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Understanding Bitcoin: Cryptography, Engineering and Economics

ISBN: 978-1-119-01916-9
288 pages
November 2014
Understanding Bitcoin: Cryptography, Engineering and Economics (1119019168) cover image

Description

Discover Bitcoin, the cryptocurrency that has the finance world buzzing

Bitcoin is arguably one of the biggest developments in finance since the advent of fiat currency. With Understanding Bitcoin, expert author Pedro Franco provides finance professionals with a complete technical guide and resource to the cryptography, engineering and economic development of Bitcoin and other cryptocurrencies. This comprehensive, yet accessible work fully explores the supporting economic realities and technological advances of Bitcoin, and presents positive and negative arguments from various economic schools regarding its continued viability.

This authoritative text provides a step-by-step description of how Bitcoin works, starting with public key cryptography and moving on to explain transaction processing, the blockchain and mining technologies. This vital resource reviews Bitcoin from the broader perspective of digital currencies and explores historical attempts at cryptographic currencies. Bitcoin is, after all, not just a digital currency; it's a modern approach to the secure transfer of value using cryptography. This book is a detailed guide to what it is, how it works, and how it just may jumpstart a change in the way digital value changes hands.

  • Understand how Bitcoin works, and the technology behind it
  • Delve into the economics of Bitcoin, and its impact on the financial industry
  • Discover alt-coins and other available cryptocurrencies
  • Explore the ideas behind Bitcoin 2.0 technologies
  • Learn transaction protocols, micropayment channels, atomic cross-chain trading, and more

Bitcoin challenges the basic assumption under which the current financial system rests: that currencies are issued by central governments, and their supply is managed by central banks. To fully understand this revolutionary technology, Understanding Bitcoin is a uniquely complete, reader-friendly guide.

