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Cryptocurrencies and blockchains - the outlook for Bitcoin into this constellation

and blockchains-
the outlook for Bitcoin
into this constellation
April 2016 Coburg, Germany
Cryptocurrencies and blockchains - the outlook for
Bitcoin into this constellation
Kristian Rosenov Hristo...
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Cryptocurrencies and blockchains - the outlook for Bitcoin into this constellation

  1. 1. 0 Cryptocurrencies and blockchains- the outlook for Bitcoin into this constellation April 2016 Coburg, Germany
  2. 2. 1 Cryptocurrencies and blockchains - the outlook for Bitcoin into this constellation MASTER THESIS Kristian Rosenov Hristov Master of Business Administration Financial Management (FM) Prof. Victor J Randall MBA – FM Department Finance and Economics Faculty University of Applied Sciences - Coburg
  3. 3. 2 Contents Abstract............................................................................................................................3 I. Introduction ...................................................................................................................4 Chapter One: Literature review ........................................................................................7 1. Definitions and terms....................................................................................................7 1.1 Cryptocurrencies ........................................................................................................7 1.2 Bitcoins.......................................................................................................................7 1.3 Block chains .............................................................................................................10 2. Technology behind cryptocurrencies and bitcoins......................................................12 2.1 Cryptography and encryption ...................................................................................12 3. The Bitcoin transaction process .................................................................................14 Chapter two: Economic theory and Monetary history.....................................................19 4. Theoretical analysis of money and Bitcoin .................................................................19 4.1 The main functions of money ...................................................................................19 4.2 Classification of money ............................................................................................20 5. The evolution of money..............................................................................................24 6. The acceptance of crypto currencies..........................................................................28 6.1 Governmental acceptance .......................................................................................28 6.2 Economic acceptance ..............................................................................................30 7. Financial Security, legality and the underworld ..........................................................36 7.1. Financial Security....................................................................................................36 7.2. Legality of Bitcoin ....................................................................................................39 7.3. Anonymity and the underworld................................................................................42 Chapter three: Empirical testing – the Bitcoin concept and acceptance.........................47 8. Primary data collection and analysis – Methodology and methods ............................47 8.1. Semi-structured interviews ......................................................................................47 8.1.1 Sampling procedure ..............................................................................................48 8.1.2 Response rate.......................................................................................................48 8.1.3 Interview issues.....................................................................................................48 8.2 Primary research results ..........................................................................................48 8.3 Analysis and hypotheses..........................................................................................56 9. Conclusion .................................................................................................................58 Literature review.............................................................................................................60 Appendix A.....................................................................................................................63
  4. 4. 3 Abstract The following paper will concentrate on a relatively new phenomenon – cryptocurrencies and bitcoin. Research will be separated into two sections – theoretical framework (main definitions, history of the phenomenon, previous research and information on the crypto-economy); and empirical part (primary and secondary data collection and analysis) – for testing several hypotheses on the functionality and efficiency of both conventional and cryptocurrencies. This paper will aim on answering the following question: How does the Bitcoin system work, and are bitcoins ‘money enough’ to cover the perception of trust and stability to be legal money substitutes? A potential sub-question is: How do decentralization, legality and anonymity affect the total vision for Bitcoin in the money constellation, and how people perceive its PROs and CONs, compared to the conventional money? The following work will aim on checking the following hypotheses: H1. Centralization does not provide security for money owners / Decentralization of the money system provides security for money owners H2. Mining incentives generate better growth, stability and transparency than the conventional currencies have through the central banks and financial institutions H3. Conventional currencies cannot provide the same value for two users (over time), like bitcoins can, (especially if these are placed in different continents)
  5. 5. 4 I. Introduction Ever since the birth of the trade relationship between people, items of different shape and material began spreading as main mean of transaction payment. It all began back in the old ages with bartering goods, manufactured or cultivated by individuals of different culture, social status and profession. Due to human population growth, the new lands discovery, the distribution of wealth (in terms of lands, slavery, trade among other lands and nations/cultures) and the growing unification of people under certain social-economic and patriarchal circumstances, the need of using certain sort of money, emerged. Thus, the social structure became more complicated, and the first “states” needed to place several rules and taxes to be able to fund its own national businesses (like warfare, communication systems, housing, religion-related structure building, etc.). Different kind of coins of precious metals, steel, and other materials were issued and these became the main mean of exchange. Through the centuries, the issue of coins and money, their later bound to gold, silver or oil, along with the emergence of money-lending institutions, the banking systems and the National Treasuries, marked the tremendous political and economic importance of money for the very existence of every individual. For the past two centuries the monetary system evolved in an international and global sense, bounding the leading world economies to the poor nations, rich in natural resources, raw materials and energy goods. The 20th century marked the creation of trade agreements, multinational political and economic structures, mega-economies and international currencies. Stock exchanges began ruling the world of international trade, dictating prices of raw materials, steel, gold, petrol, and governing the currencies worldwide. Globalization and the modern fast-developing high technologies allowed the spread of the World Wide Web and the birth of big independent online communities, new parallel social realities and the generation of knowledge of a new kind – the cyber space, advanced computer science and the new international PC languages. The era of growing interdependence of all industries, nations, systems and markets of the Internet began. Information, knowledge, know-how, science, politics and economics, mixed altogether, helped for the creation of a hyper-active, well- educated, strong and enthusiast new society of people, with individual, democratic
  6. 6. 5 behavior and desire to change and work against the mal-functioning “natural” laws of the contemporary world. The growing power of the financial institutions, the global games of the G-20, the political, economic, social crisis of the past several years, drove the beforehand mentioned people to action and led to the birth of a new type of monetary revolution – the cryptocurrencies. The contemporary high technology allows the creation of any kind of intangible items, with no material equivalent, but carrying enough added value to be exchanged against other non-tangible or tangible goods, services and currencies. Programming the new monetary systems – enthusiast from all around the world unite, under different circumstances, around the main idea of creating a paying system free of taxes, outside governance, high interest and exchange rates. Launching this new decentralized monetary system, regulated by the simple laws of demand and supply, which growth is driven and assured by the very owners of these currencies, leads to the birth of the quasi-currency phenomenon. As the new system is more trustworthy than the traditional one, guarantees anonymous transactions, saves additional expenses, as it does not pass through mediators, and is fast (in terms of time consumption per transaction) – the crypto-economy grows considerably fast. Nowadays, after a short existence of only six years, cryptocurrencies are widespread and most commonly used for online transactions as a mean of exchange for goods, services, intellectual property, etc. Cryptocurrencies, such as Bitcoin, are used for paying meals, clothes and concert tickets, to buying and selling real estate and vehicles. In fact, the Bitcoin community is one of the fastest growing, as popularity, usage and amount of “money” in rotation. The following paper will aim on adding another pattern to the vast amount of information and analysis of this recent phenomenon. Although most of the information, currently available, is mainly based on “how does it work” and “technology behind cryptocurrencies”, there are some theoretical and empirical discourses, adding considerable knowledge to the pros and cons, threads and possibilities of this new online monetary system. The author will aim, using data from previous research, and some new-generated data of open sources within the Bitcoin
  7. 7. 6 community, to provide an explanation of the potential results and future trends in the development of the crypto-economy.
  8. 8. 7 Chapter One: Literature review 1. Definitions and terms 1.1 Cryptocurrencies Cryptocurrency is a digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of this security feature. A defining feature of a cryptocurrency is that it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation. The anonymous nature of cryptocurrency transactions makes them well-suited for a host of nefarious activities such as money laundering and tax evasion.1 These types of currencies make it easier to transfer funds between two parties in transactions. The transfers use public and private keys for security purposes. The fund transitions are done with minimal or none processing fees, allowing users to avoid the steep fees charged by most banks and financial mediators for wire transfers. Since most of the scripted currencies are based on supply and demand, the rate at which a cryptocurrency can be exchanged for another currency can fluctuate widely. The first cryptocurrency to capture the public attention was Bitcoin (BTC), which was launched in January 2009. BTC's success led to the creation of a number of competing cryptocurrencies such as Litecoin, Namecoin and PPCoin. 1.2 Bitcoins Bitcoins are digital coins which are not issued by any government, bank, or organization, and rely on cryptographic protocols and a distributed network of users to mint, store, and transfer. Bitcoin is a decentralized electronic cash system using peer-to-peer networking to enable payments between parties without relying on mutual trust.2 A scheme of how the Bitcoin system works can be found below (scheme 1): 1 - Cryptocurrency definition. Available on: [27/12/2015] 2 Dorit, R, Shamir, A. (2012) Quantitative Analysis of the Full Bitcoin Transaction Graph. Available at: [28/12/2015]
  9. 9. 8 Scheme 1: How bitcoins work: Bitcoin is a protocol for exchanging value over the Internet without an intermediary. It is based on a public ledger system, known as the block chain that uses cryptography to validate transactions. Bitcoin users gain access to their balance through a password known as a private key. Transactions are validated by a network of users called miners, who donate their computer power in exchange for the chance to gain additional bitcoins.3 There is no monetary authority that creates bitcoins. That means that there is no government or central entity to make discretionary decisions about how much currency to be created or attempt to defend it via monetary actions.4 3 Wan, T. Hobitzell, M (2014) Bitcoin. Fact. Fiction. Future. Deloitte University Press. Available at: [29/12/2015] 4 Warden, C (2014) “Bitcoins: Currency of the future?” The impact lab, Georgetown University Centre.
