Bitcoin, Money & Trust

Functions of money

Medium of exchange + store of value + unit of account. Guests add means of final payment and standard of deferred payment

Chartalists

View that money is a socially recognised token. Money is an abstract claim backed by authority and the state

Metallists

View that money derives value from intrinsic commodity properties such as precious metal content or hard-to-quarry stones

Yap stones

Large stone discs used as money on the Pacific island of Yap. Set-piece example for the chartalist vs metallist debate

First metal coins

Appeared in Lydia (modern Turkey) around 650 BC

Aristotle on money

Money is both a useful commodity AND something symbolic. Exists not by nature but by convention

Seigniorage

Profit a sovereign makes by issuing money at face value greater than the cost of its metal content

Roman debasement

Reducing silver content of the denarius while keeping nominal value. Caused inflation as 1 denarius bought less work over time

Intrinsic vs nominal value

Intrinsic = value of the underlying material. Nominal or token = face value. Symbolic power lets the two diverge

Oresme 1360

Medieval scholar who condemned debasement. How unjust to reduce the weight without altering the mark

Fractional reserve banking

Banks hold only a fraction of deposits as reserves and lend out the rest. Effectively creates money

Great Monetary Settlement 1694

Founding of the Bank of England fusing sovereign and private money. Bedrock of the modern monetary system

Irish Bank Strike 1970

Banks shut for nearly a year yet the economy carried on using personal cheques. Evidence that trust and social convention can be money

Pre-Bitcoin attempts

DigiCash by Chaum (blind signatures)

Bitcoin whitepaper date

31 October 2008. Released by Satoshi Nakamoto

Bitcoin genesis block

3 January 2009. When Bitcoin first entered existence

Bitcoin two core systems

Digital signatures (private/public-key cryptography) PLUS competitive miners maintaining one shared public ledger

Bitcoin three analogies

Coins (cash and UTXO) + Ledger (bank accounts and blockchain) + Cheques (conditional spending and smart contracts)

Caesar cipher

Symmetric encryption shifting each letter by a fixed amount (Caesar used 3). Weaknesses are frequency analysis and the key exchange problem

Asymmetric crypto two uses

1) Confidentiality by encrypting with the recipient public key. 2) Authentication by signing with the sender private key

Hash function

Deterministic function taking inputs of any size and producing fixed-length outputs. Written H(m) = h

Hash function four properties

1) Efficiency. 2) Pre-image resistance. 3) Second pre-image resistance. 4) Collision resistance

SHA-256

Secure Hash Algorithm producing a 256-bit output from any input. Developed by the NSA. The hash function Bitcoin uses

Digital signature

Signer produces Sig(m sk) = σ with private key. Verifier checks Ver(σ m pk) = True with the public key

Bitcoin address generation

AGen(pk) using SHA-256 plus RIPEMD-160. Produces a fixed-length address that hides the public key until you spend

Proof of Work intuition

Miners compete to find a nonce making the block hash have a required number of leading zeros. First to find it adds the block

PoW probability formula

Probability that a random hash output has n leading zeros = (1/2)^n. Example 4 zeros = 1/16

Difficulty adjustment

Recalculated every 2016 blocks (~2 weeks) so the average block time stays around 10 minutes regardless of total mining power

Block subsidy

Reward for mining a block. Started at 50 BTC

Long-run miner incentive

Once subsidies reach zero (2140) miners are paid only by transaction fees

Bitcoin block header fields

Version (4B) + previous block hash (32B) + Merkle root (32B) + timestamp (4B) + difficulty target (4B) + nonce (4B)

Merkle tree

Binary tree of hashes built by repeatedly hashing pairs of transactions. Root summarises all transactions in a block

Merkle tree formulas

Rows = ceiling of log2(X) for X transactions. Hashes needed for proof of inclusion = ceiling of log2(X) + 1

Longest Chain Rule

Also called Nakamoto consensus. Nodes accept the chain with the most cumulative proof-of-work as the valid history

Double-spending problem

Risk that the same digital coin is spent twice. Solved in Bitcoin by global blockchain consensus on transaction order

UTXO set

Set of all Unspent Transaction Outputs. Represents all spendable bitcoin at any moment

