1138618152

Inside Blockchain, Bitcoin,
and Cryptocurrencies
Inside Blockchain, Bitcoin,
and Cryptocurrencies
By
Niaz Chowdhury
CRC Press
Taylor & Francis Group
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To my mother
Parveen Chowdhury
Contents
List of Figures...............................................................................................xix
List of Tables................................................................................................ xxv
About the Author.......................................................................................xxvii
Section I BLOCKCHAIN AND BITCOIN

1 Introduction to Blockchain.....................................................................3
1.1 The Birth of Bitcoin............................................................................3
1.1.1 A Mysterious Scientist............................................................4
1.1.2 What is Bitcoin?.....................................................................4
1.1.3 Double-Spending Problem.....................................................5
1.1.4 Nakamoto’s Solution..............................................................6
1.2 Blockchain..........................................................................................7
1.2.1 Motivation.............................................................................7
1.2.2 Definition of Blockchain........................................................8
1.2.3 Distributed Ledger.................................................................8
1.2.4 Key Properties........................................................................9
1.3 Architectural Overview....................................................................10
1.3.1 Centralised vs Decentralised Architecture...........................10
1.3.2 Peer-to-Peer Network...........................................................11
1.3.3 Characteristics.....................................................................13
1.4 Block................................................................................................14
1.4.1 Structure..............................................................................14
1.4.2 Block Identifier and Height..................................................15
1.4.3 Genesis Block.......................................................................16
1.5 Mining.............................................................................................16
1.5.1 What is Mining?..................................................................16
1.5.2 Consensus............................................................................16
1.5.3 Incentivisation.....................................................................17
1.6 Forks................................................................................................17
1.6.1 When Does a Fork Occur?...................................................17
1.6.2 Types of Forks......................................................................18
vii
viii ◾ Contents
1.7 Consensus Mechanisms....................................................................18

1.7.1 Proof of Work (PoW)...........................................................18
1.7.2 Alternative Consensus Algorithms.......................................19
1.7.3 Comparison.........................................................................20
1.8 Types of Blockchains........................................................................21
1.8.1 Public and Private Blockchains............................................21
1.8.2 Consortium, Shared Ledger, Sidechain................................21
1.8.3 Hybrid Blockchains.............................................................22
1.8.4 Comparison.........................................................................22
1.9 Applications......................................................................................23
1.10 Revisiting the Double-Spending Problem.........................................26
1.11 Summary..........................................................................................26
2 Immutability of Blockchain..................................................................27
2.1 Cryptography...................................................................................27
2.1.1 What Are Cryptography and Cryptanalysis?........................28
2.1.2 Background.........................................................................28
2.1.3 Basic Concepts.....................................................................29
2.2 Modern Cryptography......................................................................30
2.2.1 Symmetric-Key Cryptography.............................................31
2.2.2 Public-Key Cryptography....................................................33
2.3 Cryptographic Applications..............................................................36
2.3.1 TLS and SSL........................................................................36
2.3.2 Cryptographic Hash Function.............................................37
2.3.3 Digital Signature..................................................................38
2.4 Elliptic Curve Cryptography (ECC).................................................41
2.4.1 Basic Concept......................................................................41
2.4.2 Public and Private Keys....................................................... 42
2.4.3 How Does ECC Compare to RSA?......................................43
2.5 Making Blockchain Immutable....................................................... 44
2.5.1 Block and Block Header..................................................... 44
2.5.2 Timestamp.......................................................................... 44
2.5.3 Merkle Tree.........................................................................45
2.5.4 Building the Chain..............................................................45
2.6 Summary..........................................................................................48
3 Consensus Mechanisms of Blockchain..................................................49
3.1 Distributed Systems and Consensus.................................................49
3.1.1 Distributed Systems.............................................................50
3.1.2 Coordination and Agreement..............................................50
3.1.3 Consensus............................................................................51
3.2 Byzantine Generals Problem.............................................................52
3.2.1 Two Generals Paradox..........................................................52
Contents ◾ ix
3.2.2 Byzantine Generals Problem................................................53

3.2.3 Byzantine Fault Tolerance....................................................55
3.3 Blockchain’s Consensus Mechanism.................................................56
3.3.1 Hashcash Proof of Work......................................................56
3.3.2 Proof of Work in Blockchain...............................................57
3.3.3 BFT in Blockchain...............................................................58
3.4 Solving the Double-Spending Problem.............................................59
3.5 Summary..........................................................................................60
4 Bitcoin: World’s First Cryptocurrency..................................................61
4.1 What is Bitcoin?...............................................................................61
4.2 Brief History of Bitcoin....................................................................63
4.2.1 Before Bitcoin......................................................................63
4.2.2 Bitcoin Era.......................................................................... 64
4.3 Token: BTC.................................................................................... 64
4.3.1 Bitcoin Mining and Supply..................................................65
4.3.2 Units of Bitcoin................................................................... 66
4.4 Bitcoin’s Blockchain........................................................................ 66
4.4.1 Block Header.......................................................................67
4.4.2 Timestamp...........................................................................67
4.4.3 Merkle Tree.........................................................................67
4.4.4 Hash Generation..................................................................68
4.4.5 Genesis Block.......................................................................68
4.5 Bitcoin Address.................................................................................69
4.5.1 Formats................................................................................71
4.5.2 Hash Generation..................................................................72
4.5.3 Address Structure.................................................................72
4.6 Transactions.....................................................................................73
4.6.1 Input and Output................................................................74
4.6.2 Redeeming Tokens.............................................................. 77
4.6.3 Multi-Signature...................................................................78
4.6.3.1 Escrow..................................................................78
4.6.3.2 Cold Storage.........................................................78
4.6.4 Generation Transaction.......................................................79
4.6.5 Storing Data........................................................................79
4.6.6 Contracts.............................................................................79
4.7 Mining.............................................................................................80
4.7.1 Method................................................................................80
4.7.2 Proof of Work......................................................................82
4.7.3 Target and Difficulty...........................................................83
4.7.4 Mining Process................................................................... 84
x ◾ Contents
4.8 Split Coins and Altcoins...................................................................85

4.8.1 Split Coins...........................................................................85
4.8.1.1 Bitcoin Cash.........................................................85
4.8.1.2 Bitcoin Gold.........................................................85
4.8.1.3 Bitcoin Private.......................................................86
4.8.2 Altcoins................................................................................86
4.8.2.1 Namecoin.............................................................87
4.8.2.2 Litecoin.................................................................87
4.8.2.3 Peercoin................................................................88
4.8.2.4 Nxt........................................................................88
4.8.2.5 Dash.....................................................................88
4.9 Summary..........................................................................................89
Section II SMART CONTRACTS

5 Ethereum and Smart Contracts.............................................................93
5.1 Introduction to Smart Contracts......................................................93
5.1.1 Vending Machine Analogy..................................................94
5.1.2 Nick Szabo and Bit Gold.....................................................95
5.1.3 Turing-Completeness...........................................................96
5.2 What is Ethereum?...........................................................................96
5.3 Token: ETH.....................................................................................97
5.3.1 Pre-Mining..........................................................................97
5.3.2 Price.....................................................................................98
5.3.3 Units....................................................................................98
5.4 Architecture......................................................................................99
5.4.1 Ethereum Virtual Machine (EVM).....................................99
5.4.2 Account.............................................................................100
5.4.3 Address..............................................................................101
5.4.4 Mist...................................................................................101
5.5 Mining...........................................................................................102
5.5.1 Mining Process..................................................................102
5.5.2 Block-Generation Rate.......................................................103
5.5.3 Rewards.............................................................................103
5.6 Smart Contracts in Ethereum.........................................................103
5.6.1 Transactions.......................................................................103
5.6.2 Gas....................................................................................104
5.6.3 High-Level Languages.......................................................104
5.7 ERC Standards...............................................................................105
5.7.1 ERC-20..............................................................................105
5.7.2 ERC-223............................................................................106
5.7.3 ERC-721............................................................................106
5.7.4 Other Standards................................................................107
Contents ◾ xi
5.8 Comparison to Bitcoin...................................................................107

5.9 Summary........................................................................................107
6 NEO....................................................................................................109
6.1 What is NEO?................................................................................109
6.2 Token: NEO and GAS................................................................... 110
6.2.1 Token Generation.............................................................. 110
6.2.2 Token Distribution............................................................ 111
6.3 Architecture.................................................................................... 111
6.3.1 Basic Structure................................................................... 111
6.3.2 Advanced Features............................................................. 111
6.4 Consensus Mechanism: dBFT........................................................112
6.4.1 Algorithm..........................................................................112
6.4.2 Procedure...........................................................................113
6.4.3 Transaction Validation.......................................................113
6.4.4 View Change..................................................................... 114
6.4.5 Fault Tolerance and Transaction Time............................... 114
6.5 Smart Contracts............................................................................. 114
6.6 Summary........................................................................................ 116
7 EOS..................................................................................................... 117
7.1 What is EOS?................................................................................. 117
7.2 Token: EOS.................................................................................... 118
7.2.1 Initial Coin Offering.......................................................... 118
7.2.2 Transaction Fees................................................................ 119
7.2.3 Inflation............................................................................. 119
7.3 Architecture.................................................................................... 119
7.4 Consensus Mechanism: DPoS........................................................120
7.4.1 Algorithm..........................................................................120
7.4.2 Procedure...........................................................................121
7.4.3 Reward..............................................................................122
7.5 Smart Contracts.............................................................................122
7.6 EOS.IO Operating System.............................................................123
7.6.1 Schema-Defined Actions and Database..............................123
7.6.2 Separation of Authentication from Applications................124
7.6.3 Inter-Blockchain Communication.....................................124
7.7 Summary........................................................................................124
Section III FINANCIAL NETWORKS

8 Ripple..................................................................................................127
8.1 What is Ripple?..............................................................................127
8.2 Token: XRP....................................................................................128
xii ◾ Contents
8.2.1 Token Generation and Distribution...................................128

8.2.2 Bridge Currency.................................................................129
8.2.3 Market Capitalisation........................................................129
8.3 Architecture....................................................................................129
8.3.1 Hawala...............................................................................130
8.3.2 XRP Ledger.......................................................................131
8.3.3 Transactions.......................................................................132
8.4 Consensus Mechanism: RPCA.......................................................133
8.4.1 Components......................................................................133
8.4.2 Consensus Process.............................................................134
8.4.3 Correctness........................................................................135
8.5 Codius and Interledger...................................................................136
8.6 Real-Time Gross Settlement System...............................................136
8.6.1 RippleNet..........................................................................137
8.6.2 xCurrent............................................................................138
8.6.3 xRapid...............................................................................139
8.6.4 xVia....................................................................................139
8.7 Partners..........................................................................................139
8.8 Summary........................................................................................ 141
9 Stellar ..................................................................................................143
9.1 What Is Stellar?..............................................................................143
9.2 Token: Lumens (XLM)..................................................................144
9.2.1 Generation and Distribution..............................................144
9.2.2 Price and Market Cap........................................................ 145
9.2.3 Role of XLM in the Protocol............................................. 145
9.3 Architecture....................................................................................146
9.4 Consensus Mechanism...................................................................146
9.4.1 Quorum and Slices............................................................146
9.4.2 Agreement..........................................................................148
9.5 Applications....................................................................................148
9.5.1 Anchors..............................................................................148
9.5.2 Distributed Exchange........................................................149
9.5.3 Multi-Currency Transactions.............................................149
9.6 Partners.......................................................................................... 153
9.7 Summary........................................................................................ 153
Section IV ADVANCED LEDGERS AND APPLICATIONS

10 Purpose-Built Distributed Ledgers.....................................................157
10.1 Purpose-Built Ledgers and Blockchains.......................................... 157
10.2 Internet of Things: IOTA............................................................... 159
10.2.1 Overview........................................................................... 159
Contents ◾ xiii
10.2.2 Technical Details............................................................... 159

10.2.3 Applications....................................................................... 161
10.2.4 Alternatives: IBM Watson and Waltonchain...................... 161
10.3 Supply Chain: OriginTrail..............................................................162
10.3.1 Overview...........................................................................162
10.3.2 Technical Details...............................................................163
10.3.3 Applications.......................................................................163
10.3.4 Alternatives: VeChain and OpenChain..............................163
10.4 Connectivity: Moeco......................................................................164
10.4.1 Overview...........................................................................164
10.4.3 Applications.......................................................................166
10.5 Cybersecurity: Naoris.....................................................................166
10.5.1 Overview...........................................................................166
10.5.3 Applications.......................................................................168
10.6 Private Network: HydraChain........................................................168
10.6.1 Overview...........................................................................168
10.6.3 Applications.......................................................................170
10.7 Framework: Hyperledger................................................................170
10.7.1 Overview...........................................................................170
10.7.3 Application........................................................................173
10.8 Emerging Distributed Ledgers........................................................173
10.8.1 Medical Services: MediChain and MediLedger.................173
10.8.2 Drug Development: BlockPharma..................................... 174
10.8.3 Quality Assurance: Ambrosus............................................ 174
10.8.4 Sharing Economy: Slock.it................................................. 174
10.8.5 Genomic Data Collection: Nebula Genomics.................... 174
10.9 Summary........................................................................................175
11 Applications of Blockchain.................................................................177
11.1 Hype or Hope?...............................................................................177
11.2 Classification..................................................................................180
11.2.1 Classifying the Domains.................................................... 181
11.2.2 Classifying the Categories.................................................. 181
11.3 Citizen Services..............................................................................182
11.3.1 e-Governance.....................................................................182
11.3.2 Healthcare.........................................................................183
11.3.3 Education..........................................................................185
11.4 Business and Financial Services......................................................186
11.4.1 Financial Services...............................................................186
xiv ◾ Contents
11.4.2 Smart Property..................................................................187

11.4.3 Exchange and Trading.......................................................187
11.5 Online Marketplace........................................................................187
11.5.1 e-Commerce......................................................................188
11.5.2 Online Betting, Gambling and Gaming............................189
11.5.3 e-Auctions and Online Bidding.........................................189
11.6 Supply Chain, Production and Provenance..................................... 191
11.6.1 Commercial Supply Chain................................................. 191
11.6.2 Food Production................................................................ 191
11.6.3 Drug Manufacturing.........................................................192
11.7 Safety and Security.........................................................................193
11.7.1 Cybersecurity.....................................................................193
11.7.2 Physical Safety, Security and Tracking...............................194
11.8 Smart City......................................................................................195
11.8.1 Smart Home......................................................................195
11.8.2 Smart Transportation.........................................................196
11.8.3 Smart Grid.........................................................................196
11.8.4 Citizen Engagement...........................................................197
11.8.5 Quality Control.................................................................197
11.9 Summary........................................................................................198
Section V CRYPTOCURRENCY
12 Evolution of Money: From Barter to Bitcoin.......................................201
12.1 Money............................................................................................201
12.1.1 Functions of Money...........................................................202
12.1.2 Properties...........................................................................202
12.1.3 Money Supply....................................................................203
12.1.4 Central Bank.................................................................... 204
12.2 Origin and Early Forms................................................................. 204
12.2.1 Barter: The Origin of Money?........................................... 204
12.2.2 Commodity and Representative Money............................ 206
12.2.3 Coinage.............................................................................207
12.2.4 Banknotes..........................................................................209
12.3 Fiat Money.....................................................................................212
12.3.1 Gold Standard...................................................................212
12.3.2 US Dollar Standard...........................................................212
12.3.3 Nixon Shock and Creation of Fiat Money..........................213
12.4 Digital Money................................................................................213
12.4.1 Centralised Digital Money.................................................213
12.4.2 Decentralised Digital Money............................................. 214
12.5 Cryptocurrency.............................................................................. 215
12.6 Summary........................................................................................ 217
Contents ◾ xv
13 Cryptocurrency Mining......................................................................219
13.1 Mining........................................................................................... 219
13.1.1 Evolution of Mining......................................................... 220
13.1.2 Mining Process................................................................. 220
13.1.3 Difficulty...........................................................................221
13.1.4 Rewards.............................................................................221
13.2 Hash Rate.......................................................................................221
13.2.1 Understanding Hash Rate..................................................221
13.2.2 Calculating Hash Rate...................................................... 222
13.2.3 Hash Rate and Profits....................................................... 222
13.3 Mining Hardware.......................................................................... 222
13.3.1 Non-Specialised Hardware............................................... 222
13.3.2 Specialised Hardware (ASICs)...........................................224
13.3.3 Profitability Factors............................................................225
13.4 Pooled Mining................................................................................225
13.4.1 Pooled Mining Basics.........................................................225
13.4.2 Mining Pools.................................................................... 226
13.4.3 Reward Sharing................................................................ 228
13.5 Mining Nations............................................................................. 228
13.6 Criticism of PoW Mining...............................................................229
13.7 Summary........................................................................................231
14 Cryptocurrency Wallet........................................................................233
14.1 Wallet.............................................................................................233
14.1.1 Private Key and Address.................................................... 234
14.1.2 Transferring Funds........................................................... 234
14.2 Types of Wallets.............................................................................235
14.2.1 Web Wallet........................................................................236
14.2.2 Software Wallet.................................................................236
14.2.3 External Storage Media......................................................238
14.2.4 Paper Wallet.......................................................................238
14.2.5 Hardware Wallet................................................................239
14.2.6 Brain Wallet.......................................................................240
14.3 Special Wallets...............................................................................241
14.3.1 Multi-Signature Wallet......................................................241
14.3.2 Cold-Storage Wallet...........................................................241
14.3.3 Receive-Only Wallet..........................................................242
14.4 Deterministic Wallet......................................................................242
14.4.1 Type-1 Wallet....................................................................242
14.4.2 Type-2 Wallet....................................................................243
14.4.3 HD Wallet........................................................................ 244
14.5 Wallet Providers............................................................................ 246
14.6 Summary........................................................................................247
xvi ◾ Contents
15 Cryptocurrency Trading and Investment............................................249

15.1 Investment......................................................................................249
15.1.1 Financial Instruments........................................................250
15.1.2 Commodities.....................................................................251
15.1.3 Currencies..........................................................................251
15.1.4 Derivatives.........................................................................252
15.1.5 Status of Cryptocurrency...................................................253
15.2 Portfolio.........................................................................................253
15.2.1 Funds.................................................................................253
15.2.2 Indices...............................................................................254
15.2.3 ETFs..................................................................................256
15.3 Exchanges and Platforms................................................................257
15.3.1 Cryptocurrency Trading Exchange....................................258
15.3.2 Derivative Trading Exchanges...........................................259
15.3.3 Investment Platforms........................................................ 260
15.4 Investment Strategy........................................................................261
15.4.1 Day Trading.......................................................................261
15.4.2 Buy and Hold....................................................................262
15.4.3 Value Investment...............................................................262
15.5 Investing in Cryptocurrencies.........................................................262
15.5.1 Self-Investment..................................................................263
15.5.2 Guided Investment........................................................... 264
15.6 Regulation and Tax Affairs.............................................................265
15.7 Summary....................................................................................... 266
16 Initial Coin Offerings (ICOs)..............................................................267
16.1 Overview........................................................................................267
16.1.1 The Creation of ICOs....................................................... 268
16.1.2 How Do ICOs Work?........................................................269
16.2 Token Creation...............................................................................269
16.2.1 Token.................................................................................269
16.2.2 Platforms............................................................................270
16.3 Understanding ICOs......................................................................271
16.3.1 ICOs vs IPOs.....................................................................271
16.3.2 Signs of Good and Bad ICOs.............................................272
16.3.3 Advantages and Disadvantages..........................................273
16.4 ICOs in Number............................................................................274
16.4.1 Amount Raised..................................................................274
16.4.2 Breakdown by Industry......................................................274
16.4.3 Biggest Winners and Losers...............................................275
16.5 Scams and Criticisms.....................................................................275
16.6 Summary........................................................................................277
Contents ◾ xvii
Section VI SOCIO-ECONOMIC LANDSCAPE

17 Economic Outlook of Cryptocurrency................................................281
17.1 Classification..................................................................................281
17.1.1 Currency............................................................................282
17.1.2 Commodity.......................................................................283
17.1.3 Stock................................................................................. 284
17.2 Price of Bitcoin.............................................................................. 284
17.3 Volatility of Bitcoin........................................................................285
17.4 Historic Price Predictions...............................................................287
17.5 Price Movement of Major Cryptocurrencies...................................287
17.5.1 ETH..................................................................................288
17.5.2 XRP...................................................................................288
17.5.3 XLM..................................................................................289
17.5.4 NEO..................................................................................289
17.5.5 EOS...................................................................................289
17.6 Reception.......................................................................................290
17.6.1 Acceptance by Merchants..................................................290
17.6.2 Acceptance by Investors.....................................................291
17.6.3 Acceptance by Governments..............................................292
17.7 Summary........................................................................................293
18 Crime, Criminals and Cryptocurrencies.............................................295
18.1 Criminal Activities.........................................................................295
18.2 Deep Web.......................................................................................296
18.2.1 Darknet and Dark Web.....................................................297
18.2.2 Onion Routing and Tor.....................................................297
18.2.3 Bitcoin: The Missing Piece.................................................298
18.3 Darknet-Based Crimes...................................................................299
18.3.1 Silk Road...........................................................................299
18.3.2 Post-Silk Road Markets......................................................301
18.3.3 Assassination Markets....................................................... 304
18.3.4 Cybercrimes...................................................................... 306
18.4 Financial Crimes........................................................................... 308
18.4.1 Money Laundering........................................................... 308
18.4.2 Market Manipulation........................................................ 310
18.5 Fraudulent Activities....................................................................... 310
18.5.1 False Claims....................................................................... 311
18.5.2 Scams.................................................................................312
18.6 Prevention......................................................................................312
18.6.1 Regulation.........................................................................313
18.6.2 Cooperation....................................................................... 314
18.6.3 Participation...................................................................... 315
18.7 Summary........................................................................................ 316
xviii ◾ Contents
19 Regulations, Laws and Practices......................................................... 317

19.1 Legality of Blockchain and Cryptocurrency................................... 317
19.2 Regulatory Issues............................................................................ 318
19.2.1 Misuse of Pre-Mining and ICOs........................................ 319
19.2.2 Crackdowns on Mining and Trading................................. 319
19.3 Current Landscape.........................................................................320
19.3.1 Challenges.........................................................................320
19.3.2 Areas..................................................................................321
19.3.3 Blockchain-Friendly Nations.............................................322
19.4 Regulations for Blockchain Technology and Cryptocurrency.........323
19.4.1 The Americas.....................................................................323
19.4.2 Europe...............................................................................324
19.4.3 Asia....................................................................................326
19.4.4 Australia and Africa...........................................................327
19.5 Summary........................................................................................328
20 Criticism, Scepticism and Support......................................................329
20.1 Before It All Started........................................................................329
20.2 Early Days of Bitcoin......................................................................330
20.3 Bitcoin Grabs Attention..................................................................331
20.4 Beginning of the Bull Run.............................................................332
20.5 Crazy Price Hike............................................................................334
20.6 To Invest or Not to Invest?.............................................................335
20.7 $10K and Counting........................................................................337
20.8 Nosedive.........................................................................................338
20.9 Summary....................................................................................... 344
Bibliography.................................................................................................345
Index............................................................................................................355
List of Figures
Figure 1.1 Centralised and decentralised currency transfer................................5

Figure 1.2 Double-spending
in digital currency is the act of using the
same token more than once...............................................................6
Figure 1.3 A general ledger from the 19th century.............................................9
Figure 1.4 A
centralised client–server architecture where the server
retains the absolute power of providing or denying any
service and data...............................................................................10
Figure 1.5 A
blockchain over a peer-to-peer network is an example of
a decentralised architecture where every participating node
simultaneously acts as a server and a client......................................11
Figure 1.6 A peer-to-peer network....................................................................12
Figure 1.7 A
blockchain over a P2P network is an example of a
decentralised architecture where every participating node
simultaneously acts as a server and a client by keeping a copy
of the blockchain.............................................................................13
Figure 1.8 A
blockchain where the main chain consists of the longest
series of blocks from the genesis block (in black) to the
latest block......................................................................................15
Figure 1.9 Types of major and customised blockchains....................................23
Figure 2.1 Steps of a symmetric-key encryption...............................................31
Figure 2.2 Steps of a public-key encryption.................................................... 34
Figure 2.3 B
itcoin.org, the original domain that Nakamoto registered
for Bitcoin, using “https” protocol..................................................37
xix
xx ◾ List of Figures
Figure 2.4 Th
e SHA256 hash generation of an excerpt from a Sherlock
Holmes book and its title................................................................38
Figure 2.5 Steps of a typical digital signature.................................................. 40
Figure 2.6 Examples of elliptic curves............................................................. 42
Figure 2.7 A typical Merkle tree..................................................................... 46
Figure 2.8 E
ach block in a blockchain is chained to one another using
cryptographic hashes.......................................................................47
Figure 3.1 Two generals planning an attack on a common enemy...................53
Figure 3.2 Th
ree Byzantine lieutenant generals led by a commanding
general planning to attack an enemy city........................................54
Figure 3.3 Th
ree Byzantine lieutenant generals led by a commanding
general, who is the traitor in this scenario, planning to attack
an enemy city..................................................................................55
Figure 3.4 A sample Hashcash version 1 header...............................................56
Figure 3.5 Byzantine fault tolerance in blockchain...........................................58
Figure 3.6 Heat map showing Bitcoin miners from around the globe..............59
Figure 4.1 Bitcoin price from 18 December 2016 to 18 December 2018..........65
Figure 4.2 Th
e headline of the British newspaper The Times published on
3 January 2009...............................................................................70
Figure 4.3 The hexadecimal version of the Genesis block of Bitcoin................71
Figure 4.4 Steps showing the address generation of Bitcoin.............................73
Figure 4.5 The address where Bitcoin.org receives donations............................74
Figure 4.6 A
s of 15 December 2018, the donation address of Bitcoin.org
was involved in 364 transactions receiving 17.60 BTC...................74
Figure 4.7 A conceptual transaction on the Bitcoin network............................76
Figure 4.8 A real transaction on the Bitcoin network.......................................76
Figure 4.9 Th
e cold storage wallet of the Bitcoin exchange Bitfinex that
uses a single 3-of-6 multi-signature address.................................... 77
Figure 4.10 H
eat map showing the presence of miners from around
the globe.......................................................................................80
List of Figures ◾ xxi
Figure 4.11 The number of miners throughout 2018........................................82

Figure 4.12 A
Bitcoin Gold address used to transfer the funds from
exchanges after a successful 51% hashing attack by an
unknown adversary in 2018..........................................................86
Figure 5.1 A vending machine selling cold drinks............................................94
Figure 5.2 Th
e price chart of Ether in USD (black) and BTC (grey) from
August 2015 to December 2018......................................................98
Figure 5.3 A
n example of a state transition diagram showing the states of
a door – either closed or opened....................................................100
Figure 5.4 The interface of the Ethereum wallet application Mint.................102
Figure 6.1 N
EO consensus mechanism in the presence of a no dishonest
node; hence the view change is not shown.................................... 115
Figure 7.1 A
s of December 2018, 100 individuals owned over 75% of
the tokens with only 20 people retaining over 60%
of the total..................................................................................... 118
Figure 7.2 The consensus mechanism of EOS blockchain platform................121
Figure 8.1 Th
e competition between Ripple (XRP) and Ethereum (ETH)
between 4 December 2017 and 4 December 2018 to become
the second largest cryptocurrency by market capitalisation
after Bitcoin (BTC).......................................................................130
Figure 8.2 The execution of a hawala transaction...........................................131
Figure 8.3 A page of the Ripple ledger showing its various components.........132
Figure 8.4 Unique Node List (UNL) in Ripple..............................................134
Figure 8.5 The consensus process of Ripple....................................................135
Figure 8.6 The cooperation between Codius and Interledger.........................137
Figure 8.7 The RippleNet Ecosystem.............................................................138
Figure 9.1 The price chart of XLM against USD (black) and BTC (grey)...... 145
Figure 9.2 Quorum and slices as formed in the Stellar network.....................147
Figure 9.3 Multi-currency transactions in Stellar........................................... 151
Figure 10.1 Tangle, consensus mechanism of IOTA......................................160
xxii ◾ List of Figures
Figure 10.2 Layers of the OriginTrail platform..............................................162