  10. 10. 9 Bitcoin is a collection of concepts and technologies that form the basis of a digital money ecosystem. Units of currency called bitcoins are used to store and transmit value among participants in the bitcoin network. Bitcoin users communicate with each other using the bitcoin protocol primarily via the Internet, although other transport networks can also be used. The bitcoin protocol stack, available as open source software, can be run on a wide range of computing devices, including laptops and smartphones, making the technology easily accessible. Bitcoin was invented in 2008 with the publication of a paper titled "Bitcoin: A Peer-to- Peer Electronic Cash System," written under the alias of Satoshi Nakamoto. The author combined several prior inventions such as b-money and HashCash to create a completely decentralized electronic cash system that does not rely on a central authority for currency issuance or settlement and validation of transactions.5 Payments are made in bitcoins (BTC’s), which are digital coins issued and transferred by the Bitcoin network. The data of all these transactions, after being validated with a proof-of-work system, is collected into what is called the block chain.6 Bitcoin is a scheme designed to facilitate the transfer of value between parties. Unlike traditional payment systems, which transfer funds denominated in sovereign currencies, Bitcoin has its own metric for value called bitcoin. Bitcoin is a complex scheme, and its implementation involves a combination of cryptography, distributed algorithms, and incentive driven behavior. Moreover, recent developments suggest that Bitcoin operations may involve risks whose nature and proportion are little, if at all, understood.7 Bitcoin is an electronic token without reference to any commodity or sovereign currency, and is not a liability on any balance sheet, nor a legal tender status in any jurisdiction. Owning bitcoins results only to the ability to move and use these bitcoins in the Bitcoin ecosystem. The bitcoin's value is derived mainly from its use for making payments in the Bitcoin system, and from the purpose of accruing gains from bitcoins' possible appreciation.8 5 Antonopoulos, A. (2014) Mastering Bitcoin. Unlocking digital cryptocurrencies. Available at: [28/12/2015] 6 Dorit, R, Shamir, A. (2012) Quantitative Analysis of the Full Bitcoin Transaction Graph. Available at: [28/12/2015] 7 Badev, A, Chen, M. (2014) Bitcoin: Technical Background and Data Analysis, p 1. Available at: [2/2/2016] 8 IBID
  11. 11. 10 Bitcoin is a protocol for exchanging value over the Internet without an intermediary (figure 1). It’s based on a public ledger system, known as the block chain that uses cryptography to validate transactions. Bitcoin users gain access to their balance through a password known as a private key. Transactions are validated by a network of users called miners, who donate their computer power in exchange for the chance to gain additional bitcoins. Bitcoin has three qualities that differentiate it from other currencies and payment systems. First, Bitcoin is peer to peer, transferring value directly over the Internet through a decentralized network without an intermediary. Current payment systems, like credit cards and PayPal, require an intermediary to validate transactions; Bitcoin does not. As a result, Bitcoin has been referred to as “Internet cash,” as it can be exchanged from person to person much like paper currency today. Second, Bitcoin is open, yet securely authenticated. Traditional payment systems rely on the privacy of transaction information to maintain security. For example, the compromise of a credit card transaction can result in the release of valuable information that can be used to conduct future transactions. In comparison, Bitcoin relies on cryptography. As every transaction is validated with cryptography by the network of miners, Bitcoin functions because of its openness, not despite it. Third, Bitcoin is self-propelling. Bitcoin uses its own product, bitcoins, to reward or “pay” miners who are providing the computing power that serves as the engine of the transaction verification system. As a result, the system does not require the same type of overhead that traditional payment systems might require. In this sense, Bitcoin functions because of those participating in the system. These three aspects are part of what drives Bitcoin’s success, enabling a nearly frictionless global payment system. However, these same factors have also created challenges.9 1.3 Block chains Because of the lack of a centralized body, or a bank, that deals with transactions history and validity of the same, along with the validity of the bitcoins 9 Wan, T, Hobitzell, M. (2014) Bitcoin. Fact. Fiction. Future. Deloitte University Press. Available at
  12. 12. 11 themselves, the creators of Bitcoin use a particularly decentralized mean of governing the “money” flows. As already mentioned in the previous sub-section, the Bitcoin system uses a method of validation of each unit transaction, popularizing and registering all of the bitcoin operations on a public ledger. The ledger, available at collects all the real-time data for transactions and payments with bitcoins from all around the net/world. Block chains are cryptographic lines of bitcoin addresses, along with their history of transaction, validated by all users who worked in contact with the bitcoin units from their moment of creation till their last transfer. That is to say – block chains are a puzzle like validation chains, created through computing operations, build to provide a proof-of-validity of every cryptographic currency unit being in transaction, to assure it is not fraud and to decrease the possibility of double-spending. A block chain or blockchain is a permissionless distributed database based on the bitcoin protocol10 that maintains a continuously growing list of transactional data records hardened against tampering and revision. The initial and most widely known application of the block chain technology is the public ledger of transactions for bitcoin.11 The block chain is primarily tamper resistant through time stamping the hash of batches of recent valid transactions into "blocks", proving that the data must have existed at the time. Each block includes the prior timestamp, forming a chain of blocks, with each additional timestamp reinforcing the ones before it, thus giving the database type its name. Each block chain record is enforced cryptographically and hosted on machines working as data store nodes extending this validation to the network as a whole.12 Thus, bitcoin block chains are using mining (user provided hardware computer capacity for validation of nodes, or transactions, of each unit of currency) to guarantee the security and eliminate fraud and undesirable losses of its users. This semi-centralized public system (which the blockchain database provides) 10 Satoshi Nakamoto (2008). "Bitcoin: A Peer-to-Peer Electronic Cash System", Available at: [27/12/2015] 11 Postscapes (2013) Block chains and the Internet of things. Available at: and-the-internet-of-things#sidechains [28/12/2015] 12 Bitcoin Wiki. Block chain Definition. Available at: [28/12/2015]
  13. 13. 12 functions as a regulator for a transparent and enhanced (capacity reinforced) real- time monitor of Internet transactions. The maintenance (or mining) of the block chain database assures the issue of currency, used to serve as payment for the voluntary computer owners to share their hardware capacity for the validation of the system. That process is, in fact, the main currency generator. 2. Technology behind cryptocurrencies and bitcoins 2.1. Cryptography and encryption The technology behind all cryptocurrencies is called cryptography. Cryptography is the discipline of writing a message in ciphertext with the aim or protecting a secret from malicious or unauthorized parties. This is usually done by translating from plaintext according to some key text. Professional cryptography protects not only the plaintext, but also the key and tries to protect the whole cryptosystem (Tilborg, 2005)13 . The Bitcoin ecosystem uses three of the most important aspects of cryptography: encryption and decryption; the hashing functions and the digital signature schemes. Each one of those will be explored in the following paragraphs. The process of “writing” is technically called encryption. An encryption is a mapping of plaintext to ciphertext, based on some chosen keytext. It is performed by a stepwise application of an encryption algorithm (Tilborg, 2005). Currently, encryption has been used for a wide variety of functions and operations in everyday life, such as security protocols over sending e-mails or other messages via Internet, ensuring safety on personal computer’s data, securing personal and financial information on servers, etc. practically, without the processes of encryption and decryption (the process of reestablishment of the information to a readable language) any data, transferred or stored on a memory device (server, hard drive, etc.) would be easily readable and could be stolen and used in malicious ways. 13 Tilborg, H (2005) "Encyclopedia of Cryptography", ISBN-13: (HB) 978-0387-23473-1, USA, Springer Science+Business Media, Inc.
