj6mfBsbifRoD4miY36v)

which

they have publicized on the internet in order to get
donations
, you can see easily determine all users
who have completed transactions with them
.


EMM
28


3
.
2

Security

&

Trust

All new modern currencies are built on
distributed

systems and
so require end user trust in
order to function.
If users do not feel comfortable making transactions, the
user base

will be eroded to
only those committed users, where the reward is worth the risk involved.
It is arguable that in Bitcoins
case, this set of

users would be those with nefarious goals, who stand to gain from the
, supposed,

anonymity of the system.
I
t is nearly impossible
,

or at the very least not worthwhile, to successfully
tamper with pre
-
existing Bitcoins

so

scammers must find other ways to p
rofit from the system.
In an
anonymous system, users must trust each

other or the system fails. If you pay your Bitcoins for
something, you must believe that you will receive the goods you have purchased
.
The exchanges again
present a threat to users here.

There is no audit process for Bitcoin exchanges, as there is no authority
which manages the currency.
There is therefore nothing to prevent an exchange owner from decreasing
the cost of Bitcoins so they can purchase many of them cheaply, and then increasi
ng the exchange rate
again so that the Bitcoins they pos
s
ess are now worth more

(Bitcoin Exchange Scam
-

Bitcoins are now
Worthless 2011)
.


Here is where we see the flaws in deregulation.

With no authority in place, there is no

way to
hold the exchanges accountable, or ensure they are not artificially modifying the price.
This makes
Bitcoin a risky venture for the average user, who does not stand to gain from any anonymity that it does
provide, while leaving them open to manipul
ation by nefarious entities.
The exchanges dictate the value
of Bitcoin relative to fiat currencie
s
;

there is no other method of valuation.

The user trades risk of
government manipulation
of the money supply

for the risk of the exchanges manipulation of th
e
currencies valuation

(Bitcoin Exchange Scam
-

Bitcoins are now Worthless 2011)
.

There is another security issue related to Bitcoin,

in the form of Trojan.Badminer. This Trojan
mines
b
itcoins using the GPU on an infected mach
ine.

GPGPUS (general purpose GPUs) are better than
CPUs for performing repetitive tasks, like mathematical functions and can perform many parallel
EMM
29


operations. This is beneficial for altruistic projects like folding@home, which harnesses the power of
volunt
eered computers to manipulate protein molecules for research purposes, but can also be used if
the computer is hijacked as part of

a

botnet.

Bitcoin mining is analogous to password cracking, for which
GPUs have a 20 times increase in speed over CPUS.
A hig
h end system with 8 GPUs would allow a
password typically taking 6 months to crack to be found in a day.
Even amongst GPUs there are
advantages, with Radeons being twice as fast as the geForce video cards, due to specific integer
instructions like bitalign

and bitselect which speed up cryptographic operations

(Goodin 2011)
.

To profit you must be able to do better than other miners at finding the latest hash, which is
what prevents a malicious attacker from taking down the netwo
rk unless they control the majority of
the computing po
wer, so twice the computing power means twice the potential earning power.
For a
miner, the profits must exceed the cost of hardware and electricity, so it is still profitable at the current
exchange r
ate.
An attacker using an entire botnet does not have this overhead, and so may be able to
make a greater profit if they c
a
n amass enough computing power

(Goodin 2011)
.
The threat of this kind
of Trojan will increase as the pop
ularity of Bitcoin increases, but if Bitcoin loses its value there will be no
profit and the attackers will turn their attention to other

sources of money.

Bitcoins face a threat at all times even when they are not being traded.
Bitcoins must stay on
your

hard

drive in a wallet if you do not choose to use an online wallet service, which means they are
vulnerable

to theft if your computer becomes infected with malware.
A patch
in the most recent version
of Bitcoin
, released on the 21
st

of November,
addresse
s the encryption of wallets
. Previously an attacker
who managed to gain access to a victim’s encrypted wallet file would have had partially exposed private
keys, allowing the attacker to steal the coins associated with those keys.
The fact that patching is

still
ongoing demonstrates that this product may not be as secure as early adopters may have assumed.
There may still be holes to patch and
attackers will find and exploit them

(Bitcoin Project 2011)
.


