Regulators have jumped on regulation of Bitcoin[1] yet the UK Treasury and its Chief Scientific Advisor have celebrated its technology, Blockchain.[2]The blockchain could bring everything that is good about Bitcoin and translate it into decentralised applications. This will certainly merit further disinterested independent research in the coming years,[3] separated from the hype and financial self-interest of the Bitcoin community. Bitcoin is a revolutionary idea in achieving decentralisation, but suffers from the current implementation based on libertarian economic dogma and critical mistakes, such as the potential for a large entity with access to large computing power to take over the public records. The wider research questions relate to the future of fiat currencies, and the possibility of social production and sharing based on blockchains as the basis for the record of exchange.[4] The most interesting development turns the blockchain, Bitcoin’s proof-of-transaction open log, into a platform for creating a smart contract decentralised platform. We may very well be talking about blockchain in the future, and Bitcoin might simply be known as the first implementation of open ledgers.
Before we examine blockchain’s future, let’s look at its brief past.
Blockchains Invented for Bitcoins
Bitcoin was developed in 2008 as a concept by an anonymous developer going by the pseudonym Satoshi Nakamoto, who posted a paper detailing the currency to a cryptography mailing list.[5] The paper details a decentralised system with no issuing authority that would serve as both a means of exchange but also as an anonymous and fully open log of all transactions (known as the blockchain). People running a client that would ‘mine’ value by verifying transactions would create the value, which encourages users to allocate processor time to confirm trades.
The paper gained some traction in cryptology circles, and it was coupled with the anonymous registration of the Bitcon.org domain, as well as the release on 9 January 2009 of the first version of the Bitcoin client.[6] The currency continued to become more popular, but it was not until the creation of the Silk Road in 2011 that it achieved more mainstream notice.[7]
Bitcoin was devised as a non-fiat currency; in other words, its proponents claim that it has ‘real’ value. The value arises from computing power, that is, the only way to create new coins is by allocating distributed CPU power through computer programs named ‘miners’; the miners create a block after a period of time that is worth an ever-decreasing amount of bitcoins in order to ensure scarcity. Each bitcoin consists of 100 million smaller units, called a satoshi. The operations performed to mine are precisely to authenticate other transactions, so the system both creates value and authenticates itself, an elegant and simple solution that is one of the appealing aspects of the currency. Once created, each Bitcoin (or 100 million satoshis) exists as a cryptographic address that is part of the block that gave birth to it. The person who mined the coin owns the address, and can transfer it by sending value to another address, which is a ‘wallet’ file stored in a computer. The blockchain is the public record of all transactions.
Another way of looking at the currency is that Bitcoin is simply allocating value arbitrarily to a program that performs the mathematical equations necessary to support the creation of a bitcoin. It is a self-referential and circular currency, and its only value is that which people give it, just like fiat money but with faith placed in computer programming not sovereign states.
Bitcoin has undoubtedly become the most talked-about cryptocurrency, but it is easy to forget that it began mostly as a proof of concept. Because the software is completely open source,[8] any developer can download it, modify it, and create his or her own version of the software. This capability has led to an explosion of alternative bitcoin implementations, popularly known as altcoins. There are no limits to the number of altcoins that can be released, but in practice there are a few dozen real alternatives that implement minor or major changes, these are known as forks.
There is no single reason why a developer should fork the original code and create their own version. Some may do it to improve the code, to create better security, to modify some of the existing parameters, as a joke, or to attempt to convert altcoins into bitcoins.[9]
Some of the most popular implementations are:
· IxCoin (IXC): The International eXchange Coin[10] is the first Bitcoin clone, it was released in 2011 and it can be mined at the same time as BTC. It also has a limit of 21 million coins, but much shorter mining period (all coins should be mined in 2015).
· Namecoin (NMC)[11]: It is one of the most innovative altcoins. It uses Bitcoin to create a decentralised domain name system outside of the existing international system operated by ICANN. The service allows the registration of domain names that cannot be shut down or taken over by law enforcement.
· Litecoin (LTC)[12]: This is one of the more popular Bitcoin alternatives, it was created specifically to fix perceived shortcomings in BTC, and it boasts faster transaction verification times and improved storage efficiency.