  14. 14. 13 According to Tilborg’s book "Encyclopedia of Cryptography" (2005) “cryptographic hash functions take input strings of arbitrary length and map these to short fixed length output strings. In computer science, the term hash function refers to a function that compresses a string of arbitrary length into a string of a fixed length. Cryptographic hash functions are divided into keyed and unkeyed hash functions, based on whether or not they use a secret parameter or a secret key”. The hashing algorithms are mainly used as a form of validating data integrity. To avoid malicious intent, in case of any attempt for intervention in the initially generated code, the result is a hashing ciphertext that will not match the input data, and in such a way – the new manipulated code will be considered as fraud and not accepted for further “consideration” by the system, i.e. the hashing function allows for building a security system against malicious actions. Another function, provided by the hashing algorithms is the so called “free of collision” principle, meaning that for any two different messages, used as an input of the function, their digest should always be different. If the principle is not applied to the algorithm it may be considered broken and opens a possibility of data manipulation. Digital signature schemes (DSS) are techniques that are used to assure that a given entity has sent a certain message. Typically, an entity has a private key and a corresponding public key which is tied to that entity's identity. The entity generates a signature string which depends on the message to sign and their private key (Tilborg, 2005). Digital Signature Algorithms (DSA) allow a user (seller or buyer) to ensure that the data being sent does not contain errors, is not modified, and the signer of the data is verifiable with appropriate information. The main Digital Signature Schema used by Bitcoin is the Elliptic Curve Digital Signature Algorithm (ECDSA), a variant of Digital Signature Algorithm (DSA) which uses Elliptic Curve Cryptography (ECC).14 Elliptic curve cryptographic schemes were proposed independently in 1985 by Neal Koblitz and Victor Miller. They are the elliptic curve analogues of schemes based on the discrete logarithm problem where the underlying group is the group of points on an elliptic curve defined over a finite field. The security of all elliptic curve 14 Piasecki, P (2012) Design and security analysis of Bitcoin infrastructure using application deployed on Google Apps Engine”, p 11. Available at: [03/02/2016)
  15. 15. 14 signature schemes are based on the apparent intractability of the elliptic curve discrete logarithm problem (Tilborg, 2005). The ECDSA algorithm relies on generating a random private key used for signing messages and a corresponding public key used for checking the signature. The security of ECC depends on the ability to compute a point multiplication and the inability to compute the multiplicand given the original and product points.15 3. The Bitcoin transaction process Prior to using the Bitcoin system any seller or buyer must install an application, which handles all the cryptocurrency related operations. In the B-world it is usually called “the Standard client”. Before explaining the entire process of generation, transaction and processing of data around Bitcoins, we must introduce some bitcoin-related terms (Appendix A). The bitcoin transaction process encompasses a broad number of operations, starting from the generation of simple ciphertext codes. Upon installation of the Standard client, the user receives a set of ECDSA key pairs, called addresses. In order to transfer Bitcoins from one Address to the other, the Client needs to sign a specific message (called Transaction) with the private key of the user. The public key is used by anyone wishing to check if the given user has rights to those Bitcoins. A sample Bitcoin Address looks like this: 12tRLZvXjKnj78nNd0SDMsVDgNjUPeXQ It contains information about what Network it is used for, a hash of the public key owned by the user, and a checksum for ensuring data validity.16 15 Wikipedia, "Elliptic curve cryptography - Cryptographic premise", Available at: [02/02/2016] 16 Bitcoin Wiki, "Technical background of Bitcoin addresses", Available at: [02/02/2016]
  16. 16. 15 A Transaction is a simple operation moving a set of Bitcoins between different Bitcoin Addresses. To be able to start a new transaction, the user must first obtain a transaction on his address, which will deliver a bitcoin unit. Having an unspent Transaction, the user specifies the Address they want to send a part of their money to, and how much they want to send. The Client then creates a full Transaction containing all the necessary information. It states which Transaction it is claiming the outputs of (by specifying the Transaction’s hash and index of the output of the Transaction), and how many Bitcoins it is sending to which Address. In order to claim an output of the Transaction, the Client needs to sign a correct message with the private key stated in the output of the Transaction. This ensures that only the user in possession of the appropriate private key associated with a given Address is able to spend Bitcoins sent to them. Most common Transactions consist of two outputs – one crediting the Address of the desired recipient, and the other sending the remaining balance to an Address possessed by the same user who issued the Transaction. A simple bitcoin transaction visual can be found on figure 1. Figure 1. Bitcoin transaction visual
  17. 17. 16 Source: If the amount of Coins sent in a Transaction exceeds the amount of Coins claimed by the Transaction, it is considered invalid and is disregarded by the Network. If the amount of outgoing Coins is smaller than the number of incoming Coins, the difference is recognized as a Fee for the Transaction and it is claimed by the Miner that creates a Block containing that Transaction. (Piasecki, 2012). A Block is a package of information containing all Transactions issued through the Bitcoin Network. New transactions are constantly being processes by miners into new blocks which are added to the end of the chain and can never be changed or removed once accepted by the network. Each block consists of a Block Header, containing all the meta-information, and the list of the Transactions encoded in the package. Each block is referring to the block that came before it. All the blocks in chronological order represent a block chain, which links back to the Generic block, or the first one created since the Bitcoin system began its function. Each consequent block contains information from the previous one, which provides and ensures the validity of all the previous transactions and the true value of bitcoin per private keys. In order to approve the generation of a new block of transactions in the block chain, the Bitcoin system uses the so called Proof of work. A proof of work is a piece of
  18. 18. 17 data which is difficult (costly, time-consuming) to produce but easy for others to verify and which satisfies certain requirements. Bitcoin uses the Hashcash proof of work system. Hashcash proofs of work are used in Bitcoin for block generation. In order for a block to be accepted by network participants, miners must complete a proof of work which covers all of the data in the block. The difficulty of this work is adjusted so as to limit the rate at which new blocks can be generated by the network to one every 10 minutes. Due to the very low probability of successful generation, this makes it unpredictable which worker computer in the network will be able to generate the next block.17 This fact allows for the block chain to be secured of random or fraud blocks or of malicious intervention from third party hardware, and produces a valid and reliable transaction information for the Bitcoin ecosystem. A visual example for a block chain can be found on figure 2. Figure 2: Block chain structure Source: The process of creating new Blocks is called Mining. As the process of Mining requires a lot of technical resources, due to the vast amount of computing needed for the verification of data in the process of “proof of work”, it is incentivized by design in form of Block reward. Thus, along with helping the Bitcoin system to work properly 17 Wikipedia. “Proof of work” Available at: [02/02/2016]
  19. 19. 18 and create transaction database, the mining process (and the block creation one) are the main mechanism for issuing new Bitcoins. In the first months of functioning of the Bitcoin system, the block reward was responsible for the initial distribution of the cryptocurrency across users. Now that the transaction process is explained it is important to note, that the Bitcoin Infrastructure lies on three main pillars: the Bitcoin network, the miners and all applications that use Bitcoins for transferring and storing value. The core of the Bitcoin infrastructure is the Bitcoin Network, which is composed from a number of active Bitcoin clients (nodes). Each Node is responsible for storing its own copy of the Block Chain and a list of Transaction not yet included in a Block. It also verifies every Message it receives in terms of validity, as well as replies to those Messages, usually by sharing information about Transactions, Blocks and other bitcoin clients it has information on. The second most important part of the Bitcoin infrastructure is the Bitcoin Miners. Those applications communicate directly with a client connected to the B-Network. They do not store any information related to the Bitcoin Network. They rely on the information provided by the single Node they are connected to, and are tasked with creating new block. Most often Miners are connected to the Node through a web application that optimizes work balancing and allows for a shared Block reward distribution. The third part of the Bitcoin infrastructure is all applications that use information about Bitcoin. Those applications are not required for the Bitcoin Network to function, but are essential for the users. Most notable of these applications are the Bitcoin Exchanges and Stores. The Exchanges allow the users to exchange between Bitcoin and other form of currencies, such as “traditional currencies” (such as the US dollar and the Euro), or other cryptocurrencies (Piasecki, 2012).