Figure 10.3 The architecture of the Moeco platform......................................165
Figure 10.4 A rchitecture of the Naoris blockchain ecosystem........................167
Figure 10.5 Block-building process in HydraChain.......................................169
Figure 10.6 The architecture of the Hyperledger Fabric.................................172
Figure 11.1 Gartner hype cycle for emerging technologies (August 2018)......179
Figure 11.2 A
classification of blockchain domains and categories for
potential use-cases.......................................................................182
Figure 11.3 A
n electronic voting machine sarcastically showing the
voting options for the Sheriff of Nottingham Forest from the
Robin Hood folklore...................................................................184
Figure 11.4 A
blockchain-based auction website for individuals to buy
and sell goods through live bidding.............................................190
Figure 11.5 S upermarkets in the United Kingdom often claim their beef
is of British and Irish origin.........................................................192
Figure 12.1 A
Carthaginian shekel made of a naturally occurring alloy of
gold and silver commonly known as electrum from 310–290
BC, bearing the image of Tanit, consort of Ba‘al Hammon,
the chief god of Carthage............................................................207
Figure 12.2 ( a) An oxhide ingot from Crete. Late Bronze Age metal
ingots were given standard shapes, such as the shape of an
“ox-hide”, suggesting that they represented standardised
values. (b) The earliest inscribed coinage, an electrum coin
of Phanes from Ephesus, 625–600 BC. (c) Coin of Alyattes
of Lydia (620–564 BC). (d) Gold Croeseid, minted by King
Croesus circa 561–546 BC......................................................... 208
Figure 12.3 A
Song dynasty jiaozi, the world’s earliest paper money (left)
and a Yuan dynasty banknote with Chinese and Mongol
words (right)...............................................................................210
Figure 12.4 G
old standard dollar bill of 1928. The bottom reads “20
dollars in gold coin payable to the bearer on demand.”...............212
Figure 12.5 A
taxonomy of money showing the position of
cryptocurrency and virtual currency within the major
categories.................................................................................... 214
List of Figures ◾ xxiii
Figure 13.1 M
ining hardware (clockwise from top left): CPU, GPU,
FPGA and ASIC.........................................................................223
Figure 13.2 Profit estimation from Bitcoin mining....................................... 226
Figure 13.3 Standing of the mining pools during early 2019.........................227
Figure 13.4 A mining farm operated by Genesis Mining in Iceland...............229
Figure 13.5 E
nergy consumption for mining cryptocurrencies compared
to precious metals.......................................................................230
Figure 14.1 A typical fund transfer of major cryptocurrencies.......................235
Figure 14.2 A typical paper wallet.................................................................239
Figure 14.3 A
n actual Bitcoin transaction from a web-based
cryptocurrency exchange to a hardware wallet............................240
Figure 14.4 The five wealthiest Bitcoin addresses...........................................243
Figure 15.1 Cryptocurrency distributions in CRIX Index.............................256
Figure 15.2 A n exchange offering Bitcoin CFD............................................ 260
Figure 15.3 eToro gives the option to copy experienced traders..................... 264
Figure 17.1 A
Bitcoin ATM at a shop in Wien Westbahnhof railway
station, Vienna.............................................................................282
Figure 17.2 The historic price movement of Bitcoin...................................... 286
Figure 17.3 B
itcoin is accepted as a method of payment at a cafe in Delft,
the Netherlands...........................................................................291
Figure 17.4 A
map showing outlets accepting Bitcoin as a method of
payment in London (left) and New York (right)..........................292
Figure 18.1 A
flowchart depicting Silk Road’s payment system submitted
as evidence in a US court at the trial of the founder of Silk
Road...........................................................................................299
Figure 18.2 D
igital Citizens Alliance reported that a trade volume of
almost $50,000 involved drugs in the darknet markets from
2013 to 2015 (the Y-axis shows data in thousands)..................... 304
Figure 18.3 Th
ere are websites such as www.darkwebnews.com that gives
nearly live status of the existing darknet markets........................305
xxiv ◾ List of Figures
Figure 18.4 A
screenshot from the Tor Assassination Market showing
the listing of an influential person from the United States
and the prize money of the equivalent of about $1.7 million
(as of December 2017)................................................................307
List of Tables
Table 1.1 Consensus Mechanism Comparison.................................................20

Table 1.2 Blockchain Comparison...................................................................24
Table 2.1 Renowned Symmetric-Key Algorithms.............................................33
Table 2.2 NIST Recommended Key Size........................................................ 44
Table 4.1 Bitcoin Units................................................................................... 66
Table 4.2 Bitcoin Header Fields.......................................................................68
Table 4.3 Transaction Format..........................................................................75
Table 4.4 Percentage of Bitcoin Miners from Top 15 Countries ......................81
Table 5.1 Ether Units.......................................................................................99
Table 8.1 Notable Partners of Ripple..............................................................140
Table 9.1 List of Anchors on the Stellar Network...........................................150
Table 9.2 List of Stellar Partners..................................................................... 152
Table 12.1 List of Notable Cryptocurrencies..................................................216
Table 13.1 P
rice and Hash Rate Comparison of the Latest Bitcoin-
Mining ASICs (as of January 2019)..............................................224
Table 14.1 Major Financial Regulatory Bodies...............................................237
Table 14.2 Major Wallet Providers.................................................................245
Table 15.1 Renowned Cryptocurrency Funds................................................255
Table 15.2 Renowned Blockchain ETFs.........................................................257
Table 16.1 ICOs vs IPOs................................................................................271
Table 16.2 Key Advantages and Disadvantages of ICOs................................273
Table 16.3 ICOs by Industry (as of 2018).......................................................276
xxv
About the Author
Dr Niaz Chowdhury is a postdoctoral researcher working with blockchain tech-

nology in the European Union-funded project QualiChain. His research expe-
rience spans over a decade across England, Scotland and Ireland. He presently
holds a Research Associate position in the Open Blockchain group of Knowledge
Media Institute, a small but renowned and well-regarded research lab within the
Open University in England. He also completed two more postdocs before joining
this position, one in the Department of Computing and Communication in the
same university, working for the Big Data and Smart City project MK:Smart, and
another at his current lab in the Data Science group.
Dr Chowdhury earned his PhD from the School of Computing Science at the
University of Glasgow in Scotland, as a recipient of the prestigious Scottish ORS
Scholarship. He was also a research scholar at the School of Computer Science in
Trinity College Dublin where he received the Government of Ireland IRCSET
Embark Initiative Scholarship. His earlier academic achievements include a bach-
elor’s degree and a master’s degree with gold medal distinction in computer science
and engineering from East West University, Bangladesh. Dr Chowdhury has pub-
lished numerous journal articles, conference papers and book chapters on block-
chain technology, the Internet of Things, wireless networks and data science.
xxvii
Part I
BLOCKCHAIN I
AND BITCOIN
Chapter 1
Introduction to
Blockchain
Blockchain was first introduced to facilitate the virtual currency Bitcoin. The devel-
opment of this disruptive technology, however, did not stop there. Researchers and
developers around the world have been continuously exploring new areas where
blockchain can be used to expedite innovative applications beyond Bitcoin. It is
now considered one of the most influential inventions of the 21st century capable of
reshaping the face of many existing industries. While this book presents an elabo-
rate commentary on this technology as to how it aids the development of exciting
new applications and improves current use-cases, this chapter provides a general
overview to start. The subsequent chapters will be arranged on this foundation to
expand the discussion and understand blockchain technology without limiting its
capacity as the Bitcoin facilitator.
1.1 The Birth of Bitcoin

Unless someone lives in a stranded island or on a remote mountaintop, it is highly
unlikely that he or she has not heard the name Bitcoin. When this virtual currency
reached a price as high as approximately $20,000 in December 2017, the internet
was flooded by news, views and rumours related to Bitcoin and other cryptocur-
rencies. TV channels, newspapers and web portals all tried to cover news circling
this price hike. Many people called it the biggest bubble of the century, prominent
figures in the tech and financial industries expressed their scepticism against it, and
many openly declared their faith in this new technology. If the entry of this tech-
nology sounds grand, its making was no less appealing either. It all started in 2008.
3
4 ◾ Inside Blockchain, Bitcoin, and Cryptocurrencies
1.1.1 A Mysterious Scientist

The year 2008 saw the world adapting many new technologies. The mobile phone
model that revolutionised the use of smartphones, the iPhone 3G, hit the market
in July followed by the first commercial Android device launch in September. The
social networking site Facebook reached the 100-million-users milestone, while
Twitter experienced a massive 250 times growth in its tweets-per-quarter metric
compared to that of the previous year. Camera giant Nikkon launched the first
video-enabled SLR camera, pocket cameras became HD, notebook laptops began
to show up in the stores and USB 3.0 was released. GPS, an old technology that
almost stayed out of sight of the public for many years, suddenly popped up every-
where triggered by the rise of the smartphone and notebook computers. The launch
of Apple’s App Store took place the same year [Ganapati, 2008].
Amid the arrival of these thriving technologies, most people were oblivious to a
discovery that a mysterious scientist stated. Nobody knew him. Nobody ever heard
of him. Google searches for his name returned no relevant information. He fan-
cied staying behind the curtain, disregarding the conventional norms of scientific
discoveries. Generally, scientists submit their works in peer-reviewed journals that
follows a long and stressful journey of getting scrutinised by the experts and gain-
ing recognition through discussions and constructive criticisms. This mysterious
scientist, instead of picking up a journal, published his work on the cryptographic
mailing list metzdowd.com. Initially, he failed to gain much attention from the
core scientific community, but within a couple of years, researchers around the
world realised the potential of his invention. His work that was supposed to be a
digital currency transaction protocol turned out to be a whole new branch of tech-
nology centred on the fundamental concept known as blockchain.
The name of the mysterious scientist that appeared on the publication is Satoshi
Nakamoto, and the currency transaction protocol that made him famous is Bitcoin.
It is now widely anticipated that this name is a pseudonym. It could refer to an indi-
vidual or a group of individuals whose identity remained undisclosed and untrace-
able. It means there is no one to publicly take the credit for one of the most famous
inventions of the 21st century.
1.1.2 What is Bitcoin?
Bitcoin (BTC) is a virtual currency or more particularly a currency transaction pro-
tocol. It transfers money over a digital medium [Nakamoto, 2008]. This invention
does not sound groundbreaking; rather pretty ordinary as we frequently use digital
transactions in the form of bank-to-bank money transfers, credit card transactions,
PayPal payments and so forth. Why would we call Bitcoin special in the presence
of so many alternatives? The answer lies in how it functions. There is a big differ-
ence between a bank transaction and a Bitcoin transaction. Transactions offered
by banks and financial institutions as a service do not move the money physically,
Introduction to Blockchain ◾ 5
instead the providers need to facilitate the actual transfer between them afterwards.
What they offer is a centralised infrastructure that users can rely upon and trust.
For example, if Bob* sends $100 to Alice using his mobile banking app, Alice’s
account could be debited instantly by her bank based on the trust that Bob’s bank
will settle this payment later. What makes Bitcoin a groundbreaking invention is
its ability to virtually move the money over a digital medium and settle the pay-
ment almost immediately without the need for a central body. If Bob sends 100
BTC to Alice, she receives the amount in her wallet straightway. There will be no
institutional involvement and no need for a further settlement process (Figure 1.1).
1.1.3 Double-Spending Problem
One might think, what would go wrong if we send digital money as if sending an
image or an email. The short answer is sending money like an image or an email
- 100 USD - 100 BTC
Bob Bob
Bob’s Alice’s
Bank Bank
+ 100 USD + 100 BTC

Alice Alice
Money Transfer Bitcoin Transfer
Figure 1.1 Centralised and decentralised currency transfer.
* Alice and Bob are fictional characters commonly used as placeholder names in cryptology. Ron
Rivest and his fellow co-authors Adi Shamir and Leonard Adleman created these characters
for their 1978 paper “A method for obtaining digital signatures and public-key cryptosystems”.
The primary motivation of creating Alice and Bob is to describe the cryptosystem conveniently
to the readers. Subsequently, these characters have become common archetypes in many sci-
entific and engineering fields including quantum cryptography, game theory and physics. As
the use of Alice and Bob became more popular, additional characters were added, each with a
particular meaning. In this book, Carol is used as an honest third participant and Chuck as a
third participant of malicious intent.
is technically and technologically possible. In fact, Bitcoin transfers money using a

similar method, if not the same. The problem, however, is not in how to send the
money but rather how many times the same money is sent; hence it introduces a
puzzle – the double-spending problem [Antonopoulos, 2010].
This problem states a flaw in the system allowing a person to spend the same
money more than once. In an ideal world, the same money can be spent only once.
To facilitate this requirement, there exists some mechanisms that prevent the bearer
from copying or recreating money again and again. Banknotes and metal coins
carry some special features to validate the authenticity and are made such a way
that those features cannot be counterfeited to reproduce the same token.
It is difficult to adapt the same concept in the digital world as files, or more
specifically bits can be easily copied. For example, as shown in Figure 1.2, Chuck
has 100 BTC that he is to send to Alice. Before executing the transaction, he makes
copies and sends the same tokens to Bob. Since Alice and Bob are unaware of the
other transactions made, they become victims of a counterfeit and eventually the
whole system will collapse.
1.1.4 Nakamoto's Solution
Every magic act has a trick. The magician carefully keeps it out of sight of the
audience and successfully creates an illusion to bag all the credits. If Bitcoin is
B4056DF6691F8
Bob
A copy of the same

token is sent to Bob
and Alice separately
Chuck
B4056DF6691F8
Alice
Figure 1.2 Double-spending in digital currency is the act of using the same
token more than once. Here, Chuck sends the same token to Alice and Bob creat-
ing double-spending of the token B4056DF6691F8 (an imaginary serial number).
a magic trick, Nakamoto’s magic trick must be the underlying blockchain. It

endows Bitcoin with the ability to transfer money over a digital network and
settle the transaction in real time that no bank or financial institution could ever
demonstrate.
The blockchain is like an accounting ledger that sits over a distributed network
and keeps records of all previous transactions. From the data-structure viewpoint,
it is a continuously growing list of records linked one after another. Each of these
records is called a block, which contains transactions. Blocks are linked to each
other using cryptographic principles in such a way that if a single block is edited
out of order, the whole chain collapses; thus making blockchain immutable where
transactions cannot be rewritten or altered. This arrangement prevents Chuck from
sending the same 100 BTC to Bob, as the blockchain would already hold a trans-
action against the token that had been sent to Alice. If Chuck makes copies of
the token and tries to send them to Bob, the blockchain reveals that Chuck no
longer retains the token and, therefore, that transaction will be rejected. Nakamoto
solved the double-spending problem using the blockchain and successfully started
transferring money over a digital medium without the presence of a central entity;
hence, Bitcoin, the world’s first cryptocurrency, was born.
1.2 Blockchain
Despite multiple proposals in the literature to solve the double-spending prob-
lem for digital currencies using a decentralised approach that predate Bitcoin,
Nakamoto’s method remains the first successfully implemented solution to this
problem. Although blockchain was first introduced to facilitate Bitcoin transac-
tions, the potential of this technology extends well beyond the concept of virtual
currencies. This new technology looks so powerful that it is already considered a
game changer by the experts who anticipate this will change the face of many exist-
ing industries that operate differently at the moment. Let us now look inside the
blockchain to understand more of its technical details.
1.2.1 Motivation
The concepts that led to the birth of Bitcoin and blockchain are not inventions of
Nakamoto. His role, in this case, is merely a collaborator. The notion of blockchain
sits on three ideas, namely distributed ledger, decentralisation and incentivisation,
which all existed before the arrival of Bitcoin.
The idea of a cryptocurrency was not even new; in 1998, Nick Szabo and
Wei Dai independently proposed two conceptualised versions of such currency
in Bit gold and B-money respectively. None of them, however, implemented their
ideas. Of those, Dai discussed his proposal as a possible application of another
algorithm: Hashcash. Hashcash arrived just a year before B-money when British
cryptographer Adam Back described this algorithm to fend off the spamming
attacks in emails.
What makes Nakamoto’s invention unique is the blend of Bit gold, B-money,
Hashcash and other related concepts. Throughout Part I of this book (Chapters
1–4), readers will experience the amalgamation of many pre-existing concepts in
one solution that conclusively delivered the blockchain.
1.2.2 Definition of Blockchain
A blockchain is an immutable public ledger for recording transactions. Its trans-
actions are called ‘immutable’ because once inserted, they become permanent
and cannot be modified retroactively, not even by the authors, without the alter-
ation of all subsequent transactions. A formal definition of blockchain can be
given as:
A blockchain is an immutable distributed ledger secured by cryptographic

techniques and managed by a decentralised community over a peer-to-peer
network through incentivisation.
1.2.3 Distributed Ledger
The blockchain is often called a distributed ledger because of its operating as a dis-
tributed system and impersonating the general ledger book used in accounting as
shown in Figure 1.3. As a matter of fact, the name blockchain was first given to the
distributed ledger of Bitcoin. The terms blockchain and distributed ledger are often
used interchangeably, although they have different meanings.
A distributed ledger is a consensus of replicated, shared and synchronised
digital data geographically spread across multiple sites, countries or institutions
without any central administrator or centralised data storage [Scardovi, 2016].
This definition is also partially valid for blockchain, which creates the confusion.
A close look at this definition reveals that it states the working principles rather
the actual structure of the ledger. In practice, the model of distributed ledger can
vary, and despite having the same working principles, depending on their data
structure, distributed ledgers can be of different types. For example, Tangle is
a distributed ledger that solves the double-spending problem decentrally using
consensus, but unlike blockchain that uses linked list, its data structure is very
different due to using a directed acyclic graph (DAC). So the bottom line is all
blockchains can be considered distributed ledgers, but not all distributed ledgers
are blockchains.
Figure 1.3 A general ledger from the 19th century. The blockchain impersonates
this book digitally and operates distributedly over a peer-to-peer network provid-
ing incentives to the participants. (Image created by RaphaelQS.)
1.2.4 Key Properties
The blockchain has some typical properties that can be considered its hallmarks.
◾◾ A blockchain is open, verifiable and permanent by nature. Data of a block-

chain is shared across the network where each node has a copy of it.
◾◾ A decentralised consensus needs to be achieved with a blockchain to create
each block.
◾◾ Its transactions are immutable. When a set of transactions is validated, a new
block is created based on a consensus making the data of those transactions
permanent. It is not possible to alter a single transaction in that block without
the support of the majority of the participating nodes.
◾◾ As opposed to a centralised client–server architecture, it is managed by decen-
tralised networks for internode communication and validating new blocks; thus,
it embodies a distributed computing system with high Byzantine fault tolerance.
◾◾ Because any transaction of a blockchain is verifiable, it establishes digital
trust. The ‘openness’ of a blockchain also makes it permissionless, meaning
there will be no need to have access control and passwords (considering the
blockchain is of public type).
◾◾ The blockchain is often called secure-by-design. As an open system, block-
chain does not require safeguarding the data from the attackers. The data is
already open, and there is no point for the attackers to manipulate it as any
such change will soon be disregarded.
The remainder of this chapter, along with Chapters 2 and 3, explains the block-
chain and the jargon used to describe the aforementioned properties. Chapter 4
then shows how this technology actually works using the example of Bitcoin.
1.3 Architectural Overview
A blockchain is a mesh network of computers, commonly known as nodes, having
no central server; rather they are linked to one another. Nodes in this architec-
ture define and agree upon a shared state of data and adhere to certain constraints
imposed upon the data.
1.3.1 Centralised vs Decentralised Architecture

The blockchain apparently looks no different than a website hosted over the inter-
net, apps running on a smartphone or computers connected to a local area net-
work. The differences become noticeable when we look at the architecture level.
A website, an app or a local area network all have one thing in common – they are
all part of a centralised structure managed by a supreme authority. This structure is
commonly known as the client–server architecture as shown in Figure 1.4.
When a user visits a website, she or he becomes the client of a central server that
provides with all the services and data. A smartphone app also operates in the same
fashion. In a local area network, there is a server doing the job of assigning partici-
pating devices with the IP addresses and handling their joining and leaving activi-
ties, as well as giving them access to the internet. Under the client–server hood, the
Server
Client Client
Client
Client
Figure 1.4 A centralised client–server architecture where the server retains the
absolute power of providing or denying any service and data.
Client/Server Client/Server Client/Server Client/Server
Figure 1.5 A blockchain over a peer-to-peer network is an example of a decen-

tralised architecture where every participating node simultaneously acts as a
server and a client.
central authority retains the supreme power of denying the users of services and
data, and amends rules without prior notices.
However, when we look at the blockchain in Figure 1.5, a different architecture
can be seen. This architecture is very distinct from that of a client–server archi-
tecture. Every participating node in this architecture acts as a client as well as a
server, removing the need for a central authority. This type of network is called a
peer-to-peer network, or simply P2P network. Blockchain adapts this network as its
underlying communicating and operating framework to achieve a number of goals
fundamental to this new technology.
1.3.2 Peer-to-Peer Network
The idea of a P2P network predates even the invention of the internet. The basic
concept of such computing was envisioned in earlier software systems and net-
working discussions, reaching back to principles stated in the first Request for
Comments (RFC) [Crocker, 1969]. Tim Berners-Lee’s vision for the World Wide
Web was close to a P2P network that assumed each user of the web would be an
active editor and contributor, creating and linking content to form an intercon-
nected “web” of links [Berners-Lee, 1996]. As time passed, the internet became an
ideal example of the client–server paradigm.
SMTP, the standard protocol to send email, also had an architecture that par-
tially imitated that of a P2P network at its early stage. However, a true imple-
mentation of a P2P network first appeared in 1999 when the music-sharing
application Napster released its file-sharing platform, and many applications
including BitTorrent, Gnutella, Netsukuku, Gossip, Kazaa, CoopNet and P-Gird
followed suit [Oram, 2001].
A P2P network is a distributed system where peers are equipotent and equally
privileged participants as shown in Figure 1.6. In an ideal P2P network, peers make
a portion of their resources, such as processing power, disk storage or network
bandwidth, directly available to other network participants, without the need for
central coordination by servers or stable hosts. This arrangement makes each peer
both a supplier and a consumer, in contrast to the traditional client–server model
where the client consumes and the server acts as a resource and service provider
[Steinmetz and Wehrle, 2005].
Peer-to-peer networks generally implement virtual overlay networks over the
physical network topology with nodes in the overlay forming a subset of the nodes
in the physical network [Ahson and Ilyas, 2008]. In this form of network, data is
still exchanged directly over the underlying TCP/IP network, but at the application
layer peers are able to communicate with each other directly via the logical overlay
links [Zhu, 2010]. P2P networks use overlays for indexing and peer discovery, and
Figure 1.6 A peer-to-peer network.

making the system independent from the physical network topology. Based on how
the nodes are linked within the overlay network, and how resources are indexed and
located, P2P networks are divided into two categories: unstructured or structured.
Unstructured P2P networks do not impose a particular structure on the overlay
network by design; rather they are formed by nodes that randomly establish con-
nections to each other. In structured P2P networks, on the other hand, the overlay
is organised into a specific topology, and the protocol ensures that any node can
efficiently search the network for files or resources, even if the resource is extremely
rare [Jin and Chan, 2010; Filali, 2011].
1.3.3 Characteristics
Blockchain, operating over P2P networks, exhibits many characteristics inherited
from the network architecture. Being distributed is arguably the most noticeable
trait that anyone having moderate knowledge of computer networks can quickly
identify looking at the architectural overview presented in Figure 1.7. What may
not be very clear to many, however, is that the architecture also indicates block-
chain is decentralised. What is the difference between being distributed and being
decentralised, and how are both of these characteristics applied to a blockchain.
The notion of being distributed implies the resources are shared over the par-
ticipating nodes, while decentralised means there is no central node to dictate the
operations [Raval, 2016]. As a distributed system, a blockchain sits on hundreds of
Figure 1.7 A blockchain over a P2P network is an example of a decentralised

architecture where every participating node simultaneously acts as a server and
a client by keeping a copy of the blockchain.
thousands of nodes and shares their resources as it keeps operating. It also demon-
strates attributes fundamental to distributed systems such as the need for a consen-
sus in making key decisions, fault tolerance and so on.
Blockchain, as a decentralised system, demonstrates no node instructing any
other node what to do. Such an operational principle seems chaotic, particularly
if not all nodes wish to play by rule, but in reality that never happens. There will
always be nodes that try to bend the rules in their favour. However, the distributed
nature of blockchain prevents such nodes from taking unwanted benefits by enforc-
ing consensus through proof of work or similar method.
Blockchain stores data across its P2P network, eliminating a number of risks
that comes with data being held centrally. There is no dependency on a single
server; hence blockchain does not have a central point of failure. Its decentralised
architecture makes every participating node keep a copy of the blockchain, mak-
ing data quality maintained by massive database replication and computational
trust [Raval, 2016]. There is no centralised official copy of data, and no user is
‘trusted’ more than any other in this architecture. With a blockchain, transactions
are broadcast to the network and messages are delivered on a best-effort basis. On
arrival of new transactions, validator nodes, known as miners, validate and add
them to the block they are building, and then broadcast the completed block to
other nodes. This operation continues to run until the end of the blockchain's life
cycle in exchange for small rewards or incentives for the nodes that take part in the
validation process, commonly known as block mining.
1.4 Block
The blockchain is digitally constructed using a continuously growing list of records
linked and secured by cryptographic principles as shown in Figure 1.8. Each of
these records represents a block connected with the previous block; hence they
jointly form a chain, from which its name is derived.
1.4.1 Structure
Each block in a blockchain holds batches of valid transactions that are hashed and
encoded into a Merkle tree or a more appropriate data structure. The size of the
block varies from blockchain to blockchain. For example, a Bitcoin block size is 1
MB and holds information from more than 500 transactions, while the block size
of Bitcoin Cash is 8 MB to enable it to process more transactions every second.
The elements of a block include the block identifier, data, a timestamp and a
cryptographic hash of the previous block header in addition to other extra fields.
The insertion of the hash of the last block header in the following makes the block-
chain resistant to modification of the data, and any attempt to alter a single block
results in the collapse of the whole chain. Because of this characteristic of the
Genesis
block
Main Chain
Orphan blocks
Latest
block
Figure 1.8 A blockchain where the main chain consists of the longest series of
blocks from the genesis block (in black) to the latest block. Orphan blocks (in
white) created by forks exist outside of the main chain.
blockchain, despite being decentralised, it remains immutable without the coop-

eration of the network majority.
1.4.2 Block Identifier and Height

The block identifier is the cryptographic hash of its header. Different blockchains
may generate this hash differently. For example, Bitcoin uses the double hash of
its header as its identifier, which means hashing the hash of the header. There is
another way to identify a block. It is using the block height. This metric represents
the position of the block in the blockchain. Block height is not unique, as several
blocks may compete for the same position in the event of a fork (discussed later).
1.4.3 Genesis Block
There is a particular block in each blockchain which is called the genesis block. It is
sometimes called block 0 or block 1 depending on the indexing of the blocks. The
genesis block is the first block of a blockchain that is almost always hardcoded into
the software of the applications. It is a special case that does not have a reference to
its previous block.
1.5 Mining
Block mining is a vital requirement for the survival of the blockchain. It would be
misleading to think that there is an analogy between gold mining and cryptocur-
rency mining, such as Bitcoin. The fact is that gold miners receive rewards for pro-
ducing gold, while Bitcoin miners do not receive a reward for producing Bitcoins;
rather they provide a service that protects the whole system.
1.5.1 What is Mining?
Block mining is a record-keeping service performed through the use of computer
processing power by the participating nodes. Miners authorise new transactions
and write them on the blockchain. By regularly grouping new transactions into a
block, which is then broadcast to the network and verified by recipient nodes, they
keep the blockchain consistent, complete and unalterable.
In Bitcoin, a block is mined approximately every 10 minutes when miners com-
pete to determine a mathematical problem, which is moderately difficult but the
solution easy to verify, based on a cryptographic hashing algorithm. The answer to
this problem is called the proof of work (PoW). This proof shows that a miner did
spend a significant amount of time to solve the problem and is not an adversary
with the intention to gain improper benefits from the blockchain. In this context,
it must be realised that mining is not about creating new Bitcoins; rather mining
allows the blockchain to continue operating in the absence of a central authority
without letting any adversary jeopardise its principles and security.
1.5.2 Consensus
The process of building a block involves a particular consensus mechanism for each
blockchain. The PoW is one of the earliest mechanisms that many blockchains
including Bitcoin use. PoW received heavy criticism due to its inefficient energy
usage approach leading to the wastage of a large amount of electricity every year.
More recent blockchains, however, use energy-efficient consensus mechanisms such
as proof of stake, proof of space, proof of authority and so on that shifted the focus
from the energy usage to something else such as allocating a significant amount
of memory in proof of space. We learn more about various consensus mechanisms
later in this chapter.
The consensus mechanism, alongside the chaining of blocks using crypto-
graphic principles, makes modifications of the blockchain extremely hard, as
an attacker must modify all subsequent blocks in order for the modifications of
one block to be accepted. As new blocks are mined all the time, the difficulty of
modifying a block increases as time passes and the number of subsequent blocks
increases.
1.5.3 Incentivisation
Block mining utilises the concept of incentivisation. Because the miners act as
record-keepers by verifying the transactions, each time a block is built, the quickest
miner who solves the puzzle first receives a reward in exchange for his or her service,
usually in the form of some native currency, fees or both.
1.6 Forks
The decentralised nature of public blockchains means that participating nodes
must agree on the shared state of the ledger. A consensus amongst the participants
results in a block that everyone deems as correct. A fork is an unusual situation
when a blockchain diverges into two potential paths forward following a consensus.
1.6.1 When Does a Fork Occur?

