Crypto-

Currencies
Submitted By: Samra Tariq
Submitted To: Dr. Uzair
Crypto-Currency:

Term Crypto-currency derived from Greek word kpurtos meaning hidden and prefix crypto
meaning concealed or secret. They are digital or virtual currencies.

Crypto currency is basically a currency designed for e-transactions or e-payments. Crypto-

currencies have no physical existence, but are best thought of as electronic accounting systems
that keep track of people’s transactions mediated with the currency and hence remaining
purchasing power. Crypto currencies are typically decentralized, with no central authority
responsible for maintaining the ledger and no central authority responsible for maintaining the
code used to implement the ledger system, unlike the ledgers maintained by commercial banks
for example.

Properties of Crypto Currency:

 Decentralized currency
 Used in e-payments
 Used for exchange
 Have own unit of account
 Store of value

Cryptography:
Cryptography is used to secure the transaction messages and the integrity of the ledgers
containing account balances.
Cryptographic techniques are used to secure two related elements. First, they are used to secure
transactions, to ensure that only an appropriate authority (the ‘address holder’) can ‘spend’ the
funds attributed to a particular address. Second, cryptography is used to secure the transaction
ledgers of the system, ensuring that people cannot fraudulently tamper with their crypto-currency
balances.

Impacts of Crypto Currency:

1. Crypto-currencies also raise consumer protection, anti-money laundering, and counter-
terrorism financing concerns.
2. As niche payment systems, crypto-currencies do not currently pose material financial
stability concerns, but risks could increase in materiality if crypto-currencies become more
popular and/or more integrated with the activities of traditional financial institutions.

Exchange Mechanism:
Normally in financial system we use different modes of payment for the exchange of goods and
services:
1. Legal Tender
2. E-payments
3. E-money
If we extend our discussion, legal tender is notes and coins issued by a central banks. E-
payments are electronic transfer from deposit and credit accounts facilitated by financial
institutions such as commercial banks.
E-money is a medium of exchange in which monetary value is stored on hardware or software,
enabling people to pay for goods and services bought from third-party merchants. E-money does
not usually entail a physical exchange of goods. Instead, the e-money device keeps track of a
balance of funds that can be used to purchase goods and services.

Categories of E-Money:
1. Centralized e-money
2. Decentralized e-money

Centralized e-money: To administer the issuance of the e-money and the facilitation of
transactions. e.g. Snapper

Decentralized e-money: e.g. Bitcoin

Crypto-currency is not backed:

Although crypto-currencies often have no centralized issuer, they are predominantly fiduciary in
the sense that they are not backed by precious metal and require trust.
Difference of Crypto-currency & Private bank deposits:

1. Crypto-currencies as competing private irredeemable monies. Irredeemable crypto-currencies

stand in contrast to redeemable private monies, such as bank deposits.
2. Crypto-currencies are not backed by the promises of a similar institution and they are usually
denominated in their own units.
3. Crypto-currencies are not a liability of any given institution, and are not subject to the same
accounting scrutiny and assurance.

Bitcoin – Crypto Currency:

Bitcoin is a peer-to-peer electronic cash system. It is a consensus network that enables a new
type of payment method and a completely digital form of money. It is the first decentralized
peer-to-peer payment network that is powered by its users with no central authority or
middlemen. From a user perspective, Bitcoin is perhaps best described as ‘cash for the Internet’.

Bitcoin‘s inventor, Satoshi Nakamoto, outlined what Bitcoin is in the original 2009
Bitcoin whitepaper—a document which created the roadmap for Bitcoin.

All Bitcoin transactions are recorded permanently on a distributed ledger “blockchain” – this
ledger is shared between all full Bitcoin “miners” and “nodes” around the world, and is publicly-
viewable. These miners and nodes verify transactions and keep the network secure. For the
electricity they use to do this, miners are rewarded with new bitcoins with each 10-minute block
(the reward is currently 12.5 BTC per block).

The Bitcoin protocol is also hard-limited to 21 million bitcoins, meaning that no more than that
can ever be created. This means that no central bank, individual or government can come along
and simply ‘print’ more bitcoins when it suits them. In this sense Bitcoin is a deflationary
currency, and as such is likely to grow in value based on this property alone.
Emergence of Block Chain:
The idea of transactions by ‘blockchain’ was first suggested by Satoshi Nakamoto in 2008 on a
cryptography mailing list. Block Chain, a universal distributed ledger that enables the
confirmation of transactions and makes it possible to keep track of individual crypto-currency
balances. A distributed ledger is a database of financial records ‘distributed’ across multiple
nodes of a computer network.

