Knowledge Continuum 2014
BitCoin & the
Disruptive Potential
of Cryptocurrency
April, 4th 2014
Stefano Grazioli
Objective: Assessing BitCoin’s
disruptive potential
 What is it?
 What is its business value?
There are No
BitCoins
BitCoin “it’s a method of
transmitting money”
A distributed ledger that tracks
fund transfers among accounts
‘Block Chain’
Mt. Gox
bankrupt
Nov.08
Nakamoto
paper
Silk Road shut down
by the FBI
Jan.09 Bitcoin
(BTC) is launched
German finance
ministry recognizes BTC
as a unit of account
IRS
recognizes
BTC as
property
‘09 BTC trades at
$0.14
2009
2010
2011
2012
2013
2014
Use of BitCoin follows a
pre-existing business agreement
SAM the consumer
Account ABC123
with secret key Secret123
RHONDA the merchant
Account XYZ678
“I accept BitCoin Payment
12 roses = 0.1 BTC
Account: XYZ678”
“Please send 12 roses to 839 Hilton Rd., Cville, VA.
I am sending a transaction (from ABC123)”
Fund transfers use public key cryptography
to insure non-repudiation and integrity
SAM the consumer
Account ABC123
with secret key Secret123
Transfer of funds
Sender: ABC123
Transfer to: XYZ678
Amount: 0.1 BTC
RHONDA the merchant
Account XYZ678
Transaction
Digital Signature: 973sdskhu9dft
Proof of BTC ownership
Sender: RST234
Transfer to: ABC123
Amount: 5 BTC
Transactions are propagated
through a P2P network
SAM the consumer
Account ABC123
RHONDA the merchant
Account XYZ678
BitCoin P2P
client network
Transaction
Transfer of funds
Digital Signature
Transfer of funds
Transfer of funds
Proof of ownership
Digital Signature
Proof of ownership
Transfer of funds
Digital Signature
Digital Signature
Proof of ownership
Proof of ownership
Transfer of funds
Transfer of funds
Digital Signature
Digital Signature
Proof of ownership
Proof of ownership
Transfer of funds
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Proof of ownership
Transfer of funds
Digital Signature
Proof of ownership
The peers verify the ownership of
funds using the block chain
BitCoin P2P
client network
Unverified
transactions
Verified
transactions
Transfer of funds
Transfer of funds
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Transfer of funds
Proof of ownership
Check
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Transfer of funds
Proof of ownership
‘Locked’ into
the next block
of the Block
Chain
Digital Signature
Digital Signature
Proof of ownership
Proof of ownership
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of
ownership
Proof of Transfer of funds
ownership
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Transfer of funds
Transfer of funds
Transfer of funds
Transfer of funds
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of
ownership
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of
ownership
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of
ownership
‘Block Chain’ of verified transactions
Once in the block chain, the
transaction is irreversible
RHONDA the merchant
Account XYZ678
Transfer of
funds
Transfer of
funds
Transfer of
funds
Digital
Signature
Digital
Signature
Digital
Signature
Proof of
ownership
Transfer of
funds
Proof of
ownership Digital
Signature
Transfer of
funds
Proof of
ownership Digital
Signature
Transfer of
funds
Proof of
ownership Digital
Signature
Proof of
ownership
Transfer of
funds
Proof of
ownership
Transfer of
funds
Digital
Signature
Proof of
ownership
Proof of
ownership
Transfer of
funds
Digital
Signature
Transfer of
funds
Proof of
ownership
Digital
Signature
Proof of
ownership
Transfer of
funds
Proof of
ownership
Proof of
ownership
Proof of
ownership
Digital
Signature
Transfer of
funds
Digital
Signature
Proof of
ownership
Proof of
ownership
Transfer of
funds
Digital
Signature
Proof of
ownership
Transfer of
funds
Digital
Signature
Digital
Signature
Transfer of
funds
Transfer of
funds
Digital
Signature
Transfer of
funds
Proof of
ownership
Digital
Signature
Transfer of
funds
Digital
Signature
Digital
Signature
Digital
Signature
Proof of
ownership
Transfer of
funds
Transfer of
funds
Digital
Signature
Proof of
ownership
Proof of
ownership
Transfer of
funds
Digital
Signature
Proof of
ownership
Knowledge Continuum 2014
Bitcoin
Strategic Analysis
Network Analysis is a better fit than Porter’s Five
Forces for many Internet businesses.
Content
Providers
Consumers
Google
Platform
Advertisers
Network Effect = when the value of
a service changes for the user,
based on how many others adopt it.
Based on Iyer & Davenport HBR 2008
We will apply Network Analysis to
assess BitCoin’s business potential
Users
Miners
BitCoin
Platform
Services:
Wallets &
Exchanges
Merchants
Based on Iyer & Davenport HBR 2008
Knowledge Continuum 2014
Users and
Merchants
An awkward experience
BTC has a poor value proposition
for buyers and sellers
SAM the consumer
Low Transaction Costs
Semi-anonymous
Irreversible
10-minute confirmation
Volatile
Difficult legal remediation
Taxed as property
RHONDA the merchant
The same characteristics make BTC
attractive for dishonest players
Low Transaction Costs
Semi-anonymous
Irreversible
10-minute confirmation
Volatile
Difficult legal remediation
Taxed as property
Knowledge Continuum 2014
Miners
Reward Schema Introduce a Serious Flaw
Verification (‘Mining’) includes a
reward to the Miner
BitCoin P2P
client Network
Unverified
Transactions
Verified
Transactions
Transfer of funds
Transfer of funds
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Transfer of funds
Proof of ownership
Check
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Transfer of funds
Proof of ownership
Newly minted
BTC that is
owned by the
miner
Digital Signature
Digital Signature
Proof of ownership
Proof of ownership
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of
ownership
Proof of Transfer of funds
ownership
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Transfer of funds
Transfer of funds
Transfer of funds
Transfer of funds
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of
ownership
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of
ownership
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of
ownership
‘Block Chain’ of verified Transactions
Transfer of funds
Digital Signature
Proof of
ownership
Many Miners compete to create the
next block and reap the reward
BitCoin P2P
client Network
Unverified
Transactions
Transfer of funds
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Proof of ownership
Verified
Transactions
Check
Check
Check
Check
Check
Check
Transfer of funds
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Transfer of funds
Proof of ownership
Digital Signature
Proof of ownership
Transfer of funds
Transfer of funds
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
‘Locked’ into
the next block
of the Block
Chain
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Transfer of funds
Proof of
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
ownership
Digital Signature
Proof of
ownership
Proof of Transfer of funds
ownership
Digital Signature
Proof of Transfer of funds
Transfer of funds
ownership
Digital Signature
Digital Signature
Proof of
ownership
Proof of
ownership
‘Block Chain’ of verified Transactions
Mining requires solving cryptopuzzles
by brute-force methods
Application
Specific
Integrated
Circuit
1 ASIC = 70,000
Intel CPUs
Source: HashFast
Mining activity is determined by
hard economics