As a distributed system, forks may occur when two miners find a block almost at
the same time. The ambiguity is resolved when subsequent blocks are added to one
chain, making it the longer chain, and the other block gets orphaned or abandoned
by the network. In Figure 1.8, the grey blocks represent the main chain, while the
white blocks are orphaned. They were built at the same time, but eventually one
chain got established and the other became orphaned.
Forks can be willingly introduced to the network by the developers when they
seek to bring in a change. It is a technical event where diverse participants need to
agree on common rules. This kind of fork may occur because of many reasons such
as the protocol needs a change or a new rule is required in deciding what makes a
transaction valid. As a result, those who use the blockchain have to show support
for one choice over the other.
1.6.2 Types of Forks
Forks can be of three types: temporary fork, hard fork and soft fork. A temporary
fork occurs when miners discover a block at the same time as explained earlier. The
other two types of forks are not incidental but rather enforced by the community.
A hard fork is a software upgrade requiring a new rule that is not compatible with
the previous version. For example, changing a blockchain from 1 MB to 2 MB will
require a hard fork.
A soft fork introduces changes which are backwards compatible. For example,
instead of a 1 MB block, a new rule may enforce a block size of 500 KB. This does
not require a hard fork as non-upgraded nodes will still see the new transactions
as valid.
A classical example of hard fork is the creation of Bitcoin Cash, forked at block
478558 on 1 August 2017, where for each Bitcoin an owner got 1 Bitcoin Cash.
Amongst the soft forks, Bitcoin’s change of address formatting is worthy of mention.
1.7 Consensus Mechanisms
A fundamental problem in distributed systems is achieving overall system reliabil-
ity in the presence of some faulty nodes. A solution to this problem can be nodes
agreeing on some data value during computation making the system achieve agree-
ment. This process is called consensus within the scope of distributed systems and
computing. Blockchain being a distributed system requires its nodes to reach a
consensus while running the system and keeping its data secure.
1.7.1 Proof of Work (PoW)

The PoW is a system requiring an amount of effort that is not significant yet feasible
enough to deter malicious actors in a distributed system. These actors generally
attempt to send spam emails and launch denial-of-service (DoS) attacks. Cynthia
Dwork and Moni Naor developed the concept, and later Adam Beck indepen-
dently improved and used it in his anti-spam system Hashcash. Nakamoto adapted
a Hashcash-like PoW system in Bitcoin that also forms the basis of many other
cryptocurrencies that followed the footsteps of this pioneering virtual currency.
Within the context of the blockchain, PoW ensures coordination of the net-
work and security of the data. It requires participating nodes or miners to compete
for a position to determine who gets the chance to build the next block. In doing so,
they use computational power to find a specific hash value. There exists no known
shortcut or optimised approach to discover the hash other than going one by one
incrementally. This approach requires huge energy and time for a miner to find the
targeted hash, but the verification process is simple enough for others to quickly
check if the claim is justified.
The PoW system in a blockchain acts as a consensus mechanism for the miners
to decide who will build the next block. Blockchain is a distributed system oper-
ates decentrally, meaning there is no leader to lead the block-building process. As
such, PoW helps miners to get selected as the lucky winner to fill the position of the
one-off leader in the expense of energy and time. Chapters 3 and 4 of this book
present thorough descriptions as to how this system works in the real world using
Bitcoin as an example.
Because of this system needing energy and time, it becomes expensive for the
attackers to launch spamming attacks in the network. The same constraint work-
ing with cryptographic principles also shields the blockchain from being altered.
Attackers want to change the entries face, a nearly impossible task of redoing old
blocks due to the need of enormous computing power.
1.7.2 Alternative Consensus Algorithms

The biggest drawback of the PoW system is the misuse of enormous energy. Critics
of Bitcoin often criticise this virtual currency for not being sustainable and energy
efficient because of its consensus mechanism [O’Dwyer and Malone, 2014].
Although PoW effectively deters potential attackers, the concerns surrounding
energy issues drove researchers to look for alternative approaches [Vranken, 2017].
The proof of stake (PoS) is arguably the most used alternative to the PoW sys-
tem. Instead of making operation expensive by consuming electricity, this system
requires miners to deposit a wealth that bad actors will lose if try to bend the
rules. PoS uses several randomised approaches to select the miner who is going
to build the next block. For instance, two blockchains, Nxt and BlackCoin, use
the “randomised block selection” strategy, while Peercoin incorporates “coin age”,
a numerical value derived from the product of the number of coins multiplied by
the number of days the coins have been held, in selecting the miner. The delegated
proof of stake (DPoS) is another method that utilises a limited number of nodes,
known as the delegate, to verify transactions and build blocks for the blockchain.
The native token holders generally retain the right to vote in the election to select
delegates. EOS is amongst the most notable blockchains that use DPoS as its con-
sensus mechanism.
The proof of burn (PoB) is another distributed consensus mechanism and an
alternative to PoW and PoS. It can also be used for bootstrapping one cryptocur-
rency off another. The idea is that the miners show the proof of burning some
tokens by sending them to a verifiably unspendable address. This is expensive from
their individual point of view, just like PoW, but consumes no resources other
than the burned underlying asset. PoB is often criticised due to its reliance on
PoW-mined tokens. Critics identify the fact that if miners only burn PoW-mined
tokens while practising the PoB mechanism, the ultimate source of scarcity remains
the same and unnecessary energy consumption seems to become inevitable.
However, that may not always be the case. For example, on average, it takes 48,800
kWh to mine 1 Bitcoin. By burning 10 Bitcoins or consuming 488,000 kWh and

releasing 488,000 Tincoin tokens, each of the new coins would be considered the
equivalent result of 1 kWh of work done, which is significantly lower than Bitcoin
and less energy consuming. In addition to Tincoin, Slimcoin and XCP are amongst
the many that have used PoB as their consensus mechanism [Prahalad, 2018].
Proof of space (PoSpace), also called proof of capacity (PoC), is a means of
showing that one has a legitimate interest in a particular service by allocating a
non-trivial amount of memory or disk space to solve a challenge presented by the
service provider. PoSpace is very similar to PoW, except that instead of computa-
tion, storage is used. The concept was formulated by Dziembowski et al. in 2015
[Dziembowski et al., 2015]. Proof of authority (PoA) is another consensus mecha-
nism based on identity as a stake where approved accounts, known as validators,
validate transactions and blocks. It has many similarities with the DPoS method
described earlier [Naumoff, 2017].
1.7.3 Comparison
Amongst the aforementioned consensus mechanisms, there is no one clear favourite.
Protocols prefer one over another depending on the type of service and necessary
security they seek. Some blockchain protocols also modify the generic algorithm
to further enhance its security. To compare the mechanisms and obtain an idea
of their nature, three parameters, namely sustainability, usability and security, are
used in Table 1.1. Amongst the methods described here, PoW is not sustainable at
all, while PoB is partially sustainable as it could use PoW-based coins that in turn
misuse energy. Because of the other three methods not using energy as a means of
proving genuine interest, those mechanisms can be deemed sustainable.
From the usability perspective, PoW, PoB and PoSpace are more user-friendly.
These methods generally do not require further arrangements such as organising
election or monitoring behaviours. However, PoS and PoA require participating
nodes to go through a number of extra steps.
While participating in a consensus process using the PoS method, nodes
need to create an impression to win the election, followed by forming a team of
Table 1.1 Consensus Mechanism Comparison
Consensus Mechanism Sustainability Usability Security
Proof of work Not sustainable High High
Proof of stake Sustainable Low Medium
Proof of burn Partially sustainable High High
Proof of space Sustainable High Medium
Proof of authority Sustainable Low Low

delegates, and in event of failure to wait for the right moment to get elected. The
PoA process requires monitoring the nodes to screen out potential malicious actors.
Security-wise, PoW and PoB are considered the most secure methods due to these
methods needing to sacrifice real assets. While PoS and PoSpace are also secure,
PoA may pose threats as reputation is used as the asset in this method. Nodes will-
ing to perform a one-off foul play could potentially target blockchains using the
PoA consensus mechanism.
1.8 Types of Blockchains
There are several types of blockchains available [Bashir, 2017]. Some are permis-
sionless, while some require permission or access approval; some are controlled by
a predefined set of entities, whereas some demonstrate a mix of multiple types. The
following presents a discussion covering possible blockchains; their compositions;
and a comparison based on security, services and suitability for specific domains.
1.8.1 Public and Private Blockchains

There are primarily two different types of blockchains available, namely the public
blockchain and private blockchain. All other blockchains are either public or pri-
vate blockchain with a variety of setups, structures and controls.
A public blockchain has absolutely no access restrictions. Anyone with an inter-
net connection can act as a participating node, send transactions and become a
validator. For such a network to keep operating and motivating miners to con-
tinue mining, the blockchain provides some form of economic incentive or reward.
Often it comes in the form of giving away some native currency, but sometimes it
can be fees too.
A private blockchain, on the other hand, requires permission, as nodes’ par-
ticipation and validator access in such blockchains are restricted. One cannot join
a private blockchain unless invited by the network administrators. This type of
blockchain can be considered middle ground for companies that are interested in
the blockchain technology in general but are not comfortable with a level of control
offered by public networks. Typically, companies seek to incorporate blockchains
into their accounting and record-keeping procedures without sacrificing autonomy
and running the risk of exposing sensitive data to the open internet.
1.8.2 Consortium, Shared Ledger, Sidechain

As mentioned earlier, all blockchains are either public or private, yet they can form
different types. A consortium blockchain is one of those blockchains. It is sometimes
referred to as a shared ledger or federated ledger because of multiple approved par-
ties using this blockchain within a federated environment. These blockchains are
private blockchains operated by a group or consortium. Shared ledgers are usually

semi-decentralised and require permission. However, instead of a single body con-
trolling it, various organisations might each operate a node on such a network. The
administrators of a consortium blockchain may restrict users’ reading rights and
allow a limited set of trusted nodes to execute a consensus protocol.
A sidechain is another special type of blockchain. It is an emerging type that
stays alongside a so-called parent blockchain or main chain. It allows tokens and
other digital assets from the main chain to be securely used in it and then be moved
back to the main chain if needed. Typically a sidechain remains attached to its main
chain using a two-way peg. The two-way peg enables interchangeability of assets
at a predetermined rate between the parent blockchain and the sidechain. Many
new blockchains which are public in nature allow creating private sidechains. It
is anticipated that this trend will help to build more robust applications on top of
large blockchains.
1.8.3 Hybrid Blockchains
It is not rare to encounter hybrid blockchains coming from the combination of
properties seen in both public and private blockchains. For example, semi-private
blockchains and proprietary blockchains are the kind of blockchains that inherit
properties from both private and public types. The former (semi-private) is a pri-
marily public type having some private properties, while the latter (proprietary) is a
very restricted blockchain but still demonstrates some public properties.
1.8.4 Comparison
We have seen so far a variety of blockchains that might lead to the question of why
we would need so many types if one or two are good enough. The answer to this
question is simple: there is no one perfect blockchain, as the nature of applications
and requirements may vary. For instance, a public blockchain offers open access
and governance but comes with slow performance.
A private blockchain, however, can be much faster than a typical public block-
chain, but it takes away the essence of this technology which is freedom. Private
blockchains are controlled by one or more central authorities bringing back the
central control to blockchain technology. This in no way indicates that such block-
chains are worthless, as many use-cases such as banks, hospitals and other organisa-
tions that work with sensitive data can benefit from these blockchains that public
blockchains fail to offer.
The concept of the consortium blockchain brings back freedom despite being
private. Because a number of organisations control a consortium blockchain, it cre-
ates the vibe of a public blockchain within the territory of a private type. A sidechain
can be public or private. It depends on how the applications are designed. For exam-
ple, a medical application storing patient information can have a private sidechain
Public Private
Blockchain Blockchain
Consortium
Blockchain
Sidechain
Semi-private Blockchain
Proprietary Blockchain
Figure 1.9 Types of major and customised blockchains.
where it stores sensitive data, while the main chain can have information that is
suitable to share with third parties such as drug manufacturers, pathological labs,
administrative divisions of hospitals and so on. Semi-private and proprietary block-
chains also have their pros and cons that the users need to look at carefully before
deciding on which type they actually require. Figure 1.9 overlays the customised
blockchains over public and private counterparts to show their relative positioning
as to how much each of those customised blockchain acquires from the two major
types. Later Table 1.2 complements this figure by comparing their properties.
1.9 Applications
Bitcoin is the most discussed application of blockchain technology that assisted
in solving the double-spending problem. The ability of this disruptive technology,
however, goes beyond Bitcoin. Numerous use-cases can benefit from using this
technology and many existing applications would perform better in the presence
of a blockchain.
Because storing a piece of information in a blockchain remains there forever,
blockchain technology helps to establish trust. In other words, it eradicates the
need for trust, hence it is often referred to as trustless. On the contrary to the usual
convention of trust that heavily relies on knowing the actualities, a blockchain
operates over a decentralised network formed by people whom the users may or
may not know; but that hardly matters. It creates a world where everybody is trust-
worthy because nobody is capable of cheating.
The ability of a blockchain to establish trust in a decentralised digital environ-
ment makes it an instant solution for many working use-cases. e-Governance is
Table 1.2 Blockchain Comparison
Public Private Consortium Sidechain Semi-Private Proprietary
Access Open Restricted Controlled Controlled Controlled Restricted
Speed Slow Fast Fast Slower Slower Fast
Security Consensus Pre-approval Pre-approval Pre-approval Pre-approval Pre-approval

and/or and/or
consensus consensus
Identity Anonymous and/ Known Known Known Known Known

or pseudonymous
Asset Native token Anything Anything Anything Anything Anything

an excellent example where building citizen-centric applications can appropriate

blockchain technology. National identity management, voting, birth certificate
generation, event recording, electronic auction and citizen welfare services are a
few examples.
Blockchain has the potential to contribute to the education sector. Day-
to-day management activity such as record-keeping, tuition fees payment, and
badge and identity management are some of the applications that some institu-
tions around the globe have already initiated. One of the finest use-cases for edu-
cation is qualification verification. It takes a substantial amount of time to verify
a candidate’s diploma and degree credentials in current practice. Blockchain can
make it faster and reliable. Alongside education, healthcare is another huge sec-
tor where blockchain can play a pivotal role in building a diverse range of appli-
cations. Data provenance and integrity, patients’ data management, and data
security for clinical trials are amongst the essential use-cases that hospitals and
general practitioner authorities can adopt to ensure more secure and faster ser-
vices. Drug traceability is another application that pharmaceutical industries are
considering implementing.
Financial services is amongst the most discussed sectors that blockchain is
capable of changing from the core. Industries such as asset management and insur-
ance are likely to adopt this technology within a few years. Cross-border payments,
remittance, interbank money transfers and regular payment facilities are some
areas where blockchain can help build useful applications. Smart property or smart
agreement is a futuristic concept that can be developed using blockchain technol-
ogy. It has the potential to revolutionise the traditional lending system. Mortgage,
car loan, industrial loan, purchase of land and so on can be tied up with block-
chain to remove traditional credit rating systems making the process simple and
less bureaucratic.
Production and supply chain is an area where traceability is the most important
and challenging subject. It is difficult to establish and maintain trust, particularly
when products move over international borders. Blockchain, having immutability
property at its core, is an ideal technology to develop tracking applications for areas
like this.
Online marketplaces and gaming, bidding and betting industries can signifi-
cantly improve the quality of their services and introduce a high degree of account-
ability and transparency by using blockchain-based decentralised applications.
Physical and cybersecurity of workplaces like sensitive laboratories, drug manu-
facturing industries and nuclear power plants can be ensured using blockchain
technology.
Last but not least, the Internet of Things (IoT) and artificial intelligence (AI) are
two thriving technologies heavily used in building contemporary applications. If
blockchain joins them in developing applications such as smart cities, smart homes,
smart transportations and smart grids, then the quality and the ability of the fin-
ished product would be far better than what they can achieve without blockchain.
1.10 Revisiting the Double-Spending Problem

Earlier this chapter we discussed the double-spending problem and how Nakamoto
solved it. The description of Nakamoto’s solution was consciously kept simple to
avoid delivering lots of jargon at the beginning of the book.
Now that at the end of Chapter 1 when we have sufficient knowledge about
blockchain technology, let us revisit the problem.
So far we have learned that Nakamoto solved the double-spending problem
employing an immutable ledger book called blockchain where every transaction
gets recorded. This ledger reveals any attempt of sending the same token multiple
times. Validators encountering such mischief reject the transactions and prevent
the system from double-spending.
There remain two issues that the chapter did not resolve. First, there were sev-
eral mentions in the cryptographic principles that would make the entry of the
blockchain permanent and irreversible. In a digital world where bits are easy to
copy and modify, how cryptography institutes such a challenging job of making
blockchain immutable is yet to be seen. Second, we know that because of the P2P
network being distributed and decentralised, blockchain does not sit in a central
server; rather each participating entity of the system keeps a copy of this ledger. For
the sake of argument if we accept that cryptographic principles make transactions
immutable, how can blockchain stop someone from recreating everything from
scratch when the participating nodes remotely hold the copies? Without resolving
these two issues, Nakamoto’s solution cannot be considered complete.
The solution Nakamoto presented had these two situations for which he used the
application of cryptographic hash functions and a consensus mechanism called the
proof of work to establish trust in a decentralised trustless environment. Next, we
cover these two topics and learn the complete solution. Chapter 2 of this book tells us
how Nakamoto made blockchain immutable, and Chapter 3 describes the method of
preventing individual nodes from recreating and distributing counterfeit blockchains.
1.11 Summary
This chapter introduced blockchain and explained how it came into being. It
stated the double-spending problem leading to the development of the blockchain
distributed system by Satoshi Nakamoto that is open, immutable and decentral-
ised. The architecture, network, data structure, fundamental characteristics, con-
sensus mechanisms and types of blockchains are amongst the topics discussed in
this chapter. However, the chapter left out two important topics of blockchain:
cryptographic principles that make blockchain immutable and how a consensus is
agreed upon to keep the blockchain updated. These two topics will be addressed
in Chapters 2 and 3 respectively before concluding the first part of this book in
Chapter 4 describing the Bitcoin protocol.
Chapter 2
Immutability of
Blockchain
The blockchain is immutable – once a transaction is written, it cannot be changed,

modified or deleted, even by the author of the transaction. This property of block-
chain is fundamentally vital as Nakamoto used it in Bitcoin to solve the dou-
ble-spending problem. Bitcoin, however, is just the beginning and many other
applications can benefit from using this property where trust plays a central role.
Two branches of computer science namely cryptography and distributed systems
laid the foundation of blockchain where cryptography offers the underlying prin-
ciples required to make blockchain data immutable. This chapter presents the nec-
essary theory to realise how blockchain introduces the immutability property and
prevents its data from being altered.
2.1 Cryptography
If blockchain is the magic trick behind Bitcoin, then cryptography is the trick
behind blockchain. Several essential components of blockchain technology includ-
ing the immutability property are built using cryptographic principles. It is, there-
fore, necessary to present a brief discussion on cryptography before we proceed
further. Nevertheless, cryptography is a vast area, and a part of a chapter can hardly
do justice to such a rich and broad discipline; hence it will not be attempted to
encompass everything related to cryptography in this brief review. The objective of
having this discussion is to present a summary of the necessary principles to help
readers understand the subsequent topics of this book.
27
2.1.1 What Are Cryptography and Cryptanalysis?

Cryptography is the practice and study of methods to secure communications in the
presence of potential third-party adversaries [Rivest, 1990]. More formally it can be
defined as the protocols to prevent third parties and the public from reading private
messages [Bellare and Rogaway, 2015]. Numerous features of information security
such as authentication, data confidentiality, data integrity and non-repudiation are
central to modern cryptography [Menezes et al., 2005]. Its existence can be recog-
nised in the disciplines of mathematics, computer science, electrical engineering,
communication science and physics where applications include electronic com-
merce, chip-based payment cards, computer passwords, military communications
and, of course, cryptocurrencies.
Cryptanalysis is the opposite of cryptography. It is the method of breaching
cryptographic security systems and gaining access to the contents of encrypted
messages, even if the cryptographic key is unknown. It is the branch of study of
the information system to understand the hidden aspect of an encrypted message.
2.1.2 Background
Cryptography predates the invention of the modern computer by thousands of
years. The period before the computer was made available for applying the crypto-
graphic algorithm is known as the classical era. Methods and techniques to secure
messages during the classical era are called classical cryptography.
Classical cryptography perhaps traces its roots to carved ciphertext on
stones in Egypt around 1900 BCE. The scholarly consensus on this, however,
rules it out as cryptographic work and identifies it as a drawing created out of
amusement of literate observers that had nothing to do with concealing infor-
mation. If we accept this verdict, the Greek transposition tool scytale and the
Hebrew monoalphabetic substitution cipher Atbash would be the earliest form
of cryptographic tools. The mention of a scytale by the Greek poet Archilochus,
who lived in the 7th century BC, is the oldest documented evidence of any
cryptographic tool, although its operation was unknown until around the 2nd
century AD when Greek biographer Plutarch described it in his book Plutarch’s
Lives [Perrin, 1916].
Sometimes Biblical commentators such as the medieval French rabbi Shlomo
Yitzchaki and Rabbi David Kimhi claimed that there are verses in the Hebrew
Bible that concealed the original names of several places and instead replaced
those with Atbash words. One famous example in favour of this claim is the 26th
verse from the 25th chapter of the book of Jeremiah. This verse states: “The king
of Sheshach shall drink after them.” In this verse, “Sheshach” is claimed to be a
cipher word that can be reverted to “Babylon” in Atbash. There appears to have
been the mention of two different ciphers in the 2000-year-old Kamasutra of
Vatsyayana in India. The ciphers are called Kautiliyam and Mulavediya where the
Immutability of Blockchain ◾ 29
substitutions are made based on phonetic relations. In the Kautiliyam, vowels

become consonants, while the cipher alphabet in the Mulavediya is comprised of
pairs of letters [Kahn, 1967].
The oldest cryptographic system with a practical purpose is generally credited
to the Caesar cipher. It is due to the fact that this system had been in place with
real applications and a documented history since the beginning of the systematic
use of cryptography. The association of Julius Caesar’s name may have created a
false impression that Caesar is the inventor of this technique, which may not be
true. It is anticipated that the Greeks might have known this technique before the
Romans; however, Caesar made it famous by adapting its use in his communica-
tions [Singh, 2002]. Roman historian Suetonius mentioned this method in the Life
of Julius Caesar stating that Caesar was in use of this encryption technique shift-
ing three alphabets to the right to communicate with his generals. Although there
exists evidence that Caesar used even more complicated systems, Caesar cipher
had been the most common and iconic secret communication method during that
period, which his nephew and the first Roman Emperor Augustus also adapted
with a minor alteration [Graves, 1957].
A more complex system involving the use of a series of interwoven Caesar
ciphers, commonly known as Vigenere cipher, had been in use since the 15th
century, but it was centuries later that German military officer and cryptogra-
pher Friedrich Kasiski first published a general method of deciphering Vigenere
ciphers [Martin, 2012]. In recent time but still predating the modern computer,
the Enigma machine, invented by the German engineer Arthur Scherbius at the
end of World War I, was one of the most advanced and arguably the most popular
encryption device to protect military, commercial and diplomatic communica-
tions. A superior version of the Enigma machine was used by Nazi Germany in
World War II and subsequently the breaking of its code by British scientist Alan
Turing and his team at Bletchley Park in England has been a celebrated event for
the West [Singh, 2002].
The invention of the computer marked the beginning of the modern cryptogra-
phy era. Although sometimes the Enigma machines and similar mechanical devices
are considered to be the beginning of the modern cryptography, they were more like
a bridge between the classical and modern periods, and the first work of modern
cryptography is credited to Claude Shannon and his paper titled “A Mathematical
Theory of Cryptography” written in 1945 at Bell Laboratory in the United States
and published in 1948 [Shannon, 1948].
2.1.3 Basic Concepts
The goal of cryptography is to transform any data from its original form, called
the plaintext, into an obscure form known as the ciphertext. This process is called
encryption. The reverse process of recovering the plaintext from the ciphertext is
called decryption. It is essential to understand that the plaintext does not have to be
a textual message. It can be a computer file representing binary or other types of

data, an image, a database and so on. A particular cryptosystem works depending
on specific encryption and decryption algorithms. An algorithm is a computational
procedure that follows some set of rules. The process of encrypting plaintext using a
particular algorithm depends on a code, commonly known as the secret key. A secret
key is nothing but a large number.
There exists a fundamental principle of modern cryptography, known as
Kerckhoffs’s principle. Dutch linguist and cryptographer Auguste Kerckhoffs
in the 19th century stated that an algorithm defining a cryptosystem should
be publicly known, but the key must remain secret [Shannon, 1949]. Modern
cryptography follows this principle where a publicly known cryptographic algo-
rithm using a secret key jumbles up the plaintext to make it incomprehen-
sible. The process is performed such a way that although the ciphertext looks
like a meaningless piece of information, by employing the secret key it can be
reversed.
Cryptographic algorithms use several methods. Most classical algorithms either
use a substitution or transposition approach. A substitution approach is a method
of encrypting by which units of plaintext are replaced with ciphertext where the
units may be single letters, pairs of letters, triplets of letters, mixtures of these and
so forth. The receiver deciphers the text by performing the inverse substitution. A
transposition approach is a method of encryption by which the positions held by
units of plaintext are shifted according to a regular system so that the ciphertext
constitutes a permutation of the plaintext; hence the orders of the units change.
Mathematically a bijective function is used on the characters’ positions to encrypt
and an inverse function to decrypt [Reinke, 1992].
In the modern era, cryptographic algorithms deal with digital bits instead of
plain letters and the operations are performed using exclusive-OR. There are two
main approaches used in regular symmetric-key encryption, namely stream cipher
and block cipher. In a stream cipher, each plaintext bit is encrypted one at a time
with the corresponding bit of a stream of random characters commonly known as
the keystream and each bit of the ciphertext stream is generated. A block cipher,
in contrast, is a deterministic algorithm operating on fixed-length groups of bits,
called a block, with an unvarying transformation that is specified by a symmetric
key [Paar and Pelzl, 2009].
2.2 Modern Cryptography
Modern cryptography is the cornerstone of computer and network security. Its
foundation is laid on various concepts of mathematics such as probability the-
ory, number theory and computational complexity theory. There are two prin-
cipal branches of modern cryptography, namely symmetric-key cryptography and
public-key cryptography.
2.2.1 Symmetric-Key Cryptography
An encryption system where both the sender and receiver of a message share a
single, common key to encrypt and decrypt the message is called symmetric-key
cryptography. Symmetric-key systems are simpler and faster, but they come with
a big drawback. The two parties involved in the process must exchange the key to
successfully decrypt the ciphertext. This exchange process is potentially vulnerable,
as it could reveal the key to a third party.
For example, Bob wants to exchange a message with Alice as seen in Figure 2.1.
Using a secret key, Bob encrypts the message “Hello Alice” and sends it to Alice.
Bob also exchanges the secret key with Alice. This exchange of the secret key may
or may not take place online, as Bob can give Alice the key in a pen drive. Having
received the message, Alice, who we assume that in possession of the secret key,
decrypts the message using the key. Although a cryptographic algorithm secures
the transfer of the message described in this example, the key is not. An adversary
gaining possession of the key would be easily able to reveal the secret message. This
process necessitates the two parties to securely exchange the key to make symmet-
ric-cryptography work.
Amongst the popular symmetric-cryptography algorithms, the Data Encryption
Standard (DES) had been in use for many years and was highly influential in the
Encryption
``Hello Alice''
Bob
Encrypted
Message
Possible Man-in-the-Middle Attack
Encrypted
Message
``Hello Alice''
Alice
Decryption
Figure 2.1 Steps of a symmetric-key encryption.

