Bitcoin and Cryptocurrency Technologies

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7.5: Governments Notice Bitcoin The rest of this chapter is about governments — government interaction with Bitcoin and attempts to regulate Bitcoin. Let’s start with the moment when governments noticed Bitcoin, that is, when Bitcoin became a big enough phenomenon that government started to worry about the impact it might have and how to react to it. In this section and the next we’ll discuss why governments might worry about Bitcoin specifically. Then in Section 7.7 we’ll turn to areas where Bitcoin businesses may be regulated for similar reasons as other types of businesses. Finally in Section 7.8 we’ll look at a case study of a proposed regulation that combines elements of regular consumer financial protection with Bitcoin‐specific aspects. Capital controls.One reason why governments would notice a digital currency like Bitcoin is that untraceable digital cash, if it exists, defeats capital controls. Capital controls are rules or laws that a country has in place that are designed to limit the flow of capital (money and other assets) into or out of the country. By putting controls on banks, investments, and so on, the country can try to regulate these flows. Bitcoin is a very easy way, under some circumstances, to defeat capital controls. Someone can simply buy bitcoins with capital inside the country, transmit those bitcoins outside the country electronically, and then trade them for capital or wealth outside the country. That would let them move capital or wealth from inside to outside and similarly they can move capital from outside to inside. Because wealth in this electronic form can move so easily across borders and can't really be controlled, a government that wants to enforce capital controls in a world with Bitcoin has to try to disconnect the Bitcoin world from the local fiat currency banking system. That would make it infeasible for someone to turn large amounts of local currency into Bitcoin, or large amounts of Bitcoin into local currency. We have indeed seen countries trying protect their capital controls do exactly that, with China being a notable example. China has engaged in increasingly strong measures to try to disconnect bitcoins from the Chinese fiat currency banking system by preventing business from exchanging bitcoins for yuan. Crime.Another reason governments might worry about untraceable digital cash is that it makes certain kinds of crimes easier — in particular, crimes like kidnapping and extortion that involve the payment of a ransom. Those crimes become easier when payment can be done at a distance and anonymously. Law enforcement against kidnappers, for example, often has relied upon exploiting the hand‐off of money from the victim or the victim’s family to the criminals. When that can be done at a distance in an anonymous way, it becomes much harder for law enforcement to follow the money. Another example: the “CryptoLocker” malware encrypts victims’ files and demands ransom in Bitcoin (or other types of electronic money) to decrypt them. So the crime and the payment are both carried out at a distance. Similarly, tax evasion becomes easier when it's easier for people to move money around and to engage in transactions that are not easily tied to a particular individual or identity. Finally, the sale 204
of illegal items becomes potentially easier when the transfer of funds can happen at a distance and without needing to go through a regulated institution. Silk Road.A good example of that is Silk Road, a self‐styled “anonymous marketplace” which has also been called “the eBay for illegal drugs.” Figure 7.5 shows a screenshot of Silk Road’s website when it was operating. Illegal drugs were the primary items for sale, with a smattering of other categories that you can see on the left. Silk Road allowed sellers to advertise goods for sale and buyers to buy them. The goods were delivered typically through the mail or through shipment services and payment was made in bitcoins. The website operated as a Tor hidden service, a concept we discussed in Chapter 6. As you can see in the screenshot, its address was http://silkroadvb5piz3r.onion. This way the server’s location was hidden from law enforcement. Due to the use of bitcoins for payment it was also difficult for law enforcement to follow the money and figure out who the people participating in the market were. Figure 7.5: Screenshot of Silk Road website (April 2012). 205
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Bitcoin and Cryptocurrency Technolo
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Preface — The Long Road to Bitcoi
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work, there is also the issue of co
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Finally, CyberCash has the dubious
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This was the first serious digital
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and so on — powers of two. That w
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Figure 3 shows the user side of the
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initial cost to acquire all the equ
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the system is to record the relativ
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original design. However, after Bit
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A final reason that’s often cited
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Chapter 1: Introduction to Cryptogr
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Figure 1.2 Because the number of
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Property 2: Hiding The second pr
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ecome: ● ● Hiding: Given H(
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SHA‐256 uses a compression functi
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Figure 1.5 Block chain.A block c
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Figure 1.7 Merkle tree. In a Mer
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throughout this book. 1.3 Digital S
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Figure 1.9 Unforgeability game.
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andomness just in making a signatur
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1.5 A Simple Cryptocurrency Now let
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The first key idea is that a design
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Figure 1.13 A PayCoins Transa
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Perusing the NIST standard that def
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Chapter 2: How Bitcoin Achieves Dec
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state of the system. The implicatio
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consensus is somewhat pessimistic,
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Implicit Consensus. This assumpt
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Figure 2.2 A double spend attempt.
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In general, the more confirmations
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Figure 2.4 The block reward is c
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puzzle‐friendliness property from
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possible outcomes, and the probabil
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theory problem that’s not easily
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this interlocking interdependence b
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Further reading The Bitcoin whitepa
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Chapter 3: Mechanics of Bitcoin Thi
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In this example, Alice specifies tw
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3.2 Bitcoin Scripts Each transactio
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the Bitcoin language and one has to
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exactly the same script, which is i
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in the normal case, this isn’t th
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Technically all of these transactio
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The header mostly contains informat
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in turn sends it to all of its peer
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Figure 3.10 Block propagation ti
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that actually affect them. So they
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that the old version would accept a
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Exercises 1. Transaction validation
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Chapter 4: How to Store and Use Bit
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software can automatically turn the
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The cryptographic magic that makes
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may never know (or care) who the co
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Given this stringent requirement, s
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There is a formula called Lagrange
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Ideally, the site will encrypt thos
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seen exchanges that fail due to bre
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Figure 4.5: Proof of liabilities.
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crypto and we won’t cover it here
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Figure 4.8: Payment process involvi
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transaction can't create coins, but
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of U.S. dollars per day pass throug
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Now if you look at a particular sec
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alance of 500,000 BTC. It then sign
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Chapter 5: Bitcoin Mining This chap
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In most cases you'll try every sing
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You can see in Figure 5.3 that over
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steady‐state, the period to find
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TARGET=(65535
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Disadvantages of GPU mining. GPU
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may be the fastest turnaround time
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Figure 5.10: Evolution of mining
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Hopefully, over time the embodied e
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Still, if we could replace Bitcoin
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Figure 5.11: Illustration of uncert
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Page 159 and 160: Figure 5.15 Forking attack.A mal
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Page 167 and 168: Unlinkability. To understand unl
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Page 175 and 176: Figure 6.5. Labeled clusters.
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Page 179 and 180: they are unhappy with anonymity pro
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to predict the low‐level fluctuat
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design, because miners have to veri
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Here's another example, this time f
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You can also trade shares for futur
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Order books.The final piece o
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Chapter 10: Altcoins and the Crypto
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Attracting miners has special impor
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with the launch date of the altcoin
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Namecoin is technically interesting
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10.3 Relationship Between Bitcoin a
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Switching costs are certainly not z
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If our altcoin is merge‐mined, we
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When we think about a rational mine
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DepositA [Altcoin block chain] Refu
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Sidechains. The sidechains vision i
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lock themselves could tell us. This
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written in bytecode and executed by
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Bitcoin. In particular, there are c
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The simple binary Merkle tree used
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Chapter 11: Decentralized Instituti
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Bitcoin, Alice can remotely transfe
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only these signatures of limited fo
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11.3 Template for Decentralization
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Sidebar: trust.Some people in th
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competition among intermediaries. P
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To drive home the mismatch between
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Conclusion to the book Some people
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