EMM
30


3
.
3

Hoarding and Deflation

Bitcoin has exhibited a problem since it was first created, which
h
as only worsened with time.
The
economy is very uncertain and dominated by speculators, who are more likely to hoard their bitcoins
instead of spending them.
They believe that Bitcoins will

increase in value as they become more
popular, and so it will be more worthwhile to save them now

in order

to spend

them when they are
worth more. This thinking is very damaging to the Bitcoin ecosystem. Successful currencies need to be
used in day
-
to
-
day

transactions and c
ommerce or the economy cannot last.
Bitcoins inherent design

encourages hoarding
as the money supply is limited
so th
at th
e currency cannot be d
ebased as with fiat
currencies. This design means that as demand rises, so
too

does the value

of bitcoins. A user who is
confident in

the success of Bitcoin will reasonably wish to wait until their Bitcoins (inevitable) increase in
value.
This reduces the number of bitcoins in circulation and discourages spending

(Surowiecki 2011)
.


This problem is called a deflationary spiral, and it occurs with fiat currencies as well. Falling
prices can lead people to hoard cash in expectation that prices will continue to fall, thus decreasing
demand and causing further price drops.

Japan experienced this in the 1990s with their real estate
market.
The effect is somewhat limited in normal markets because people need to spend money in
order to eat and pay bills, so they cannot hoard all of their money. You do not need to spend bitcoin
s in
order to survive howeve
r, so they are easier to hoard
.

The number of transactions has been shrinking,
which
bodes very ill as successful network technologies rarely see usage plateau
much less
decrease
early on in their lifecycle.
There are few places

which accept Bitcoin and a limited number of products
which can actually be purchased, so users have few methods to spend their Bitcoins. If businesses see
the number of transactions shrinking however they are less likely to adopt Bitcoin, translating int
o a
vicious

cycle with fewer transactions being made each day.

Users must stop thinking of Bitcoin as an
investment rather than a currency or the bubble might burst.
In the end, the hype around Bitcoin could
prove to be its downfall

(Surowiecki 2011)
.

EMM
31


There are counterarguments which suggest that hoarding is not necessarily a problem for Bitcoin.
It
increases their value, as there are less Bitcoins in circulation, thus increasing the profits from mining.
This in turn encourage
s more people to mine, increasing the total hashing power and thus the security
of the overall system.

Holding
Bitcoins

will then
increase in
profitability which

encourag
es

more people
and business to accept them in trade.

Currently there is a difficulty i
n
pricing items in Bitcoins due to
large
fluctuations ev
e
n

on a daily basis in their value
, which should eventually stabilize
.
For example, if
hoarding makes Bitcoins worth twice as much, theoretically only half as many will be used in trade, and
so the to
tal value of trades will remain roughly even.

If Bitcoins are valuable because inflation will not
deprive them of value, they will be more appealing than dollars which can suffer the
effects

of inflation,
and so they will be more appealing to merchants.

P
roponents

of this theory argue that people assume
currency hoarding is bad because it traditionally is for fiat currencies, but because
Bitcoin

is a minority
currency the

same rules

do not apply here.

This thinking is only true up to a certain point, and a
ssumes
that there is
, and will continue to be,

an active economy of trading going on.
This has not demonstrated
itself to be the case so far, with a
verifiable

decrease in transaction levels

(Surowiecki 2011)
.