  20. 20. 19 Chapter two: Economic theory and monetary history 4. Theoretical analysis of money and Bitcoin 4.1 The main functions of money Historically, economists and scientists have aimed to propose a universal and abstract definition for money, according to its main functions. Although many theories exist, based on the different currents in academy and research, and the unique perspective of the topic, some of the most valuable examples can be found in the following sub-section. We will try to define the main functions of money, based on theory, and test these functions through the bitcoin concept. Classical economists define money through its functionality. According to Krugman (1984) “money serves three functions: it is a medium of exchange, a unit of account and a store of value”. On the other hand, economists of the Austrian school, define money as the most liquid good, emphasizing on it being the main function of money. Miles (1912) gives a refined sense to the term, pointing out that after all goods, used as media of exchange at some point in human history, must be one by one rejected, until “a single commodity remains, which is universally employed as a medium of exchange”. Moreover, according to Menger (1971) “the functions of being a measure of value and a store of value are of an accidental nature and are not essential part of the concept of money”. “All other functions of money, are and must remain subsidiary to money’s primary function as medium of exchange” (Salerno, 2010). According to White (1984) there is a direct relation between the secondary functions and liquidity: “It should be readily apparent by extension to this perspective on the origin of money that a unit of account emerges together with and wedded to a medium of exchange (…) A non-exchange medium numeriare commodity would furthermore be subject to greater bid-ask spreads in barter against other commodities as by hypothesis it is less saleable than the medium of exchange”
  21. 21. 20 From that perspective, Bitcoin cannot be classified as money, according to most researchers, as it is not the universal medium of exchange. However, cryptocurrency does serve as a medium of exchange in a more narrow sense, as it proved its ability to be defined as a valuable pseudo-commodity. Thus, Mises (1999), as part of the Australian school, defines all non-universal medium of exchange as secondary (or substitute) mediums of exchange: “Consequently, there emerges a specific demand for such goods on the part of people eager to keep them in order to reduce the cost of cash holding. The prices of these goods are partly defined by this specific demand; they would be lower in its absence. These goods are secondary media of exchange, as it where, and their exchange value is the resultant of two kinds of demand: the demand, related to their services as secondary media of exchange, and the demand, related to the other services they render” Yet another perspective is Rothbard’s research on money (2004), where he argues, that: “We have implicitly assumed that are one or two media that are fully marketable – always saleable – and other commodities that are simply sold for money. We have omitted mention of the degrees of marketability of these goods. Some goods are more readily marketable than others. And some are so easily marketable that they rise practically to the status of quasi moneys.” Thus, Bitcoin can be classified as some sort of payment commodity, which does not contain the main function of money, as not being a universal medium of exchange, but has the secondary function of delivering liquidity and the status of quasi money. 4.2 Classification of money The representative of the Austrian school, Mises (1912) introduced a classification system for money (see Figure 3). According to the author, money “in the broader sense” can be divided into “money in the narrower sense”
  22. 22. 21 (approximately corresponding to the terms “monetary base” or “outside money” used by other economic schools) and “money substitute” (corresponding to the terms “other forms of money” or “inside money”, used by other economic schools).18 Money in the narrower sense is further subdivided into “commodity money”, “credit money” and “fiat money”. “We can give the name commodity money to that sort of money that is at the same time a commercial commodity; and the name fiat money to money that comprises things with a special legal qualification” Money substitutes are defined as: “The special suitability for facilitating indirect exchanges possessed by absolutely secure and immediately payable claims to money, which we may briefly refer to as money substitutes, is further increased by their standing in law and commerce” 18 Surda, P (2012) Economics of Bitcoin: is bitcoin an alternative to fiat currencies and gold? VU, Thessis, Vienna University of Economics and Business. P 23
  23. 23. 22 In his book, entitled “The Theory of Money and Credit”19 Mises proposes two interchangeable definitions of money substitutes: (1) secure claims on money in the narrower sense with zero maturity, and (2) things that act as substitutes to money in the narrower sense from economic point of view. According to the Austrian school money substitutes are further divided (as per the presented Figure 3) into money certificates and fiduciary media. The difference between these two categories is in the amount of reserves backing them. Money certificates are 100% backed by reserves, and fiduciary media is covered on a lesser extent. Currently, the new quasi-money (such as the bitcoins, litecoins and other cryptocurrencies) allows for the existence of substitutes where the reserve can be entirely absent All fiat money begins as a money substitute. The US dollar for example, was originally defined as a weight of gold. Legislative intervention then eliminates that link, and the former money substitute becomes a new monetary base. Even the Euro started originally with pegged exchange rates among several European currencies. During a nationwide adoption of the Euro, the old currency and the Euro circulate side by side, merchants being obliged to accept both. This obligation is only temporary; it lasts several weeks for normal merchants. Commercial banks are required to exchange the old currency for Euro for several months, while the deposit accounts and other financial instruments are centrally re-denominated. The central banks allow an even longer period for the exchange. During this time, from the perspective of the citizens of the country, the Euro is gradually to a smaller and smaller extent a money substitute and to a larger extent – money in the narrower sense, until the old currency vanishes from use and the process is concluded. (Surda, 2012, p 26). According to the Austrian theory of money, presented by now, the Bitcoin is not money yet. However, according to Surda, the process of accepting and developing Bitcoin into money might present a problem and is a very controversial question. Based on the previous conclusions and analyses of money, Bitcoin does not classify in any of the categories as per the Austrian model, as is was never a money substitute, nor had a legal status, or a claim again anybody, or a commercial commodity. 19
  24. 24. 23 As a possible classification, Selgin (2012), in his research, proposes for Bitcoin the term “quasi-commodity money” for base money that does not have non-monetary uses, but is absolutely scarce. However, according to Schlitcher we can find that Bitcoin can actually be referred as potential commodity money, with the justification that it has an inelastic supply: “Equally it is commodity money because it is based on a cryptographic algorithm, which requires time and considerable computing energy to create Bitcoins and which is designed so that the overall supply of bitcoin is strictly limited” (Schlitcher, 2012 b) Elasticity is important in the functions of the money in circulation as it allows exchange and availability, based on the market dynamics itself. Schlitcher emphasizes of the importance of the factor in one of his research: “The most important difference between commodity money, such as a proper gold standard, and ‘paper money’, such as our present fiat money system, is the elasticity of the money supply” (Schitcher, 2011). Thus, Bitcoin does have a potential to become money, however, with the several needs of change in the way the same system operates and generates demand and supply, based on the online performance of its own ecosystem. Other economists, outside the Austrian school, classify money on the base of different criteria. On the basis of legality, money can be classified as A. Legal Tender Money – the money, which is accepted as a means of payment by the government and the citizens of a country. Usually this type of money has a legal sanction behind it. B. Optional money. We can define this category of money as such, ordinary accepted by the people, but has no legal sanctions behind it. That is to say, no one is obliged to accept this type of money, to be used as a way of payment, against his will. Examples of optional
  25. 25. 24 money are all types of credit instruments, like cheques, hundies and bills of exchange. As per this classification, we may propose that Bitcoin, to some extent, enters into the optional group, as it does provide the freedom to be used, with no legal sanctions. Thus, Bitcoin, in the money constellation, can be defined as a quasi-commodity money, accepted as existing by the market participants, and has no legal sanctions behind it; it provides freedom to be used and might serve as a fiat money, in an international community-based ‘nation’ – the modern on-liners. Although we cannot classify Bitcoin as money in the narrower sense, nor a commodity money it is real sense, the work, invested in the issue of Bitcoins in the virtual space does provide us with a good basis to conclude that, maybe in other circumstances and in-depth research for a better definition of the main functions and ‘items’ of the crypto-money ecosystem, Bitcoin might actually be accepted as money. One of the main considerations is that, due to the inelastic supply, based on reward system on a work carried out (by technical means), the path towards equalizing bitcoins to money is not well-trodden, if we proceed of the perception what money does mean as per our traditional view. 5. The evolution of money Ever since trade began, in its most common sense, people offering different stock searched for the best mean of exchange to be able to secure his own efforts and work on growing/manufacturing the ‘item in sale’. Bartering was first recorded in Egypt in 9000 B.C., when farmers would go to market to exchange cows for sheep, with grains passing through the hands of harvesters in exchange for oils. As barter developed along ancient trade routes, articles of exchange became more sophisticated. Egyptian papyrus, precious stones and chariots could now buy you exotic animals, skins and minerals from Africa and Asia. Although hieroglyphics
  26. 26. 25 show us trade was not hassle-free, with arguments over price a common occurrence.20 However, with the human development and the growing trade migration, evolution of the monetary system was more than necessary in terms to provide a sort of unified, or measurable, set of substitutes of the cattle and grains, silk and other precious for these times stocks. Some ancient nations began using precious metals for their main way of payment when travelling long distances in the search of new customers, partners and wealth. The first known currency was created by King Alyattes in Lydia, now part of Turkey, in 600BC. Irregular in shape and size, the coins were made from electrum – a naturally occurring mix of gold and silver – and minted according to weight, with the lowest denomination weighing a meager 0.15 grams. For that reason, coins were often weighed rather than counted (Daychopan, 2016). Following the same trend, lots of nations, regions and territories, governed by a more organized and stable political and economic system came out with their own currency, with the one common thing in place – coins of all forms and shapes were made of precious metals, which can be measured “internationally”. Most of the currencies, issued in the 13th and 14th century were not stable enough to guarantee the international existence of one stable coin system, but a need was defined to begin working on the creation of an unified “currency” to serve as the overall accepted means of payment. That partially was accomplished with the emergence of the Florian. It was issued in Florence around 1250 A.D.; this gold coin kept a stable value for more than a century. It was accepted across Europe and its stability played an important role in encouraging international trade on the continent (Daychopan, 2016). In the mid-13th century, the beginning of the world-tour travelers and the emergence of trans-continental shipping trade, gave birth to the adoption of the paper money concept in the form that we now understand them as bank notes. The paper money has a long history on its credit. China was the first country in the world to make use of it in the 9th century. This type of money was fully backed up by fold and silver reserves. In the 13th century, travelers such as Marco Polo introduced the concept of banknotes to Europe from China, where paper currency had been in circulation. But Europe was not ready for banknotes; it took another 300 years for them to take off, with Sweden the earliest adopter (Daychopan, 2016). 20
  27. 27. 26 The first monetary crisis was experienced in the end of 1400s due to the discovery of America and the beginning of intensified trade and export of precious metals outside of the European continent. This action caused a big inflation in the national and international markets, and the European trade faced its first troubles along the way. Thus, this event opened the path for the infiltration of paper money into the new concepts of monetary systems across Europe, and allowed for the emergence of the centralized bank money government system. The paper money, which began circulation in several national economies, was bound with silver or gold reserves and was strictly governed by the policy makers in the country. Thus, the conventional money system was built somewhere around the 16th -17th century and its concept began spreading across lots of nations as to test and introduce a more relevant mean of payment system to encourage trade and national development. On a later stage, intergovernmental credit agreements began spreading, for the assurance of a better-operating national system, when industries does not work well enough to supply the needs of money in the country’s banks, to assure the normal function of the nation, itself. Thus, the evolution of the banking systems and the emergence of the new paper money, its development and improvement over time, provided for the birth of a complex interdependent transnational monetary system, bound with bank reserves (in precious metals), international credits (leading to interdependence on each-others buying power of currency) and a regulated money system, often leading to collective issues in the slight change of one or another leading in strength currency, taken as main mean of payment in international trade (such as the dependence on the US Dollar). The concept of e-money was born in the late 19th century in the US, where the first fund transfer was made via telegram. Ever since, thanks to the good bank representation in all nation states across the economically well-developed world, and the evolution of the communication technologies, the transfer of money ‘in written guarantees’ launched with a great success, enabling the transfer of value across country, without an actual physical movement. Although transportation costs were saved, the new transfer system allowed for other fees and taxes to be added, for the equipment maintenance, the human factor, involved in the transaction, and – most of all – the bank fees for the ‘service’, being provided.
