Cryptocurrency

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A ledger is defined as a book of financial transactions.

• if all transactions were recorded reliably and securely in a ledger,
  • there would be no need for dollars in a physical world
  • the ledger could server as the currency itself
• thus, a fully digital currency with digital ledger does not need a physical currency
• ledger can be maintained without trusting a central authority as a distributed ledger using a blockchain

Cryptocurrency Construction

• to construct a decentralized digital currency, we need a digital unit of work
  • one cryptographic hash computation can serve as a basic unit of work
    • more work is considered “better”
      • because ambiguous cases will always be resolved in favor of the result that represents the most work
• how do we know that an entry in a distributed ledger is valid?
  • by requiring ledger entries be digitally signed
• To mitigate duplicate ledger entries
  • we add a transaction number to each entry
  • this makes each ledger entry unique, so duplicates are known to be fraudulent
• To prevent overspending (offering to pay an amount they can’t afford to pay):
  • require everyone to pay an initial amount to buy into the ledger
  • then check to ensure they don’t overspend

Decentralized Distributed Ledger

• To make the distributed ledger decentralized,
  • we allow anyone to have a copy of the ledger and anyone can make modifications to it
• problems of a distributed ledger
  • maintaining a consistent view of the ledger across multiple copies that are constantly being modified
  • people trying to cheat
• to mitigate these problems, the following rules are imposed:
  • transactions must be signed
  • nobody can be overdrawn at any time
  • transactions are broadcast to everyone
• even with the above rules, multiple ledgers can and will exist at any given time
  • solving this is the core issue of a viable distributed cryptocurrency
  • we deal with this in terms of work
    • a hash is the unit of work
    • a ledger with the greatest expected work is considered the “correct” ledger
    • since more hashes = more work, a ledger that represents more hashes is better
  • individual transactions are grouped into blocks
    • a certain amount of work (hash computations) is needed to validate a new block
      • anyone can do the work to validate, but it is computationally expensive
      • so this work is incentivized by rewarding cryptocurrency for finding a valid hash for a block
      • people who compute hashes to search for one that validates a block are known as miners
        • this generates new “money” similar to how physical minders find new gold from the ground
  • we don’t want to revalidate each block at each step, so blocks are chained together
    • to create a chain,
      • the hash value of the previous block is put into the header of the current block
    • any user can create new transactions, which are formed into blocks
    • these blocks then get appended to the blockchain when a miner computes a validating hash
  • since anyone can create blocks and compute hashes, there can be multiple blockchains at any time
    • but the blockchain representing more work (hashes) wins
    • what happens in a tie?
      • user must wait until there is a longer blockchain to break the tie

Varying Aspects of Cryptocurrency Approaches

• additional refinements to cryptocurrency approach:
  • may want to adjust the expected number of hashes as the computing power in the network grows
    • e.g. Bitcoin’s threshold is adjusted repeatedly to maintain an expected time of 10 minutes for each new block to be validated
  • may want to limit the total amount of currency that will every exist
    • since source of new currency is mining,
      • the mining reward can be reduced over time
      • when it reaches 0, there will be no incentive to mine for new coins
    • e.g. Bitcoin is limited to 21,000,000 bitcoins
    • but there must be an incentive for miners to continue to validate transactions
      • accomplished by adding transaction fees
        • can be allowed to vary or even be optional
        • the greater the transaction fee, the greater the incentive to include the transaction in a block, and the sooner it will be validated
  • using Merkle trees
    • consists of hashing the individual transactions in a block and then computing the hashes of these hashes, and so on, resulting in a tree
    • advantage is that only the root hash of the Merkle tree is needed in each block computation
      • which greatly reduces the amount of data that must be hashed
  • privacy
    • cryptocurrency outlined above requires digital certificates
      • these identify the user
      • but the identity within the cryptocurrency network does not need to be the users actual identity
      • thus cryptocurrencies like Bitcoin are pseudonymous