3
.
4

Legality

Bitcoin

is problematic from a legal perspective, perhaps intentionally so as it threat
e
ns the concept
of a centralized money system over which the government has a large amount of control.
In a post
replying to an MIT article on Bitcoin, the CEO of StrikeSapphire
.com, a legal Bitcoin casino, says the
threat to Bitcoin from hoarding is negligible compared to the legal threat it faces. Citizens of the United
States cannot legally gamble online, but this restriction can be circumvented if you pay with Bitcoins, as
th
e government theoretically cannot trace your payments.
This particular casino claims to turn away
American customers to stay within the law, but the post points out that others very likely don’t, which
will bring
scrutiny

and
legal problems

for those who a
re identified.
Illegal

gambling and the purchase of
EMM
32


illicit substances means the government will have many arguments against Bitcoin, should they ever
chose to oppose it

(Surowiecki 2011)
.

Federal law in the United States spec
ifically prohibits “private coin or currency systems [which]
compete with the official coinage and currency of the United States


(Grinberg 2011)
.
This law is not
strictly enforced, as community currencies have existed unthreat
ened for some time, but would provide
the government with some pretense to oppose Bitcoin in the United States, were it to ever become a
real threat.

This statute was created in response to companies issuing small denominations of private
currencies after
shor
t
ages in official U.S. small coins which were being hoarded for the value of the
metal they were made from.

The government argued having alternative currencies was
facilitating

this
hoarding and contributing to inflation.
The act specifically was writt
en to protect small coins, and so is
easily circumvented by only creating denominations larger than a dollar. Virtual world currencies are not
affected as they are not meant to be used in lieu of USD.
Bitcoin however is not int
en
d
ed to be limited in
scope,

and is easily divisible into small amounts, and so could find opposition under this antiquated act

(Grinberg 2011)
.


Naturally this is only within the U.S., and the government could not actually shut down or kill
Bitcoin glob
ally; they would however be able to affect merchants and exchanges which accept Bitcoins
and operate within the U.S.

This again brings up the example of Mt. Gox, who has been asked to provide
information on users

(Vince 2011)
.
Attempting to ban Bitcoin outright would likely be unproductive for
the American government, and would only serve to make them seem oppressive.
Bitcoin in its current
form is of little threat, and only its illicit

uses
should

pique the

interest of f
e
deral authorities.



3
.
5

Instability


So what is th
e great threat to the consumer who
chooses

to invest his money in Bitcoin? It is
likely not the legal threat, or that of malicious exchanges, but of the failure of the overall Bitcoin system
EMM
33


itself.
Bitcoin

is being promoted as a competitor instead of as a supplement to the dollar economy.
This
is not

an image

based in reality however, as there are tens of thousands of bitcoins traded each day and
several hundred businesses
accepting

it as payment; number
s

w
hich pale in comparison to those of
even small economies.
It appeals to paranoid users who fear the banking system, a belief which is
increasingly entering
mainstream

thought

but not enough to mak
e the risk worthwhile for most.
Moreover
,

because the virtue
s of the system are not appealing to the
majority of consumers
, only to
niche and illicit markets
, it is unlikely to ever be competitive with the USD

(Surowiecki 2011)
.

Bitcoin
’s value

is very much based on speculation.
In Jul
y of 2010 after a post on the technology
forum Slashdot, the value of bitcoins jumped tenfold in five days. Its value then took another eight

months

to achieve the same amount of growth.
Many see it as an investment or are interested in its
speculative wor
th
; which is a poor method
of investing and also hurts the Bitcoin economy.
Its value
tumbled over fifty percent in a matter of days in
A
ugust
, from $13.50 to under $7
, as media coverage
has an excessive impact on its value
, though not on the level of tran
sactions

(Jackson 2011)
.

The fiat
economy experiences this as well, mainly in the securities markets, but the effect is not as pronounced

as it is not occurring for entire economy

(Surowiecki 2011)
.

This begs the question every investor wishes to have answered: is Bitcoin sustainable?
History
has proven the appeal of a currency that
cannot

be inflated by government intervention is real. The Iraqi
Swiss Dinar is an example of a successful currency whic
h did not have government backing. After
Saddam Hussein caused massive inflation of the Saddam Dinar by printing excessive amounts of
currency
it

retained its value

(Grinberg 2011)
.


