Decentralized Cryptocurrency Security and Financial Implications: The Bitcoin Paradigm

Decentralized Cryptocurrency Security and Financial Implications: The Bitcoin Paradigm

Amany Mohammed Alshawi (King Abdulaziz City for Science and Technology, Saudi Arabia)
DOI: 10.4018/978-1-7998-3645-2.ch001
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Abstract

The worldwide growth in electronic commerce has led to the emergence of digital currencies, which have been gaining public and research attention as an alternative method of payment. In recent years, Bitcoin has become a global currency with a multibillion USD market value. This is a result of the many attractive features of the currency including its distributed algorithms, cryptography, and incentive-driven performance. This chapter offers an in-depth investigation of the Bitcoin network along with its security and financial implications. All the components of the network are described along with details of the cryptographic foundations of the system. The chapter also describes the security and privacy implications of Bitcoin and proposes methods to minimize their effect. Finally, the chapter discusses the regulatory and financial implications of the Bitcoin network to show how countries around the world are reacting to the widespread use of cryptocurrencies.
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Introduction

Digital cryptocurrencies, such as Bitcoin, pose regulation challenges to financial and governmental institutions due to the decentralized open source nature of their creation and exchange. First put into circulation in January 2009, Bitcoin is one of the first online currencies to provide peer-to-peer, open-access tracking instruments for monetary transactions without external backing from a central bank (Nakamoto, 2008). Digital currencies based on a mathematics-backed payment protocol, such as Bitcoin, have also exhibited extreme upward and downward swings in their valuation; for example, Bitcoin grew in value to reach a record high value of more than 20,000 USD in October 2017. The starting value of the Bitcoin was only 0.0009 USD when it was first sold in 2009 (Beigel, 2019).

Cryptographic transaction protocols establish distributed networks of trust that are independent of social support structures for the verification of identity (Chait, 2015). Unlike conventional payment platforms (e.g., PayPal), digital cryptocurrencies (e.g., Bitcoin) can be less secure because of the increasing customization, centralization, and regulation of their transactions. Although the original design of Bitcoin aims at a fully decentralized payment system, recent events have revealed the true limits of the decentralization of the Bitcoin network. One is that a considerable number of centralized services currently host Bitcoin and control a large share of the Bitcoin market. Also, a number of Bitcoin developers hold privileged rights in the conflict resolution and maintenance of the official client version. These entities can decide the fate of the entire Bitcoin network by bypassing the rights and computing powers of the majority of other network users (Gervais, Karame, Capkun, & Capkun, 2014).

This has spawned a host of alternative cryptocurrency platforms, such as Ethereum (Youssefzadeh, 2014), which has created tension in the Bitcoin community between those who support its integration with existing institutions and those who resist its mediation by human judgment (Lustig & Nardi, 2015). Since digital cryptocurrencies enable direct money exchanges between different agents by eliminating intermediaries, they also create novel, legal possibilities of bargained-for exchanges (Fairfield, 2014). Virtual currencies such as Bitcoin are not inherently resistant to abuse, for instance, money laundering, financial fraud, or tax evasion. The illegal use of digital currencies can occur because they exist outside of established international institutional frameworks that intermediate the delivery of financial services (Abadi & Brunnermeier 2018; Pflaum & Hateley, 2014). As their computational models and verification protocols limit existing cryptographic currencies, virtual monetary transactions may involve inherent security risks (Kumaresan & Bentov, 2014).

At present, the value of Bitcoin, which already serves as a means of monetary exchange, can be predicted through transaction network characteristics, the cryptocurrency transaction volume, and the digital money supply. From a law enforcement and financial perspective, bringing Bitcoin into wider circulation may demand radical changes to the domain of international monetary control (Jeans, 2015). In recent years, digital cryptocurrencies have attracted an increasing amount of public attention. This is because they represent a novel kind of financial instrument that involves both risks, such as cybercrime facilitation, and financial opportunities derived from their innovative nature (Rehman et. al., 2019 and Huhtinen, 2014). This chapter presents the implications the tradeoff between distributed, decentralized, and deregulated foundations of digital cryptocurrencies (e.g., Bitcoin) and their cryptographic security has for their status as a means of unmediated digital monetary exchange (Spethoven, 2019)

Key Terms in this Chapter

Cryptocurrency: A digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank.

Blockchain: A system in which a record of transactions made in Bitcoin or another cryptocurrency is maintained across several computers that are linked in a peer-to-peer network.

Transaction: A Bitcoin transaction is a transfer of Bitcoin value that is broadcast to the network and collected into blocks. Standard transaction outputs nominate addresses, and the redemption of any future inputs requires a relevant signature.

Cryptographic Security: The study of secure communications techniques that allow only the sender and intended recipient of a message to view its contents. Data are encrypted using a secret key, and then both the encoded message and secret key are sent to the recipient for decryption.

Wallet: A blockchain wallet is a digital wallet that allows users to manage Bitcoin and Ether. A blockchain wallet is provided by blockchain technology.

Bitcoin: A type of digital currency in which a record of transactions is maintained, and new units of currency are generated by the computational solution of mathematical problems, and that operates independently of a central bank.

Cryptographic Algorithm: The means of altering data from a readable form (also known as plaintext) to a protected form (also known as ciphertext), and back to the readable form. Changing plaintext to ciphertext is known as encryption, whereas changing ciphertext to plaintext is known as decryption.

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