Avalon ASIC Miner
75 GigaHash/sec
Network speed: 140 TeraHash
0.05% of BTC network
0.05% of 3600 BTC /day =
1.8 BTC /day
$200/day
Source: Dec. 2013 data self-reported by a miner
BTC has a good value proposition
for miners in the short term
“Printing money”
Rewards ingenuity
Rapid depreciation
Malicious mining pools can rig the
ledger
“The system is secure as
long as honest nodes
collectively control more
CPU power than any
cooperating group of
attacker nodes”
– Satoshi Nakamoto
Hashrate distribution from
BitcoinX.com, Apr. 2014
Knowledge Continuum 2014
Exchanges &
Wallet Services
Weakest point in the BitCoin Ecosystem
Wallet services companies build software
that makes Bitcoin easier to use
 1,100,000 consumer wallets
 28,000 merchants
 U.S. bank integration
Source: coinbase.com Apr 2014
Exchanges trade BTC for other
currencies
Source: The wayback machine
Mt. Gox is no Ft. Knox
 Feb 7 – suspended
withdrawals
 Feb 28 - Bankruptcy
 850K BTC missing
 7% of the BTC supply
 No FDIC
Mark Karpeles, CEO of Tibanne Co.
The BTC platform is unsecure at its
outer edges
Sheep Marketplace lost $6 mil
Black Market Reloaded lost 200 BTCs
Silk Road 2.0 lost $2-6 mil
Flexcoin forced to close after hackers stole $590,000
Inputs.io (storage) was compromised and hackers stole
4,100 bitcoins ($1.2 million) in two separate attacks.
 MyBitcoin and Instawallet, have both shut down due to
thefts