Bitcoin is vulnerable to any changes to the

system which decrease
confidence
, and to its
competitors. Any fragmentation of the
Bitcoin

economy, for example due to a conflicting coalition who
releases a compatible version of Bitcoin with different inflationary settings, would cause fatal damage if
EMM
34


a

majority of users could be convinced to switch.
A government crackdown could also cause a crisis of
confidence,
leading to users bailing out en masse and rendering Bitcoin effectively valueless

(Grinberg
2011)
.

Failures in te
chnology can also impact Bitcoins appeal.
The problems with anonymity discussed
earlier could irreversibly damage Bitcoin, if and when the government obtains the means to deduce a
majority of users


identities, one of the major selling points of the curren
cy

would be lost
.

Theft of
Bitcoins

or denial of service attacks on the network could also cause irreversible damage to already
shaky

consumer confidence.

There has already been one documented theft of Bitcoins in June of this
year. A user lost 25,000 BTC
(then valued at $487,749) after the attacker gained access to his computer

s
hard drive

(Falconer 2011)
.

Bitcoin offers no security against this, and without a third party, there is no
recourse for the user to get his money bac
k.

Without government backing, and with no inherent value,
Bitcoin relies on its users to keep it going.

There does not currently exist a community of users who
trade exclusively in Bitcoins, and so there is no solid base for i
t to fall back on

(Grinberg 2011)
.




EMM
35


4.

The Future


4
.
1

Will Bitcoin Succeed?


What can be determined from this examination of Bitcoin?
It seems that Bitcoin is unlikely to
succeed. Though its
purported

benefits are very appealing, they do not seem to withstand
scrutiny
.
Arguably
it’s

most attractive qualities are anonymity,
decentralization
and its reliance on cryptography.

On the decentralization front, Bitcoin has
definitely

succeeded. When the financial institutions froze
Wikileaks’s
bank account, donations w
ere still possible in Bitcoins. There is no trusted third party, for
good

or for
ill
. When 25,000 BTU were stolen from a hard drive, there was no recourse for the user. The
transaction is
publicly recorded
for all to see, but no intermediary is available t
o reverse it and prosecute
the thi
e
f.
If money were spent using stolen credit card credentials online for example, insurance would
allow the bank to reverse the charges and the victim would not be affected. With Bitcoin you gain the
benefit of having no o
ne tampering with your money transfer but you also take on some risk.

This decentralization means nothing however if it is not coupled with anonymity, and this paper
has shown Bitcoin to not be as anonymous as it is evangelized to be.
Even with every poss
ible
precaution taken,
B
itcoins purchased with cash and then used only through TOR, the user must still
provide their address to have products delivered to them. There may not be a
n intermediary financial
institution which can be controlled by the governme
nt, but businesses must still comply

with requests
for information.
Purchasing Bitcoins with cash
is complicated and requires additional effort, and mixing
bitcoins using a service like Bitlaunder carries a transaction fee and is not guaranteed to be effec
tive.
This means the consumer must use an exchange, over which the government

s influence has already
been demonstrated.
Network graphs and deep packet analysis
can produce information about the other
members of the network, so even if you take every preca
ution, you could still be exposed by the actions
of another user.

EMM
36


4
.
2

Potential Improvements

Most security for internet communications focuses on preventing eavesdropping, where
outsides listen in on an electronic conversation.
For a service like Bitcoin howe
ver, traffic analysis
becomes a much bigger threat.
By
analyzing

the flow of packets, encrypted messages can still be tracked
and
reveal who is talking to whom. For example, knowing which companies are collaborating can be
valuable information to an invest
or.
Journalists and nonprofits working in foreign c
ountrie
s can also be
compromised if their internet use reveals who they are communicating with.
It is for this reason that
anonymous connections are necessary
. These connections are designed to make it dif
ficult for observers
to determine any identifying information from the connection.
Onion routing is one method of
protecting against both eavesdropping and traffic analysis.
I
t

is used in the previously mentioned TOR,
which this paper suggested solves some

of the issues with Bitcoin’s anonymity.
Onion routing, through
TOR, could be implemented as part of the Bitcoin protocol to protect against traffic analysis.
I will now
explain how onion routing works, and the
ways it could be beneficial to B
itcoin.