51% attack

Entity controlling more than 50% of mining power can rewrite recent history and double-spend. Bitcoin main centralisation threat

Proof of Stake

Validators selected by stake committed. Replaces mining with staking. Ethereum moved to PoS on 15 September 2022. Misbehaviour punished by slashing

Stablecoin taxonomy

1) Fiat-backed (USDC USDT). 2) Crypto-collateralised over-collateralised (DAI by MakerDAO). 3) Algorithmic (Terra UST

Terra UST collapse

May 2022. Algorithmic stablecoin UST depegged and crashed losing billions. Major case study in stablecoin design risk

CBDC

Central Bank Digital Currency. Examples include China e-CNY and proposed digital euro. Motivations are payments resilience

Shor's algorithm

Quantum algorithm that efficiently factors integers and computes discrete logs. Would break RSA and ECDSA threatening Bitcoin digital signatures

UTXO vs Account model

UTXO = money held as discrete unspent outputs (Bitcoin Cardano). Account = single balance per address updated by transactions (Ethereum Solana Ripple)

UTXO advantages

More parallelisable and scalable. Better privacy. Harder for developers to use than the account model

M-Pesa launch

March 2007 by Safaricom in Kenya. First major mobile money system. M = mobile

M-Pesa model

Telecom-led SMS-based money transfer system. No bank account needed. Runs on basic mobile phones

M-Pesa scale

Over 70 million users. More than 30 million monthly active. Around 100 million transactions per day. Over 604000 human agents

M-Pesa vs Bitcoin volume

M-Pesa processes more transactions per day than Bitcoin

Test and learn approach

Kenya regulatory philosophy under Prof Ndung'u. Allow innovations to develop in the market rather than stifle them

M-Pesa risks

Credit + liquidity + operational + settlement + legal + systemic. Plus fraud + money laundering + financing of terrorism

UPI launch

2016 by the Reserve Bank of India (RBI). Operated by the National Payments Corporation of India (NPCI)

UPI definition

Real-time retail fast payment system in India enabling instant interbank transfers via mobile. Over 23 billion transactions per month

Money flower

BIS 2018 taxonomy classifying money by issuer + form + accessibility + technology. Used to place Bitcoin CBDCs mobile money and stablecoins

Mobile money vs mobile banking

Mobile money like M-Pesa needs no bank account and runs on SMS. Mobile banking is access to a bank account via mobile

Bitcoin vs M-Pesa decentralisation

Bitcoin is decentralised. M-Pesa and UPI are centralised

Bitcoin vs M-Pesa policy

Bitcoin is not supported by monetary policy makers. M-Pesa and UPI are policy-backed and adopted by banks and fintech

Bitcoin vs M-Pesa accessibility

Bitcoin has worldwide accessibility. M-Pesa is limited outside Africa and UPI outside India

Bitcoin vs M-Pesa cost

Bitcoin has expensive equipment and operating costs. M-Pesa needs only a cheap phone and is cheap to run

Bitcoin vs M-Pesa internet

Bitcoin requires internet. M-Pesa and UPI do not (SMS suffices for M-Pesa)

Bitcoin vs M-Pesa privacy

Bitcoin transactions are publicly visible on the network. M-Pesa and UPI transactions are not public but authorities can access user data like banks

Bitcoin vs M-Pesa attack surface

Bitcoin is resistant to single-point attack. M-Pesa and UPI are vulnerable due to centralisation

Martha thesis

Emerging economies solve the right problem with efficient means. Mobile money and fast-payment systems are cheaper to run than Bitcoin but Bitcoin is harder to attack. The systems may coexist

Felix Martin 4D

Monetary History in 4D. Divine then Despotic then Democratic then Digital

Felix Martin three ideas of money

Money = concept of value (a standard unit) + institution of accounting (credits and debts) + principle of transferability (settlement)

Felix Martin governance vs standard

Two questions for any money. Who gets to decide (governance) and what actually is a pound or a bitcoin (standard)

Neil Smith moneyness

Money is a system of social relations. Competing money-things have varying degrees of moneyness. Context is key

Authority vs trust

Authority without trust is a non-starter. Trust without authority is unstable. Monetary balance requires both