Transaction Mechanics

Transaction Mechanics

Innovation and Cryptoventures Transaction Mechanics Campbell R. Harvey Duke University, NBER and Investment Strategy Advisor, Man Group, plc January 27, 2017 Campbell R. Harvey 2017 2 The Landscape http://coinmarketcap.com/ • Bitcoin is the leader (approximate $13 billion in market capitalization) founded in 2009 • Ethereum is #2 with $0.9 billion in market capitalization • Currently, Coinmarketcap.com lists over 500 crypto‐currencies. However, 98% of them are highly illiquid (and not secure as we will discover). Campbell R. Harvey 2017 3 January 21, 2017 3:25pm Campbell R. Harvey 2017 4 The Landscape • Visa/Mastercard/Paypal are centralized and for profit businesses • Bitcoin and others operate on peer‐to‐peer (P2P) networks, i.e. distributed • Bitcoin network is “guaranteed” by cryptographic algorithms rather than governments or corporations • The currency “bitcoin” is a result of the Bitcoin network, i.e. Bitcoin is not just a currency. Campbell R. Harvey 2017 5 The Innovation • Cypto‐currencies have been around since the 1980s • The early ones, Digicash and Ecash failed because they did not provide a solution to the “double spend” problem. That is, with the same digital key you could spend twice or more. • Bitcoin solves the double spend problem Campbell R. Harvey 2017 6 Triple‐Entry Accounting • Usually, we think of a transaction as having a debit and a credit (double entry accounting) • With Bitcoin, there is a third entry. Every transaction goes into a repository of common knowledge. • This repository or public ledger is highly secure and maintained by everyone on the network • The public ledger is the final word –so there can be no disagreement about the debits and credits and there can be no “double spending” • The public ledger is called a“blockchain” (more later) Campbell R. Harvey 2017 7 The Founder https://bitcoin.org/bitcoin.pdf Campbell R. Harvey 2017 Published on Internet November 2008 8 Craig, Dorian or Nick Szabo? The Founder Electronic payment system P2P No double spending Secure via hash Warning about majority of computing power https://bitcoin.org/bitcoin.pdf Published November 2008 Campbell R. Harvey 2017 9 The Founder Campbell R. Harvey 2017 Published March 14, 2014 10 The Founder Campbell R. Harvey 2017 Published March 14, 2014 11 The Founder Campbell R. Harvey 2017 Published May 2, 2016. Earlier outted in Wired and Gizmodo (December 2015) 12 The Founder https://www.cryptocoinsnews.com/technical‐proof‐craig‐wright‐not‐satoshi‐nakamoto/ Campbell R. Harvey 2017 Published May 2, 2016. Earlier outed in Wired and Gizmodo (December 2015) 13 The Beginning • An Open Source Project, with developer mailing list and github repositories • Satoshi remained a visible member of the community until December, 2010 before disappearing • Satoshi handed over development to Gavin Andresen • Core development team maintains the reference client Bitcoin‐QT (GUI) / bitcoind • There is are many competing proposals for the future of bitcoin –yet no centralized authority to decide on which one is the best Source: Brad Wheeler, Bitcoin: What is it? Campbell R. Harvey 2017 14 Competing Client Proposals Bitcoin Classic: Official Website: https://www.bitcoinclassic.com Official Subreddit: https://www.reddit.com/r/bitcoin_classic Official Github: https://github.com/bitcoinclassic/bitcoinclassic Bitcoin Unlimited: Official Website: http://www.bitcoinunlimited.info Official Subreddit: https://www.reddit.com/r/bitcoin_unlimited Official Github: https://github.com/gandrewstone/BitcoinUnlimited Bitcoin XT: Official Website: https://bitcoinxt.software Official Subreddit: https://www.reddit.com/r/bitcoinxt Official Github: https://github.com/bitcoinxt/bitcoinxt Bitcoin Core: Official Website: https://bitcoincore.org Official Subreddit?: https://www.reddit.com/r/bitcoin Official Github: https://github.com/bitcoin/bitcoin The above list is not comprehensive and lists clients/proposals that seem to be being discussed/questioned most atm. Campbell R. Harvey 2017 15 Genesis • The network was “started” January 3, 2009 with the Genesis Block • Bitcoin v0.1 was released January 9, 2009 • Latest version is v0.13.2 released January 3, 2017 https://bitcoin.org/en/version‐history Campbell R. Harvey 2017 16 Foundation/MIT Digital Currency Initiative • Gavin Andresen (Lead Core Dev) and team moved from Bitcoin Foundation to MIT Digitial Currency Initiative (April 22, 2015) http://gavintech.blogspot.com/2015/04/joining‐mit‐media‐lab‐digital‐currency.html • Mike Hearn (senior developer) calls bitcoin a “failed project” https://www.theguardian.com/technology/2016/jan/15/mike‐hearn‐senior‐bitcoin‐developer‐says‐ currency‐failed‐experiment Campbell R. Harvey 2017 17 The Mechanics How does it work?