Onio
n routing works in real time over TCP sockets

by

making a connection to the recipient
computer through a series of machines known as onion routers
.

The onion routers in a network are
connected by longstanding permanent socket connections, through which ano
nymous connections are
multiplexed.
The route is
defined

at connection setup but each onion router can only identify the
previous and next hops along a route.
The data which is passed along this anonymous connection
appears different at each onion router,
a
n
d so cannot be tracked. This al
s
o

prevents compromised onion
routers from cooperating by correlating data streams
, and
forestalls

the use of replayed onions or data

(Reed, Syverson and Goldschlag 1998)
.


The system operates
as such:

1.

the initiating application makes a socket connection to an application proxy

EMM
37


2.


the application proxy modifies the connection message format (and data) into a generic
form which can be passed through the onion network

3.

the application proxy connects

to the onion proxy

4.

the onion proxy defines a route through the onion routing network by constructing a
layered data structure called an onion

5.

the onion is passed to the entry funnel (one of the lon
g
standing connections to the routing
network at that oni
on router)

6.

this router is the one for which the out
ermost layer of the onion is in
t
ended

7.

each layer of the onion defines the next hop in th
e

route


Each layer of the onion contains the next hop information and key seed material from which keys are
generat
ed for encrypting or decrypting data sent forward or backward along anonymous connections.

Once the
initial
connection is established data can be sent freely

(Reed, Syverson and Goldschlag 1998)
.

This strategy is an improvemen
t over a link encrypted system because the data moving through
the network appears differen
t

to each onion router. The anonymous connection is as strong as its
strongest

link, with the routes privacy maintained if even one node remains honest.
In the case
where
the ISP is spying on their customers, the ISP can tell that the connection is coming from the
customer
,
but has no way of determining who it is going to

(Reed, Syverson and Goldschlag 1998)
.

This is
important for preventi
ng Deep Packet Investigation
.
The data component of the packet will be
constantly changing and unreadable to an observing node. The packet will also
be unable to reveal the
recipient of the packet, as no node will know the full path taken by the packet.

T
OR is an implementation of onion routing initially designed for use by the U.S. Naval Research
Laborato
r
y in order to protect government communications.
As described above, TOR can provide some
EMM
38


anonymity when using or purchasing Bitcoins. I believe that if

onion routing were implemented as part
of the Bitcoin network, it would improve on the security
.
One type of attack

that TOR does not prevent
is

end
-
to
-
end
timing attacks, meaning if an attacker can monitor traffic coming out of your computer
and the traf
fic arriving at your destination, statistical analysis can discover they are part of the same
circuit
(Tor Project 2011)
.

Even with this vulnerability, it is considerably more secure than
using IP
routing

alone
.

4
.
3

Concluding Th
oughts

Bitcoin is an interesting experiment and the most advanced decentralized payment system we
have seen so far.
It is not however a viable currency for
everyday

use, which will stifle its growth.
The
majority of the populous will be disinterested, as t
hey see no threat from the financial institutions acting
as middle man for the transactions, and actually enjoy the security it provides. They have no desire for
anonymity and are likely to be wary about a system which is fairly technical to explain.
Thoug
h we are
used to seeing our bank

account

balances

as figures on paper or

a

screen, we still deal with cash for
many transactions and there is comfort in knowing that figure represents something tangible. Bitcoi
n
has no such tangible element. For the niche
market it is seemingly created for, Bitcoin might

still

fall
short. Without anonymity the remaining draw is the decentralization, but as previously mentioned these
two are of little consequence without the other. What benefit is there to system which is no
t
constrained by the financial institutions, but which reveals publicly all your purchases?