advancement of modern cryptography. This block cipher was developed in 1975 at

IBM based on an earlier design of the German-born cryptographer Horst Feistel
and standardised in 1977. The National Bureau of Standards (NBS) and National
Security Agency (NSA) of the United States led this project to protect sensitive and
unclassified electronic government data.
As the computational power increased over time, DES and similar algorithms
became vulnerable to brute-force attack. The International Data Encryption
Algorithm (IDEA) was developed by James Massey and Xuejia Lai to replace DES
in 1991. Blowfish, a more sophisticated algorithm developed by Harvard University
professor Bruce Schneier, came into existence in 1993. The following year the
Russian government declassified the GOST algorithm that was developed by the
KGB in 1989 to protect the sensitive information of the Soviet and Russian gov-
ernment. The same year academics David Wheeler and Roger Needham from the
University of Cambridge presented the Tiny Encryption Algorithm (TEA) in an
academic workshop held at KU Leuven in Belgium. The implementation of TEA
typically needs a few lines of code, and the algorithm is not subject to any patents.
In 1998, a variant of the DES algorithm that applies encryption three times on each
block was released in a bid to strengthen the original algorithm. It is commonly
known as Triple DES.
In January 1997, the National Institute of Standards and Technology (NIST)
of the United States announced that it wished to choose a successor for DES to be
known as the Advanced Encryption Standard (AES). Like DES, this was to be an
unclassified, publicly disclosed encryption algorithm capable of protecting sensitive
government information well into the next century. However, instead of publish-
ing a successor, NIST asked for input from the open cryptographic community
and received a great many submissions during the 3-month comment period. Later
NIST shortlisted five algorithms that are collectively known as the “AES final-
ists”, and experts decided the following ranking through voting: Rijndael, Serpent,
Twofish, RC6 and MARS. Amongst these five algorithms, Belgian cryptographer
duo Vincent Rijmen and Joan Daemen from KU Leuven had designed the winning
cipher Rijndael. Ross Anderson, a professor from the University of Cambridge,
led the design of Serpent, while Bruce Schneier, the designer of Blowfish, devel-
oped Twofish. A group of academics led by MIT professor Ron Rivest designed
RC6, and Don Coppersmith, one of the key persons involved in the design of
DES at IBM, led the development of MARS. Subsequently, NIST made Rijndael
the official standard encryption protocol for NSA in 2000, and its British equiva-
lent Government Communications Headquarters (GCHQ) soon followed suit
[Ferguson et al., 2010].
The strength of a symmetric-cryptography algorithm can be determined by
its key and block size. A sizeable secret key indicates it would be difficult to guess
while a large block size would be hard to attack. Nevertheless, what is a “good size”
would be an interesting discussion to have. A key size of 80 bits is not secure given
today’s computational power, but extending it to 128 bits dramatically increases the
amount of effort required to guess the key. To put it in context, if there was a com-
puter capable of searching a billion keys per second, and we employed a billion such
computers, it would still require 10,783 billion years to explore all possible 128-bit
keys. Scientists anticipate that within the next 4 billion years our sun will become
a red giant and destroy the Earth and humanity, meaning a 128-bit encryption
key should be adequate for most cryptographic uses, considering that there are no
other weaknesses in the method used [Garfinkel et al., 1991]. Table 2.1 presents
known and renowned symmetric-key algorithms and their keys and block sizes to
promptly comprehend the strength of each of those ciphers.
2.2.2 Public-Key Cryptography
Public-key cryptography, or asymmetric cryptography, is the cryptographic system
that uses pairs of keys: a public key which may be disseminated widely and a private
key which is known to the owner only. This process accomplishes two purposes:
authentication, where the public key verifies that a holder of the paired private key
sent the message, and encryption, where only the paired private key holder can
decrypt the message encrypted with the public key. Figure 2.2 shows the following:
(a) Bob encrypts the message “Hello Alice” using his private key which is known
to him only. Once Bob sends this message to Alice, she decrypts it using the
public key of Bob. The decryption yielding a positive outcome authenticates
Table 2.1 Renowned Symmetric-Key Algorithms

Year Name Key Size Block Size
1975 DES 56 bits (+ 8 parity bits) 64 bits
1989 GOST 256 bits 64 bits
1991 IDEA 128 bits 64 bits
1993 Blowfish 32 – 448 bits 64 bits
1994 TEA 128 bits 64 bits
1998 Triple DES 168, 112 or 56 bits 64 bits
1998 MARS 128, 192 or 256 bits 128 bits
1998 RC6 128, 192 or 256 bits 128 bits
1998 Twofish 128, 192 or 256 bits 128 bits
1998 Serpent 128, 192 or 256 bits 128 bits
1998 AES (Rijndael) 128, 192 or 256 bits 128 bits

Encrypted by
Bob's Private key
Encrypted
``Hello Alice''
Message
Encryption
``Hello Alice'' Encrypted

Message
Decryption
Decrypted by
Bob's Public key
A: Authentication
Encrypted by
Alice's Public key
Encrypted
``Hello Alice'' Message
Encryption

Message
Decryption
Decrypted by
Alice's Private key
B: Encryption
Encrypted by Bob's Private

Key followed by Alice's
Public key
Encrypted
``Hello Alice''
Message
Encryption

Message
Decryption
Decrypted by Alice's
Private key followed by
Bob's Public key
C: Both Authentication and Encryption
Figure 2.2 Steps of a public-key encryption.

that the message is sent by Bob. Although this communication ensures

authenticity, it does not provides the encryption and is subject to a poten-
tial man-in-the-middle attack where anyone with Bob’s public key, which is
known to the world by convention, can read the message.
(b) Bob encrypts the message “Hello Alice” using the public key of Alice. Once
Bob sends this message to Alice, she decrypts it using her private key. This
communication is safe from the man-in-the-middle attack as it offers encryp-
tion confirming that nobody can decrypt it without the private key of Alice
which is known to her only. This, however, does not confirm the authenticity
of the message as anyone can send it by using Alice’s public key.
(c) Bob encrypts the message “Hello Alice” using his private key, followed by
Alice’s public key. Having received the message, Alice decrypts the message
using her private key followed by Bob’s public key. Unlike part (a), this com-
munication is safe from the man-in-the-middle attack. Nobody can read
the message without Alice’s private key; hence it provides encryption. If the
decryption yields a positive result, this also confirms the authenticity of the
message.
Public-key cryptography systems often rely on cryptographic algorithms based

on mathematical problems that currently admit no efficient solution, particularly
those inherent in certain integer factorisation, discrete logarithm and elliptic curve
relationships. Because of the computational complexity of asymmetric encryption,
it is usually used only for small blocks of data, typically in the transfer of a sym-
metric encryption key. This symmetric key is then used to encrypt the rest of the
potentially long message sequence.
Merkle’s puzzle is considered one of the earliest forms of public-key encryption.
Computer scientist Ralph Merkle, as an undergraduate student at the University of
California, Berkeley in 1974, attended a course taught by Lance Hoffman, another
celebrated computer scientist. In this course, Merkle submitted a term paper titled
“Secure Communications over Insecure Channels” where he proposed a method
allowing two parties to agree on a shared secret by exchanging messages, even
if they have no secrets in common beforehand. Merkle failed to make Hoffman
understand his proposal and eventually dropped the course. Later when he pub-
lished this work 4 years later, it became Merkle’s puzzle [Schneier, 1996].
Arguably the first person to develop a public-key cryptosystem was British
cryptographer and mathematician Clifford Cocks, who, while working at GCHQ
in 1973, implemented an idea previously conceptualised by his colleague James
H. Ellis [Cocks, 2001]. The discovery remained classified until 1997, and the RSA
became the first known public-key cryptosystem that Ron Rivest, Adi Shamir
and Leonard Adleman developed and published in 1978. The asymmetry in RSA
is obtained based on the practical difficulty of the factorisation of the product of
two large prime numbers, commonly known as the “factoring problem” [Rivest
et al., 1978].
Since the 1970s, a large number and variety of encryptions, digital signatures,
key agreements, and other techniques have been developed in the field of pub-
lic-key cryptography. This includes the Rabin cryptosystem published by Turing
Award–winning Israeli computer scientist Michael O. Rabin; ElGamal encryp-
tion based on Diffie–Hellman key exchange (DH), originally conceptualised by
Ralph Merkle; the Digital Signature Algorithm (DSA) developed at NIST; and
elliptic curve cryptography (ECC) first proposed in 1985 by Neal Koblitz from
the University of Washington and Victor Miller at IBM. The ECC is particularly
important in the context of this book, as Bitcoin utilises this algorithm to execute
transactions. We learn more about this scheme later in this chapter.
2.3 Cryptographic Applications
Cryptographic algorithms and theories have a wide range of use in securing infor-
mation, files, filesystem, databases, communication channels and so forth. Many
applications have been developed using one or more algorithms combined into a
system that provides a specific service. Amongst those, the following presents three
popular applications.
2.3.1 TLS and SSL

Transport Layer Security (TLS) and its predecessor Secure Sockets Layer (SSL)
are cryptographic protocols designed to provide security over a computer network
[Dierks and Rescorla, 2008]. A website can use TLS to secure all communications
between the servers and the browsers. This protocol can also be found in applica-
tions providing email, instant messaging and Voice over Internet Protocol (VoIP)
services.
The TLS protocol aims primarily to provide privacy and data integrity between
two or more communicating computer applications. When secured by TLS, con-
nections between a client and a server are considered secure because symmetric
cryptography is used to encrypt the data transmitted. The keys for this symmetric
encryption are generated uniquely for each connection and are based on a shared
secret negotiated at the start of the session commonly known as TLS handshake.
The server and client negotiate the details of which encryption algorithm and cryp-
tographic keys to use before the first byte of data is transmitted. The negotiation
of a shared secret is both secure, because the negotiated secret is unavailable to
eavesdroppers and cannot be obtained, even by attackers who place themselves in
the middle of the connection, and reliable, due to attackers’ inability to modify the
communications during the negotiation without being detected.
The identity of the communicating parties can be authenticated using public-key
cryptography. This authentication can be made optional, but generally requires at
least one of the parties. The connection remains reliable because each transmitted
Figure 2.3 Bitcoin.org, the original domain that Nakamoto registered for Bitcoin,
using “https” protocol. The HTTPS is referred to as “HTTP over SSL” (now TLS).
message includes an integrity check using a message authentication code to prevent

undetected loss or alteration of the data during transmission.
The use of TLS can be found in secure website connections. When we try to
log into Facebook, Gmail or similar sites, the “http” protocol becomes “https” indi-
cating the secured nature of the communication as shown in Figure 2.3. HTTPS
uses TLS underneath to make the end-to-end connection secured. The messenger
service WhatsApp and Telegram also use TLS-like public-key cryptography to pro-
vide secure communications.
2.3.2 Cryptographic Hash Function

A cryptographic hash function is a mathematical algorithm that maps data of arbi-
trary size to a bit string of a fixed size, called hash, and is designed to be a one-way
function which is infeasible to invert. The only way to recreate the input data from
the output of an ideal cryptographic hash function is to attempt a brute-force search
of possible inputs to see if they produce a match.
Figure 2.4 shows an excerpt from the book The Memoirs of Sherlock Holmes
written by Scottish author Sir Arthur Conan Doyle. The excerpt presents a famous
conversation between Sherlock Holmes and his friend John Watson. The SHA256
hash of the conversation and the title of the book yielded the same length hash val-
ues. Despite the title being much smaller than the conversation text, the length of
the generated hashes remains equal. If it were not the conversation rather the whole
works of Doyle, the length would still have been the same. The point is, regardless
of the size of the input, the hash function results in a fixed size output.
The ideal cryptographic hash function has five main properties: (1) it is deter-
ministic, so the same message always results in the same hash, (2) computing the
hash value for any given message is quick, (3) it is infeasible to generate a message
from its hash value except by trying all possible combinations, (4) a small change
to a message should change the hash value so extensively that the new hash value
appears uncorrelated with the old hash value, and (5) finding two different mes-
sages with the same hash value is infeasible.
The Merkle–Damgard construction, a scheme independently developed by
Ralph Merkle who described it in his PhD thesis at Stanford University in 1979
and Danish cryptographer Ivan Damgard who published it in 1989, is credited to
be the first cryptographic hash function that many popular algorithms use today
[Merkle, 1979; Damgard, 1989]. Ron Rivest, one of the authors of RSA, devel-
oped the MD2 algorithm in 1989 [Kaliski, 1992]. Although MD2 is not secure
"I have the advantage of knowing your habits, my dear Watson,"

said he. "When your round is a short one you walk, and when it is
a long one you use a hansom. As I perceive that your boots,
although used, are by no means dirty, I cannot doubt that you are
at present busy enough to justify the hansom."
"Excellent!" I cried.
"Elementary," said he. "It is one of those instances where the

reasoner can produce an effect which seems remarkable to his
neighbour, because the latter has missed the one little point
which is the basis of the deduction. The same may be said, my
dear fellow, for the effect of some of these little sketches of yours,
which is entirely meretricious, depending as it does upon your
retaining in your own hands some factors in the problem which
are never imparted to the reader."
SHA256
The Memoirs of Sherlock Holmes
SHA256
BF015FA97997F59C7C72AC89A9A687DE
F4D720507F0AB6B8DEA5066219851180
AFF32959CA07C03ADD01CA461F3F812
912547A8E772293C31E85F5A1F3B2B992
Figure 2.4 The SHA256 hash generation of an excerpt from a Sherlock Holmes

book and its title. It is notable that regardless of the size of the input, hash func-
tion results in a fixed size output.
anymore, it remains in use in public-key infrastructures as part of certificates gener-

ated with MD2 and RSA.
Several algorithms can be used to build a hash function, including MD5,
SHA-1, SHA-2 (all use Merkle–Damgard construction), SHA-3, Whirlpool and
BLAKE. The cryptographic hash function is particularly important in the context
of blockchain, as its immutability is established using the SHA256 algorithm from
the SHA-2 family that we discuss later in this chapter.
2.3.3 Digital Signature
A digital signature is a cryptographic analogue of a handwritten signature to val-
idate the authenticity integrity and non-repudiation of a message or documents
transferred over a digital medium. A valid digital signature provides a recipient

with the basis of believing that a known sender created the message; hence it
ensures authenticity, that the sender cannot deny sending the message indicating
non-repudiation and that the message was not altered in transit confirming the
integrity.
A digital signature scheme is generally used by a signer who generates a pair of
private and public keys followed by publicising his or her public key so that we can
assume the verifier will have it or can obtain it at the time of verification. Once the
public key of a signer is established, the digital signature scheme allows the signer to
sign or certify the message in such a way that any other party knowing the signer’s
public key and the corresponding algorithm can verify that it is originated from the
signer and nobody modified it in the middle [Katz, 2010].
Whitfield Diffie and Martin Hellman first described the possibility of such
a concept in 1976 before the invention of public-key cryptography [Diffie and
Hellman, 1976]. Later when RSA became available, it paved the path for the digital
signature to become a reality. The following example shows the steps of a simple
RSA and hash-based digital signature scheme.
Let suppose Bob wants to send a message to Alice using an RSA-based
digital signature as shown in Figure 2.5. He needs to go through the following
steps:
1. Bob generates a hash value of the message.

2. Bob encrypts the hash value using his private key. The encrypted hash value
can only be decrypted by his public key; hence it acts as his signature.
3. Bob attaches his signature at the bottom of the original message and sends it
to Alice using a digital communication medium.
4. Having received the message, Alice performs two tasks: first, she decrypts
Bob’s signature using his public key to obtain the hash value, and, second,
she creates a hash value for the original message sent.
5. By comparing two hash values, Alice can confirm the authenticity of the
message. It is because if someone in the middle changes the message, the new
hash value will be different than that of stored in Bob’s signature. Due to
this signature being encrypted, the man in the middle would not be able to
change it, or any modification attempt would result in a damaged signature
that cannot be decrypted using the public of key of Bob anymore revealing
the alteration.
The digital signature is another essential cryptographic principle used in the mak-
ing of cryptocurrency and blockchain technology. There are several digital signa-
ture algorithms available, of which Bitcoin uses the Elliptic Curve Digital Signature
Algorithm (ECDSA). The foundation of ECDSA is based on elliptic curve cryptog-
raphy. A brief introduction to this cryptosystem is presented next. Various chapters
of this book will later refer to that discussion.
Encrypted by
Hash
the private key
Function
of Bob
Signature
Message Hash (x)
(Encrypted Hash)
Message
Signed
Message
Signature
Bob
Signed message
sent to Alice
Message
Received
Message
Signature
Alice
Signature
Message
(Encrypted Hash)
Decrypted
by the public
key of Bob
Hash (y) Hash (x)
Hash (y) = Hash (x)
Confirmation of Authenticity
Figure 2.5 Steps of a typical digital signature.

2.4 Elliptic Curve Cryptography (ECC)

ECC is a process of encrypting data using publicly known information so that only
a specific person or a group of people having certain secrets in hand can decrypt it;
hence it forms a public-key cryptosystem. There are many such cryptographic tech-
niques in use, notably RSA and Diffie–Hellman (DH). Unlike RSA and DH, ECC
is much complicated and more secure. Due to the complex nature of ECC, it is
beyond the scope of this book to explain detailed procedures as to how this system
works, therefore, it provides a brief overview of ECC. Interested readers, however,
may consider reading the book Guide to Elliptic Curve Cryptography published by
Springer to obtain a broad knowledge on this topic [Hankerson et al., 2004].
2.4.1 Basic Concept
The foundation of all public-key cryptosystems is the same. There must be a pro-
cess commonly known as “trapdoor” to obtain a piece of information using some
publicly available knowledge that cannot be reversed. For instance, if A + X easily
gives us B, to form a public-key cryptosystem, obtaining A using B + X must not be
feasible. The following would shed more light on this.
If this is feasible:
“This is a simple message” + Public Key = “s80s1q8sadjds9s”
Then this must not be feasible:
“s80s1q8sadjds9s” + Public Key = “This is a simple message”
The RSA is designed utilising the difficulty of very large prime factorisation.
This algorithm uses two large prime numbers (let us suppose p and q) in its trap-
door function to obtain r such that p × q. If we have p and q, we can quickly deter-
mine r, but if we have r, it is infeasible to obtain p and q, at least within a practical
timeframe.
ECC utilises the difficulty of solving number problems instead of prime facto-
risation. It employs curves given by equations of the form
y 2 = x 3 + ax + b (2.1)
where a and b are constants.

The elliptic curve, shown in Figure 2.6, has two interesting properties that help
to develop the cryptosystem: (1) drawing an intersecting line will cut at three points
maximum, and (2) the curve is symmetric over the x-axis. It is possible to the two
properties in elliptic curve point multiplication operations to successively add a point
along an elliptic curve to itself repeatedly. This method in ECC ultimately leads to
producing the one-way trapdoor function. Because it is a scalar multiplication, the
1 R 2 3 4
Q P
P P
P
Q
Q
P+Q+R=0 P+Q+Q=0 P+Q+0=0 P+P+0=0
Figure 2.6 Examples of elliptic curves. (Image created by Chas zzz brown and
released under Creative Commons [CC BY-SA 3.0].)
most common name for it in literature is elliptic curve scalar multiplication. It is also
called the “double-and-add” algorithm [Hankerson et al., 2004].
Due to a cryptographic elliptic curve being a very large succession of points,
an arbitrary point on the curve can be reached quickly from a predecessor if the
number of steps is known. The elliptic curve protocol begins from a given known
point called the generator. A public key is a point in the curve, and a private key
is the number of steps from the generator that must be traversed to arrive at the
public key point.
The process of obtaining the public key is swift if we have the private key. It
is calculated using the double-and-add algorithm. However, the reverse, given the
public key finding out the private key, is very difficult. This is known as the discrete
logarithm problem. The brute-force algorithm to solve the discrete logarithm prob-
lem would traverse the points in the elliptic curve one at a time commencing from
the generator until it arrives at the desired point. This algorithm is computationally
infeasible, taking many years to complete with classical computers [Franco, 2015].
2.4.2 Public and Private Keys

The ECC is designed based on the generalised discrete logarithm problem on ellip-
tic curves. The curve in Figure 2.6 is on a two-dimensional plane whose points
verify Equation 2.1. Our interest in this curve is not the real numbers but rather
the integers. We set a maximum value – a prime order p that defines the boundary.
All operations are performed modulo this p in the calculation. Therefore, the new
equation will look like
y 2 = x 3 + a· x + b mod p (2.2)
All the points Pi = (xi, yi) that satisfy this condition are said to belong to the elliptic
curve. A group operation, often called addition, is defined over this set of points as
follows:
P 3 = P1 + P 2 (2.3)
If the two points are the same, then the tangent to the elliptic curve at this point
is drawn. The result of the operation is then the reflection over the x-axis of the
intersection of this line with the elliptic curve. This operation is sometimes called
point doubling.
P ′= P + P (2.4)
This leads to point multiplication – given a point on the elliptic curve A and an
integer d, point multiplication is defined as the point T in the elliptic curve, which
is the result of adding A to itself d times:
T = d · A = A + A + ... + A (2.5)
The discrete logarithm operation is the inverse of point multiplication. Given a

starting point A, it is computationally fast to advance d positions in the sequence of
points using point multiplication to reach T.
T = d · A (2.6)
However, given a point T in the group it is difficult to know how it has been
reached or, in other words, the number of elements in the sequence from the gen-
erator to this point. In order to achieving this, we must visit points in the curve one
by one to discover the number of steps taken to reach the destination point. This
operation requires an exponential number of steps making the discrete logarithm
problem hard [Franco, 2015].
Having gone through the preceding calculation, we obtain two elements,
T and d, that give us the required key pairs. T is the public key, which is a
point on the elliptic curve. It is made of two components: x and y coordinates
where both are large integer numbers. The private key, on the other hand, is
represented by d, which is the number of steps taken to reach T; hence a large
single integer.
2.4.3 How Does ECC Compare to RSA?

The biggest differentiator between ECC and RSA is the key size compared to cryp-
tographic strength. As Table 2.2 shows, ECC can provide the same cryptographic
strength as an RSA-based system with much smaller key sizes. For example, a 256-
bit ECC key is equivalent to RSA 3072-bit keys, which are 50% longer than the
2048-bit keys commonly used today. Earlier in Table 2.1, we saw that the latest and
the most secure symmetric algorithm currently in use is AES. This algorithm uses
at least 128-bit keys demonstrating that the asymmetric keys provide ECC’s level
of security [Olenski, 2015].
Table 2.2 NIST Recommended Key Size

Symmetric (bits) RSA and DH (bits) ECC (bits)
80 1024 160
112 2048 224
128 3072 256
192 7680 384
256 15360 521
2.5 Making Blockchain Immutable

The immutability of blockchain is confirmed using cryptographic principles and
applications. The idea of using a distributed ledger is to prevent double-spending by
keeping records of previous transactions. In doing so, distributed computing played
a vital role, but for the time being, if we ignore the contribution of that discipline,
what we have is all cryptography. Nakamoto used linked timestamping, Merkle tree
and cryptographic hash functions to make transactions of the blocks irreversible
even for the authors. The following sections first discuss the components and then
seek to explore how those components are used to make blockchain immutable.
2.5.1 Block and Block Header

Each block of a blockchain is made of at least two parts: a block header and a data
structure. The block header contains some meta information, and the data structure
holds the actual data. The type of data structure depends on the data itself. Because
Nakamoto’s design of blockchain administers virtual currency transfers, it holds
transactions. Seemingly a simple list or a vector would have been sufficient to store the
data, but auditing transactions from a large pool of data would be an expensive opera-
tion. In dealing with this problem, blockchain uses Merkel tree as its data structure.
A block header contains a variety of information, amongst which three fields are
particularly important for ensuring immutability. These are a time variable indicating
the block generation time, a link to the data structure and a link to the previous block.
Blockchain uses the Unix timestamp to designate the block-building time, while
Merkle tree provides the Merkle root that establishes a connection with the data struc-
ture, and the hash value of the previous block header is used to connect the blocks.
2.5.2 Timestamp
A timestamp is a representative of a specific time. A Unix time timestamp is the
number of seconds that have passed since 00:00:00 (UTC), Thursday, 1 January
1970, minus leap seconds. In this timestamping, every day is considered to have
precisely 86,400 seconds to subtract the leap seconds since the epoch. In addi-
tion to working as a source of variation for the block hash, the timestamps also
make it more challenging for an adversary to manipulate the blockchain. Bitcoin
protocol considers a timestamp valid if it is greater than the median timestamp
of the previous 11 blocks, and less than the network-adjusted time plus 2 hours.
The “network-adjusted time” means the median of the timestamps returned by all
nodes connected to a participating node.
2.5.3 Merkle Tree
A Merkle tree is a binary tree data structure designed by Ralph Merkle. Unlike a
regular tree, it is constructed by recursively hashing pairs of nodes. Every leaf node
of a Merkle tree contains the cryptographic hash of a data, whereas every non-leaf
node stores the hash of concatenated hashes of its child nodes. If there remains an
odd number of child nodes, the last hash gets duplicated.
Merkle tree is used to summarise and verify the integrity of a large dataset.
Figure 2.7 shows a Merkle tree with eight transactions (T1 to T8). If we are to
ascertain the integrity of T5, we would require H6, H78, H1234 and the Merkle
root, and must compute and compare the following:
MerkleRoot → Hash (Hash (Hash (Hash (T 5) + H 6) + H 78) + H 1234) (2.7)
If the above equation satisfies, this proves that T5 belongs to the tree. It is because
if the integrity of T5 gets compromised, H56 will be affected that subsequently
returns a different Merkle root for the tree. The use of the Merkle tree in blockchain
enables miners with the ability to verify the transactions efficiently and securely
from a large pool of data. When N data elements are hashed and summarised in a
Merkle tree, a miner can ascertain if a particular transaction is already in the tree
with at most 2log2(N) number of calculations.
2.5.4 Building the Chain

Having acquired the required knowledge, now we explore how blocks are chained
in a blockchain using a visual description presented by Figure 2.8. In a blockchain,
the genesis block, which is also the first block of the chain, is a special case that
does not have a reference to its previous block; every other block is chained using
cryptographic principles. The genesis block is almost always hardcoded into the
software of the applications that utilise the blockchain.
The blockchain uses two components to chain the blocks. The first is the Merkle
root that represents all the transactions of a block in a hashed format. Any attempt
of changing a single transaction in the tree leaf would result in a new Merkle root
revealing the change. The second component is the hash of the previous block’s
Merkle Root
H12345678
hash
( H1234 + H5678 )
H1234 H5678
hash hash
( H12 + H34 ) ( H56 + H78 )
H12 H34 H56 H78
hash hash hash hash

( H1 + H2 ) ( H3 + H4 ) ( H5 + H6 ) ( H7 + H8 )
H1 H2 H3 H4 H5 H6 H7 H8
hash (T1) hash (T2) hash (T3) hash (T4) hash (T5) hash (T6) hash (T7) hash (T8)
T1 T2 T3 T4 T5 T6 T7 T8
Data
(Transactions)
Hash ( Hash ( Hash ( Hash (T5) + H6 ) + H78 ) + H1234 )
Root (H12345678)
T5 is in the tree
Figure 2.7 A typical Merkle tree.