  28. 28. 27 However, money transfers involved cash deposit into one bank, financial institution or intermediary and the note in another subsidiary for the “transfer” being made. As the computing technologies and the ‘fast and reliable’ network of money disposal was not yet well developed and introduced, often deposits and cash requests lead do a certain point of imbalance in the institution account – such as, places with better economic development and potential growth had bigger amount of money in circulation of the ones the money are transferred to, which leads to the need of additional transfer costs, to subside the office with smaller amount of money availability. The concept of being able to re-organize the amount of money in the entire financial entity led to the emergence of the ATM cards and the related deposit bank accounts, which allowed the consumer and owner of a card to be able to use his/her money anytime and anywhere, depending on his/her personal needs. Historically the invention of the ATMs came in 1967 in the UK, where the initial form of ‘cards’ was represented by cheques which paid out a maximum of £10 at a time. Ever since, the expanding ATM network then paved the way for the rise of debit cards. Globalization and the evolution of the computing, visual and phone technologies, the new ‘interfaces’ and the possibilities of the World Wide Web, led to the emergence of internet banking, phone banking, contactless fuel payments, and other forms of modern payment via the latest technologies. Historically, in 1983, the Bank of Scotland offered Nottingham Building Society customers the first Internet banking service, named Homelink. Customers needed a television set and a telephone to send transfers and pay the bills, building the foundations for Internet banking as we know it. The beginning of the 90s marked the bloom of click-and-brick euphoria, wherein businesses and banks alike sought to gain the loyalty of their customers by expanding into the web. But this strategy proved trickier than previously thought, as it took over 10 years for Bank of America to acquire 2 million Internet banking users. In 1997, Mobil Oil Corp introduced Speedpass, an electronic payment tag that let consumers pay for fuel at the pump. Speedpass was the first example of contactless payment, a concept that has now spread across the globe (Daychopan, 2016). The Y generation, currently representing more than 75% of the active users of money in the modern way (through mobile apps, the internet, POS terminals, etc)
  29. 29. 28 brought and developed the new concept of ‘free trade with no borders’, representing the main idea of decentralization, transfers and payments fee removal, optimization of the bank-ruled system, and especially – the ever growing creativity and innovation, flourishing thanks to the emergence of the software industry. Mastering the ‘language’ of computers and being able to visualize an idea with several simple natural laws of demand and supply, a simple idea for fee-liberation and a self- governing system, like the Bitcoin one, is, somehow, evolving as a natural consequence of the global development. Thus, the existence of the cryptographic currencies, their emergence and evolution, development and fall, is actually a natural process, following the trend of the global political and economic development, along with the creative growing personal culture of the new tech-generation. In line with the simple economic rule of barter, that “out of all the goods available at the market, the market actors voluntarily choose media of exchange according to their own preferences and use them in exchange” (Surda, 2012), we can conclude that, in the era of online currencies, Bitcoin is playing a substantial role of being a mean of exchange on goods and services, as a stock, carrying certain changing value, according to the system conditions. 6. The acceptance of crypto currencies 6.1 Governmental acceptance Crypto currencies, and in particular Bitcoin, is novel because it does not rely on a central authority charged with creating currency units or verifying transactions. Owing to its distributed architecture, it is the system users who implicitly and in a democratic way take these global decisions. The owners and spenders themselves take the decisions, normally taken by a central monetary authority. As a democratic and decentralized currency, the evolution of the ecosystem is shaped by the demand and desire of the population, involved in the system. Although democratic, the bitcoin world changes disproportionately, meaning there is no ‘one user=one vote’ equation in the decision of trend for development, but rather it depends on the computing power the users dedicate to the network, e.g. “x% of computing power = x% of
  30. 30. 29 votes”. Thus, as long as more than 50% of the network’s computing power is in the hands of honest users, the same will evolve in the direction that they decide (Nakamoto, 2008). The principle here can be imagined as a “weighted democracy”, determined by the scale of the users’ involvement in the system (Vico and Arago, 2015). Understood this way, Bitcoin represents a totally new economic and social scenario. The adoption of any cryptocurrency should mean that governments and financial authorities would be unable to control the evolution of the currency directly. Indirect legislative influence could be played, but not control over the systems’ behavior. An electronic currency has an international rather than national character, which means that an effective control over it would be a complicated matter. Moreover, these scenarios are without historic precedent in the economic theories and practice. Thus, the effect of Bitcoin’s acceptance and use on a multinational scale cannot be predicted. In the business practice, the number of companies, and especially small and medium enterprises, providing digital and online services of the modern type, who accept Bitcoin as a means of payment, is constantly growing. Its rate of adoption can be explained not only by its international reach, but also in part by the sense of anonymity that it guarantees and generates, which has stimulated its use for illegitimate purposes and in situations in which political pressures prohibit other forms of virtual payment (Vico and Arago, 2015, p9). The adoption of Bitcoin is not exempt from attempts to exert control over it on the part of governments and regulatory bodies. For example, in mid-2013 the State of California, USA, wrote to the Bitcoin Foundation, informing it that if it did not register as a money transmitter it would not be able to operate in the state. In the official letter the Department of Financial Institutions of California suggest that “the BitCoin Foundation is engaged in the business of money transmission without having obtained [a] license or proper authorization, required by the California Financial code”. The letter continues “you are hereby wanted to cease and desist from conducting the business of money transmission in the state. Failure to do so will result in appropriate actions being taken.”21 The official representatives of the financial department found a legal way to affect the BitCoin payment system in terms 21
  31. 31. 30 of receiving remuneration for the items, being sent for real money. However, the only legal action that can be taken is in this phase of realization of the Bitcoin business is to cease the real-currencies transfer into bank accounts or cash transfers. The buy- and-sell system, with takes place virtually, can not be affected directly, although it expected a certain drop in the state for a small period of time. Another example of government regulation over the Bitcoin system can be found in China. Again in 2013 the Central Bank of China alerted all the financial institutions in the country to seize the use and transfer of bitcoins, as the same currency, although not affecting directly the country’s monetary system, carries a high risk of uncertainty of its market. In an official statement, the state financial representatives confirmed that actions will be taken to act against any “black market” operations, involving bitcoin payments. They also stated that will closely monitor the risks associated with bitcoin, as the possibility of using the “money” for illegal activities and for speculation. In mid-2013 the use of bitcoins has grown a lot in the country, especially in the transfer of value outside its borders. However, the government did not put a ban on the bitcoin transactions and payments done by citizens, although noted and alerted all bitcoin users that the currency carries out lots of risks.22 6.2 Economic acceptance In early 2014 Bitcoin received two important endorsements: from February 2014 eBay allows transactions in Bitcoin (UK only) and Google confirmed that is working on integrating the e-currency in its mobile and PC applications and online stores. In Spain lots of businesses accept bitcoin payments as a mean of exchange for obtaining products and services. Taking advantage of the repercussions that the use of Bitcoin is having on international scale, adoption of the currency is seen newsworthy. Thus, given increasing public awareness of the use of bitcoin in the world of commerce as an alternative to traditional card payment methods, its acceptance has been used as leverage in terms of publicity and visibility (Vico and Arago, 2015, p 10). 22
  32. 32. 31 The fact that Bitcoin is a “quasi-currency” that is outside of government control makes it an object of controversy. On one hand, there are the organizations and individuals that consider it a great tool to limit the control of the states over the popular economy. On the other hand, it is seen as a source of illegal activities. Moreover, the fast-growing Bitcoin ecosystem and the possible new scenario of development of the online community and commerce, it is not clear what effects on the global economy the massive adoption of Bitcoin, and cryptocurrencies as a whole, would have. From a pure economic point of view, the value of Bitcoin is determined like it is done with the traditional ones. Bitcoin might be seen as fiat money, whose value is based on the trust that society deposits in it. Nevertheless, the fact that Bitcoin is uncontrolled by any authority means that the basis of its trust is different. In the case of official currencies, it is the trust of the state or authority which supports it what determines its value and which provides it with mechanisms to prevent its value from raising or falling beyond limits, considered inadvisable (Vico and Arago, 2015). In the case of Bitcoin, the quasi-currency has value, according to for the following reasons:  It is popular. In short, people accept and trade in Bitcoin because other people accept and trade in Bitcoin. It is recognized and accepted as a currency by many.  Bitcoin is decentralized and limited. This is a major factor for many Bitcoin users. Bitcoin is hard for governments to trace and tax. Also, unlike fiat money produced by central banks, there is a cap set on total Bitcoins, limiting how much the currency can devalue through inflation.  Bitcoin acts like an equity investment. The market value of Bitcoins has had wild swings in value and even a market cap.  Bitcoin is a social network. The Bitcoin "community" is active and acts like other online social networks.23 Due to the different and new character of the bitcoin “currency” its exchange value fluctuates greatly owing to the fact that the level of trust invested in bitcoin id not as great as that invested in other official currencies. In addition, due to the technical character of the quasi-currency, its level of trust can be affected by technical factors. 23