From a technical perspective Bitcoin is fascinating, and it will definitely engender currencies in
the future which can live up to all the promises made.
For a cu
rrency like this to succeed there needs to
be trust, which will require a multigenerational change in thinking. Our current society is heavily reliant
on our financial institutions, but if any period in history has given rise to the potential for change, i
t
could be said to be this one.
#
OccupyWall
S
treet and the global #Occupy movement it has begun are on
EMM
39


the cover of every newspaper.
Many do not agree with their methods, but few disagree that the current
state of the global markets
is

unacceptable, and cha
nge needs to
occur
.
Bitcoin’s successors will need to
ride that wave of change and show the world that we can rethink the way our money is represented.
In
a world where few business transactions occur without a technological medium, the future will surely
need a viable type of e
-
currency, and Bitcoin is an important step towards that goal.





EMM
40


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EMM
43


Appendix A




from math import exp, pow

from decimal import *


# Simulation of an attackers success probabil
ity given the probability
the attacker finds the next block (q)

# and the number of blocks he's behind (Z)

def AttackerSuccessProb(q, z):


p = 1.0
-

q


lam = z * (q/p)


sum = 1.0


for k in range (0, z+1):


poisson = exp(
-

lam)


for i in range (1,

k+1):


poisson *= lam / i


sum
-
= poisson * (1
-

pow(q/p, z
-
k))


return Decimal(sum).quantize(Decimal('.000000000001'),
rounding=ROUND_DOWN)



print("q = 0.1")

print("z = 0 P=" + str(AttackerSuccessProb(0.1, 0)))

print("z = 1 P=" + str(Attacke
rSuccessProb(0.1, 1)))

print("z = 2 P=" + str(AttackerSuccessProb(0.1, 2)))

print("z = 3 P=" + str(AttackerSuccessProb(0.1, 3)))

print("z = 4 P=" + str(AttackerSuccessProb(0.1, 4)))

print("z = 5 P=" + str(AttackerSuccessProb(0.1, 5)))

print("z = 6 P="

+ str(AttackerSuccessProb(0.1, 6)))

print("z = 7 P=" + str(AttackerSuccessProb(0.1, 7)))

print("z = 8 P=" + str(AttackerSuccessProb(0.1, 8)))

print("z = 9 P=" + str(AttackerSuccessProb(0.1, 9)))

print("z = 10 P=" + str(AttackerSuccessProb(0.1, 10)))



print("q = 0.3")

print("z = 0 P=" + str(AttackerSuccessProb(0.3, 0)))

print("z = 5 P=" + str(AttackerSuccessProb(0.3, 5)))

print("z = 10 P=" + str(AttackerSuccessProb(0.3, 10)))

print("z = 15 P=" + str(AttackerSuccessProb(0.3, 15)))

print("z = 20 P="

+ str(AttackerSuccessProb(0.3, 20)))

print("z = 25 P=" + str(AttackerSuccessProb(0.3, 25)))

print("z = 30 P=" + str(AttackerSuccessProb(0.3, 30)))

print("z = 35 P=" + str(AttackerSuccessProb(0.3, 35)))

print("z = 40 P=" + str(AttackerSuccessProb(0.3,
40)))

print("z = 45 P=" + str(AttackerSuccessProb(0.3, 45)))

print("z = 50 P=" + str(AttackerSuccessProb(0.3, 50)))

EMM
44


Appendix B



A SAMPLE TRANSACTION


{


"hash":"2a8cbe50702951ffe2bc1ca3b43b0c5f89015fe0fe89804e6044a1a062deefe7",


"ver":1,


"vin_sz":1,


"vout_sz
":1,


"lock_time":0,


"size":135,


"in":[


{


"prev_out":{


"hash":"0000000000000000000000000000000000000000000000000000000000000000",


"n":4294967295


},


"coinbase":"04b1610f1a02dc01"