Block Header
Timestamp
Hash
Merkle Root
0 x
Merkle Tree
Block Header
Timestamp
Merkle Root Hash
1 Previous Header’s Hash
Merkle Tree
Block Header
Timestamp
Merkle Root Hash
2 Previous Header’s Hash
Merkle Tree
Block Header
Timestamp
Merkle Root
Previous Header’s Hash
3
Merkle Tree
Figure 2.8 Each block in a blockchain is chained to one another using crypto-

graphic hashes. Putting the hash of the previous block’s header in the header of
the following block, that also contains the Merkle root, creates the ultimate bond
to develop the whole chain.
header. Because the Merkle root is part of this header, its hash effectively ties up the
transactions in the chaining mechanism. Finally, the hash of the previous block’s
header is placed in the header of the following block to complete chaining of two
consecutive blocks. Every time miners build a block, they put it at the end of this
chain; hence the chain keeps growing.
Only chaining the blocks with each other, however, does not make blockchain
immutable. Its immutability also depends on the block-building process. If the
task of building a block becomes too easy, anyone willing to alter a transaction can
rebuild the whole chain from scratch. Thus, if half of the credit of making block-
chain goes to the cryptography disciple, the other half is due to the principles of
distributed systems that we learn in the next chapter.
2.6 Summary
This chapter presented the cryptographic principles required to understand block-
chain and explained how it is made immutable using those techniques. It described
a brief history of cryptography, introduced its modern branches and stated the nec-
essary cryptographic algorithms including hash functions, digital signature and
the elliptic curve cryptography that play a vital role in blockchain technology. The
chapter concluded showing how blockchain utilises a combination of some of those
algorithms to construct blocks that are impossible to erase, alter or rewrite.
Chapter 3
Consensus Mechanisms
of Blockchain
Two branches of computer science, cryptography and distributed systems, act as

the enabling technology of blockchain. We learned about cryptography in the pre-
vious chapter that discussed how the principles of this branch make blockchain
immutable. Although it is no overstatement that cryptographic principles make
blockchain data immutable, cryptography can achieve this success only when all
nodes agree upon a constructed block to be included in the blockchain. This agree-
ment requires a mechanism to coordinate thousands of participating nodes in the
network to reach a consensus, and this chapter takes the opportunity to explain
how that is accomplished.
3.1 Distributed Systems and Consensus

Blockchain is a decentralised system without the existence of a central authority
that leads and coordinates. While this removes the possibility of corruptions from
a single entity, the decentralised approach creates some significant concerns such as
who is going to take the decisions and how the executions of the process are per-
formed. If we think of a centralised system, it is easy to figure out a boss who makes
all the decisions. This is not possible in a blockchain because a blockchain has no
“leader”. For the blockchain to make decisions, all participating nodes must reach
a consensus on the best choice for the system.
Reaching a consensus is a fundamental element of a distributed system. Being
a distributed ledger, the blockchain is a distributed system at its core. It uses one
of the finest examples of the distributed system, a peer-to-peer network, to keep
49
the data stable, permanent and immutable where nodes agree upon the decision of
building new blocks through consensus. It is, therefore, necessary to briefly intro-
duce distributed systems to readers and explain how participating nodes, or more
appropriately miners, reach an agreement remotely about the data integrity of the
blockchain.
3.1.1 Distributed Systems
A distributed system is a computing paradigm where two or more components (also
referred to as nodes, processes and actors) work with each other in a coordinated
fashion intending to achieving a common goal. Although the system remains dis-
tributed at its execution, it is modelled in such a way that the end users recognise it
as a single logical platform. The components or nodes of a distributed system stay
apportioned amongst multiple machines to improve efficiency and performance;
hence computer networking is used to communicate and coordinate the actions
of the components by passing messages to one another. A distributed system dem-
onstrates three vital characteristics – concurrency of components, lack of a global
clock and independent failure of components – that govern its execution and per-
formance [Andrews, 2000; Coulouris et al., 2011].
Distributed computing uses distributed systems to solve computational prob-
lems. The problems are divided into numerous tasks, each of which is solved by one
or more nodes spread across the network via message passing. A computer program
that runs within a distributed system is called a distributed application (DApp).
Examples of distributed systems can be as small as an office where employees share
resources like printers and file storages via the Local Area Network (LAN) to big
cloud platforms such as Dropbox and Google Drive to massive peer-to-peer plat-
forms like BitTorrent.
Typical properties of a distributed system include the following [Ghosh, 2007;
Lynch, 1996]:
◾◾ The system must tolerate failures in the individual node.

◾◾ The structure of the system including network topology, network latency and
the number of nodes is not known in advance.
◾◾ The system may consist of different kinds of computers and network links,
and may change during the execution of a distributed program.
◾◾ Each node has only a limited, incomplete view of the system.
◾◾ Each node may know only one part of the input.
3.1.2 Coordination and Agreement

Distributed nodes often require coordination of their activities, particularly when
they share a collection of resource, to prevent interference and ensure consistency of
accessing the resources. Coordination in a synchronised system with no failures is
Consensus Mechanisms of Blockchain ◾ 51
relatively easy, but if a system is asynchronous where failures may occur or messages
may be delayed, an indefinite amount of time, coordination and agreement become
much more challenging.
A node in a distributed system is said to be correct if it exhibits no failures at
any point in the execution under consideration. If a node fails, it can fail in one of
two ways: a crash failure or a Byzantine failure. A crash failure means a node stops
working and does not respond to any messages. A Byzantine failure implies that
a node exhibits arbitrary behaviour. For example, it may continue to function but
send incorrect values.
3.1.3 Consensus
A fundamental problem in distributed computing is achieving overall system reli-
ability in the presence of some faulty nodes. This often requires nodes to agree on
some data value that is needed during computation. The method that makes a dis-
tributed system achieve this agreement is called consensus. In simpler terms, a con-
sensus is a dynamic way of reaching agreement in a group. While a general voting
system rectifies the majority rule without caring for the well-being of the minor-
ity, a consensus, on the other hand, ensures an agreement is reached which could
benefit the entire group as a whole. The method by which a consensus is achieved
is called the consensus mechanism. Examples of distributed executions where a con-
sensus mechanism is required by design include committing a transaction to a
database, state machine replication, atomic broadcasts, agreeing on the identity of
a leader and so on.
There are some properties a consensus mechanism typically has:
◾◾ Agreement seeking: A consensus mechanism should bring about as much

agreement from the group as possible.
◾◾ Collaborative: The participating nodes should aim for working together to
achieve a result that benefits the best interest of the group.
◾◾ Cooperative: The participating nodes should not put their own interests first,
but rather work as a team than a collection of individuals.
◾◾ Inclusive: As many people as possible should be involved in the consensus
process.
◾◾ Participatory: The consensus mechanism should be such that everyone
actively participates in the process.
◾◾ Impartial: A group trying to achieve consensus should be as fair as possible.
It essentially means that each vote has equal weighting where one vote cannot
be more significant than another.
The consensus mechanism requires agreement between a number of nodes for a

single data value. Some of the nodes may fail or be unreliable in other ways, so con-
sensus protocols must be fault tolerant or resilient. The nodes must somehow put
forth their candidate values, communicate with one another and agree on a single
consensus value. One approach to generating consensus is for all nodes to agree on
a majority value. In this context, a majority requires at least one more than half of
the available votes, where each node is considered to have one vote. However, one
or more faulty nodes may skew the resultant outcome such that consensus may not
be reached or reached incorrectly.
Before Bitcoin, many failed attempts saw scientists and developers trying to
establish decentralised peer-to-peer currency, but they were unable to answer the
most significant problem when it came to reaching a consensus. This problem is
called the Byzantine Generals Problem.
3.2 Byzantine Generals Problem

The Byzantine Generals Problem is derived from another problem commonly known
as the Two Generals Paradox. It is an analogy of computer communication. It was
first proposed by Akkoyunlu et al. in their paper “Some Constraints and Trade-
Offs in the Design of Network Communications” in 1975 [Akkoyunlu et al.,
1975]. The paper described the problem in the context of communication between
two groups of gangsters, but later Turing Award–winning computer scientist Jim
Gray named it the Two Generals Paradox. Roughly six years later, the Byzantine
Generals Problem came as a modified version of this paradox that another Turing
Award–winning computer scientist Leslie Lamport and his co-researchers Robert
Shostak and Marshall Pease published in 1982 [Lamport et al., 1982]. This problem
is now widely used to explain the fault tolerance of the distributed systems.
3.2.1 Two Generals Paradox

Let suppose two generals (A and B as seen in Figure 3.1) planning an attack on a
common enemy struggle to decide on an attacking strategy due to the location of the
enemy city. The city is securely placed in a valley and has a solid defence that can easily
fight off a single army. The only chance of winning against this enemy is to attack from
two sides of the city at the same time. This constraint requires the generals to com-
municate with each other to plan a synchronised attack. As the enemy’s city separates
two attacking armies, the generals must communicate with each other by sending a
messenger across the territory. If the enemy captures the messenger of General A, the
message will go lost, and General B would not know when to attack and vice versa.
Now, consider a scenario where General A, who is the leader amongst them,
sends a message to General B – “Attack at dawn tomorrow”. General B receives the
message and acknowledges sending another message, “Message received, attack-
ing at dawn tomorrow”. A receives B’s confirmation and starts preparing for the
attack. But, is this enough to reach a consensus between the generals? Sadly, not.
General A knows B received the message, but B still does not know if A received his
Figure 3.1 Two generals planning an attack on a common enemy.
acknowledgement and will be ready for the attack. If General A sends a confirma-
tion of receiving B’s response, that makes B relieved, but then A starts to worry.
This way they end up in an infinite exchange of confirmations.
In another scenario, let us assume that General A posts a message to General
B. As time passes, General A starts to wonder what might happen to his message
because of General B not sending an acknowledgement yet. There might be two
possibilities. Either General A’s messenger got captured and failed to deliver the
message, or B’s soldier carrying the message ended up in the enemy’s hand. In both
situations, the two generals cannot come to a consensus again. A is not sure if his
message or B’s confirmation was lost, and B is doubtful if A received his response.
The preceding scenarios show no matter how many different combinations we
try and how many messages we send, it is not possible to guarantee that a consensus
is reached and the generals cannot be certain that their ally will attack at the same
time. This is an unsolved problem to date.
Many people tried to solve this paradox and came up with a few useful
approaches. Although there exists mathematical proof that this problem is unsolv-
able, accepting the uncertainty of the communication channel is a potential solu-
tion that can improve the likelihood of a synchronised attack. The Transmission
Control Protocol (TCP), the backbone of the modern World Wide Web (WWW),
establishes the connection between a client computer and the server using a mecha-
nism called three-way handshake that mimics the attempted agreement between
the generals described in this paradox.
3.2.2 Byzantine Generals Problem

The Byzantine Generals Problem is a modified version of the Two Generals Paradox.
In this setup, the leader is called the commanding general or the commander who
leads the Byzantine army consisting of n–1 number of lieutenant generals responsible
for their battalions. The commander and every lieutenant general must agree on the
decision of attack or retreat. This new version introduces a twist stating that one
or more of the generals can be a traitor to the Byzantine state who lies about his
choices.
The problem stated that the commander must send an order to his n–1 lieuten-
ant generals such that (1) all loyal lieutenants obey the same order; or (2) if the com-
manding general is loyal, then every loyal lieutenant obeys the order he sends. In
this problem, the algorithm to reach consensus is based on the value of the majority
of the decisions a lieutenant observes.
Let us do a hands-on approach to find out how a possible consensus can be
achieved. We consider a scenario where three Byzantine lieutenant generals led by
a commanding general take their positions around an enemy city. Amongst them,
Lieutenant General 3 is a traitor. The message from the commanding general is
Attack but the traitor changed it to Retreat as shown in Figure 3.2. Having received
the message from the commander, each lieutenant forwards it to other lieutenants.
Despite having a traitor, the general consensus, in this case, is Attack, which was
the original message sent by the commander.
In the same scenario, what if the commander himself is the traitor rather than
a lieutenant? Let us draw the same diagram again but with commander as the trai-
tor who sends three different kinds of messages – Attack, Wait and Retreat – to his
lieutenants as shown in Figure 3.3. Despite the commander being the traitor, the
Attack
Attack
Attack
Commanding
General
Attack
Attack Attack
Attack
Attack Attack
Attack Retreat
Retreat Traitor
Lieutenant
Lieutenant Attack General 2 Retreat Lieutenant
General 1 General 3
Attack Attack
Attack
Retreat
Figure 3.2 Three Byzantine lieutenant generals led by a commanding general

planning to attack an enemy city. The message from the commanding general is
Attack, but the traitor (Lieutenant 3) changed it to Retreat. Despite that, the con-
sensus is Attack, which was the original message sent by the commander.
Traitor
Commanding
General
Wait
Attack Wait Retreat
Attack Attack Retreat
Wait Retreat Wait
Retreat Attack
Lieutenant
Lieutenant Attack General 2 Retreat Lieutenant
General 1 General 3
Wait Wait
Attack
Retreat
Figure 3.3 Three Byzantine lieutenant generals led by a commanding general,

who is the traitor in this scenario, planning to attack an enemy city. The message
from the commanding general is Attack, Wait and Retreat. Despite that, the con-
sensus is “Retreat” is the default option.
generals still reach a consensus. To understand the outcome of this consensus we

must realise that because each lieutenant receives three different kinds of messages
from multiple sources, they cannot decide on attacking the city and act on the
default option, which is Retreat.
The original paper by Lamport et al. provided a theorem stating that for any m,
the algorithm reaches consensus if there are more than 3m generals and at most m
traitors. This implies that the algorithm can reach consensus as long as 2/3 of the
generals are honest. If the traitors are more than 1/3, consensus is not reached, the
armies do not coordinate their attack and the enemy wins.
3.2.3 Byzantine Fault Tolerance

The fault tolerance is the property that enables a system to continue operating prop-
erly in the event of the failure of some of its components. The Byzantine fault toler-
ance (BFT) is a special class of fault tolerance that is very challenging to achieve. In
a “Byzantine failure”, a component such as a server can inconsistently appear both
failed and functioning to failure-detection systems, presenting different symptoms
to different observers. BFT is the characteristic defining a system that tolerates the
Byzantine failure.
Blockchains are decentralised ledgers by definition that are not managed by
a central authority. This gives bad nodes the motivation to try to cause faults to
achieve unfair economic benefits. In the absence of BFT, a node will be able to
send false transactions nullifying the reliability of the blockchain. To make things
worse, no central authority can step in to take over and repair the damage in this
context. Thus having the Byzantine fault tolerance and a solution to the Byzantine
Generals Problem for blockchains is much needed.
3.3 Blockchain’s Consensus Mechanism

Nakamoto used the proof-of-work (PoW) system to achieve high BFT in the block-
chain. PoW is an economic measure to deter denial-of-service attacks and other
service abuses such as spam on a network by requiring some work from the service
requester, usually meaning processing time by a computer.
The 1980s and ’90s saw distributed systems researchers achieving some remark-
able feats, and PoW is one of those. Harvard University professor Cynthia Dwork, a
recipient of the prestigious Dijkstra Prize in distributed computing, invented the PoW
technique collaborating with Israeli computer scientist Moni Naor in 1993. Four years
later in 1997, British cryptographer Adam Back proposed Hashcash, an anti-spam sys-
tem, and customised the PoW system to work with his application. Nakamoto almost
identically used the Hashcash PoW algorithm in his Bitcoin protocol.
3.3.1 Hashcash Proof of Work

Back developed Hashcash to limit email spamming. The Hashcash PoW algorithm
requires a selectable amount of work to compute, but the proof can be efficiently veri-
fied. For email, a textual encoding of a Hashcash stamp is added to the header of an email
to prove the sender has expended a modest amount of CPU time calculating the stamp
prior to sending the email. In other words, as the sender has taken a certain amount of
time to generate the stamp and send the email, it is unlikely that he or she is a spammer.
The receiver can, at negligible computational cost, verify that the stamp is valid.
However, the only known way to find a header with the necessary properties
is brute force, trying random values until the answer is found; though testing an
individual string is easy, if satisfactory answers are rare enough it will require a sub-
stantial number of tries to find the answer. The hypothesis is that spammers, whose
business model relies on their ability to send large numbers of emails with very little
cost per message, will cease to be profitable if there is even a small cost for each
spam they send. Receivers can verify whether a sender made such an investment
and use the results to help filter email.
Let us examine an example to understand how the PoW is used to send
emails. There is a sample Hashcash version 1 header line shown in Figure 3.4.
Figure 3.4 A sample Hashcash version 1 header.

In this header, “ckvi” represents a counter in base64 that the sender must ran-
domly generate and append at the back of all other required fields. Once all set,
the sender computes the 160-bit SHA-1 hash of the header including the coun-
ter. If the first 20 bits, which is the 5 most significant hex digits, of the hash
are all zeros, this is an acceptable header. If not, then the sender increments the
counter and tries the hash again. Out of 2160 possible hash values, there are 2140
hash values that satisfy this criterion. Thus the chance of randomly selecting a
header that will have 20 decimal or 5 hex zeros as the beginning of the hash is
1 in 220.
The number of times that the sender needs to try to get a valid hash value is
modelled by geometric distribution. Hence the sender will on average have to try
220 values to find a valid header. Given reasonable estimates of the time needed
to compute the hash, this would take about one second to find. A normal user on
a desktop PC would not be significantly inconvenienced by the processing time
required to generate the Hashcash string, but spammers would suffer significantly
due to a large number of spam messages sent by them.
3.3.2 Proof of Work in Blockchain

We know that blockchain is a decentralised system with no central authority. As
such, it is necessary that someone plays the role of a leader for a brief period to
choose the next block to be added to the blockchain. Participating nodes, called
miners hereafter, in a blockchain elect this leader using the PoW algorithm that
engages them to find the hash fulfilling the criterion. The node discovering the
hash first gets elected to choose the next block.
Like the Hashcash where the header of the email is used as the base string,
blockchain uses the block header. The header of a blockchain contains a counter – in
Bitcoin it is called nonce – that the miners need to increase gradually. There are two
more elements in blockchain PoW: target and difficulty. A target is a large number,
and the hash of the block header must be lower than or equal to this number to be
accepted. The difficulty is a measure of how difficult it is to find a hash below a given
target. The protocol generally monitors the block-building process and adjusts the
difficulty to keep the block generation rate the same.
This mining process is used in blockchain to coordinate the block-building
process by electing a miner out of thousands of them who want to build the next
block. All miners get the chance to construct a block by picking up transactions
of their choices. However, only one of those blocks becomes the next block in the
blockchain. Once individual blocks are created, miners attempt to find the required
hash which must be smaller than or equal to the given target at that moment. The
miner who finds the appropriate hash first becomes the leader to build the next
block and receives the reward. All other miners destroy their blocks and start over
from the beginning to compete in the next round of the block-building process;
hence the operation continues to run and despite being decentralised, blockchain
operates in a coordinated and organised manner. Section 4.7 of Chapter 4 further

describes this process as it happens in Bitcoin.
3.3.3 BFT in Blockchain
It is important to realise that PoW helps blockchain achieve high Byzantine Fault
Tolerance. In order for a miner to insert false information in a block, it must have
at least 51% of the computational power of the whole network. How difficult it is
to achieve such power is explained in Figure 3.5.
Let suppose miners have been working to build block 40 where Chuck is one of
the miners in the process. Instead of building block 40, he wants to alter a trans-
action in block 23. If Chuck does that, the link of the blockchain will be broken,
and the community will reject the copy of the blockchain presented to them later.
So he must redo blocks 23 to 39, which is 17 blocks before all other miners finish
building block 40. This is the only way Chuck can cheat the network and alter one
or more transactions in the blockchain.
1. Everybody's
working on
Block 40
40
39
2. Chuck is a miner
who wants to alter a 23
3. Chuck must redo
transaction in block 23 blocks 23 to 39 before
all other miners finish
doing 40. That is 17
blocks of expensive
computing.
4. To put it in context, Chuck has to find the hashes

for 17 blocks before a combined attempt of the
whole network find the hash of just a single block.
Figure 3.5 Byzantine fault tolerance in blockchain.

However, doing this is not an easy task. Changing a transaction will effectively
give a new Merkle root leading to a new block header. When the block header is
different, Chuck must find a new hash for that block fulfilling the condition; other-
wise, the community will find the cheat and reject Chuck’s copy of the blockchain.
Therefore, he must find 17 new hashes to connect the blocks, and he must do it
before a combined attempt of the whole network finds the hash for a single block.
The preceding example tells us that the success of Chuck’s attempt depends on
computational power. If Chuck could gain a computational power greater than
the whole network, he can achieve this exploit. This can be accomplished either by
building a powerful computer having the computational power greater than the
power of the network combined or by convincing the majority of the miners to join
him in the cheat; hence, the 51% Byzantine fault tolerance.
3.4 Solving the Double-Spending Problem

In Chapter 1, we left the explanation of the double-spending problem incomplete
due to the lack of sufficient knowledge required to comprehend the answer. As we
have now covered the fundamental theories and mechanisms to understand how
blockchain works, it is time to complete that explanation.
There is a blockchain for Bitcoin that keeps the record of all transactions. This
blockchain hypothetically floats over a peer-to-peer network managed by remote
nodes commonly known as miners. Figure 3.6 shows a heat map of Bitcoin miners
from around the globe. Between 9000 and 12,0000 miners generally take part in
the mining process, where every miner has a copy of the blockchain that it stores
in its local computer. However, miners do not have the ability to change the block
entries or add new blocks, as the network will reject any such attempt. Miners
Figure 3.6 Heat map showing Bitcoin miners from around the globe.
manage the blockchain in a decentralised and distributed manner where editing

an entry of the blockchain is restricted by the cryptographic principles, and add-
ing new blocks or attempting to rebuild old blocks are prevented by distributed
consensus.
As such, Bob wants to send 100 Bitcoins (BTC) to Alice. What he does next is
to initiate a transaction stating the amount he intends to send to Alice. However,
the money does not go to Alice instantly; rather goes through a verification pro-
cess. Bob’s request for transferring the Bitcoin stays in a request pool that miners
regularly monitor. Some miners pick up Bob’s transaction from the pool and look
up at the blockchain entries to verify that he retains sufficient Bitcoin for send-
ing the requested amount to Alice, and therefore not attempting to double spend.
Once confirmed, those miners place the transaction in the Merkle tree of their
blocks. The transfer of the money remains pending until the blocks go through the
consensus and a miner discovers the hash smaller than or equal to the target. The
block-building process comes to an end when a consensus is achieved, and the win-
ner block becomes the new addition in the blockchain.
If Bob is lucky enough to have his transaction in this block, Alice becomes the
rightful owner of the 100 BTC sent from Bob. Otherwise, Bob needs to wait until
his transaction gets included in a winning block and transferred to Alice. There will
be no need for an arrangement to move the money physically or involve a central
authority having superior power.
3.5 Summary
This chapter presented distributed systems and explained the need for a consensus
to make such systems operational. It described the Byzantine fault tolerance (BFT)
and how it relates to blockchain technology. As the discussion proceeded further, a
Hashcash-like proof-of-work method explained focusing on how it helps to achieve
consensus with a high BFT in picking up the next block. The chapter concluded
by revisiting the double-spending problem and completed the explanation of how
Nakamoto solved it with the help of cryptography and distributed systems.
Chapter 4
Bitcoin: World’s First