  33. 33. 32 Such technical factors, for example, might be an update of the Bitcoin software, a glitch in the system , or any fraud attack by hackers in attempt to steal some bitcoin amounts. As an example of technical issues might be linked the update of the database used in the main miner software (bitcoind), which produced an inconsistency between versions of the quasi-currency. This led to the appearance of two parallel blockchains, called a ‘fork’. For a period of time, one set of bitcoin users followed one chain, while the rest followed the other, generating a confusion which led to a depreciation of the currency, illustrated in Figure 4. Nevertheless, owing to the specific construction of bitcoin, such situations self-correct over time, through annulling one of the chains, leaving only the valid one. Figure 4. The depreciation of Bitcoin during the fork on March 2013 As already mentioned, the value of bitcoins can also be affected by theft, scams and contingencies, which can introduce uncertainty and mistrust into the BitSystem. One of the most significant events for the past several years, which had a significant
  34. 34. 33 effect on the bitcoin value are: the Linode hacks24 of March 2012, which saw the theft of approximately 46,653 bitcoins and the first “closing down” of Silk Road25 on 2nd of October 2013, when 144,336 bitcoins were confiscated from its founder and transferred under the FBI control. The effects of these events can be seen on figure 5 and 6. Figure 5.Effects of the Linote hacks on the price of Bitcoin 24 25
  35. 35. 34 Figure 6. Effects of the Silk Road closing down on the price of Bitcoin Other problems, related with the electronically managed character of Bitcoin, are in line with attacks of malicious software. An example is the 31st of December and 3th of January 2014 Yahoo security problems. At this period Yahoo experienced a security problem with adverts on its homepage. Some of these were infected with malware which allowed the hidden installation of Bitcoin mining software, creating what was effectively a mining botnet.26 According to economic and cryptographic specialists this kind of botnet is capable of generation around $100,000 a day. Another problem that has currently being causing issues for some organizations, institutions and individuals is the cryptographic malware, blocking all the computer’s text data and documents, asking for remuneration in bitcoins for the unlock of the information. For the past few years damages for around $5,000,000 have been caused worldwide by this sort of ransoms. 26
  36. 36. 35 6.3 Market acceptance The current state of the Bitcoin market is considerably stable. Now that is has been functioning for more than five years, the system has recovered and strengthened its positions among businesses and individuals. More people invest in buying bitcoin currency online to be able to consume services and goods internationally with no transaction fees. The reasons for Bitcoin payments across the world to be rapidly growing in popularity are the lower transaction costs and being cheaper for retailers than credit cards: such reasons suggest the potential for considerable future growth in the legitimate use of Bitcoin. In several big trading areas there are reports of Bitcoin ATMs, which exchange conventional currencies for bitcoins, and of companies paying their employees in Bitcoin, especially those in multinational software companies, paying freelancers overseas in bitcoins to avoid the high charges of PayPal (such as Expensify Ltd). There are also various forms of physical Bitcoin – in essence physical tokens, convertible into real (i.e. electronic) bitcoin, which can be used in hand-to-hand exchange. These include physical bitcoin coins and Bitbills (plastic cards or ‘bitcoin notes’). Both of these have hologram-protected sealed components, containing the keys to access a Bitcoin. These can circulate as hand-to-hand currency, with value assured by their convertibility into digital Bitcoin to be spent in the system. At any time the seal can be broken and the key recovered to allow the digital Bitcoin to be spent. Once the seal is broken it becomes obvious that the coin has been spent and no longer valuable. Similar physical-to-digital innovations include PrintCoin, which is similar to cheques or debit cards drawn on bitcoin accounts, and Firmcoin, which is essentially a reloadable Bitbill. Thus, in five years of its existence, Bitcoin achieved the remarkable distinction of being the first currency in history to go from digital to physical, rather than the other way around. (Schurman, 2011) For the past two years, economists and researchers observe on another trend – the emergence of Bitcoin financial derivatives. These consist of futures, options and Contracts of Difference. New accounts are also being offered by brokers and exchanges to allow short selling and margin trading in Bitcoin, and Bitcoin hedge funds and Exchange Traded Funds. These work to facilitate both risk management
  37. 37. 36 and speculation in Bitcoin markets and can and will deepen and increase the liquidity of these markets.27 7. Financial Security, legality and the underworld 7.1. Financial Security The 2002 report, named “The Future of money”, published by the Organization for Economic Co-Operation and Development (OECD), claims substantial changes regarding the monetary policies and their implementation, such as the possible emergence of new currencies with a global significance. According to the paper, globalization leads to the need of a worldwide currency to act as a mean for direct payment despite the country of origin of the service/product and the payee location. With the current need in mind, buyers and sellers are looking for an international form of currency that provides the “greatest confidence and can perform fully all of the money’s primary function” (Miller et all, 2002, p 12). Miller suggests that a universal system should be established in order to provide access to a digital money account.28 There are many obstacles to realizing this type of peer-to-peer digital money that is network based, transparent, and easy to use and highly secure. The difficulty most often rose when considering this trajectory is the contention that network transactions will never be able to acquire the virtues of anonymity, accessibility and security that characterize hard cash. (Miller et al, 2002, p. 18). In this sense, although the concept of decentralization and free market value generation and price formulation, it is based on high risks. Most risks come from the absence of thrust in the Bitcoin system from the main financial institutions, as money, invested in uncertain quasi-commodity money might easily be lost from the purchaser, owner or dealer of Bitcoins in case of any ecosystem shock, caused by technical issues or other threads and obstacles. 27 Schurman, K (2011) Bitcoin: Free money or fraud, HyperInk, USA 28 Hauschildt, H (2012) Bitcoin’s Potential to Become the World’s Currency, Bachelor thesis. University of Paderborn, p 4. Available at: [03/02/2016]
  38. 38. 37 However, the pros of owing and using Bitcoin as a mean of payment, through its transnational characteristics, is the absence of need to pay transfer costs, technical time waiting for inner and inter-bank transactions, the lack of business days and working hours, and many more. Thus, the number of Bitcoin users continue to grow in a very big pace, promising the development and strengthening of the BitEconomy and rise in speed of liquidity of the quasi-currency. The Bitcoin system has the chance of becoming a single world currency, developed in a totally free market. That concept is well developed in an article on the website.29 According to Hoddinott (2013) the security system of illegal “bitcoin print” is impossible, as “the client creates a random private key. The private key can be expressed in hexadecimal. From this private key, a point is then chosen on the elliptic curve based on the random number. The genius of this system is that the random number that is generated can only has one unique public key, but that public key could have many different numbers using the equation. Trying to calculate the private key by knowing the public key is statistically improbable.” Thus, the actual issue of additional bitcoins in the system can occur only through the official mining process, discussed in Chapter one. Moreover, the value of a newly generated bitcoin is actually “worked out” through the process of calculation and processing of cryptographic data, as remuneration for the use of external services. The special way of generating new coins in the Bitcoin system makes the same more than just innovative – it allows the entire community to work together as being equal in a democratic operational chain. According to Hoddinott (2013) for the perfect market to exist, and maximum opportunity for entrepreneurs to grow their customer base, a currency that is available to everyone without favor or prejudice must be established without a central authority (a one as Bitcoin). An ideal currency is one that can transcend national borders, without political discrimination or non-market driven forces and is not controlled or monitored by any one group, but instead by the entire network, and that is truly transparent yet assures privacy. The author’s arguments in favor of a single world currency are spot-on. Indeed the most obvious of the reasoning is that it will result in increased global trade. Thus, 29 Hoddinott, A (2013) The Only True Free Market Currency in the World? Available at:
  39. 39. 38 with reduced barriers, global trade will see a massive increase and online startups will grow at a rapid pace. This kind of opportunity would result in higher average income levels as the velocity of money speeds up. If adopted on a massive scale globally, Bitcoin’s velocity would be unprecedentedly high. With one global currency, nations would be built on the strength of their innovation, not the ability to exploit cheap labor. (Hoddinott, 2013) Hoddinott (2013) suggests that a totally free market has no limitations on what is bought or sold. In a free market, there must be no undue influence or power exerted from one player over the next. To truly advance a global neutrality of commerce, there must be a medium of exchange which is not managed or regulated by any one country’s government. So far, only Bitcoin fits the definition. In an attempt to summarize the concept of the paper (The Only True Free Market Currency in the World?) we will present a SWOT analysis, explaining the driving forces of the Bitcoin survival and potential. S.W.O.T. Analysis Bitcoin has its inherent strengths and weaknesses which need to be understood in order to advance this currency on to the world stage and be adopted by entrepreneurs like ourselves. Strengths  Non-discriminating  Increasing popularity  Available to be exchanged for conventional currencies  Secured by intractable cryptology  Limited number of coins to be produced (cap at 21 million) Weaknesses  Deflationary  Hacker attacks and technical uncertainties and vulnerabilities  The (still) limited use of Bitcoin in the economy