}


],


"out":[


{


"v
alue":"50.01400000",


"scriptPubKey":"0444be0616bedaf687d12fd2442ee08c58b461234ee97e7b0c5ca3bb8784f6
f1728d0678aabf04fe5a772dd81842389817bf02637dc9a6e176a5cad3b3e94ea499
OP_CHECKSIG"


}


]

}


EMM
45


Appendix C





A SAMPLE BLOCK

CONTAINING ONE TRANSACTION

{


"hash":"0
000000000000ab654da9557bc5497b7863b9d8fca2a251b6375ce96662119e0",


"ver":1,


"prev_block":"000000000000053b9b5b98c38382ad83692f282fa03f94b7a18f71b380f7524e
",


"mrkl_root":"ce00b9ede6deabf94d27dd12e0e3e53aff2da87facb150938473c647393f023e"
,


"time":13235
36488,


"bits":437215665,


"nonce":3223544391,


"n_tx":1,


"size":216,


"tx":[


{


"hash":"ce00b9ede6deabf94d27dd12e0e3e53aff2da87facb150938473c647393f023e",


"ver":1,


"vin_sz":1,


"vout_sz":1,


"lock_time":0,


"size"
:135,


"in":[


{


"prev_out":{


"hash":"0000000000000000000000000000000000000000000000000000000000000000",


"n":4294967295


},


"coinbase":"04b1610f1a02550d"


}


],


"out":[



{


"value":"50.00000000",


"scriptPubKey":"0459499b0166c0228523bb1ad9649c5ebd71f7a311a9487627380142d63af8
78f1f54bd479bb9d71efddf9f11772553770bd6e3127a2dd762d5b1427538c72e254
OP_CHECKSIG"


}


]


}


],


"mrkl_tree":[



"ce00b9ede6deabf94d27dd12e0e3e53aff2da87facb150938473c647393f023e"


]

}




EMM
46


Appendix
D



Here are the results for Block_156353.

There were 11 transactions in this block.

The user who received bitcoins for creating the block is:
1HLteGF3XWSjnUGbPzUHbhdRPDAYszjdt and
they got 50.0015 BTC.

The user who sent the most bitcoins is: 1JWVCXdJdp9SgpXjtopynmNAFhFbg27Mgq and
they sent 84.4995 BTC.

The user 1JWVCXdJdp9SgpXjtopynmNAFhFbg27Mgq sent bitcoins to the following
address(es):


1EU8WC2ZrBXP3zicg2uZe6SiQDGfdANgDr


1JWVCXdJdp9SgpXjtopynmNAFhFbg27Mgq


1DPm2Wmr2jUj5MCgAKKTqkxSKCzHQASQY6


1JNHsPAAkGHnsHoyxDQ37Wx852EkJGE8zQ


1LDZv7UfoW6F3TuifUXYskXEX4ST4tpPXY

The user 1JWVCXdJdp9SgpXjtopynmNAFhFbg27Mgq was involved in the following
transaction(s):


4dcc333109db2609e7a38
dbc917fd5a2c2058fb0526f7600b02c07f6a339156e

The user who received the most bitcoins is: 1LDZv7UfoW6F3TuifUXYskXEX4ST4tpPXY
and they got 200 BTC.

The user 1LDZv7UfoW6F3TuifUXYskXEX4ST4tpPXY received Bitcoins from the
following address(es):


1JWVCXdJdp9SgpXj
topynmNAFhFbg27Mgq


1DPm2Wmr2jUj5MCgAKKTqkxSKCzHQASQY6


1JNHsPAAkGHnsHoyxDQ37Wx852EkJGE8zQ


1EU8WC2ZrBXP3zicg2uZe6SiQDGfdANgDr

The user 1LDZv7UfoW6F3TuifUXYskXEX4ST4tpPXY was involved in the following
transaction(s):


4dcc333109db2609e7a38dbc917fd5a2c2058f
b0526f7600b02c07f6a339156e