Designed by an anonymous creator, Bitcoin is an intriguing and revolutionary modern technology and payment transaction infrastructure. But as with any new technology, there are many obstacles and threats on the path towards mainstream acceptance. What are the shortcomings of the Bitcoin protocol and Bitcoin as a currency? Moreover, which competitors may one day be able to surpass Bitcoin and make it obsolete? Could a suitable competitor replace Bitcoin, or will the open source virtual currency keep improving itself to make competition obsolete?
Traditional classifications for currencies do not adequately apply to Bitcoin. It is a new type of financial technology that entered the global market in 2008 and has since been able to draw the attention of investors, business leaders, regulators and politicians.
Whereas a Dollar, Yen, Yuan or Euro can be hold like a currency, they cannot be secured and transacted simply by itself. Individuals have to rely on third party intermediaries in order to transfer funds for them and in order to store them securely. Contrary to that, one cannot focus on Bitcoin as a currency without acknowledging that it is also a transaction system in itself and would not be able to function is one part of this duality is gone. In fact it is even more precise to look at Bitcoin as a decentralized transaction and financial services system, with a currency function being only one aspect of the technology.
In this book:
- Bitcoin;
- Ripple;
- cryptocurrency;
- financial technology;
- financial service;
- virtual currency
Table of Contents
1 Executive Summary
2 Definition of Bitcoin
2.1 Technical Description of Bitcoin Transaction
2.2 Blocks
2.3 The Byzantine Generals Problem
2.4 Double Spending Solution
2.5 Decentralization
3 Technology of Bitcoin
3.1 Method of Operating
3.2 Network
3.3 The Block Chain
3.4 Wallets
3.5 Bitcoin Addresses
3.6 Public Key
3.7 Private Key
3.8 Mining
3.9 Difficulty
3.10 Anonymity
4 The Shortcomings of Bitcoin
4.1 Zero-Sum Game and Investor Problem
4.2 Price Volatility
4.3 51% Attack
4.4 Mining Incentive Scheme Flaws
4.5 Private Key Vulnerability
4.6 Irreversible Transactions
4.7 Information Asymmetry
4.8 Fraud and Hacking
4.9 Confirmation Times
4.10 Deflationary Bias
4.11 Bitcoin Wealth Distribution
4.12 Scalability
4.13 Energy Consumption
4.14 Illicit Transactions and Money Laundering
4.15 Conclusions
5 Analysis: Alternative Cryptocurrencies
5.1 Alternative Cryptocurrencies
5.2 Litecoin
5.3 Dogecoin
5.4 Darkcoin
5.5 Peercoin
5.6 Ethereum
5.7 Primecoin
5.8 Mastercoin
5.9 Network Effect of Bitcoin
6 Analysis: Ripple
7 Analysis: Bitcoin Side Chains
8 Conclusion
Research Objectives and Key Topics
This thesis examines the virtual currency Bitcoin, evaluating its role not merely as a currency, but as a decentralized transaction and financial services system. The core research question addresses whether a suitable competitor can successfully replace Bitcoin or if the protocol can be improved to render competition obsolete.
- Technological foundations and infrastructure of Bitcoin
- Key shortcomings of the Bitcoin protocol and currency
- Analysis of alternative cryptocurrencies and their features
- Evaluation of innovative transaction systems like Ripple and Bitcoin side chains
Excerpt from the Book
2.3 The Byzantine Generals Problem
One of the key characteristics of Bitcoin is that it provides a solution to the Byzantine Generals problem. This problem is an abstractly expressed form of an agreement problem in the context of geographical remoteness, communication by messengers and presence of traitors within the ranks of the Byzantine Empire’s army. A reliable system must cope with conflicting information of its parts in order to avoid malfunction. The question at hand is how to establish trust between unrelated parties within an untrusted network.
The Byzantine Generals problem is exemplified by a thought experiment, in which the fortified city-state Byzantinum is surrounded by ten smaller city-states. Hypothetically, all surrounding city-states plan to invade Byzantinum in order to obtain its wealth but none of them is strong enough to do so on its own. Moreover, any uncoordinated attack would fail and result into the annihilation of the attacking city-state. In order to successfully invade Byzantinum the majority of city-states must invade simultaneously. The major problem that the attacking city-states face is that if one or more of the attackers betray the other city-states, they and the remaining non-attacking neighbors will be able to pillage the annihilated city-states. The problems faced by the city-states are based on trust and communication. Each individual city has an incentive to betray the next and all generals must decide unanimously whether to attack at certain times.