  40. 40. 39 Opportunities  To replace global currencies or take a portion of the market  Become a relevant currency for global online trade Threats  Possible copy-cat currencies  Increased computer and networking power that could crash the system (hackers)  Governmental regulations for illegality 7.2. Legality of Bitcoin Some discussion centers on whether, at some point in the future, some governments will declare bitcoins illegal. Perhaps some countries could outlaw the system of Bitcoin, calling it illegal currency. Other governments might launch investigations into determining whether the Bitcoin system is being used by citizens to illegal launder money. Such legal concerns caused the Electronic Frontier Foundation to stop accepting donations of Bitcoins. The anonymity of Bitcoin system could lead to an instance where federal governments could prosecute users. In the U.S., for example, anyone involved in transaction that has a value of $ 15,000 or more must report it to the IRS. If Bitcoin users fail to make this report, they could be prosecuted. The IRS then would have to figure out how to identify the anonymous user. If the bitcoins are used to purchase goods, law enforcement authorities could have the clue to break the anonymity. As soon as someone, for example, ships a package, the police could find either the buyer or the seller, based on the physical address they use. If this package contains illegal goods, the police could have a chance to attempt to prosecute a bitcoin user. Another potential option for law enforcement involves freezing assets, similar to other types of currencies. Certainly, with the digital nature and encryption built into the Bitcoin system, law enforcement officials would be unable to freeze accounts as
  41. 41. 40 they do with other types of currencies. Law enforcement would seize a user’s computer during an investigation, however, thereby potentially seizing all of the bitcoins the suspect owns.30 This kind of government action would be difficult to enforce, however. Moreover, the Bitcoin system is built on anonymity. It is also a worldwide system with no legal office or centralized headquarters, thus making it difficult for a single governmental entity to police. Another perspective is to claim Bitcoin legal for several type of transactions. In case several provisions are included in the financial laws of the national governments, allowing certain type of payments for services. Although the anonymity is an aspect of the Bitcoin system that carries out risk for the actual observance of money transfers and quasi-currency ownership, owning such a resource might carry positive effects for the economy as well, especially in the service sector of a country. For example, for startup companies in one of the fastest growing sectors – the software development services, the Bitcoin payment might allow for users and developers to not be obliged to own conventional currency for trade operations. The international aspect of the software commerce might allow the developing sector to gain foreign market share without actually being involved in transaction operations involving the exchange of value in foreign currencies, which can provide an ease in the commerce and will help the growth in net sales. Using Bitcoins as a mean of payment for these organizations might help them gain a competitive advantage. In such a way, governments can stimulate growth in the national export and allow payments on such services to be allowed in bitcoins, as one way or another, the financial results can be sensed in terms of growth in employment, growth in the added value and positive overall effect on the national GDP. In his work Omri Marian (2015)31 suggested that “cryptocurrencies (and especially Bitcoins) are protocols that allow for the validation of transactions without the need for a trusted third party (a bank, credit card company or recording agency). As such, cryptocurrencies hold great innovative potential. They have been described as a “generative”32 technology on which powerful applications can be built. For example, cryptocurrencies may dramatically reduce transaction costs associated 30 31 Marian, Omri (2015) A Conceptual Framework for the Regulation of Cryptocurrencies. Available at: 32 Lee, T (2013) Here’s What Critics Miss about Bitcoin’s Long-Term Potential, The Switch Available at
  42. 42. 41 with value transfers, engender access to financial transactions within sectors of the population that do not have access to traditional financial institutions, avoid the pitfalls of managed or commodity-based monetary systems, and allow for the creation of self-enforcing smart contracts that do not rely on financial institutions, lawyers, or accountants for their execution.”33 According to Marian (2015) “cryptocurrencies are also uniquely suited to facilitate harmful behaviors for two reasons. First, the only truly public feature of the ledger is the documentation of ownership and transfers. The owners themselves are not identified by name on the ledger, but rather by a set of letters and numbers representing their public cryptocurrency address (which, together with the private key that proves ownership of that address, constitute the owner’s cryptocurrency “wallet”). Anyone can freely create as many wallets as he or she desires, at practically zero cost, without providing any identifying information. This relatively high level of anonymity makes it difficult for regulators to identify individuals who use the protocol for illicit value transfers.” Mariam suggests that “the second reason that cryptocurrencies are suited for criminal activity is that our financial-regulation system heavily relies on regulating intermediaries that are uniquely positioned to disrupt misconduct. For example, we subject financial institutions to “know-your-costumer rules” in order to prevent money laundering, use banks as tax-withholding agents to prevent tax evasion, and regulate securities exchanges to protect investors. Some commentators argue that the public ledger has the potential to “eliminate intermediaries without eliminating the underlying conduct.” If that is the case, then regulators would lose the ability to use intermediaries as regulatory agents. In theory, this would necessitate the regulation of dispersed crowds—meaning direct regulation of individuals who participate in financial markets. Such regulation is immensely costly—a problem exacerbated by the fact that the users, as explained above, are relatively anonymous. The combination of anonymity and the decentralization of financial dealings present governments with formidable regulatory challenges.34 ” 33 Buterin, V (2014), DAOs Are Not Scary, Part 1: Self-Enforcing Contracts and Factum Law, Bitcoin Magazine Available at 34 Marian, Om. (2015) A Conceptual Framework for the Regulation of Cryptocurrencies. Available at:
  43. 43. 42 According to Mariam (2015) some “skepticism about the elimination of intermediaries from cryptocurrency markets is warranted. Intermediaries are market-created, not government-created, constructs. Intermediaries do not just serve as agents for buyers and sellers but in fact add value to financial markets. The cryptocurrency market demands the creation of new financial intermediaries to serve it. Such intermediaries include exchanges of cryptocurrencies to fiat currencies, cryptocurrency-wallet service providers, and clearinghouses for cryptocurrency transactions. These new intermediaries can be subjected to traditional models of intermediary regulation, and indeed they have been.” 7.3. Anonymity and the underworld The abovementioned paper of professor Marian argues “that regulation should not prevent cryptocurrencies from achieving their positive potential. On the other hand, regulation should prevent cryptocurrencies from becoming a vehicle for criminal activity. Therefore, regulation of cryptocurrencies should not treat any cryptocurrency as a homogeneous instrument. Rather, the idea is to deconstruct cryptocurrencies into their unique traits, dealing with their vices and virtues separately. For example, decentralization is a positive trait that should not be disrupted. Anonymity should be targeted only to the extent that it increases the likelihood that individuals use cryptocurrencies to engage in criminal behavior.” In his Essay, Marian works with the following assumptions and qualifications:  First, the current level of criminal activity in the market is taken as a benchmark. Regulating cryptocurrencies is not intended to reduce the current level of criminal activity but rather to ensure that cryptocurrencies do not increase criminal activity.  Second, it is assumed that financial anonymity has an independent normative appeal even though it may facilitate criminal behavior. The current status of financial anonymity is taken as a benchmark—any regulatory framework should not decrease the current level of financial anonymity. However, regulation is also not aimed at increasing the level of anonymity.  Third, the regulatory framework assumes that, if no new regulatory costs are imposed on the legitimate use of cryptocurrencies, the market will allow the
  44. 44. 43 new technology to develop to the extent that it offers benefits (other than anonymity) that fiat currencies do not. Under the classic utility model of criminal behavior suggested by Professor Gary S. Becker, a rational, profit-seeking individual will engage in criminal behavior if the utility of doing so is greater than zero (that is, greater than not engaging in criminal behavior).35 As it was already noted, the current level of criminal activity in the market is taken as a benchmark. “This means that all individuals have already calculated their expected utility from criminal behavior and are either engaged or not engaged in criminal activity.” (Marian, 2015) After the assumption that cryptocurrencies are introduced, an individual that previously calculated negative utility in engaging in criminal behavior with traditional currencies is now presented with the option to use quasi- currencies. “Using cryptocurrencies to facilitate the previously contemplated illicit activity significantly reduces the probability of being sanctioned due to the anonymity associated with cryptocurrencies. Thus, if an individual expects to extract the same value from illicit behavior—meaning that the only difference is the denomination of the illicit gain—the utility function produces a greater expected outcome.” (Marian, 2015). Thus, “individuals who had previously calculated negative utility from engaging in criminal behavior might now calculate positive utility solely because the illicit activity is executed through the use of cryptocurrencies. Thus, in the absence of a regulatory response, a simple utility model predicts that the introduction of cryptocurrencies would increase the level of criminal activity, because more individuals would engage in it.” (Marian, 2015) The raise in the criminal behavior, after the introduction of Bitcoin into the world trade of services and outputs, has led to the emergence of lots of illegal trade markets (online), speculators and fraud dealers, along with allowing the birth of a new type of criminal activity – terrorist donations and funding through anonymous organizations and websites. In a research paper from 2013, named “The Rising of Gyges: Using Smart Contracts for Crime”36 the authors suggest, that “cryptocurrencies such as bitcoin remove the need for trusted third parties from basic monetary transactions 35 Becker, G (1968) Crime and Punishment: An economic approach. Univ. of Chicago. USA, Available at: 36