BTC has a fair value proposition for
Wallet Services and Exchanges
Wallet Services
Low transaction costs
Semi-anonymous
Irreversible
Security
Volatile
Difficult legal remediation
Taxed as property
Exchanges
Knowledge Continuum 2014
Conclusion
“Stay Away!” - Warren Buffett
For the general public BitCoin has
low usefulness and ease of use
Users
Miners
BitCoin
Platform
Services:
Wallets &
Exchanges
Merchants
BitCoin has strong network effects
Users
Miners
BitCoin
Platform
Services:
Wallets &
Exchanges
Merchants
Users are the engine for BitCoin’s growth, but do
not have sufficient reasons to adopt it
Users
Miners
BitCoin
Platform
Services:
Wallets &
Exchanges
Merchants
As a currency, BTC scores
well below the Dollar
Jevons’ Functions of Money
Medium of exchange
- recognized / accepted
Store of value
- constant intrinsic value, or linked to a basket of goods
- safe
Unit of account
- standard unit of measurement for the value of goods,
services, or assets (e.g., Euro 1999-2002, UF in Chile)
Standard of payment
- enforceable legal tender
USD BTC
Ideal
crypto
currency
“It is a bubble, there is no
question about it.”
“The central problem with Bitcoin … is that it
doesn’t really solve any sensible economic
problem.”
Exhaustion of the pool of Bitcoins
will lead to transaction fees
Total Coins In Millions
2014: 12 Mil.
Source: Wikipedia
Satoshi Nakamoto Is The Alleged
Inventor of BitCoin
“I did not create, invent or otherwise work on Bitcoin” -Dorian Satoshi Nakamoto
An Experiment by Wired Confirmed
The Claims By Miners
 Butterfly Labs Bitcoin Miner, $274
 5.5 GH/s on average
 Eclipse Mining
Consortium
 2 BTC in 10 days.
“Our best definition would be that it is currently a
speculative financial asset that can be used as a medium
of exchange”
2009
2010
2011
2012
2013
2014
BTC is a bubble
 High volatility
 Market inefficiencies manifested as persistent
forex arbitrage opportunities
Forex Arbitrage Opportunities
 Exchange A: BTC = $1,000
 Exchange B: BTC = $1,100
1. Purchase 10 BTCs in Exchange A for $10,000
2. Immediately sell 10 BTCs in Exchange B for
$11,000
BitCoin is “Evil”
Trust
“Any transaction issued with Bitcoin cannot be
reversed, they can only be refunded by the
person receiving the funds. That means you
should take care to do business with people and
organizations you know and trust, or who have
an established reputation. ”
– BitCoin Website
BitCoin Faces a Long List of Serious
Challenges







Better articulation of CVP with users
Fostering trust in the face of high technical complexity
Credit and interest require legal framework (regulation)
Weeding out illegal uses of currency
Required 10-minutes delay in transaction confirmation
Deflationary and recessionary effects of fixed monetary bases
“Fatal flaw” of the verification schema
BitCoin is an electronic payment
system based on cryptographic proof





“electronic payment system based on cryptographic proof instead
of trust
allowing parties to transact directly with each other without the
need for a trusted third party
Transactions that are computationally impractical to reverse protect
sellers, and routine escrow mechanisms protect buyers.
peer-to-peer distributed timestamp server to generate
computational proof of the chronological order of transactions.
The system is secure as long as honest nodes collectively control
more CPU power than any cooperating group of attacker nodes”
A Chain of Transactions
[Source] 10 BTC to Paul15
I give 10 BTC to Bob34, signed: Paul15
I give 5 BTC to Mary82, signed: Bob34
I give 5 BTC to Ellen23, signed: Mary 82
…..
The Original Paper
 Mediation increase transaction costs
 Small transactions impractical
 Mediated transactions are reversible
 Increases fraud
 Reversibility requires trust
An electronic coin is a chain of
digital signatures
Source: Satoshi Nakamoto 08
The Double Spending Problem
Source: Satoshi Nakamoto 08
Distributed Timestamp Server
Source: Satoshi Nakamoto 08
Proof of work
Source: Satoshi Nakamoto 08
Network
1) New transactions are broadcast to all nodes.
2) Each node collects new transactions into a block.
3) Each node works on finding a difficult proof-of-work for its block.
4) When a node finds a proof-of-work, it broadcasts the block to all
nodes.
5) Nodes accept the block only if all transactions in it are valid and not
already spent.
6) Nodes express their acceptance of the block by working on creating
the next block in the chain, using the hash of the accepted block as the
previous hash.
Simplified Verification
Source: Satoshi Nakamoto 08
Silk Road
 Dread Pirate Roberts in jail
 Utopia closed after nine days in D and NL
 Charlie Shrem (24) founder of Bitinstant.com
arrested for recycling BTCs
Incentive
 “the first transaction in a block is a special
transaction that starts a new coin owned by
the creator of the block”
 “analogous to gold miners”
 Transaction fees also possible
Mining Profitability Over time is
Declining
US Government Stance
 US Treasury secretary Jack Lew said that he has
decided [on ] a wait-and-see strategy.
 “From the government’s perspective, we have to
make sure it does not become an avenue to funding
illegal activity or to funding activities that have
malign purposes like terrorist activities. You know, it
is an anonymous form of transaction, and it offers
places for people to hide.”
The days of anonymous transactions in Bitcoin and
operating an exchange with no outside interference are
over.