Moreover, their means of communication are limited, as none of the generals can leave the city to meet with other generals as they cannot trust that the other generals will not harm them. As such, their only way to communicate is sending messengers. They are not limited as to how many messengers they send or at which time they send messengers. When messengers of general 1 reach the other nine generals they hand them a sealed letter. The letter informs the other generals about the time general 1 plans to attack and requests to know which of the other generals will join him. As a response, each of the nine generals attaches his response to the original letter and hands the sealed response letter to the messenger.
Summary of Chapters
1 Executive Summary: This chapter outlines the thesis goal of investigating Bitcoin as a decentralized financial services system and introduces the core research themes including technological evaluation and competitive analysis.
2 Definition of Bitcoin: This chapter defines Bitcoin's peer-to-peer nature, its inception, and the fundamental problems it solves, such as the Byzantine Generals problem and double-spending.
3 Technology of Bitcoin: This section provides a technical deep-dive into the Bitcoin infrastructure, including the block chain, wallet mechanisms, keys, mining, and network protocols.
4 The Shortcomings of Bitcoin: This chapter explores critical flaws such as price volatility, security risks, scalability, energy consumption, and the implications of its deflationary bias.
5 Analysis: Alternative Cryptocurrencies: This chapter evaluates several altcoins, detailing how they attempt to address specific weaknesses inherent in the original Bitcoin protocol.
6 Analysis: Ripple: This section provides an analysis of Ripple, focusing on its decentralized payment protocol and its utility as a bridge currency for financial institutions.
7 Analysis: Bitcoin Side Chains: This chapter explores the potential of side chains as an evolutionary step for Bitcoin to incorporate new features without altering the base protocol.
8 Conclusion: The final chapter summarizes the research findings, noting that while Bitcoin faces significant hurdles, its open-source nature allows for iterative improvements and technological adaptation.
Keywords
Bitcoin, Cryptocurrencies, Blockchain, Mining, Decentralization, Byzantine Generals Problem, Proof-of-Work, Altcoins, Ripple, Side Chains, Private Keys, Digital Signatures, Financial Innovation, Transaction Security, Network Effect
Frequently Asked Questions
What is the primary focus of this work?
The work focuses on Bitcoin as a decentralized transaction and financial services system, analyzing its technological architecture, persistent flaws, and competitive landscape.
What are the central themes discussed in the book?
The core themes include the technological infrastructure of Bitcoin, the economic and operational shortcomings of the protocol, the rise of alternative cryptocurrencies, and the potential for technological evolution through side chains.
What is the main research question of this thesis?
The main question is whether an alternative cryptocurrency can successfully surpass Bitcoin or if the Bitcoin protocol can evolve to effectively eliminate its competition.
Which scientific method is utilized in this thesis?
The research is based on a structured analysis of technical documentation, academic literature, and empirical data regarding cryptocurrency markets, mining networks, and network propagation.
What topics are covered in the main section of the book?
The main body treats the definition and technology of Bitcoin in detail, followed by a critical assessment of its shortcomings, such as volatility and scalability, and an analysis of how competitive alternatives address these issues.
What key terms define the essence of this research?
The research is characterized by terms such as decentralization, proof-of-work, blockchain technology, network effects, and cryptographic finance.
How does the author explain the Byzantine Generals problem in the context of Bitcoin?
The author describes it as an agreement problem in an untrusted network, where Bitcoin utilizes a proof-of-work chain to reach consensus and ensure transaction validity without a central authority.
Why is energy consumption considered a major challenge for Bitcoin?
The work highlights that the proof-of-work mechanism requires significant computational resources, leading to high electricity usage, which creates a floor for mining costs and potentially forces centralization as less efficient miners are driven out.
What role do "Side Chains" play in the future of Bitcoin according to the author?
The author suggests that side chains offer a way to incorporate innovative features—such as enhanced privacy or smart contracts—without compromising the security of the original Bitcoin chain.
- Quote paper
- Lukas Leys (Author), 2014, Bitcoin and Cryptographic Finance. Technology, Shortcomings and Alternative Cryptocurrencies, Munich, GRIN Verlag, https://www.grin.com/document/380675