Cryptocurrency
Bitcoin is the first application of blockchain technology. Although it is a currency

transaction protocol, the application is useful to understand blockchain as a whole.
The opening three chapters of this book introduced blockchain and described how
principles of cryptography and distributed systems contributed to its development.
In this chapter, readers will mostly find the same topics but from a practical point
of view. The chapter arranges the discussion in such a way that readers can relate
the theories with a working example (e.g. Bitcoin) to comprehend the operation of
blockchain technology in the real world.
4.1 What is Bitcoin?
Bitcoin is a virtual currency constructed using cryptographic principles and con-
ceived by the blockchain and proof-of-work mechanism in a distributed and decen-
tralised environment; hence it is also called cryptocurrency. Although there had
been proposals in the literature for developing similar currency employing cryp-
tographic techniques, it remains the world’s first implemented cryptocurrency. In
solving the double-spending problem using a distributed ledger, Nakamoto deliv-
ered the process of moving money virtually that was previously impossible. This
ability of Bitcoin made it one of a kind and introduced a new branch of technology.
This virtual currency, however, has more mystery to it. Bitcoin is called a virtual
currency because it does not have an existence in reality. We cannot touch it or feel
it despite it having a tangible value. Chapter 1 of this book discussed an example in
Section 1.1.3 where Chuck copies Bitcoin to send to Alice and Bob as if copying a
61
digital file. That example described Bitcoin at a very high level. In reality, Bitcoin is
even more virtual than a digital file. It is so virtual that it does not have an existence
even in the digital world. There exists no such digital file on our computer or on a
server that we can call Bitcoin.
Nakamoto visualised Bitcoin from a very different perspective. His protocol
examines the transactions to discover the amount of Bitcoin someone holds. From
the creation of each Bitcoin, its life story resides on the pages of a ledger famously
known as blockchain. Blockchain keeps records of every transaction revealing
whether someone claiming to have a particular unit of Bitcoin is true.
Bitcoin is created by mining. Once miners validate the transactions and build a
block, through a puzzle one miner gets selected to have a specific number of Bitcoin
as an incentive; hence new Bitcoin comes into existence. From that moment on,
every time these newly created tokens change hands, miners write transactions in
the blockchain.
An example would perhaps make it clearer. Let suppose Bob gets 10 Bitcoins
(BTC) as a reward for his mining work. If he wishes to send Alice 5 BTC, he must
declare it to the network so that miners can check existing transactions in the
blockchain and validate that Bob indeed holds sufficient units of Bitcoins to send
5 BTC to Alice, and therefore, they write a new transaction in the block showing
5 BTC going to Alice from Bob. At this point, Bob loses his claim on the tokens
and Alice becomes the rightful owner of those Bitcoins until she sends those to
someone else.
If Bob gets 10 BTC from Carol in the meanwhile and wants to send 15 BTC to
Alice, that request will be considered valid because he already holds 5 BTC from
the mining reward and received another 10 BTC from Carol. By combining two
transactions, miners will be able to reach an affirmative decision on Bob’s request.
However, if he wants to send 20 BTC, miners will identify that Bob does not have
the required amount and his request will be discarded. There will be no transaction
entry for that request in the blockchain and Alice will not get any Bitcoins.
Therefore, it is not the token but rather the transactions Bitcoin protocol keeps
track of. The tracking is implemented pseudonymously using a pair of crypto-
graphic public and private keys telling the network of the right of an individual
on that transaction. Instead of using the public key directly, the protocol uses the
hash of the public key as an address. When Bob announced his interest in sending
Alice 5 BTC, without revealing his identity Bob unlocked some of the unspent
tokens that he received in the past. While unlocking this fund, Bob used a digital
signature telling the protocol of his wish. Bitcoin protocol, having identified the
presence of Bob’s private key in the relevant tokens’ address, made those available
for him. This signature cannot be generated without the private key, ensuring min-
ers that he is indeed the person holding the tokens; hence he is not attempting to
double spend.
Bitcoin has a dark history for its use in criminal activities since its inception. Its
transactions can store information on the blockchain in obscure style and establish
Bitcoin: World’s First Cryptocurrency ◾ 63
contracts between multiple parties. The pseudonymous nature of these transactions also
gives users the ability to hide their identities while trading. These features of Bitcoin
make criminals, drug cartels and firearms dealers interested in this virtual currency.
It is no exaggeration that Nakamoto’s Bitcoin took the world by storm. The
protocol itself has a lot to offer in it, but it also hugely motivated other researchers to
come up with new ideas using blockchain technology. As we progress through this
book, it will unfold how the concept behind Bitcoin evolved into many other pro-
tocols and platforms capable of offering diverse applications far beyond the scope
of currency transactions.
4.2 Brief History of Bitcoin

Bitcoin is the world’s first cryptocurrency, which Satoshi Nakamoto proposed and
developed between mid-2008 and early 2009. The invention of Bitcoin, however,
did not happen overnight; rather this virtual currency traces its origin nearly three
decades ago. The following sections present the history of Bitcoin in brief and intro-
duce key persons and their contributions behind this invention.
4.2.1 Before Bitcoin
The first attempt at developing a currency based on cryptographic principles took
place in 1982 when American computer scientist and cryptographer David Chaum
proposed Ecash. In his seminal paper in 1982, Chaum described the architecture
of an untraceable payment system that he developed using blind signatures. He
again outlined a method for ensuring security without identification in a bid to
bypass Big Brother. This research took place in 1984 coinciding with the name of
the famous novel by George Orwell. Chaum published his work a year later in one
of the most reputed computer science journals [Chaum, 1985]. He again wrote a
refined version of Ecash in 1990 for offline transactions. His research primarily
explored the possibility of making transactions that cannot be traced. Ecash, how-
ever, never got implemented, and a significant difference between this scheme and
Bitcoin is the former was intended to be anonymous while the latter is pseudony-
mous, i.e. transactions are made in disguise.
The 1980s and ’90s were a golden period for distributed systems research.
Harvard University professor Cynthia Dwork, a recipient of the prestigious Dijkstra
Prize in distributed computing, developed the proof-of-work technique collaborat-
ing with Israeli computer scientist Moni Naor in 1993 [Dwork and Naor, 1993].
Four years later, British cryptographer Adam Back proposed Hashcash, an anti-
spam system, similar to the proof-of-work concept in 1997 [Back, 1997]. Later
Back mentioned on his website that he was not aware of the works of Dwork and
Naor, but he did praise their version of proof of work and listed it amongst the col-
lection of Bitcoin-related prior works.
The most notable works that influenced Nakamoto in developing Bitcoin are
perhaps Bit gold and B-money, two independently invented distributed digital
money schemes published in 1998. Computer scientist and cryptographer Nick
Szabo proposed the former, while Wei Dai described the latter scheme. Neither of
these schemes requires a central server; they instead utilise a distributed database
for storage. Like Ecash, these schemes also never got implemented.
4.2.2 Bitcoin Era
Nakamoto might have started developing the Bitcoin protocol a decade later since
the arrival of Hashcash, Bit gold and B-money, but he was well informed of these
works and cited two of these three schemes in the description of Bitcoin. On 18
August 2008, Nakamoto registered the domain name bitcoin.org, and later on
31 October published his famous paper “Bitcoin: A Peer-to-Peer Electronic Cash
System” to the cryptography mailing list metzdowd.com. On 3 January 2009, the
Bitcoin network became live when Nakamoto mined the genesis block of Bitcoin,
for which he had a reward of 50 Bitcoins. He released the first open-source Bitcoin
client at SourceForge 6 days later on 9 January.
One of the early supporters of and contributors to Bitcoin was programmer
Hal Finney who was the recipient of the first Bitcoin transaction. Finney down-
loaded the Bitcoin software the day it was released and received 10 Bitcoins from
Nakamoto in the world’s first Bitcoin transaction on 12 January 2009. Bit gold
creator Nick Szabo and B-money inventor Wei Dai also praised Nakamoto’s work
and later became acquaintances. Adam Back was also amongst the first people
Nakamoto contacted.
New England–based programmer Gavin Andresen and Florida-based pro-
grammer Laszlo Hanyecz are two of the earliest supporters of Bitcoin. Hanyecz
conducted the first real-world Bitcoin transaction when he indirectly purchased
two pizzas delivered from Papa John’s paying 10,000 Bitcoins. David Forster, a
Massachusetts-based farmer, was the first to accept Bitcoin as payment.
Nakamoto continued to collaborate on the Bitcoin software with other devel-
opers until 2010 when he handed over the authority of the source code reposi-
tory and network alert key to Andresen and transferred related domains to several
notable members of the Bitcoin community. As of 12 December 2010, Nakamoto
stopped his involvement in the project.
4.3 Token: BTC
Bitcoin, or BTC, is the native token for the Bitcoin protocol. This protocol is
designed to orderly generate Bitcoin token until the year 2140. There will be no
new Bitcoin in the network afterwards, but the protocol will continue to operate
normally.
4.3.1 Bitcoin Mining and Supply

Bitcoin is a mined coin, which means its token must be created out of the mining
process. The mining of Bitcoin is different from the mining of gold because in the
Bitcoin process miners act as verifiers of the transaction rather than mining the coin
like gold. In doing so, miners attempt to solve a puzzle to complete building a block.
The successful miner who gets to solve the puzzle first receives a reward as the incen-
tive for his or her service; hence new Bitcoin comes to existence.
As of December 2018, the reward amount for each block added to the block-
chain is 12.5 newly created Bitcoins. The Bitcoin protocol specifies that the reward
for adding a block will be halved every 210,000 blocks, which occurs approximately
every 4 years. As this process continues, the reward will reduce to zero ensuring
that there will be a maximum of 21 million tokens available throughout its lifetime.
As the token generation gets decreased, by 2140, the network will have the targeted
amount of tokens, and there will be no more new coin creation. The record-keeping
will then be rewarded solely by transaction fees.
Each block in its transaction list has a unique transaction called the coinbase.
Unlike other transactions that show the source of the funds, this transaction does
not have a reference to its origin. It is because the coin in a coinbase transaction is
created from scratch as soon as the block is built.
The price of a Bitcoin token has been very volatile throughout its lifetime. It
has become the centre of attention since its sharp rise in 2016. On 18 December
2016, the average price of each Bitcoin in the exchanges was $791. A year later, on
the same day, 18 December 2017, Bitcoin hit $19,758 – its all-time high price that
saw an incredible yearly gain of 2397.85%. A year later on the same day in 2018,
Bitcoin’s price fell below $3190. Figure 4.1 shows the bumpy ride of Bitcoin in the
exchanges in US dollars (USD).
Figure 4.1 Bitcoin price from 18 December 2016 to 18 December 2018.

4.3.2 Units of Bitcoin
There are provisions for Bitcoin to be divided into smaller pieces. The smallest pos-
sible unit of Bitcoin that can be recorded on the blockchain is called a satoshi. It is
one hundred millionth of a single Bitcoin (0.00000001 BTC). The unit has been
named in collective homage to the creator of Bitcoin, Satoshi Nakamoto.
The practice in Bitcoin protocol is that all amounts are denominated in satoshi
before being converted for display. The source code also uses satoshi when specify-
ing an amount of Bitcoin. When displaying an extremely fine fraction of a Bitcoin,
such as calculating fee per byte or a faucet reward, satoshi is used to display the
amount. Although the satoshi is the smallest amount to be recorded in the block-
chain, payment channels may need to make very granular payments and so are
sometimes denominated in millisatoshi, which are one hundred billionths of a
single Bitcoin.
The BTC unit was chosen to represent a value of 108 to give subunit precision
rather than large whole numbers. Mirroring the SI unit system, this allows for
divisions of 1/10 (decibitcoins, dBTC), 1/100 (centibitcoins, cBTC), 1/1000 (milli-
bitcoins, mBTC), and 1/1000000 (microbitcoins, µBTC). The microbitcoin is also
called bits. Between bits and satoshi, there exists another unit, finney, representing
1/10000000 of a Bitcoin. It is named after computer programmer Hal Finney, the
recipient of the first Bitcoin transaction. Table 4.1 demonstrates how the BTC unit
gets divided into smaller units.
4.4 Bitcoin’s Blockchain
The Blockchain data structure in the Bitcoin protocol represents a linear list linked by the
cryptographic hash that is compatible with storing in a flat file or a database. Nakamoto
Table 4.1 Bitcoin Units
Name Abbreviation Decimal (BTC)
Bitcoin BTC 1
Decibitcoin dBTC 0.1
Centibitcoin cBTC 0.01
Millibitcoin mBTC 0.001
Microbitcoin µbitcoin 0.000001
Finney — 0.0000001
Satoshi Sat 0.00000001
Millisatoshi Msat 0.00000000001

blends the ideas of linked timestamping and Hashcash-like proof of work in creating this
distributed ledger, the main innovation introduced by Bitcoin. The first three chapters of
this book offered a review of this ledger but did not provide a real example explaining its
functions. This chapter presents the nitty-gritty details of Bitcoin’s blockchain and how
this ledger helps the protocol to transfer money over a digital medium.
4.4.1 Block Header
In the blockchain, each block contains a block header and a Merkle tree to store the
transactions. The block header is comprised of seven fields, as shown in Table 4.2.
Amongst those, two 32 byte hashes (the hash of the previous block’s header and the
Merkle root of the native block) and two unsigned integers (timestamp and nonce)
are the most notable fields. The SHA256 cryptographic hash algorithm generates
the hash values in the header of the respective block. By saving the hash of the pre-
vious block’s header in the header of the current block, blockchain establishes the
link that is nearly impossible to break.
4.4.2 Timestamp
Each block contains a Unix time timestamp. This timestamp is the number of
seconds that have passed since 00:00:00 (UTC), Thursday, 1 January 1970, minus
leap seconds. In this timestamping, every day is considered to have precisely 86,400
seconds to subtract the leap seconds since the epoch.
In addition to working as a source of variation for the block hash, the time-
stamps also make it more challenging for an adversary to manipulate the block-
chain. Bitcoin protocol considers a timestamp valid if it is greater than the median
timestamp of the previous 11 blocks, and less than the network-adjusted time plus 2
hours. The “network-adjusted time” means the median of the timestamps returned
by all nodes connected to a participating node.
Bitcoin uses an unsigned integer for the timestamp rather than a signed integer
to avoid the Year 2038 problem, at least by some years. The maximum value that can
be stored in a signed integer is 2,147,483,647. It means, after 03:14:07 UTC on 19
January 2038, the timestamp will overflow causing potential disruption in the com-
munication and computing systems. Because Bitcoin uses an unsigned timestamp,
it can store values up to 4,294,967,295 delaying the overflow by another 68 years.
4.4.3 Merkle Tree
Bitcoin employs the Merkle tree data structure to store transactions. We have
already seen in Section 2.5.3 in Chapter 2 that a Merkle tree is constructed by
recursively hashing pairs of nodes until the root hash is left. In this tree, every leaf
node contains the hash of a transaction as its label, whereas every non-leaf node
stores the cryptographic hash of the labels of its child nodes as shown in Figure 2.7
Table 4.2 Bitcoin Header Fields

Size Description Data type
4 bytes Version Signed integer
32 bytes Previous block hash Characters
32 bytes Merkle root Characters
4 bytes Timestamp Unsigned integer
4 bytes Difficulty bits Unsigned integer
4 bytes Nonce Unsigned integer
1 byte Transactions count Variable length integer
(Chapter 2). Because a Merkle tree is a binary tree, if there remains an odd number
of transactions to summarise, the last transaction hash will be duplicated.
Bitcoin applies the double hash of the SHA256 algorithm in its Merkle tree as it does
for referencing blocks in the blockchain. The use of the Merkle tree in Bitcoin enables
miners to verify the transactions efficiently and securely from a large pool of data. When
N data elements are hashed and summarised in a Merkle tree, a miner can ascertain if a
particular transaction is already in the tree with at most 2log2(N ) number of calculations.
4.4.4 Hash Generation
A distinctive feature of Bitcoin is that when a hash is computed, it is computed
twice. An example of double-SHA256 hashing is shown next:
hello
2cf24dba5fb0a30e26e83b2ac5b9e29e1b161e5c1fa7425e73043362938b9824
first round of SHA256
9595c9df90075148eb06860365df33584b75bff782a510c6cd4883a419833d50
second round of SHA256
In this example, the original text is passed through the first round’s hash
function, while the second round’s hash function takes the hash generated in the
first round as input. The construction of the Merkle tree leading to obtaining the
Merkle root and the generation of the block header’s hash in the Bitcoin protocol
follow this procedure.
4.4.5 Genesis Block
The first block of the blockchain is called the genesis block. Bitcoin protocol numbers
the genesis block as block 0, although very early versions of this protocol counted
their blocks from 1. The convention in Bitcoin and all other protocols that followed
suit is to hardcode the genesis block into the software of the applications that utilise
the blockchain. It is a special case in that it does not reference a previous block, and
for Bitcoin and almost all of its derivatives, it produces an unspendable subsidy. The
hash of the genesis block of Bitcoin is
000000000019d6689c085ae165831e934ff 763ae46a2a6c172b3f1b60a8ce26f
There is a special parameter in Bitcoin called the coinbase (a later part of
this chapter explains this parameter in detail) that may contain plain text.
Nakamoto inserted the following text in the coinbase of the genesis block of
Bitcoin (Figure 4.3).
The Times 03/Jan/2009 Chancellor on brink of second bailout for banks
This refers to the headline of the British newspaper The Times published on
3 January 2009 as shown in Figure 4.2. The headline mentioning the chancel-
lor (the British equivalent to the role of finance minister in other nations) stated
the turmoil Britain had undergone during the global financial crisis in 2009. It is
anticipated that Nakamoto used this reference as proof that the block was created
on or after 3 January 2009, as well as a comment on the instability caused by tra-
ditional banking. It also suggests that Nakamoto might have lived in the United
Kingdom [Davis, 2011].
Although the average time between Bitcoin blocks is 10 minutes, the time-
stamp of the next block indicates a gap of 6 full days between the genesis block
and the second block in the blockchain. There exist multiple interpretations for this
oddity, with one suggesting that Nakamoto might have been working on the pro-
tocol when the front page of the Times prompted him to release using a backdate.
He then mined the genesis block with a timestamp in the past and matched the
headline. Another interpretation suggests that since it was the very early days and
the difficulty of the hash was high, he could have spent 6 days mining the block
before proceeding to the next.
Bitcoin protocol rewarded the first 50 BTC for mining the genesis block to the
following address:
A1zP1eP5QGefi2DMPTfTL5SLmv7DivfNa
The source code of the protocol exhibits a twist in the way that the genesis block
reward cannot be spent. Nakamoto might have intentionally designed his protocol
this way or it was accidental. There is also doubt whether Nakamoto had a private
key for this specific address.
4.5 Bitcoin Address
The phrase “Bitcoin address” is somewhat misleading, as Bitcoins cannot be indi-
vidually identified. The blockchain only keeps the record of the amount of Bitcoin
Figure 4.2 The headline of the British newspaper The Times published on 3

January 2009. This headline is used as the coinbase text in the genesis block of
Bitcoin.
Figure 4.3 The hexadecimal version of the Genesis block of Bitcoin. Headline of

The Times published on 3 January 2009 can be read amongst the texts.
moving from one hand to another. The address, instead of pointing the token,
points its bearer. As such, a Bitcoin address is an identifier that represents a possible
destination for a Bitcoin payment. For example, if Bob wants to send 10 BTC to
Alice, she must provide him with an address to where Bob directs the transaction.
Bitcoin protocol, using the blockchain, moves the authority of the tokens stated in
the transaction from Bob to the person the address belongs to – in this case, Alice.
4.5.1 Formats
The Bitcoin address is made of 26–35 alphanumeric characters. Addresses can be
generated at no cost by any user of Bitcoin using the client software, an account at
an exchange or an online wallet service. It is, however, not a requirement to stay
connected with the Bitcoin protocol while generating the address. It can also be
created while staying entirely offline.
There are several address formats available in Bitcoin, but most transactions
experience three major types. The first format is known as Pay-to-PubkeyHash
(P2PKH). It always begins with the numeric character of 1. The second format
is known as Pay-to-Script-Hash (P2SH), and starts with a 3 instead of a 1. The
third format is called Bech32 and begins with the alphanumeric characters
bc1. As of December 2017, this address format is not recommended for use
until more software supports the format. Examples of these three formats are
shown next.
Pay-to-PubkeyHash
1BvBMSEYstWetqTFn5Au4m4GFg7xJaNVN2.
The first character is 1.
Pay-to-Script-Hash
3J98t1WpEZ73CNmQviecrnyiWrnqRhWNLy
The first character is 3.
Bech32
bc1qar0srrr7xfkv y5l643lydnw9re59gtzzwf5mdq
It begins with the alphanumeric characters bc1.
4.5.2 Hash Generation
The Bitcoin address is an identifier used for each transaction. Generally, recipients
generate a brand new address each time they send an invoice or payment request.
The address is the hash representation of a public key corresponding to a private key
known to the rightful owner of the Bitcoin token.
While Bitcoin protocol uses a double-SHA256 hash generator algorithm to cre-
ate the Merkle root or block header’s hash, a shorter hash function RIPEMD-160
is applied on the first round result obtained by the SHA256 hash function. In that
case, the hash of “hello” would result in the followings:
hello
2cf24dba5fb0a30e26e83b2ac5b9e29e1b161e5c1fa7425e73043362938b9824
first round hash using SHA256
b6a9c8c230722b7c748331a8b450f05566dc7d0f
second round using ripemd-160
4.5.3 Address Structure
A Bitcoin address is comprised of a hash of the ECC public key obtained from the
double hashing described in the earlier section, a checksum and an address prefix
to distinguish different types of addresses. The process of generating an address is
illustrated in Figure 4.4. Bitcoin utilises the OpenSSL, an open-source cryptog-
raphy library that implements the SSL and TLS protocols, to execute the elliptic
curve cryptography. It denotes the points in an elliptic curve using a 65-byte data
frame. The first byte of the frame is used to store the type of point in the elliptic
curve, while the remaining 64 bytes are contributed by the x and y components of
the ECC public key as described in Section 2.4 (Chapter 2).
Once the hash becomes available, a checksum of 4 bytes is added to the end of
it. This checksum holds the first 4 bytes of the double-SHA256 hash of the public
key. A single byte is also appended at the front containing an address prefix for each
of the addresses. This value for P2PKH is 0 and for P2SH is 5, which create a lead-
ing symbol of 1 and 3 respectively.
A Bitcoin address is meant to be a single-use identifier for each transaction,
although the same address can be used multiple times. The design evolved this way
to safeguard users from theft and other cyberattacks. Using the identical address
ECC Public Key
x y
ripemd160( SHA256 ( 1 32 bytes 32 bytes )
1 20 bytes cs
Address Prefix Checksum

0: P2PKH (leading character 1) First 4 bytes of the
5: P2SH (leading character 3) Base256 double SHA256 hash
to Base58
1BvBMSEYstWetqTFn5Au4m4GFg7xJaNVN2
Figure 4.4 Steps showing the address generation of Bitcoin.
to accept multiple payments increases the risk of seizing the attention of hackers.
Keeping many tokens under a single address also means if somehow the address
gets hacked, the owner will lose everything. That said, it is not atypical finding such
an address. Visiting Bitcoin.org, the original website that Nakamoto registered in
2008, shows an address where anyone can donate to support the Bitcoin ecosys-
tem. Figure 4.5 shows the address in written form next to a QR code that can also
be scanned to obtain it. Donations from around the world move to this address
(Figure 4.6).
4.6 Transactions
We already learned that Bitcoin does not reside on our computer. It even does not
dwell on the blockchain. Despite having no virtual presence of the token, what
still makes Bitcoin real is the transactions. A transaction is a process of transferring
a token that is broadcast to the network and collected into blocks. Each transac-
tion typically references previous transaction outputs as new transaction inputs and
assigns all input tokens to new outputs. Table 4.3 presents the format of a typical
transaction.
Because transactions are not encrypted, it is possible to browse and view every
transaction ever recorded into a block. Once transactions are buried under enough
Figure 4.5 The address where Bitcoin.org receives donations.
Figure 4.6 As of 15 December 2018, the donation address of Bitcoin.org was

involved in 364 transactions receiving 17.60 BTC. Because some of the tokens
were spent, the current balance of this address is 14.50 BTC.
confirmations, they can be considered irreversible. All transactions are openly visi-
ble in the blockchain and can be explored using a blockchain browser which is a site
for viewing blockchain data in human-readable form. This is useful for examining
the technical details of transactions in action and for verifying payments. In this
book, real examples related to Bitcoin and other cryptocurrency transactions are
presented using a wide range of explorers including Blockchain.com, Blockcypher.
com and Blockexplorer.com.
4.6.1 Input and Output

A transaction is comprised of two lists, namely TxIn and TxOut, with the former
being the list of inputs and the latter holds outputs of a transaction. TxIn contains
the sources of the token to be used for a particular transaction and the TxOut
indicates the rightful owner of the tokens after the successful execution of the
Table 4.3 Transaction Format

Size (byte) Name Description
4 Version Currently 1
2 Flag If present, always 0001, and indicates the

presence of witness data.
1–9 In-counter Positive integer
List List of inputs —
1–9 Out-counter Positive integer
List List of outputs —
Variable Witness A list of witnesses, 1 for each input; omitted if

flag above is missing.
4 Lock time If non-zero and sequence numbers are less

than 0xFFFFFFFF block height or timestamp
when transaction is final.
transaction. The output list can have multiple addresses designating the recipient of
the tokens from a transaction (Figure 4.7).
The purpose of a transaction is to access and distribute the fund from one or
more old TxOuts through the TxIns of the current transaction to the new TxOut.
Figure 4.7 shows a Bitcoin transaction. Let suppose, Bob sends 7 BTC to Alice in
this transaction. In order for Bob to execute this transaction, he must unlock his
one or more old TxOuts having the required fund. In this example, Bob utilises
two old TxOuts to access 10 BTC; of those, he sent 7 BTC to Alice and 1 BTC as
the transaction fee. The remaining 2 BTC return to him as change.
In this example, Bob redeemed two TxOuts to access 10 BTC. Although he was
supposed to send only 7 BTC to Alice, he had to initially utilise both TxOuts fol-
lowed by returning the change in the form of a payment, but this time to himself.
The design of the Bitcoin protocol does not allow spending the funds of a TxOut
partially; hence this approach is used. It is called “unspent transaction output” or
simply UTXO.
Most Bitcoin transactions generally have two outputs: one is spent, and the
other unspent or change to the original owner of the token. Figure 4. 8 shows a
real transaction that took place in the Bitcoin network on 12 December 2018 in
block 553694. This example, observed using a blockchain explorer, demonstrates
that a person redeemed a previously received TxOut having 5.29309756 BTC for
the TxIn of this transaction. The person then spent 1.13899376 BTC to send the
amount to 37JJB- jZik...Vd7ez1s. The remaining 4.1537534 BTC moved to the
Transaction X
Input (3)
Input (2) Transaction Z
Input (5)
Output (5)
Input (5)
Transaction Y Output (7) To recipient
Input (1) Change to the

Output (2)
original owner
Input (4) Transaction
Fees (1)
Fees
Output (5)
Figure 4.7 A conceptual transaction on the Bitcoin network.
original input address of 17kb7c9nd...egNkcGc, which the person has access to.
A careful look at the amount would reveal that there still remains a small portion
of the token (0.0003504 BTC) that did not enter either of the TxOuts. These input
tokens that had not been redeemed in an output are considered a transaction fee.
The node that generates the block can claim it by inserting it into the coinbase
transaction of that block. In this transaction, the transferred fund had not been
redeemed until at the time of writing this chapter.
Figure 4.8 A real transaction on the Bitcoin network.