· Ripple (XRP)[13]: In the strict sense, Ripple is not a direct Bitcoin fork, but it borrows some of the main ideas of Bitcoin, such as being an open source decentralised ledger. It is both a currency and acts as an exchange protocol for existing currencies and altcoins.
· Dogecoin[14]: This started as a joke BTC fork in 2013, but quickly became a currency in its own right, with a 2015 estimated market capitalisation of over $15 million USD,[15] making it the fourth most popular altcoin. The name comes from Doge, the popular Internet meme.[16]
· Bitcoin XT[17]: This is a very recent and controversial fork to the original Bitcoin source code that adds two main changes, the block size is increased, and it removes the need to download the entire blockchain.
Blockchain Technology Benefits
There are various problems with existing financial markets and currencies that the cryptocurrency is trying to address. Some of the crypto-currrency benefits are:
· Transparency. One of the key benefits of Bitcoin is that all transactions are publicly available and verifiable in the electronic ledger called the blockchain.[18] This provides an unprecedented level of transparency and peer verification, and as it will be shown in the last section, it is one of the features that transcends the currency elements.
· Security. Bitcoin uses the 256 bit version of the Secure Hash Algorithm (SHA), an encryption protocol designed by the National Security Agency in the US. The protocol maintains the integrity of the blockchain, but is also used to sign and secure BTC wallets, providing a mathematical proof that transactions are performed from the owner of the wallet. The signature also prevents the transaction from being altered by anybody once it has been issued.[19]
· Lower transaction costs. While in theory Bitcoin transactions could be free between all parties, the system usually has transaction fees that vary from one exchange to the other.[20] Usually, the transaction fee will go to the miner (as an incentive to miners), and these transaction fees are a function of difficulty.[21] Even with these fees, Bitcoin still boasts lower transaction costs when compared to other payment methods, with some merchants estimating that the average is at 1%, as opposed to other intermediary clearinghouses such as PayPal and Western Union, which charge from 2-4%.[22] However, it must be noted that some researchers believe that low transaction costs are not sustainable in the future.[23]
· Anonymity. Bitcoin is theoretically anonymous. A person in possession of BTC in an encrypted wallet can spend it in any service without identification. While the anonymity aspect has clearly made it attractive as a means of payment for illegal goods and services,[24] it could be used for less nefarious purposes, such as funding campaigners in authoritarian regimes.[25]
· Resilience. Bitcoin is a decentralised currency with no central authority and no issuing body. This means that it is resilient to attacks, and in theory it also means that it cannot be brought down.[26]
· Engine for innovation. While it is easy to ignore some grandiose claims made by some Bitcoin developers, such as the claim that it will destroy fiat currencies, or that it has the potential to combat poverty and oppression,[27] it cannot be denied that its creation has given a much needed push towards innovation in the way in which we think about money, financial institutions, and centrality. Anything that encourages innovation is to be welcomed.
This list is non-exhaustive, and only shows some of the most cited benefits of the virtual currency. There are some benefits that are more difficult to quantify. For example, there is little doubt that whatever may happen with Bitcoin, its creation has revolutionised how we think about money, value and payments in general. It is possible to be sceptical of Bitcoin, yet to be awed by its elegance and the ambitious nature of its implementation. Even if BTC was to disappear tomorrow, it is possible that some applications of blockchain technology will survive, and be adapted for re-use.
Clarity and Size in Blockchains
A main selling points of Bitcoin is transparency. The client itself is open source, and all transactions are open to scrutiny because all transactions must be verified by the whole, so it is possible to look at each individual transaction in the public blockchain to scrutinise the outgoing and incoming wallet addresses. The addresses do not identify the person, only the possessor of the key that unlocks the address. This makes it both anonymous and transparent at the same time, a feature that explains Bitcoin’s popularity with the technical community.