Bitcoins Minners:
Crypto-currencies typically have explicit programmatic rules that prevent an explosion in supply.
In the crypto-currency framework exemplified by Bitcoin, ‘miners’ are rewarded with bitcoins
for validating transactions. With Bitcoin, the validation of transactions is central to growth in the
supply of bitcoins. But Bitcoin has a declining growth rate in supply – the reward for adding a
new block to the blockchain halves with every additional 210,000 blocks (roughly every four
years). Given the programming rules that govern the ledgers, the sum of all bitcoin balances is
approaching 21 million bitcoins.

The miners are rewarded with crypto-currency for this validation service as part of the
programmed protocols underpinning the currency. Satoshi Nakamoto ‘mined’ the first block in
January 2009 and received 50 bitcoins as a reward.

Bitcoin & Wallet:

In order to transact using Bitcoin, a user usually possesses a ‘wallet’. A wallet typically contains:

 Private cryptographic keys

 Public cryptographic keys, and
 A sequence of past transactions, which is akin to an account balance.

A wallet is typically software on an electronic device – such as an app on a smartphone – that

helps a person to manage their public and private keys, their addresses, and their balances. Some
wallets are ‘full nodes’ that contain the entire history of transactions. These nodes can use
computing power to validate transactions, adding them to the ledgers, while others are
‘lightweight’ clients that only focus on the addresses and past transactions relevant for a given
person or business.

Transaction Mechanism Using Bitcoin:

If A wants to send some bitcoin to B. Essentially, a bitcoin transaction is comprised of three
parts:
An input: This is a record of the bitcoin address from which A initially received the bitcoin he
wants to send to B.
An amount: This is the specific amount of Bitcoin A wants to send B.
An output: This is B’s public key also known as his bitcoin address.

How Does a Bitcoin Transaction Work?

Sending bitcoin requires having access to the public and private keys associated with that amount
of bitcoin. When we talk about someone “having bitcoins” what we actually mean is that person
has access to a key-pair comprised of:
 a public key to which some amount bitcoin was previously sent
 the corresponding unique private key which authorizes the BTC previously sent to the
above pub-key to be sent elsewhere
Public keys, also called a bitcoin addresses, are random sequences of letters and numbers that
function similarly to an email address or a social-media site username.
The private key is another sequence of letters and numbers. However, private keys—like
passwords to email or other accounts, are to be kept secret.

Bitcoin address is basically a transparent safe. Others can see what’s inside but only those with
the private key can unlock the safe to access the funds within.

In our example transaction above, A wants to send some bitcoin to B. To do this, he uses his
private key to sign a message with the transaction-specific details. This message is then sent to
the block chain and contains an:

 Input: the source transaction of the coins previously sent to A’s address

 Amount: some amount of BTC to be sent from A to B
 Output: B’s public address.
This transaction is then broadcast to the bitcoin network where miners verify that A’s keys are
able to access the inputs (i.e. the address(s) from where he previously received BTC) he claims
to control. This confirmation process is known as mining because it requires resource-intensive
computational labor and rewards miners, in BTC, per block solved. This is also the process by
which new Bitcoins are ‘created’.

Crypto-currency & Traditional Money:

Crypto-currencies have been a highly volatile store of value, which is most apparent in the
extremely high volatility exhibited by Bitcoin relative to traditional fiat currencies. Volatility in
the value of Bitcoin is also a negative feature for real transactions. In principle, any good or
service could be used as a unit of account – a common standard for comparing the prices of
different goods and services. Volatility in the value of Bitcoin is also a negative feature for real
transactions. It argues that bitcoin undermines its use as unit of account.

Motivation for Using Crypto-currency:

Crypto-currency users must trust the computer programmers who have taken up the design
mantle for crypto-currencies, users must trust the miners responsible for validating transactions,
and indeed transactors need to trust that others will continue to value and accept crypto-currency
units.

Although crypto-currencies arguably fail to satisfy the basic functions of money, their increased
popularity is also motivated by genuine economic considerations, including lower transaction
costs, pseudonymous’ payments, transaction irreversibility, and the potential to attract a new
customer base.

Crypto-Currency Used for:

Crypto-currencies are regularly associated with four types of transactions or motivations:
1. Speculation
2. Illegal transactions
3. Gambling
4. Cross-border transactions such as remittances.

Implications:
No doubt the integrity of block chains depend upon miners, but still there is possibility that
miners can control the block chain and reverse the transaction during the attack. Even if the
protocols and cryptography used to implement crypto-currencies are secure, consumers may be
vulnerable to errors and exploitation in a number of ways. First, if a transactor unintentionally
discloses their private key then the balances associated with their addresses could be depleted of
value by unauthorized transactions. Second, if the private key is lost then the balance associated
with an address would become permanently inaccessible. Third, crypto-currency exchanges and
even the providers of digital wallets might be susceptible to fraud.