Figure 4.9 The cold storage wallet of the Bitcoin exchange Bitfinex that uses a sin-
gle 3-of-6 multi-signature address. As of December 2018, it contained 138,660 BTC,
which will cost more than $2.5 billion if Bitcoin hits its all-time high price again.
4.6.2 Redeeming Tokens
The transaction process we learned so far is incomplete. There remains a missing
piece of a jigsaw puzzle that must be put into the right place to have the process
completed. In the example mentioned earlier, Bob sent Alice 5 BTC. The transac-
tion will only become successful if Alice can redeem those tokens. However, Bob
only had Alice’s Bitcoin address that he utilised in sending the tokens to her. This
address contains the hash of her public key, not the key itself, making it impossible
for Alice to unlock the fund using her private key. The Bitcoin address is designed
this way to disguise the original identity of the recipient. However, the protocol
employing a pair of scripts (scriptPubKey and scriptSig) pseudonymously identifies
the rightful owner of the token.
Bitcoin uses a Forth-like stack-based scripting system that is simple, not
Turing-complete and does not have loops. It is intentionally kept simple so that no
attack can be launched using the native scripts. A script in this system is a list of
instructions recorded with each transaction describing how the new owner can gain
access to the token. Scripting also provides the flexibility of changing the param-
eters as to what needs to be incorporated to spend the transferred Bitcoins. For
example, the scripting system can be used to enforce the necessity of two private
keys, or a combination of several keys or even no keys at all. The scriptPubKey is
the first half of the script that takes input from the sender, while the scriptSig is the
remaining half that communicates with the recipient to unlock the funds.
Because a Bitcoin address is only a hash, Bob was not aware of the full public
key of Alice and therefore could not pass it to the scriptPubKey. When redeeming
the token that had been sent to Alice’s address, she had to provide both the sig-
nature and the public key to scriptSig. The script first verifies that the hash of the
provided public key matches with the hash in scriptPubKey, and then it checks the
signature against the public key to confirm the identity of Alice. If the signature is
proved to be valid, it implies the person is the owner of the private key correspond-
ing to the public key used in the address; hence it unlocks the funds for her future
transactions.
4.6.3 Multi-Signature
A multi-signature is a type of Bitcoin transaction that requires more than one key
to spend the fund. It is generally used to divide up responsibility for possession of
Bitcoins.
The standard transaction of Bitcoin protocol is basically a “single-signature”
transaction because transfers require only one signature from the owner of the private
key associated with the Bitcoin address. The protocol, however, supports more com-
plicated transactions that require the signatures of multiple people before the funds
can be transferred. These transactions are often referred to as m-of-n transactions. The
idea is that Bitcoins become “encumbered” by providing addresses of multiple parties,
thus requiring the cooperation of those parties in order to do anything with those
tokens. These parties can be people, institutions or programmed scripts.
4.6.3.1 Escrow
The multi-signature endows the Bitcoin protocol with an Escrow service. An escrow
is a contractual arrangement in which a third party receives and disburses money
(or documents) for the primary transacting parties, with the disbursement depen-
dent on conditions agreed by the transacting parties. Using multi-signature, users
can create an m-of-n escrow in Bitcoin. For example, in a 2-of-3 escrow, Alice wants
to pay Bob. She sends a transaction to a multi-signature address, which requires
at least two signatures from the group of “Alice, Bob and Carol” to redeem the
money. If Alice and Bob disagree on who should get the money, such as Alice wants
a refund while Bob believes he fulfilled his obligations and therefore demands the
payment, they can appeal to Carol. Carol then grants her signature to Alice or Bob,
so one of them can redeem the funds.
4.6.3.2 Cold Storage
The multi-signature is also used to safeguard the reserved funds kept at a secured
wallet. One of the most notable examples of such kind is the cold storage wallet.
Cold storage in the context of Bitcoin refers to keeping a reserve of Bitcoins offline.
This is often a necessary security precaution, especially dealing with large amounts
of Bitcoins.
The following is the address of the cold storage wallet of the Bitcoin exchange
Bitfinex that uses a single 3-of-6 multi-signature address:
3D2oetdNuZUqQHPJmcMDDHYoqkyNVsFk9r
As of December 2018, it contained 138,660 BTC, which will be worth more
than $2.5 billion if Bitcoin hits its all-time high price again. (Figure 4.9)
4.6.4 Generation Transaction
The generation is the transaction that creates Bitcoin. The generation transaction is
also sometimes referred to as the “coinbase transaction”. It has a single input that
links to no previous outputs; hence it does not contain the scriptSig. Instead, it has
a unique parameter called the coinbase. The data in the coinbase can be anything.
If we recall the genesis block of Bitcoin, the coinbase parameter of its generation
transaction contains “The Times 03/Jan/2009 Chancellor on brink of second bail-
out for banks”.
4.6.5 Storing Data
Bitcoin facilitates storing data on the blockchain in exchange for small transac-
tion fees. It is common to find many transactions in the blockchain where output
does not point to a valid address. It happens not because of an invalid address
but rather the execution of these transactions is almost always intentional. Using
PUSHDATA in the script, users can store 32 bytes in the blockchain. Although
storage of 32 bytes capacity is too small to store anything meaningful, this can be
utilised more appropriately in conjunction with cryptographic hashing. Because
keeping anything on the blockchain establishes trust, a hash of a piece of data from
a database can be stored in the blockchain to prove the authenticity of its generation
date as well as integrity.
4.6.6 Contracts
A distributed contract is a method of using Bitcoin to form agreements with people
via the blockchain. Contracts enable users to solve common problems in a way that
minimises the need of trust. It makes things more convenient by allowing human
judgements to be taken out of the loop, creating complete automation.
By building low-trust protocols that interact with Bitcoin, users can develop
entirely new products. For example, a smart property is a type of contract-based
application that can be used to automatically trade and sanction loans to customers
using blockchain. Distributed markets are another example that pave the path to
implement peer-to-peer bond and stock trading using blockchain technology.
It is interesting that Bitcoin was not developed to support contracts. There is
no evidence that Nakamoto had this concept in his mind when he designed the
protocol. It was not until the mature phase of the protocol when programmers
and researchers identified this potential to extend Bitcoin’s capacity beyond the
currency transfer use-case. Nick Szabo was the pioneer in promoting contracts,
and many of the ideas underlying Bitcoin contracts were first described by him in
his seminal paper “Formalizing and Securing Relationships on Public Networks”.
Szabo’s effort eventually led to creating the smart contract, a concept that encom-
passes the next part of this book.
4.7 Mining
The Bitcoin protocol is a decentralised protocol that operates over a distributed
peer-to-peer network. This means the blockchain does not reside in a single com-
puter, rather every node in the network keeps a copy of it. When nodes are in
need of adding new blocks to the blockchain, they must cooperate to decide which
block should get the chance to get included. An individual node operating in the
Bitcoin network makes its own block and competes for it to be included. These
nodes are also called miners and the process of building blocks is called mining.
If a miner succeeds in adding a block to the blockchain, he or she receives two
types of rewards: transaction fees for all transactions included in its block and the
mining reward, which was 12.5 BTC at the time of this writing. Because of these
incentives, many nodes join the network and become miners and help the Bitcoin
protocol to keep operating through their mining service.
4.7.1 Method
There are thousands of nodes around the world regularly taking part in the min-
ing operation of Bitcoin. These nodes are located across six continents from more
than a hundred countries. Figure 4.10 demonstrates a 2018 heat map of the Bitcoin
Figure 4.10 Heat map showing the presence of miners from around the globe.
Table 4.4 Percentage of Bitcoin

Miners from Top 15 Countries
Rank Country Nodes (%)
1 United States 24.45%
1 Germany 19.26%
3 France 7.04%
4 Netherlands 4.46%
5 China 4.69%
6 Canada 3.88%
7 United Kingdom 3.50%
8 Russia 2.74%
9 Singapore 2.73%
10 Japan 2.47%
11 South Korea 1.94%
12 n/a 1.76%
13 Australia 1.65%
14 Hong Kong 1.48%
15 Switzerland 1.34%
Source: Bitnodes.
network showing nearly ten thousands of nodes mining blocks. To add more con-
text in the discussion, Table 4.4 lists the top 15 participating nations in the mining
process, while Figure 4.11 shows how the number of miners varied throughout
2018. These miners produce a block roughly every 10 minutes, but not all of them
can produce one. There must be only one lucky miner whose efforts will see success
and the work of the remaining miners will go in vain.
Bitcoin employs a cryptographic puzzle competition to select the lucky miner
who contributes to building the immediate next block. This puzzle could be as
simple as a lottery or evaluating a simple mathematical expression, but that in turn
would create a problem. Amongst those thousands of nodes, there exist some dis-
honest nodes which might try to misuse the system by spamming or launching a
distributed denial-of-service (DDoS) attack on the network. Some nodes would not
even verify the transactions and build nodes with false information. So there must
have been a method in place showing that any node claiming to be building a block
has a genuine interest.
Figure 4.11 The number of miners throughout 2018.
Nakamoto utilised a Hashcash-like proof-of-work (PoW) as this puzzle. It

involves producing a piece of data which is difficult (costly and time consuming) to
find but easy for others to verify the required conditions. PoW in Bitcoin establishes
consensus between the miners and selects the new block to add at the tail of the
blockchain. In this puzzle, miners search for a target hash that fulfils a particular
condition. There is no way to guess this hash, and the only option that leads to
success is to go through all the hashes one after another until reaching the targeted
piece. This process is both time and energy consuming, and any node that takes
the effort of going through PoW demonstrates its fair participation in the process.
It also prevents dishonest nodes from launching a DDoS attack on the network and
exploiting the services without the support of the majority of the network.
4.7.2 Proof of Work
PoW involves miners looking for a specific hash. Table 4.2 shows the fields of a
block header. Once a miner creates a new block, it gets a header of this format with
real data. Because this header includes the Merkle root, its values will vary from
miner to miner depending on the transactions the miners include in their blocks.
Next, each miner generates a double hash of its own header using the method
described in Section 4.4.4 and verifies if it is lower than or equal to a certain hash,
commonly known as the target, decided by the protocol. The target is correlated
to another parameter called difficulty, which Bitcoin uses to control the difficulty
of the puzzle. We learn more about this later. For now, let us consider that the
required hash must be lower than or equal to the target. In the block header, there
is a field called nonce that plays a vital role in this quest. Each time a miner fails to
find the required hash, it increases the nonce value by one, meaning that there will
be a different hash next time. This way miners continue to move forward to try to
find the hash fulfilling the condition set by the protocol, i.e. lower than or equal
to the target.
For example, let suppose “Hello, world!” is our base text (which in real mining
40
operation will be the block header) and target is 22 . The first three attempts result
in the following:
Hello, world!0
1312af178c253f84028d480a6adc1e25e81caa44c749ec81976192e2ec934c64
2252.253458683
Hello, world!1
E9afc424b79e4f6ab42d99c81156d3a17228d6e1eef4139be78e948a9332a7d8
2255.868431117
Hello, world!3
ae37343a357a8297591625e7134cbea 22f5928be8ca2a32aa475cf05fd4266b7
2255.444730341
40
As none of these is smaller than the target hash of 22 , the process continues by
incrementing the nonce. When we reach the 4250th nonce, the result shows that it
is indeed the required hash, as it is lower than the target.
Hello, world!4250
0000c3af42fc31103f1fdc0151fa747ff87349a4714df7cc52ea464e12dcd4e9
2239.61238653
The miner who finds the required hash first broadcasts its block in the network
for other miners to verify its proof of work. Having received the block, other min-
ers then verify if the hash of the block header is indeed lower than or equal to the
target. If that is the case, they send a confirmation to the network. Once the major-
ity of the network confirms that the block fulfils the condition, it becomes the next
block in the blockchain. All other miners disregard their work and start building a
block from scratch again. They cannot keep working with their old block because
of a new timestamp and possible new transactions.
If more than one miner broadcasts their blocks at the same time, all are con-
sidered the next block and added at the same height. Miners continue to build new
blocks and add on to one of the blocks. This way one chain gets established, while
other blocks become orphans [Jimi, 2018].
4.7.3 Target and Difficulty

The target in Bitcoin is a 256-bit number that miners share. It is an extremely large
number. Bitcoin protocol sets the condition that the required hash must be lower
than or equal to the current target for the block to be accepted by the network. The
lower the target, the more difficult it is to generate a block; hence the difficulty is
defined as a measure of how difficult it is to find a hash below a given target. The
Bitcoin network has a global block difficulty that is adjusted after the generation of
every 2016 blocks. It is calculated using the following formula:
difficulty = target difficulty 1/target current (4.1)

The targetdifficulty1 traditionally represents a hash where the leading 32 bits are zero
and the rest are one. This is the most difficult target in the Bitcoin protocol. It is
because each SHA256 hash gives a random number between 0 and the maximum
value of a 256-bit number, probabilistically the lower the target, the more difficult
it is to find the required hash.
Bitcoin tries to produce one block every 10 minutes to ensure the stability and
low latency in transactions; hence every 2016 blocks, which should take 2 weeks,
miners compare the actual time it took to generate these blocks with the 2-week
goal and update the target.
4.7.4 Mining Process
We have so far learned about the blockchain, addressing, transactions and the
proof-of-work system of Bitcoin. Now we combine this knowledge to understand
how this protocol works as a system. Nodes willing to become Bitcoin protocol
install a software called “Bitcoin Core”. This software provides them with the abil-
ity to take part in the mining operations. Anyone having a Bitcoin wallet with
unspent coins in it can request for a transaction.
The process starts with one single step initiated by a Bitcoin owner attempting
to send Bitcoin to someone else. In doing so, an owner (let suppose Alice) signs off
a transaction from her wallet application. She must have obtained the address of the
person she is going to send Bitcoin to. Let’s suppose it is Bob. She provides Bob’s
address to be inserted in the scriptPubKey script.
The wallet application broadcasts the transaction to the network. It then waits to
be picked up by a miner. As long as it is not picked up, the transaction hovers in a pool
of unconfirmed transactions. Miners on the network select transactions from these
pools and insert them into their own blocks, which are nothing but collections of
transactions with some metadata. Miners are free to select transactions of their choice.
This makes multiple miners select the same transaction to include in their blocks.
We can assume that one or more miners picks up the transaction Alice sent to
the network and validates if she is actually the owner of the token and not attempt-
ing to double-spend looking at the blockchain. If Alice requested a valid transac-
tion, those miners insert it into their blocks.
Once a miner finds the required hash, the miner broadcasts the block for other
miners to verify its proof of work. This verification process also verifies the trans-
actions within making those ready to be permanently placed in the blockchain.
If Alice’s transaction is one of those, it becomes confirmed making Bob the new
owner of the transferred token. However, if none of the miners who picked up
Alice’s transaction fail to find the required hash, they have to start over again and
Alice must wait for at least another round of block mining.
Once the transaction becomes confirmed, Bob can check if he receives the
token. If it is a simple one-to-one transaction, he will be able to redeem the fund
when he initiates a transaction using his wallet. Otherwise, it remains unspent.
4.8 Split Coins and Altcoins

Bitcoin was the first application of blockchain technology and the first crypto-
currency ever developed. This protocol later inspired the development of many
next-generation cryptocurrencies such as Ethereum and Ripple. Between Bitcoin
and these new cryptocurrencies, there exists a group of coins that are either created
from a hard fork of Bitcoin, or using full or part of the source code of this pioneer-
ing cryptocurrency. The former type is known as split coin and the latter is called
altcoin. A review of Bitcoin remains incomplete without mentioning split coins and
altcoins, hence the remainder of the chapter briefly describes these coins before
concluding the discussion on Bitcoin.
4.8.1 Split Coins
Hard forks create split coins in the Bitcoin network as a means of introducing
changes in the blockchain rule and sharing a transaction history with Bitcoin up to
a specific time and date. The first hard-fork splitting Bitcoin happened in August
2017 resulting in the creation of Bitcoin Cash. Later two other stable split coins,
Bitcoin Gold and Bitcoin Private, were created out of hard forks that survived the
initial turmoil despite suffering attacks from unknown adversaries.
4.8.1.1 Bitcoin Cash
Bitcoin Cash (BCH) is a split coin created by the fork occurring at block 478558.
During mid-2017, a group of developers interested in increasing Bitcoin’s block-
size limit prepared a code change. Bitcoin Cash offers several new features. It has a
much larger block size. Its 8 MB block is eight times bigger than a typical Bitcoin
block. The new design offers replay and wipe-out protection, and a transaction sig-
nature slightly different than Bitcoin. It also adjusts the block difficulty relatively
quickly compared to Bitcoin, which updates the difficulty every 2016 blocks.
The changes triggered a hard fork that took effect on 1 August 2017. As a result
of these reforms, the Bitcoin ledger and the cryptocurrency split in two. At the time
of the fork, anyone owning Bitcoin was also in possession of the same number of
Bitcoin Cash tokens [Larson, 2017].
4.8.1.2 Bitcoin Gold
Forked at block 491407, Bitcoin Gold (BTG) was created on 24 October 2017.
The stated purpose of the hard fork is to restore the mining functionality with
common graphics processing units (GPUs) in place of mining with specialised
ASIC-customised chipsets used for mining Bitcoin. The GPU-powered mining
provides a solution to become a miner with standard off-the-shelf laptop comput-
ers. As this kind of hardware is ubiquitous, anyone with minimalistic effort can
Figure 4.12 A Bitcoin Gold address used to transfer the funds from exchanges
after a successful 51% hashing attack by an unknown adversary in 2018.
join the network [Wirdum, 2017]. After the fork, owners of each BTC received a
BTG token.
In 2018, the network was hit by a successful 51% hashing attack by an unknown
adversary. The attackers successfully committed a double-spend attack on Bitcoin
Gold and transferred millions of dollars worth of tokens from the exchanges.
A Bitcoin Gold address, GTNjvCGssb2rbLnDV1xxsHmunQdvXnY2Ft (shown in
Figure 4.12), implicated in the attack had received more than 388,200 BTG in
the space of 8 days. Assuming all of those transactions were associated with the
double-spend exploit, the attacker could have stolen as much as $18.6 million
worth of funds from exchanges [Wilmoth, 2018a].
4.8.1.3 Bitcoin Private
Bitcoin Private (BTCP) was created out of fork at block 511346 on 28 February 2018.
For each Bitcoin, an owner received 1 BTCP. Jacob Brutman, Christopher Sulmone
and Rhett Creighton led the project on behalf of the Bitcoin Private Community.
The Bitcoin Private protocol gives users the choice of generating either pub-
lic or private addresses, redeemable for transactions to either address type. Private
addresses function using the Zero-Knowledge Succinct Non-Interactive Arguments
of Knowledge (zk-SNARKs), as opposed to the older technique of ring signatures
used in coins such as Monero. In this protocol, the evidence of ownership is given
without revealing units owned by an address, allowing the owner to redeem funds
without any traceable history [Brutman et al., 2018].
It was reported in October that the ethical hacker “Geocold” launched a suc-
cessful 51% attack on the network to demonstrate the vulnerability of the coins
having a low hash rate. It was, however, purely for educational purposes, and no
significant damage was done in the network because of this attack [Teodoro, 2018].
4.8.2 Altcoins
Altcoin is a union of two words: alt implying “alternative” and coin meaning “cryp-
tocurrency”. Together these words signify a category of cryptocurrency alternative
to Bitcoin. Altcoins were launched after the success of Bitcoin and generally project
themselves as better substitutes to the world’s first cryptocurrency. Bitcoin paved
the way for many Altcoins to come into existence, but only a handful of those
became successful. Altcoins typically target any perceived limitations that Bitcoin
has and come up with newer versions with competitive advantages. Many altcoins
are conceived using the source code of Bitcoin and often designed following the
architecture Bitcoin exercised. In this section, only a handful of altcoins that suc-
cessfully made a name for themselves are briefly introduced.
4.8.2.1 Namecoin
Namecoin (NMC) was the first altcoin. It was created in April 2011 intending to
establish a decentralised name server. Instead of having a central authority like the
Internet Corporation for Assigned Names and Numbers (ICANN) in control over
the DNS, the idea was to mould this process into proof-of-work mining to release
name slots with every block. Each of these slots could be used by the miner of a
block to register a free .bit domain.
The problem Namecoin attempted to solve is known as Zooko’s triangle. It is
a trilemma stating that the names of participants in a network protocol cannot
have the three following properties simultaneously: human-meaningful, secure and
decentralised. This is the reason why the DNS is administered by a central author-
ity that maps domains to IP addresses.
Despite being an excellent idea, the implementation of a decentralised, self-suf-
ficient DNS protocol is challenging. Furthermore, registering domains and renew-
ing them is not as simple as a regular domain name. These hurdles eventually make
users less interested in using the system. A study from Princeton University found
that over 120,000 domain names were registered on Namecoin in 2015. However,
only 28 of those were in use, exposing the harsh reality behind the very first altcoin
[Kalodner et al., 2015].
4.8.2.2 Litecoin
Litecoin (LTC), released in October 2011 soon after the release of Namecoin, is
the most successful altcoin. As of December 2018, it has a market capitalisation of
slightly below 3% of Bitcoin. During the early days of cryptocurrency, Litecoin was
dubbed silver to Bitcoin’s gold status.
Litecoin uses scrypt as its proof-of-work consensus mechanism. Scrypt is a
memory-hard key derivation function proposed by Colin Percival [Percival, 2012].
It requires a fairly large volume of Random Access Memory (RAM) to be evalu-
ated. The principle behind this technique is to limit the hash generation rate,
making large-scale custom hardware attacks costly. Litecoin also aims to reduce
the block generation time. With a targeted 2.5 minutes for each block, it creates
blocks four times faster than that of Bitcoin. Its creators claimed that faster block
generation of this coin led to faster transactions, although this may not always be
true [Franco, 2015].
4.8.2.3 Peercoin
Scott Nadal and Sunny King created Peercoin (PPC) in 2012. The principal inno-
vation that Peercoin offers is the use of a hybrid consensus mechanism using a
proof-of-stake (PoS) and proof-of-work (PoW) system. In this coin, a portion of the
new blocks are mined by holders of tokens in proportion to how many coins they
control. Because PoS does not involve solving a partial hash inversion problem, it
requires minimal electricity consumption; hence Peercoin is often regarded as the
green alternative to Bitcoin.
In Peercoin there exist two types of blocks generated using PoS and PoW tech-
niques respectively. The PoW-generated blocks follow rules similar to Bitcoin’s
block generation, but for PoS-generated blocks, the rules are slightly different. For
these blocks, the award is distributed in a manner that is proportional to the trans-
action’s “coin age”. Coin age can be defined as follows: the product of the number
of coins in the transaction output multiplied by the time since those funds were last
spent [Franco, 2015]. As of December 2018, Peercoin’s market capitalisation is just
over 0.02% of Bitcoin.
4.8.2.4 Nxt
Nxt (NXT) was launched in 2013 by the anonymous software developer BC-Next.
It uses the PoS system to reach consensus for transactions. The operation of Nxt
requires a static money supply, but no mining process is involved in its architecture;
hence 1 billion tokens were generated at the time of creation. Nxt was explicitly
conceived as a flexible platform to build applications and financial services.
Nxt provides the tools to create customised tokens on the blockchain. It enables
creating either assets or the more complex monetary system currencies. These
tokens can be used by projects to build a bridge from the virtual world of digital
currency to the real world. A token in the Nxt platform can represent anything:
property, stocks/bonds, commodities, or even concepts. As of December 2018, Nxt
had a market capitalisation of around 0.04% of Bitcoin.
4.8.2.5 Dash
Dash (Digital Cash) was launched in 2014 as Xcoin, but later rebranded to its current
designation in 2015. It is a global payments network with a native cryptocurrency
offering businesses and individuals instant payments for less than a cent per transac-
tion. Its use-case focuses on providing users with a better way to pay and get paid.
Dash is a form of decentralised autonomous organisation (DAO) run by a sub-
set of users known as “masternodes”. Masternodes enable Dash’s fast and secure
payments by reaching consensus via “quorums” on the validity of transactions.

The coin mining, however, still uses the PoW system using a hash function called
“X11”. It takes 11 rounds of hashing with an average time of 2.5 minutes to mine
each coin.
Running a masternode in the Dash ecosystem requires ownership of 1000 Dash;
a static IP address; and meeting the minimum requirements for CPU, RAM, disk
space and network bandwidth. The distribution of the Dash token is achieved as
follows: 45% of mined coins go to miners, 45% to masternodes and the remaining
10% into a fund that the DAO invests. As of December 2018, Dash has a market
capitalisation of around 1% of Bitcoin.
4.9 Summary
This chapter presented Bitcoin, the world’s first cryptocurrency. The discussion was
limited to technical details explaining how the protocol makes use of blockchain
technology and successfully establishes a decentralised currency transaction sys-
tem. The chapter shed light on its history, blockchain, address, transaction, mining
and altcoins. Discussions related to economic and sociopolitical topics of Bitcoin
were not part of this chapter but will be covered later in the book.
Part II
SMART II
CONTRACTS
Chapter 5
Ethereum and
Smart Contracts
Nakamoto developed Bitcoin as a currency transaction protocol. His design includes

a Forth-like stack-based scripting system that is simple, not Turing-complete and
does not have loops. It is intentionally kept simple so that no attack can be launched
using the native scripts but still be able to facilitate complex transactions between
multiple parties. Although there is no evidence that Nakamoto ever intended to
use this feature to write contracts, developers and researchers working with Bitcoin
later found it useful to extend the capacity of Bitcoin beyond a currency transaction
protocol. The scripting system, however, has some significant limitations. Writing
complicated contracts between multiple parties generally requires a programming
language with loops and features provided by high-level languages like C, Java
and Python. Because of Bitcoin’s scripting system being not Turing-complete, it
proves to be less effective in writing such complicated contracts. With this limita-
tion in mind, Vitalik Buterin co-founded Ethereum, a new blockchain platform
that is Turing-complete and enables users to write contracts using high-level pro-
gramming languages, thus the name smart contract. This chapter aims to introduce
smart contracts and describes how Ethereum stands out from Bitcoin and opens a
new world for the development of distributed applications.
5.1 Introduction to Smart Contracts

The term contract means a legal document that binds two or more parties into a
deal. In the field of distributed computing, the meaning remains almost intact with
the exception that instead of a solicitor or, in the worst case, a judge to intervene
93
and settle any dispute, this digital contract is self-sufficient to handle such situa-
tions on its own; hence the prefix smart arrives. More formally, a smart contract
is a decentralised computer protocol that digitally facilitates, verifies and executes
the agreement of a deal. Smart contracts allow the enforcement of credible transac-
tions without third parties. The transactions of a smart contract are immutable and
trackable.
5.1.1 Vending Machine Analogy

To explain the concept of a smart contract more clearly, let us reflect on an exam-
ple of a vending machine as shown in Figure 5.1. If we want to buy a Coke, the
process should be quite straightforward. We must insert the amount required in
the device and press the desired option. The vending machine then dispenses the
selected product, in this case, a bottle of Coke, and returns any change that it owes
to the buyer.
In this example, despite having no formal agreement, there always remains an
unspoken deal between the machine and the potential buyer. If the buyer provides
the necessary money, the device will be ready to release the desired product. In
the absence of a third party, the vending machine acted as the middleman and
executed the deal. The role of the machine in this instance can be compared to a
smart contract.
Figure 5.1 A vending machine selling cold drinks.