How transparent? Ron and Shamir examined very old ‘dormant’ addresses in the blockchain, and assumed that these were probably lost coins from the time when people were testing the technology and deleted their wallets.[28] The authors calculated the historical number of lost coins to be 1,657,480 bitcoins. Considering the certainty of later losses, the total value of lost coins could very well double that number. Developer John Ratcliff conducted a similar study of the blockchain, and identified a very large number of dormant coins, what he called ‘zombie coins’, which amount to 30% of all the Bitcoins ever mined.[29]
How big? The size of the Bitcoin blockchain is starting to become a problem; at the time of writing it was reaching 40 gigabytes.[30] This has some practical implications for BTC as a currency, as the size of the blockchain may hinder the speed with which transactions are verified. Average transaction times vary a lot depending on network loads, but currently it ranges from 6-12 minutes per transaction.[31] As blockchain size increases with more transactions, hosting of the entire blockchain could become a problem as well, as it is thought that the blockchain may reach 3 terabytes in size within 10 years.[32]
Alternative uses of blockchain protocols
A blockchain is quite simply any open, cryptographic, decentralised ledger, so in theory it can be implemented into any sort of scheme, financial or not, that requires a record of transactions. As has been stated repeatedly, in Bitcoin the ledger is public and decentralised, and since anyone can check past, present and proposed transactions, there is increased reliability in the system. The main function of the blockchain in Bitcoin is to avoid the potential of double-spending money. However, the blockchain idea is independent of the existence of Bitcoin. In the offline world, barring counterfeiting, it is impossible to double-spend money as people hold limited amount of physical currency. Monetary transactions however more often occur as the digital movement of value from one account to the other. [33] The idea is for the holding institution to contain a master ledger, in other words a record of the money in all of the accounts, making it possible to follow movements from one to the other.[34]
In order to have a viable blockchain alternative outside of the Bitcoin implementation, a developer can use existing protocols and open source code to create a verification mechanism that must fulfil three important functions which are key to any blockchain distribution. These are:
– Proof of Work. The proof of work (POW) is the way in which Bitcoin rewards miners for conducting transaction verification operations, which are expensive computational transactions. Any blockchain alternative will have to have an alternative POW pay-out if the intention of the technology is not monetary. This could be social, such as solving mathematical equations or finding prime numbers.[35]
– Authentication. This is the main function of a blockchain, the implementation must be designed to validate transactions securely and unequivocally.[36]
– Decentralization. The blockchain must be decentralized, so copies of the entire ledger cannot be held centrally. This presents a few technical problems, such as the increasingly unmanageable size of the blockchain as more transactions accumulate.[37]
There are hundreds of such potential applications in the financial markets, such as bonds, stocks, and derivatives;[38] but it would also be possible to apply the same type of technology to automated contracts,[39] or even copyright licensing agreements.[40] The idea is to attempt to bypass the difficulties of contract formation and other legal transactions by allocating rights and responsibilities through electronic tokens that then would be recorded in the common ledger. A recent report explains:
‘While all of the high-value applications of the first wave of blockchain innovation are explicitly financial, this is not the case for the second wave of blockchain innovation, which primarily rests on the idea of a “smart contract”. Put simply, a smart contract uses software code to implement human intentions by dynamically carrying out instructions embedded in tokens associated with a contract, rather than relying on legal texts interpreted by courts, regulatory bodies or other legal institutions.’[41]
But this principle might not only apply to contracts, but also to distributing and allocating rights within decentralised organizations themselves.[42]
There are already a number of tools that are being developed to take advantage of the blockchain beyond payment systems and cryptocurrencies. One of the most publicised has been Project Ethereum[43] which creates ‘a blockchain with a built-in Turing-complete programming language, allowing anyone to write smart contracts and decentralized applications where they can create their own arbitrary rules for ownership, transaction formats and state transition functions.’[44] In other words, Ethereum is a protocol for smart open ledgers where users can allocate their own rules and values. Ethereum has released an open source mining application to the public, directed mostly at developers, and users can mine its own currency called ‘ether’ by allocating processing power to validate transactions. The system will allow users to create legal documents that can be validated through the blockchain while at the same time allowing users to mine the new currency.
D-Cent is a European project that has proposed the creation of a social blockchain toolset that will allow adopters to generate their own alternative currency. The interesting part of this scheme is that it changes the economically-minded proof of work with a social one, which will be decided upon by the community.[45] Another project called Chain[46] is proposing to use blockchain protocols to pay for mobile minutes, to verify energy credits, to store loyalty points, and to scrutinise securities. Many other projects are being announced all the time, with applications as varied as blockchains replacing the Land Registry[47], smart solar panels,[48] and to help run stock markets.[49]
Concluding Thoughts: Hype Cycle or Real Deal?