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Table of Contents

About the Author xi

Acknowledgments xiii

Foreword xv

Prologue xvii

Preface xix

PART ONE: INTRODUCTION AND ECONOMICS 1

CHAPTER 1 Foundations 3

1.1 Decentralized 4

1.2 Open Source 6

1.3 Public Asset Ledger 8

1.4 It’s Not Only the Currency, It’s the Technology 9

CHAPTER 2 Technology (Introduction) 11

2.1 Centralized Database 11

2.2 Addresses, Transactions 13

2.3 Distributed Database, the Blockchain 15

2.4 Wallets 17

2.5 The Different Meanings of Bitcoin 18

CHAPTER 3 Economics 21

3.1 Medium of Exchange 22

3.1.1 Pros 25

3.1.2 Cons 26

3.2 Store of Value 27

3.2.1 Bitcoin as Investment 29

3.2.2 Pros 30

3.2.3 Cons 31

3.3 Unit of Account 32

3.4 Deflation 32

3.5 Volatility 33

3.6 Effect on the Financial Industry and Monetary Policy 35

3.7 Regulation 37

CHAPTER 4 Business Applications 39

4.1 Money Transfer 39

4.2 Exchanges 40

4.3 Payment Processors 43

4.4 Web Wallets 43

4.5 Multisignature Escrow Services 45

4.6 Mining 46

4.7 ATMs 48

PART TWO: BITCOIN TECHNOLOGY 49

CHAPTER 5 Public Key Cryptography 51

5.1 Public Key Encryption 53

5.2 Digital Signatures 56

5.3 RSA 59

5.4 Elliptic Curve Cryptography 62

5.4.1 Elliptic Curve Summary 63

5.4.2 Elliptic Curve Theory 64

5.5 Other Cryptographic Primitives 71

5.5.1 Blind Signatures 71

5.5.2 Shamir Secret Sharing 72

5.6 Bitcoin Addresses 73

CHAPTER 6 Transactions 77

6.1 Transaction Scripts 80

6.2 Pay-to-address and Pay-to-public-key Transactions 82

6.3 Multisignature (m-of-n) Transactions 84

6.4 Other Transaction Types 85

6.5 Transaction Signature 86

6.6 Pay-to-script-hash (P2SH) 89

6.7 Standard Transactions 92

CHAPTER 7 The Blockchain 95

7.1 Hash Functions 95

7.2 Time-stamp 99

7.3 Proof-of-work 101

7.4 The Blockchain 105

7.5 Double-spend and Other Attacks 113

7.5.1 Race Attack 115

7.5.2 Finney Attack 116

7.5.3 Transaction Spamming 116

7.6 Merkle Trees 117

7.6.1 Transaction Malleability 119

7.7 Scalability 120

CHAPTER 8 Wallets 123

8.1 Symmetric-key Cryptography 125

8.2 Offline Wallets 126

8.2.1 External Storage Media 127

8.2.2 Paper Wallets 127

8.2.3 Offline Devices 129

8.2.4 Hardware Wallets 130

8.3 Web Wallets 131

8.4 Brain Wallets 132

8.5 Deterministic Wallets 132

8.5.1 Message Authentication Code (MAC) 134

8.5.2 Hierarchical Deterministic Wallets 135

8.6 Multisignature Wallets 136

8.7 Vanity addresses 137

8.8 Simplified Payment Verification (SPV) 139

8.9 The “Payment Protocol” (BIP 70) 141

CHAPTER 9 Mining 143

9.1 Mining Technology 146

9.2 Pooled Mining 149

9.3 Transaction Fees 154

9.4 Selfish Mining 156

PART THREE: THE CRYPTOCURRENCIES LANDSCAPE 159

CHAPTER 10 The Origins Of Bitcoin 161

10.1 David Chaum’s Ecash 162

10.2 Adam Back’s Hashcash 163

10.3 Nick Szabo’s bit gold and Wei Dai’s b-money 164

10.4 Sander and Ta-Shma’s Auditable, Anonymous Electronic Cash 165

10.5 Hal Finney’s RPOW 167

10.6 Satoshi Nakamoto 168

CHAPTER 11 Alt(ernative) Coins 171

11.1 Litecoin 172

11.2 PeerCoin 173

11.3 Namecoin 174

11.4 Auroracoin 175

11.5 Primecoin 175

11.6 Dogecoin 176

11.7 Freicoin 177

11.8 Other Alt-coins 177

11.9 The Case For/Against Alt-coins 178

CHAPTER 12 Contracts (the Internet of Money or Cryptocurrencies 2.0) 183

12.1 Digital Assets 183

12.2 Smart Property 185

12.3 Micropayments 186

12.4 Autonomous Agents 187

12.5 Other Applications 189

12.5.1 Crowd-funding 189

12.5.2 External State Contract 190

12.5.3 Contract for Differences 190

12.5.4 Distributed Exchange 191

12.5.5 Deposits 191

12.5.6 Saving Addresses 192

12.6 Inserting Data into the Blockchain 192

12.7 Meta-coins 194

12.7.1 Colored Coins 196

12.7.2 Counterparty 197

12.7.3 Ethereum 199

12.7.4 Mastercoin 202

12.7.5 Nxt 203

12.7.6 Ripple 204

CHAPTER 13 The Privacy Battle 209

13.1 Network Analysis 209

13.2 Laundry Services 212

13.3 Greenlisting 213

13.4 Privacy-enhancing Technologies 214

13.4.1 CoinJoin 214

13.4.2 CoinSwap 215

13.4.3 Stealth Addresses 217

13.4.4 Merge Avoidance 219

13.4.5 Committed Transactions 220

13.5 Fully Anonymous Decentralized Currencies 221

13.5.1 Zero-knowledge Proofs 221

13.5.2 Zero-knowledge Proof of Graph 3-colorability 221

13.5.3 Zero-knowledge Proof for the Discrete Logarithm 223

13.5.4 Non-interactive Zero-knowledge Proofs 224

13.5.5 Accumulators 225

13.5.6 Zerocoin 226

13.5.7 Zerocash 228

CHAPTER 14 Odds and Ends 231

14.1 Other Transaction Protocols 231

14.1.1 Micropayment Channels 231

14.1.2 Atomic Cross-chain Trading 232

14.2 Alternatives to Proof-of-work 233

14.2.1 Proof-of-stake 234

14.2.2 Proof-of-burn 236

14.3 Merged Mining 237

14.4 Side-chains 238

14.5 Open Transactions 240

14.6 Quantum Computing 242

14.7 Recent Advances in Cryptography 244

14.7.1 Homomorphic Encryption 244

14.7.2 Obfuscation 245

Bibliography 247

Index 259

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Author Information

PEDRO FRANCO holds an MSc in Electrical Engineering from ICAI, a BSc in Economics and an MBA from INSEAD. He has been a consultant with McKinsey and Boston Consulting Group, as well as a researcher with IIT, prior to gaining more than 10 years of experience in financial markets, holding Quant and Trading positions in Credit, Counterparty Risk, Inflation and Interest Rates. He has created various mathematical libraries for financial derivatives, and managed teams of software developers. He can be contacted at pfrancobtc@gmail.com.

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Press Release

December 15, 2014
Understanding Bitcoin

Understanding Bitcoin, Cryptography, Engineering and Economics is a resource for financial professionals which addresses new ideas such as autonomous agents and meta-coins, privacy-enhancing techniques and even fully anonymous cryptocurrencies based on zero-knowledge proofs and assists the reader in understanding all the buzz and excitement around these innovative technologies.

Split into three parts the book:

  • Introduces the Bitcoin protocol in non-technical terms, presents how the different economic schools interpret Bitcoin and introduces several business models in the Bitcoin ecosystem.
  • Explains the technology behind Bitcoin (no prior knowledge of cryptography is assumed) and reviews the wallet and mining technologies.
  • Covers Bitcoin from the broader perspective of digital currencies, presenting previous attempts at cryptographic currencies, other cryptocurrencies and innovative applications of cryptocurrencies such as autonomous agents. The tension between those who want to break Bitcoin’s privacy (using big-data techniques) and those creating technologies to increase it is also covered.
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