In March 2013, the Financial Crimes Enforcement Network, a part of the Treasury
Department known as FinCen, issued guidance stating that anyone operating an exchange
for virtual currencies would be considered to be running a money transmitting business.

That designation means exchanges must collect information about customers, as required
under Bank Secrecy Act regulations, which are intended to prevent transactions through
anonymous accounts. FinCen went a step further in its guidance by including any person
who puts into circulation a virtual currency, which means that the so-called Bitcoin miners are
also subject to the regulations. (FinCen last week issued a letter clarifying that users mining
Bitcoins for their own purposes would not be considered money transmitters under the Bank
Secrecy Act).

individuals and merchants who use Bitcoin like cash do not need to comply with the
regulations imposed on those operating exchanges.
The Economist Report





ASIC-based hardware
the kit paid for itself within three days
Between July and mid-November 2013 the computational
capacity of the Bitcoin network increased 25-fold, from 200
trillion to 5 quadrillion hashes per second.
Newer generation of more efficient ASICs in November
Hashing capacity has increased so rapidly in 2013 that the
practice of hijacking thousands of PCs and using them for
mining is no longer worth the effort

As the rate of transactions increases, squeezing all financial activity
into the preset size limit for each block has started to become
problematic. The protocol may need to be tweaked to allow more
transactions per block, among other changes. A further problem
relates to the volunteer machines, or nodes, that allow Bitcoin to
function. These nodes relay transactions and transmit updates to
the block chain. But, says Matthew Green, a security researcher at
Johns Hopkins University, the ecosystem provides no compensation
for maintaining these nodes—only for mining. The rising cost of
operating nodes could jeopardize Bitcoin’s ability to scale

Bitcoin’s growing popularity is having other ripple effects. Every
participant in the system must keep a copy of the block chain,
which now exceeds 11 gigabytes in size and continues to grow
steadily. This alone deters casual use. Bitcoin’s designer proposed a
method of pruning the chain to include only unspent amounts, but
it has not been implemented.

As the rate of transactions increases, squeezing all financial activity
into the preset size limit for each block has started to become
problematic. The protocol may need to be tweaked to allow more
transactions per block, among other changes.

The original paper that sparked the creation of Bitcoin has since
been supplemented by layers of agreed-upon protocol, updated
regularly by the system’s participants. The protocol, like the
currency, is a fiction they accept as real, because rejection by a
large proportion of users—be they banks, exchanges, speculators
or miners—could cause the whole system to collapse. Mr. Hearn
notes that he and other programmers who work on Bitcoin’s
software have no special authority in the system. Instead, proposals
are floated, implemented in software, and must then be taken up
by 80% of nodes before becoming permanent—at which point
blocks from other nodes are rejected. “The rules of the system are
not set in stone,” he says. The adoption of improvements is up to
the community. Bitcoin is thus both flexible and fragile.
Explaining BTC’s Limited Success
Psychological and Sociological reasons
 Alignment with libertarianism and anarchism
 No trust required
 Qualified anonymity
 Speculative greed
 Technological novelty
 Geek factor
Explaining BTC’s Limited Success
Economics & Business reasons
 Low transaction costs
 Ecosystem
 Network effects
 Fraud resistance (maybe)
 Irreversibility (maybe)