The field of IT Law is replete with grandiose claims of life-changing technologies that will revolutionise our lives, and it is often too easy to fall prey to the latest meme adopted by every commentator.[50] Talk of the blockchain is reaching the level that previous technologies received, such as the cloud and 3D printing. While the reach of these is indeed great, we cannot lose sight of the limitations that exist within the Bitcoin environment. Furthermore, the idea of conducting legal transactions automatically by means of smart contracts and intelligent agents is not new.[51] Every generation brings a new crop of books and papers claiming that we are about to make lawyers a thing of the past, and most transactions will be taken care of by computers, yet lawyers persist.[52]
Despite this critique of the Bitcoin meme hype, the blockchain itself has immense potential, particularly for transactions that require transparency, resilience, and decentralisation. Bitcoin may be the equivalent of SecondLife a decade later, a liberating technology that is overhyped and poorly executed[53], so blockchains may be the equivalent of Web2.0 social networks, a truly transformative social technology.
Dr Andres Guadamuz is senior lecturer in intellectual property law at the University of Sussex. Professor Chris Marsden is chair in Internet law at the University of Sussex. They direct the Information Law Group at the university.
[1] Vandezande, Niels (2014) Between Bitcoins and mobile payments: will the European Commission’s new proposal provide more legal certainty? Int. J Law Info Tech 22 (3): 295-310. doi: 10.1093/ijlit/eau003; HMRC, 2014. Revenue & Customs Brief 09/14: Tax treatment of activities involving Bitcoin and other similar cryptocurrencies, issued 3 March 2014. http://www.hmrc.gov.uk/briefs/vat/brief0914.htm; Szczepa?ski, Marcin (2014) Bitcoin: Market, economics and regulation, European Parliamentary Research Service Document 140793REV1 at http://www.eprs.ep.parl.union.eu
[2] Walport, Sir Mark (2016) Distributed Ledger Technology: beyond block chain, Government Chief Scientist, 19 January, at https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/492972/gs-16-1-distributed-ledger-technology.pdf HM Treasury (2015) Digital currencies: response to the call for information, March Update, at https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/414040/digital_currencies_response_to_call_for_information_final_changes.pdf
[3] Guadamuz, Andrés and Marsden, Christopher (2015) Blockchains and Bitcoin: regulatory responses to cryptocurrencies, 20 First Monday 7 at http://firstmonday.org/ojs/index.php/fm/article/view/6198/5163
[4] Dini, Paolo (2012) Community currencies and the quantification of social value in the digital economy. The London School of Economics and Political Science, London, UK, at http://eprints.lse.ac.uk/47349/.
[5] Nakamoto S, Bitcoin: A Peer-to-Peer Electronic Cash System, (2008), https://bitcoin.org/bitcoin.pdf.
[6] History of Bitcoin, (2015), http://historyofbitcoin.org/.
[7] Bitcoin and the Silk Road became prominent with this article: Chen, A. ‘The Underground Website Where You Can Buy Any Drug Imaginable’, Gawker (June 1, 2011), http://bit.ly/1My9klz .
[8] Released under the MIT License, the code is found at: https://github.com/bitcoin/bitcoin.
[9] Hayes, A. (2015). The Decision to Produce Altcoins: Miners’ Arbitrage in Cryptocurrency Markets. SSRN Paper 2579448, http://bit.ly/1MybbXF.
[15] Market capitalization is obtained by multiplying the current value of a currency with the number of available coins.
[16] http://knowyourmeme.com/memes/doge.
[17] https://github.com/bitcoinxt/bitcoinxt.
[19] How Does Bitcoin Work (2011), https://bitcoin.org/en/how-it-works.
[20] Transaction fees explained (2015), https://en.bitcoin.it/wiki/Transaction_fees.
[21] Bitcoin Transaction Fees Explained (2014), http://bitcoinfees.com/.
[22] Wu, R. ‘Why We Accept Bitcoin’, Forbes (February 12, 2014), http://onforb.es/1JEHaao.
[23] Kaskaloglu, K. (2014) ‘Near Zero Bitcoin Transaction Fees Cannot Last Forever.’