* • Currently, 12.5 bitcoins are produced every 10 minutes • Only miners get new bitcoins • Size of each batch of new coins halves approximately every 4 years; coins divisible to 8 decimals places; 1 bitcoin=100,000,000 satoshi; bitcoin also known by BTC https://en.bitcoin.it/wiki/Units Called “bits” Campbell R. Harvey 2017 18 *I have borrowed liberally from a number of sources, including, King, Williams, and Yanofsky 2013, Quartz. The Mechanics How does it work? • In the year 2141, new coins go to zero which caps the number of coins at near 21 million, but production slows 3.125 Bitcoins 6.25 Bitcoins 12.5 Bitcoins 2016 25 Bitcoins 2012 50 Bitcoins per block 2009 Campbell R. Harvey 2017 19 The Mechanics Mining • Miners are competitive bookkeepers • Think of a huge public ledger containing the history of every bitcoin transaction • Every time someone wants to send bitcoins to someone else, the transfer is validated by network – Make sure the person has the bitcoins to transfer – If the person has the bitcoins, it is added to the ledger – To secure the ledger, the miners seal it behind computational code – There can be no double spending and no counterfeiting Campbell R. Harvey 2017 20 The Mechanics Mining • Miners are rewarded for their work in validating and sealing the ledger • The miner rewarded is the first one to validate and seal Campbell R. Harvey 2017 21 The Mechanics Double spending • Want to avoid spending the same currency more than once • Traditional banks have networks to prevent this. For example, you have $100 in your bank account and write two checks for $100. The first person to cash the check gets the $100 and the other bounces (and creates lots of fees) • With Bitcoin, there is no bouncing. The ledger* is consulted to make sure the person has the bitcoin to spend • Question: How do you ensure privacy and make the transactions transparent? *Also, the pending transactions are checked, the so called “memory pool”. Campbell R. Harvey 2017 22 The Mechanics Bitcoin accounts? • There is no traditional account, like a bank account where the bank can check your balance • The ledger keeps track of all bitcoin transfers –not the balances Campbell R. Harvey 2017 23 The Mechanics Bitcoin basics • Each bitcoin address has a public+private key • Anyone can send to a public address • However, you need a private key to send a bitcoin from any particular address • Payments are irreversible Campbell R. Harvey 2017 24 The Mechanics Simplified example: Alice buys something from Bob and sends him 1 bitcoin Alice Bob 1 BTC Campbell R. Harvey 2017 25 The Mechanics Examples: Alice 1 BTC Bob • Bob sets up a digital (public) address and sends it to Alice • Like email account with password –except it (should) changes for every transaction. • Alice adds Bob’s address and the amount of bitcoins to a 'transaction' message. • Alice signs the transaction (more later on this!) • Alice broadcasts the transaction on the Bitcoin network for all to see. Campbell R. Harvey 2017 26 The Mechanics Examples Quoted in satoshi so 50 bitcoins • Alice sends to Bob Campbell R. Harvey 2017 27 Graphics from King, Williams and Yanofsky (2013) The Mechanics Examples • Transaction sent to every Bitcoin node on the Internet • If the transaction is validated, it is added to the ledger Campbell R. Harvey 2017 28 Graphics from King, Williams and Yanofsky (2013) The Mechanics Examples continue: Bob buys something from Carol and sends her 1 bitcoin Alice Bob Carol 1 BTC 1 BTC Campbell R. Harvey 2017 29 The Mechanics Examples • Bob sends Carol 1 bitcoin • Carol sets up an address and a key • Bob takes the bitcoin he got from Alice, uses his address and key from that transfer to sign over to Carol Campbell R. Harvey 2017 30 Graphics from King, Williams and Yanofsky (2013) The Mechanics Examples • Proposed transaction gets sent to all on network to ensure Bob has not already spent the bitcoin from Alice Other transactions that have occurred since Alice’s original transfer to Bob Campbell R. Harvey 2017 31 Graphics from King, Williams and Yanofsky (2013) The Mechanics Examples • If transaction validated, then added to the ledger Campbell R. Harvey 2017 32 Graphics from King, Williams and Yanofsky (2013) The Mechanics The ledger • Ledger broken up into 10 minute “blocks” • Every block contains a reference to the block before it so you can trace every transaction all the way back to 2009 All of the blocks are called a “blockchain” Campbell R. Harvey 2017 33 Graphics from King, Williams and Yanofsky (2013) The Mechanics The Bitcoin Blockchain • All full nodes (running bitcoind or Bitcoin‐Qt) (includes miners) have the complete block chain • If a computer is turned off, when it starts up again, it will send a message to get the blocks created when computer was down • Current size of blockchain is 90gb • Updates are provided by the system of miners https://blockchain.info/charts/blocks‐size Campbell R. Harvey 2017 34 The Mechanics 2 Transferring ownership • A better metaphor for transferring ownership of bitcoins (instead of serial numbers) is to use the concept of lock boxes. • Basically, you're using your private key to open your lockbox and take out the values, then you're inserting it (say, via a one‐way slit) into someone else's lockbox that can only be opened with a different key.

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