  45. 45. 44 and offer anonymous (more accurately, pseudonymous) transactions between individuals. While attractive to some, these features have a dark side. Bitcoin has stimulated the growth of ransomware, money laundering, and illicit commerce, as exemplified by the notorious Silk Road”.37 “Criminal activity committed under the guise of anonymity has posed a major impediment to adoption for bitcoin. Yet there has been little discussion of criminal contracts in public forums on cryptocurrency.” The authors also state that “as decentralized smart contract systems typically inherit the anonymity (pseudonymity) of bitcoin, they offer similar secrecy for criminal activities. Broadly speaking, therefore, there is a risk that the capabilities enabled by decentralized smart contract systems will enable new underground ecosystems and community.” One of the most recent uses of Bitcoin in the underworld was detected within the terrorist group ISIS. created an article, named “ISIS. Are they Using Bitcoins To Fund Criminal Activities?”38 , explaining the case of the world’s richest terrorist group - The Islamic State of Iraq and Syria (ISIS). The article states: “Like most forms of technology, fraudsters, criminals and terror groups will find ways to exploit them for nefarious uses — Bitcoin is no different. Due to its anonymity and untraceability, it is used for criminal activities such as laundering money, buying and selling illegal goods and services and transferring money to support criminal or terror activities. Al-Khilafah Aridat: The Caliphate Has Returned, a pro-ISIS blog, discusses how Bitcoins can be used to fund the caliphate. The post states that they are untraceable by Western governments and, therefore, they will not be stopped by regulatory screening processes. The blog then discusses the decentralized nature of virtual currencies, specifically stating that they are able to access markets that cross all borders and nation-state regulations to send money instantly and in a way that is untraceable by “Kafir” governments. In an additional step to keep the senders’ and receivers’ identities secret, the blog post discusses the use of dark wallets. Dark wallets offer Bitcoin users more protection in relation to privacy and identity. It is also widely known that dark wallets may enable serious crimes such as murder, child pornography, drug and weapon sales and terror group financing. 37 38 Satti, B (2014)
  46. 46. 45 According to the blog, Bitcoins are an entirely anonymous donation system that could send millions of dollars instantly from the United States, United Kingdom, South Africa, Ghana, Malaysia and Sri Lanka. On Oct. 13, Reddit’s Bitcoin forum discussed how the ISIS blog site was accepting Bitcoin as a form of payment on the Swedish/Latvian conversion site The blog claims the payments are strictly for maintenance and hosting the website. Reports indicate that closed the account, claiming it has a strict terms and conditions policy that prohibits using its service for illegal activities. lists its terms of service on its site and bans the following:  Anything forbidden by Swedish law;  Spamvertising websites;  Malicious software such as mail and network bombers, spam, virus operation software and control centers;  Scam and phishing websites such as fake eBay, PayPal and bank login forms;  Network abuse (i.e., network scanning).  Analyst Comments It is not surprising that ISIS would begin to adapt to using cryptocurrencies as a way to receive funds; the group has proven to be quite skillful with technology and social media. ISIS has been known to spread propaganda, recruit individuals and seek funds through tools such as Twitter, Facebook, YouTube and There are some challenges with how ISIS would turn Bitcoins into physical currency in the states in which it operates. Many ISIS-controlled territories do not have the technology to extract high amounts of Bitcoins for cash. However, nearby Turkey, Israel and Dubai all have a small but flourishing Bitcoin community, with a few Bitcoin ATMs available. Bitcoin ATMs work just like bank ATMS and are electric communication devices that allow Bitcoins to be exchanged for cash without the need for a cashier. It is important to note that some models only allow for the purchasing of Bitcoins. When a Bitcoin ATM is not available, users can sell them online; however, this type of sale often requires users to verify their identity.”39 39
  47. 47. 46 Thus, “Digital currencies are increasingly serving as a money laundering platform for "freelance criminal entrepreneurs operating on a crime-as-a-service business model"”, according to a new Europol report. The Europol Report40 , which identified the key driving factors affecting the EU's criminal landscape, predicted that the role of freelance crime organizers is expected to "become more prominent". Criminal actors, both groups and increasingly individual criminal entrepreneurs, will adopt the crime-as-a-service business model, which is facilitated by social networking online with its ability to provide a relatively secure environment to easily and anonymously communicate. In the pursuit of new clients, organized crime will invariably seek to change the commodities they trade shifting from traditional goods to new commodities. Almost all types of organized crime activities will rely on digital infrastructures. The trade in illicit goods and the exchange of money will take place in the virtual realm requiring little face-to-face interaction between trading partners and reducing risks of discovery and interception. Virtual currencies will allow organized criminals to anonymously exchange and use financial resources on an unprecedented scale without the need for complex and cost-intensive money laundering schemes. Some actors will provide highly specialized services catering to a relatively small group of clients. These services may include the infiltration of control systems or the physical infiltration of companies using sophisticated identity fraud scams with information gathered from online intrusion and reconnaissance. In the future, with the development of the crypto-technology and the evolution in the computer sciences and hardware capabilities, it will become more difficult to trace transactions and to police the identity of the sender and receiver of illegal services and payments/funds for contiguous actions. 40
  48. 48. 47 Chapter three: Empirical testing – the Bitcoin concept and acceptance 8. Primary data collection and analysis – Methodology and methods The qualitative approach was chosen by the author for understanding the trends of the investigated problem. Although engaging a quantitative research might give deeper insights on the scope and effects of the phenomena, it will not cover the “human perception” and ambiguous characteristics of the subject, which plays an important role in understanding the nature of Bitcoin and anonymity and the possible directions of solving the Hypotheses posted. The author has chosen a mixture of research techniques for the gathering of the required amount of data for solving the problem and extraction of the possible scenarios. The primary data will be collected via semi-structured interviews and hypotheses testing. The interviews were conducted on a random principle on several points: through Facebook, meetings in person and other media (corporative blogs and corporate websites of businesses, using Bitcoin as mean of payment. Due to the inclusion of some personal and company confidential information, in some cases, within these dialogues, the personal and corporate names will remain blank. The main research method, used in this paper, is the semi-structured interviews (Gross et al. 2014, Hoehn-Saric et al. 1987), commonly used in qualitative research as a tool for interpretative methodology instrument (HADDLE 2005). The interpretative methodology approach (Cohen 1988, Curtin 2013, Maguire at al. 2014, Malone at al 2014, Riley and Love 2000) was chosen for conducting the analysis of the primary data. The author will base the main conclusions of the research on his personal perception of the problem and the possible scenarios and hypotheses following the results. 8.1. Semi-structured interviews The interview incorporated thirteen questions, divided in two sections. The first section contains questions concerning the understanding of Bitcoin functionality and the pros and cons of the new system, along with an evaluation of the ‘debth of involvement’ of the interviewees.
  49. 49. 48 The second section of the interview contains questions, regarding the economic, governmental and other threads and obstacles the participants face in their C2C, C2B and B2B transactions. 8.1.1 Sampling procedure The participants were chosen on the following requirement: being educated individuals with a bachelor’s degree (or higher) in finance or engineering, from all age groups which insured that versus type of people were included in the interviews. 8.1.2 Response rate 55 interviews were distributed with only 35 of the total responded, which puts the percentage of completion at 63.4%. The average length of the questionnaire was approximately 10 minutes. 8.1.3 Interview issues Despite the high response rate and the relatively small duration of the questionnaire the interviewees had some issues in understanding the main goal for conducting the interview. Most of the people being asked to participate in the study, and consequently gave up or refused on the way, stated their position in the need of receiving incentives for their effort. 8.2 Primary research results The first section of the interview tends on gathering the panelist’s perception on the Bitcoin aspects and main characteristics. Question Q1 classifies the panelists as per the main groups, contacted from the researcher during the interviewing period. As can be seen, the author tried to get representation of all the types of users and individuals/organizations, involved in the decentralized cryptocurrency system. The biggest group of representatives (45%) is the Bitcoin users, purchasing services and items online, followed by the group of business owners, using Bitcoins as a mean of payment (18%) and the Miners (15%). Close to the Miners are also the business representatives, planning to add Bitcoin as a mean of payment. A positive result from the greater variety of users is the big possibility to be able to draw a realistic picture of the Bitcoin system characteristic.
  50. 50. 49 The next question is Q2 “Do you consider Bitcoin as ‘the future of money?” 75% of the interviewees give a positive answer (75%) and the rest of the respondents give negative answer. Q2 is a control question, to be able to distinguish the PROs and CONs of the Bitcoin ecosystem through questions Q3 and Q4. 15% 45% 5% 18% 14% 3% 0% Q1: Please choose one of the options that fits you perfectly I am a bitcoin 'creator' (a miner) I am a bitcoin user (purchases of services and items online) I am a bitcoin dealer (buyer and seller) I represent a business organization, using bitcoin as a mean of payment I represent a business organization, planning to add bitcoin as a mean of payment I represent a business organization, dropped off using Bitcoin as a mean of payment Doesn't want to specify
  51. 51. 50 As per the respondents, the PROs, indicated by the author, and reflected from the theoretical background and previous research, have almost equal distribution. As per the CONs – 44% of the respondents indicate the possibility of illegal actions due to anonymity as the major thread, along with (31%) the absence of possibility to get a bitcoin back in terms of bad service or product. A small amount of panelists stated “the lack of possibility to account the movement of money in the company” /or the accountability of Bitcoin mobility (12%) and the thread of governmental actions against any trader or individual (13%). 29% 17% 25% 29% Q3: If yes, what is the biggest PRO of the system? The absence of transaction fees The easy pay conditions and the fast transactions The anonimity of the Bitcoin system The Visibility and publicity of the economic aspects of the system (the ledger) 44% 31% 12% 13% Q4: If NO, what Is the biggest CON of the system The posibility for illegal actions, due to anonimity The absence of possibility to get your bitcoin back in terms of bad service or product The lack of possibility to account the 'movement of money' in the company the thread of governmental actions against any trader or individual