The International Conference on Digital Security and Forensics (DigitalSec2014), http://bit.ly/1SffTwJ.
[24] Christin, N. (2013). ‘Traveling the Silk Road: A measurement analysis of a large anonymous online marketplace’. In Proceedings of the 22nd international conference on World Wide Web (pp. 213-224).
[25] Ploshay, E. ‘First Iranian Website Open to Iranians to Buy and Sell Bitcoin’, Bitcoin Magazine (July 18, 2013), http://bit.ly/1QL2IRu.
[26] Feld, S., Schönfeld, M., & Werner, M. (2014). ‘Analyzing the Deployment of Bitcoin’s P2P Network under an AS-level Perspective’. Procedia Computer Science, 32, 1121-1126.
[27] Britto, J. & Castillo, A. Bitcoin: A Primer for Policymakers, Arlington VA: George Mason University (2013), p.14.
[28] Ron, D. and Shamir, A. (2012) ‘Quantitative Analysis of the Full Bitcoin Transaction Graph.’ Cryptology ePrint Archive, Report 2012/584, http://eprint.iacr.org/2012/584. Note the ‘vigorous debate’ over their methodology: http://bit.ly/1BbT0Gk.
[29] Ratcliff, J. W. ‘Rise of the Zombie Coins.’ LTB Blog (June 22, 2014), http://bit.ly/1BbSWGt.
[30] See: https://blockchain.info/charts/blocks-size.
[31] https://blockchain.info/charts/avg-confirmation-time.
[32] Wagner, A. ‘Ensuring Network Scalibility: How to Fight Blockchain Bloat.’ Bitcoin Magazine (November 6, 2014), http://bit.ly/1SKI6Kb.
[33] Brito & Castillo (2013), p.3.
[34] Ali et al (2014), p.267.
[35] Roio, D. et al (2015). Design of Social Digital Currency, D-cent, FP7-CAPS EU Project, http://bit.ly/1Ioz0wP, p.16.
[36] Ibid, p. 17.
[37] Ibid, p.18.
[38] Ali et al (2014), p.271.
[39] Wright, A. & De Filippi, P. (2015). ‘Decentralized Blockchain Technology and the Rise of Lex Cryptographia.’ SSRN Working Paper Series, http://ssrn.com/abstract=2580664.
[40] Van Valkenburgh, P. et al (2015). Distributed Collaborative Organisations: Distributed Networks & Regulatory Frameworks. Coin Center Report, http://bit.ly/1LeE2PJ.
[41] Ibid, p.7.
[42] Bollier, D. ‘The Blockchain: A Promising New Infrastructure for Online Commons.’ David Bollier Blog (March 4, 2015), http://bit.ly/1LeDSIj.
[43] https://www.ethereum.org/.
[44] Leflet J. M. (2014). A Next-Generation Smart Contract and Decentralized Application Platform. Ethereum White Paper, http://bit.ly/1TqTldO.
[45] Roio et al (2015), p.28.
[47] Reuters (2015) GERTRUDE CHAVEZ-DREYFUSS: Honduras to build land title registry using bitcoin technology May 15,
http://in.reuters.com/article/usa-honduras-technology-idINKBN0O01V720150515
[49] Hern, A. ‘Nasdaq bets on bitcoin’s blockchain as the future of finance.’ The Guardian (May 13, 2015), http://gu.com/p/48pfp/stw.
[50] The authors do not claim to be immune from this.
[51] The inimitable Jon Bing was already writing about legal decision-making by automated systems in 1977, see: Bing J, & and Harvold, T. (1977). Legal Decisions and Information Systems, Oslo: Universitetsforlaget.
[52] Leith, Philip (2010) The Rise And Fall Of The Legal Expert System, European Journal of Law and Technology, Vol 1, No 1, http://ejlt.org/article/view/14, reviews many usch claims. Earlier, see Susskind, R. E. (1986). ‘Expert systems in law: A jurisprudential approach to artificial intelligence and legal reasoning.’ The Modern Law Review 49(2), 168-194.
[53] Stokes, Robert (2012) Virtual money laundering: the case of Bitcoin and the Linden dollar, Information & Communications Technology Law Volume 21, Issue 3, PP.221-236 DOI: 10.1080/13600834.2012.744225;