Ethereum and Smart Contracts ◾ 95
The problem arises when we feel the lack of trust and doubt in its operation as
to what if the machine fails to deliver the product and does not release the inserted
money. In case of a Coke that costs around $2, we may not care much. However, in
case of buying a car using a vending machine (let suppose the machine also sells real
vehicles worth of thousands of dollars), we think twice before inserting $10,000.
A vending machine is operated by a third party who retains the sole control of the
device. We have no reason to trust them unless they are someone well-established
and reputed.
The smart contract being decentralised separates itself from all existing applica-
tions like this vending machine. Inside a decentralised and distributed smart con-
tract with high Byzantine fault tolerance, both the data and the code are immutable
and therefore it is not possible to alter the behaviour of the contract afterwards. If
it is programmed to deliver a Tesla Model 3 car, it is going to deliver a Tesla Model
3 as long as it is in stock; otherwise, it returns the money. Smart contracts do not
establish trust, rather they remove the need for trust from an agreement.
5.1.2 Nick Szabo and Bit Gold

Bit gold is arguably the earliest attempt at creating a decentralised digital currency,
proposed by Nick Szabo in 1998. Although Szabo’s scheme had never been imple-
mented, it is regarded as the direct precursor to Bitcoin because of the many simi-
larities between the two schemes particularly in design, transaction process and the
security mechanisms.
The proof of work (PoW)–based consensus mechanism is the driving force
behind both Bitcoin and Bit gold that utilises the computing power as a means
of solving a cryptographic puzzle to establish the agreement between decen-
tralised peer-to-peer participating nodes with high Byzantine fault tolerance.
In the process, both create a cryptographic hash chain linking the most recent
solution to its predecessor to validate transactions. Bitcoin, however, remains
one step ahead of its precursor for solving the double-spending problem that
Bit gold could not address at that time. Because of such close parallels between
the schemes, people often speculate Nick Szabo being the anonymous Satoshi
Nakamoto despite his denial. We discuss more on that in the last chapter of
this book.
The main inspirations for Bit gold were the inefficiencies of the traditional
financial system and the use of precious metals as currency. Traditional financial
systems require parties to rely on trust in order for transactions to take place. For
instance, to approve loans, the bank must trust the recipients have the ability to
repay the loan, and their clients must trust that their deposits are secured and
not being mishandled by banks. Dealing through trust-based systems also imports
costly problems in the mix such as fraud or theft; for example, a 2009 study showed
that merchants in the United States are losing approximately $190 billion a year to
credit card fraud [Shaughnessy, 2011].
Too much reliance on the trust-based system and subsequent losses motivated
Szabo to conceptualise a trustless system in his seminal paper “Formalizing and
Securing Relationships on Public Networks” in 1997 where he described smart
contracts. However, due to the lack of an implemented decentralised protocol where
smart contracts can be built upon, Szabo’s concept failed to come into prominence
for at least a decade until Bitcoin came into being.
The scripts in Bitcoin finally paved the way for establishing contracts, although
within a limited capacity. Bitcoin was never designed to support contracts, and
its scripts are deliberately kept Turing-incomplete to avoid launching potential
attacks from its core. This security measure in turn significantly restricts the abil-
ity to write complex and elaborate contracts using the scripting system of this
protocol. After having a long debate as to whether Bitcoin needs to change its
scripting system, a part of the community decided to create a new protocol,
Ethereum – the world’s first decentralised Turing-complete smart contract–sup-
ported protocol that successfully implemented Szabo’s original concept nearly two
decades later in 2015.
5.1.3 Turing-Completeness
To understand the concept of Turing-completeness, we must apprehend the Turing
machine first. English mathematician Alan Turing designed this machine in 1936.
He named it an a-machine where the prefix a stands for “automatic”. The definition
of a Turing machine can be the following:
A mathematical model of computation that defines an abstract machine,

which manipulates symbols on a strip of tape according to a table of rules.
Despite the simplicity of the model, given any computer algorithm a Turing machine
is capable of simulating that algorithm’s logic. Thereby it is widely regarded as the
abstract model of what ultimately becomes the modern computer.
“Turing-completeness” can be interpreted as the ability for a system of instruc-
tions to simulate a Turing machine. In computability theory, a system of data
manipulation rules, such as a computer’s instruction set, a programming language
or a cellular automaton, is said to be Turing-complete or computationally universal
if it can be used to simulate any Turing machine. A programming language that is
Turing-complete is theoretically capable of expressing all tasks accomplishable by
computers.
5.2 What is Ethereum?
Ethereum is a protocol for building decentralised applications running on a peer-to-
peer network without a central coordinator. The purpose of developing Ethereum
was to create an alternative option to Bitcoin-like protocols. It emphasises the issues

of rapid development time, security for small and infrequently used apps, and the
capability of efficiently interacting with others. Ethereum does this by introducing
an abstract foundational layer of blockchain embedded with a Turing-complete
programming language. It enables users to write smart contracts and decentralised
applications creating their own arbitrary rules for ownership, transaction formats
and state transition functions.
Ethereum extends the concept of blockchain one step further, and instead of
only validating, storing, and replicating transaction data, it also allows users to
write and run computer programs. If Bitcoin is considered distributed data storage,
then Ethereum is a distributed computer. The small computer programs that run
on Ethereum are called smart contracts. The contracts run on the participating
node’s computer using the Ethereum Virtual Machine (EVM).
Ethereum is featureless or value-agnostic by nature. The developers decide what
it should be used for. However, because of its decentralised nature, certain applica-
tion types benefit more than others from its capabilities. Specifically, it is suited for
applications that automate direct interaction between peers or facilitate coordinated
group action across a network. Bitcoin could allow individuals to exchange cash
without involving any middlemen like financial institutions, banks or governments.
The design of Ethereum recognises that its impact can be far more than what Bitcoin
achieved; for instance, asset registries, voting, governance, the Internet of Things and
a wide variety of use-cases could be massively impacted by the Ethereum platform.
Ethereum was initially defined in a white paper by Vitalik Buterin in late 2013
[Buterin, 2013]. Buterin argued that Bitcoin must have a scripting language for appli-
cation development, but he failed to gain an agreement, which led to him proposing
the development of a new platform with general scripting language capabilities. The
core Ethereum team included Buterin, Mihai Alisie, Charles Hoskinson and Anthony
Di Iorio at the time of the public announcement in January 2014. The development
of the Ethereum project began in early 2014 and the system went live on 30 July 2015.
5.3 Token: ETH
Ether (ETH) is the native token of Ethereum. It is used to pay fees for running
smart contracts, transactions and state transitions in the protocol. As of December
2018, Ether is the third largest cryptocurrency just behind Bitcoin and Ripple, with
a market capitalisation of 19.41% of the former.
5.3.1 Pre-Mining
Unlike Bitcoin, not all Ethers are created through mining. Buterin, the creator of
Ethereum, is regularly criticised because of popularising pre-mining tokens and
selling them through initial coin offerings (ICOs). Nakamoto’s original concept
was to bring Bitcoin into existence in exchange for a service, that is verifying trans-
actions. Every Bitcoin token is created and given away as a reward to the miners.
Ethereum broke this convention and created a substantial portion of its total circu-
lation without mining. A total of 12 million tokens were pre-mined at the time of
launching the blockchain, followed by creating another 60 million that were sold
through an online public crowdsale in exchange for Bitcoin. As of December 2018,
these pre-mined tokens account for about 70% of the total circulating supply.
5.3.2 Price
Ether is listed under the code ETH on cryptocurrency exchanges where the Greek
letter xi, Ξ, denotes its currency symbol. It retained the position of the second
largest cryptocurrency by market capitalisation for most of its lifetime; although
recently during the latter half of 2018 it lost this position to Ripple.
Ether had been traded in the exchanges below $10 until the end of 2016, before
rising to prominence in April the following year as its value continually increased,
hitting an all-time high price of about $1400 on 15 January 2018. Following the
crypto-market crash of the year, the price of Ether nosedived to below $100 in 12
months. Figure 5.2 shows the price of Ether in US dollars (USD) and Bitcoins
(BTC) since its inception until the end of the year 2018.
5.3.3 Units
Ethereum has a metric system of denominations used as units of Ether. Each
denomination has a unique name with some bearing the name of seminal figures
Figure 5.2 The price chart of Ether in USD (black) and BTC (grey) from August
2015 to December 2018.
Table 5.1 Ether Units

Name Wei Value Wei
Wei 1 wei 1
Kwei (babbage) 1e3 wei 1,000
Mwei (lovelace) 1e6 wei 1,000,000
Gwei (shannon) 1e9 wei 1,000,000,000
Microether (szabo) 1e12 wei 1,000,000,000,000
Milliether (finney) 1e15 wei 1,000,000,000,000,000
Ether 1e18 wei 1,000,000,000,000,000,000
who played a role in the evolution of computer science and crypto-economics. The
base unit of Ether is called wei named after Wei Dai. Table 5.1 lists the named
denominations and their corresponding values in wei up to Ether.
5.4 Architecture
The primary motivation of designing Ethereum was to extend the capabilities of
Bitcoin, therefore, it incorporates many features and technologies that its predeces-
sor utilised. Nevertheless, it also introduces many modifications and innovations of
its own in the design. The following presents a brief introduction to the architecture
of this blockchain comparing features to that of Bitcoin’s.
5.4.1 Ethereum Virtual Machine (EVM)

As mentioned, Ethereum is a programmable blockchain. Unlike the Bitcoin pro-
tocol that provides users with a set of predefined operations in the form of trans-
actions, Ethereum allows users to create operations of any complexity they want.
In this sense, it serves as a platform for building decentralised applications. At its
heart, Ethereum utilises a virtual machine called the Ethereum Virtual Machine
or simply EVM. EVM is capable of executing code of arbitrary algorithmic com-
plexity, or, in other words, it is Turing-complete. Developers can create applica-
tions that run on the EVM using high-level programming languages similar to
JavaScript and Python.
Ethereum, like other blockchain protocols, operates over a peer-to-peer net-
work. The Ethereum blockchain is maintained and updated by many nodes con-
nected to the network that runs the EVM and executes the same instructions. This
massive parallelisation of computing across the entire Ethereum network, however,
is not arranged to make computation more efficient; rather this process slows the
computation on Ethereum and making it more expensive than on a traditional
computer. The advantage of such an architecture lies elsewhere: Every participating
node runs the EVM in order to maintain consensus across the blockchain giving
Ethereum extreme levels of fault tolerance, ensures zero downtime, and makes data
stored on the blockchain forever unchangeable and censorship-resistant.
5.4.2 Account
The account is central to the design of Ethereum. It is perhaps the most notable
architectural change that distinguishes Ethereum from Bitcoin. Previously we
learned that transactions are the heart of Bitcoin that help track the ownership of
a Bitcoin token. The Ethereum blockchain did not follow that footstep; it instead
ties up all exchanges with the account to recognise the transfers of value and infor-
mation. It functions with accounts and their corresponding balances in a manner
called state transition. The state transition is a mathematical model of computation
to represent the behaviour of an object, process, concept or system. It follows the
states of a system through transitions and represents the changes as the system con-
tinues to function. Figure 5.3 presents a simple example explaining state transitions.
The use of state transitions in Ethereum removes the need for utilising Unspent
Transaction Outputs (UTXOs) that we saw playing a vital role in Bitcoin. A state
Figure 5.3 An example of a state transition diagram showing the states of a door –
either closed or opened. Ethereum blockchain uses a similar concept in tracking
transactions.
in Ethereum denotes the current balance of an account and relevant metadata. In

order for a state to move to a new one, the network needs to reach a consensus.
Ethereum accounts can be loosely compared to Bitcoin’s wallets, although they
are fundamentally different. Accounts represent identities of external agents such
as human personas, mining nodes and automated agents. Accounts use public-key
cryptography to sign transactions so that the EVM can securely validate the iden-
tity of a transaction’s sender.
There are two types of accounts in Ethereum: externally owned accounts
(EOAs) and contract accounts (Contracts). EOAs are entities that trigger trans-
actions and send tokens to another EOA. It is, in fact, the contracts that make
Ethereum distinctive. If we remove contracts from Ethereum, what remains just
mimics the functions of Bitcoin.
The Ethereum platform defines every account by a pair of keys: a private key
and a public key, where the latter is used to generate the address of the account. The
platform encodes the private key and the address pair in a keyfile of JSON format.
This keyfile is human-readable, and the contents can be viewed using a text editor.
Because the private key of the keyfile is sensitive, the platform encrypts it using a
password provided by the user. Due to security measures, Ethereum does not allow
its users to reset the account password; hence forgetting the password means losing
access to the account forever.
5.4.3 Address
The Ethereum address is composed of the prefix “0x” concatenated with the right-
most 20 bytes of the Keccak-256 hash of the ECDSA public key. The following
is an example of an Ethereum account which is one of the Ethereum cold storage
accounts of Bitfinex that holds up nearly 2.3% of the total Ethereum circulated:
0x742d35cc6634c0532925a3b844bc454e4438f44e
A contract in Ethereum also has an address. It comes in the same format of
an account address but determined by the program. A major difference between a
contract address and an account address is that the former is capable of receiving
both data and tokens, while the latter only receives tokens.
Any valid Keccak-256 hash in the described format is a valid address, even if it
does not correspond to an account with a private key or a contract. This is unlike
Bitcoin, which uses base58check to ensure the correctness of the address.
5.4.4 Mist
Unlike Bitcoin where wallet does not have a central role, Ethereum provides a native
wallet called the Mist. It is a decentralised application that comes with a browser in
addition to its wallet features. It allows users to create accounts and wallets. While
creating a wallet, users have the option to create either an individual wallet or a
Figure 5.4 The interface of the Ethereum wallet application Mint.
multi-signature wallet. The Mist helps users to send and receive Ether, and manage
contracts using a friendly interface as shown in Figure 5.4.
5.5 Mining
The Ethereum blockchain is in many ways similar to the Bitcoin blockchain,
although it does have some differences. The following presents a brief introduction
to transactions and the mining process of Ethereum.
Ethereum employs an incentive-driven model of security. Like Bitcoin, the consen-
sus in this blockchain utilises choosing the block with the required hash using a
PoW system where miners produce blocks and others check for validity. There has
been an ongoing discussion in the Ethereum community of ditching the PoW and
replacing it with proof-of-stake (PoS) model in the near future, though nothing has
been finalised as of writing.
We have learned earlier that the state transitions manage transactions in
Ethereum. This requires blocks to contain a copy of both the transaction list and
the most recent state. The PoW algorithm used in this blockchain is called Ethash
and involves finding a nonce input to the algorithm so that the result remains below
a certain difficulty threshold. It is not drastically different from Bitcoin, but there
are some features that the current blockchain incorporates. For instance, Ethash
replaces SHA256 hashing with a stronger hash function called Keccak, which is
the superset of SHA-3. Ethash also makes mining inconvenient for Application
Specific Integrated Circuit (ASIC) by making the process memory-hard. A desk-

top computer or a laptop can be more useful than ASICs in Ethereum mining. It
engages a Directed Acyclic Graph (DAG)–based dataset known as the Ethash DAG
that regenerates 1 GB of data every 30,000 blocks. Miners are to grab a slice from
the Etash DAG to produce hashes resulting in a memory-hard job.
5.5.2 Block-Generation Rate
The protocol dynamically adjusts the difficulty of mining in such a way that on
average the network produces one block every 15 seconds, a stark contrast to
Bitcoin’s 10-minute block-generation time. This rapid generation approach helps
Ethereum achieve an excellent rate of 15 transactions per second in its blockchain.
5.5.3 Rewards
The successful miner of the winning block receives two rewards. Like the Bitcoin
protocol: a reward for building the block and the fees for verifying the transac-
tions, which in Ethereum is called gas. We learn more about gas in the discussion
of contracts.
The block-building reward is a static 5 Ethers in addition to the cost of the
gas price. An extra reward is given in Ethereum for including uncles, the orphan
blocks, as part of the block at a rate of 7/8 of the regular block reward per uncle. All
the gas consumed by the execution of all the transactions in the block submitted by
the winning miner is paid by the senders of each transaction. The gas cost incurred
is credited to the miner’s account as part of the consensus protocol. Over time, it is
expected that the gas cost will dwarf the static block reward.
5.6 Smart Contracts in Ethereum

A smart contract, or simply contract, is a collection of code and data that resides at
a specific address on the Ethereum blockchain. Contract accounts are able to pass
messages amongst themselves as well as doing practically Turing-complete compu-
tation. Contracts live on the blockchain in a binary format called EVM bytecode.
5.6.1 Transactions
A transaction refers to the signed data package that stores a message to be sent from
an EOA to another on the blockchain. It contains the address of the recipient of the
message in addition to a signature identifying the sender and proving their inten-
tion to send the message via the blockchain to the recipient. The value field of the
transaction includes the amount of wei that the sender intends to transfer to the
recipient. An optional data field is also available to send messages to the contract.
A transaction includes two special parameters representing the maximum num-

ber of computational steps its execution is allowed to take and the fee the sender is
willing to pay for gas. One unit of gas corresponds to the execution of one atomic
instruction, i.e. a computational step.
A contract can send messages to other contracts. These messages are virtual
objects that exist only in the Ethereum execution environment. It is important
to realise that a message is like a transaction but produced by a contract, not an
external user.
5.6.2 Gas
Every participating node in the network runs the EVM as part of the block verifica-
tion process. They go through the transaction in the blocks under verification and
run the code within the EVM. Each node in the network does the same calcula-
tions and stores the same values. This practice in Ethereum is not about optimis-
ing the efficiency of computation; instead, this parallel processing is redundantly
parallel. It subsists to offer an efficient way to reach a consensus on the system state
without needing the presence of a trusted third party.
The redundantly replicated nature of contract executions across nodes makes
them expensive; hence, it discourages users to use the blockchain for computation
that can be performed off the chain. As such, decentralised applications, while
interacting with the blockchain to read and modify their states, are expected to put
only the business logic and states that are crucial for consensus on the blockchain.
There is a cost for every executed operation in Ethereum. It is typically expressed
using gas units. The gas is the name of the execution fee that senders of the trans-
action need to pay for the operation performed on an Ethereum blockchain. The
real-world analogy of fuel inspires the name gas, as this fee acts as the crypto fuel
driving the motion of smart contracts.
The miners who execute the code sell gas in exchange for Ether to the users.
There is a reason for keeping Ether separated from gas in this protocol. It is because
the price of Ether fluctuates as a result of market forces while the miners charge a
specific fee for their services. Using Ether instead of gas would have created chaos,
as miners would be required to set new fees every other day. The current practice
takes the conversion out of the operation, and users pay the specific fees as long as
they have Ether in their account. Depending on the conversion rate of Ether for
gas, their accounts get debited.
5.6.3 High-Level Languages
Ethereum supports two major high-level languages, namely Solidity and Serpent.
Solidity is the most popular and the flagship language of this blockchain. It is
a contract-oriented programming language for writing smart contracts on many
blockchain platforms including Ethereum. A team of core contributors of Ethereum
including Gavin Wood, Christian Reitwiessner and Alex Beregszaszi developed

this language. Solidity is very similar to JavaScript that produces EVM bytecodes
after compilation.
The other programming language, Serpent, is equivalent to Python. It com-
bines many benefits of a low-level programming language with easy-to-use style
and particular domain-specific features. Contracts written in Serpent are compiled
using a low-level language called “Lisp-Like Language”, or simply LLL, which is
similar to assembly language. LLL is designed minimalistic and straightforward
providing just a tiny wrapper over coding in EVM directly.
5.7 ERC Standards
To make smart contracts work and communicate with one another, the developers
set up standards for the Ethereum platform. These standards are produced based
on the feedback from the developers; hence the name “ERC” or “Ethereum Request
for Comment”. ERCs are application-level standards and can include token stan-
dards, name registries, and library and package formats. An ERC is written by
developers in the form of a report describing the methods, behaviours, research and
innovations applicable to the functioning of the Ethereum ecosystem. This report is
then submitted for peer review by the network, and once approved by the developer
community, the proposal becomes a standard. The following discusses some of the
most popular ERC standards and their usage.
5.7.1 ERC-20
The ERC-20 is the most popular and well-known ERC standard. This is a token
standard used for initial coin offerings. The advantage of this standard is that the
vast majority of smart contracts and decentralised applications (DApps) is capable
of interacting with ERC-20 tokens natively without the need for token details.
As such, a smart contract implementing this standard can be quickly listed on an
exchange platform without additional integration effort.
The ERC-20 standard contains six essential functions that must be imple-
mented to meet the standard. The following outlines these functions:
◾◾ totalSupply() – Used to get the token supply of a specific ERC-20 token.

◾◾ balanceOf() – Keeps track of the token balance in each Ethereum wallet.
◾◾ transfer() – Upon token creation, this function can send all the tokens to one
wallet or distribute them to ICO investors.
◾◾ transferFrom() – Enables token holders to exchange tokens with one another
after the initial distribution occurs.
◾◾ approve() – Used to “approve” other accounts to withdraw a certain amount
of tokens from the account calling the function.
◾◾ allowance() – After approve() is used, allowance() is used to see the num-

ber of tokens the approved account is allowed to withdraw from the original
account.
ERC-20 tokens are easy to create and used for more than 80% of the total ICO
ever took place. As of December 2018, there are more than 150,000 ERC-20 con-
tracts deployed on the Ethereum blockchain.* Some of the most valuable ERC-20
tokens include Binance Coin (BNB), Maker (MKR) and VeChain (VEN) with
market caps of $1.6 billion, $687 million and $249 million respectively.
5.7.2 ERC-223
The ERC-223 standard is a suggestion to solve some problems with the ERC-20
token. As of this writing, ERC-223 remains at the proposal stage and is not widely
used. Only a few projects have decided to implement it, including MobileGo, Coss
and Follow Coin.
This standard ensures avoiding accidental loss of tokens when sending to a
smart contract that is not designed to work with the sent token. ERC-223 allows
cancelling a transaction that would lead to such a loss of tokens before it occurs.
The standard also allows reduced gas consumption during transfers compared to
the ERC-20 tokens. To implement this standard, the developers have made the
ERC-223 standard backwards compatible with the ERC-20 tokens. All functions
of the ERC-20 tokens work with the ERC-223 tokens.
5.7.3 ERC-721
The primary motivation behind suggesting the ERC-721 standard was to create a
non-fungible token (NFT) which is unique and non-divisible. ERC-20 or 223 pro-
vides a stock of fungible tokens where one unit is equivalent to another. However,
ERC-721 addresses use-cases that require non-identical tokens with specific param-
eters and a different value.
The most famous example of the use of this standard is for the blockchain-based
video game CryptoKitties that raised $12.5 million in investments. ERC-721 can
also be used in many other areas such as software license and digital art manage-
ment. Unlike ERC-20 tokens, which are present on the leading trading platforms,
ERC-721 tokens can be traded in marketplaces specialising in the sale of collect-
ables such as Rarebits, Opensea and Emoon.
* The total number of tokens on the Ethereum blockchain can be seen in the form of a ranking
using the following URL: www.etherscan.io/tokens.
5.7.4 Other Standards
ERC-777 is a new standard that aims to mitigate the shortcomings of ERC-20
tokens. It takes motivation from another standard known as ERC-820 that ensures
backwards compatibility with older standards. ERC-1400, proposed in September
2018, offers a common framework so that issuers, investors, wallets, trading plat-
forms and developers can work under the same conditions.
5.8 Comparison to Bitcoin
Ethereum is similar to Bitcoin in many ways. It closely follows the design approach
of Bitcoin and mimics many of its functionalities. There are, however, differences in
terms of performances where Ethereum improved the quality of its blockchain sig-
nificantly compared to that of Bitcoin. Although the chapter already described these
contrasts between the blockchains, the following aims to summarise the differences:
◾◾ The block-building time of Ethereum is 14 to 15 seconds, compared with 10

minutes for Bitcoin.
◾◾ Mining of Ether generates new coins at a usually consistent rate, occasionally
changing during hard forks, while for Bitcoin the rate halves every 4 years.
◾◾ For proof of work, Ethereum uses the Ethash algorithm, which reduces the
advantage of specialised ASICs in mining. Bitcoin uses a regular Hashcash-like
proof of work that encourages the use of specialised ASICs.
◾◾ Transaction fees (known as gas) in Ethereum differ by computational com-
plexity, bandwidth use and storage needs, while Bitcoin transactions compete
using transaction size in bytes.
◾◾ Ethereum gas units each have a price that can be specified in a transaction.
This is typically measured in gwei. Bitcoin transactions usually have fees
specified in satoshis per byte.
◾◾ Transaction fees are generally considerably lower for Ether than for Bitcoin.
During the cryptocurrency bull run in December 2017, the median transac-
tion fee for Ether corresponded to $0.33, while for Bitcoin it corresponded
to $23.
◾◾ Ethereum uses an accounting system where values in wei are debited from
accounts and credited to another, as opposed to Bitcoin’s UTXO system,
which is more analogous to spending cash and receiving change in return.
5.9 Summary
This chapter presented Ethereum, the world’s first smart contract–supported block-
chain platform. Because this new blockchain is designed following the footsteps of
Bitcoin, the discussions of this chapter frequently compared this new blockchain
with its predecessor. It introduced the concept of a smart contract followed by
describing the Ethereum platform, its native token, architecture, mining process
and ERC standards. The chapter concluded with a comparison between Bitcoin
and Ethereum blockchain to give users the necessary idssswea of how this new
blockchain extended the capacity of Bitcoin.
Chapter 6
NEO
Ethereum revolutionised blockchain technology by introducing the concept of

smart contracts and proves that this innovative technology is far more capable than
just being a currency transaction protocol. Following the success of Ethereum,
many blockchain platforms adapted its concept and made the smart contract fea-
ture available in their core – NEO is one of them. This chapter intends to provide
a brief introduction to the NEO blockchain platform introduced from China. The
chapter seeks to describe two native tokens of this blockchain (NEO and GAS), its
network, its customised consensus mechanism commonly known as dBFT and its
ability to support smart contracts with a wide range of programming languages.
The focus will be given to introducing readers to the technical details of the NEO
blockchain and how it works. These details also help interested buyers of the NEO
token to understand the potential of this blockchain and evaluate its future.
6.1 What is NEO?
NEO is a blockchain platform and cryptocurrency designed to build a scalable
network of decentralised applications [NEO, 2014]. It supports a wide range of
commonly used programming languages including JavaScript, C#, Python, Java
and Go. Using a customised version of Docker called NeoVM, the blockchain plat-
form compiles the code into a secure executable environment to run applications.
NEO is often regarded as the Chinese reply to Ethereum and called “Ethereum’s
killer” [Khatwani, 2018]. It was originally launched in 2014 as AntShares to become
the first open-source blockchain project in China. The founders, Da Hongfei and
Erik Zhang, thought of an economy where digital and real-life assets are traded on
the blockchain. AntShares was a reply to the problems caused by China’s Digital
Signature Act 2005, which allowed people to sign legal documents digitally.
109
Hongfei and Zhang presented an ideal solution to these identity verification prob-
lems using this blockchain.
Their intention was always to build a government-compliant blockchain so that
companies can legally develop their contracts on AntShares. They continued with this
name until 2017 when they rebranded it as NEO to give a more credible image to the
company. All AntShares tokens subsequently became NEO tokens [Garner, 2018].
6.2 Token: NEO and GAS

This blockchain has two native tokens known as NEO and NeoGas, abbreviated as
GAS. The former token manages the network, while the latter is the operational token
to power the smart contract. Development of the NEO blockchain was motivated by
and created as a competitor to Ethereum. It followed a number of footsteps of its prede-
cessor including a gas token. In Ethereum, ETH is used as the gas token, but the NEO
blockchain from the beginning kept bookkeeping and fuel tokens separate. A total of
100 million NEO tokens represent the right to manage the network where manage-
ment rights include voting for bookkeeping and NEO network parameter changes.
Unlike Bitcoin, ETH and many other tokens, the minimum unit of NEO is 1 mean-
ing it cannot be subdivided. GAS has the maximum total limit of 100 million with a
minimum unit of 0.00000001 GAS. This token can be utilised for fractional usage.
6.2.1 Token Generation
NEO is a pre-mined token; in the genesis block of the network 100 million tokens
were generated. An equal amount of GAS will be generated through a decay algorithm
in about 22 years time corresponding to each of its counterpart tokens. If NEO is
transferred to a new address, the subsequent GAS will be credited to the new address.
GAS is generated with each new block. The initial total amount of GAS is zero.
With the increasing rate of new block generation, the total limit of 100 million will
be achieved in about 22 years. The interval between each block in this blockchain is
about 15–20 seconds, meaning 2 million blocks are generated each year. The initial
generation of GAS is 8 tokens per block with an annual reduction of 1 GAS per
block per year to coincide with the passing of every 2 million blocks. The reduction
will continue down to just 1 GAS per block and then the rate stays unchanged until
reaching the 22-year milestone. After the generation of the 44 millionth block, the
total number of GAS reaches 100 million, and from this point on there will be no
further generation of tokens from the new blocks. According to this release curve,
16% of the GAS will be created in the first year, 52% in the first 4 years and 80% in
the first 12 years. The GAS tokens will be distributed proportionally in accordance
with the NEO holding ratio, recorded in the corresponding addresses. NEO hold-
ers can initiate a claim transaction at any time to receive these GAS tokens at their
holding addresses.
NEO ◾ 111
6.2.2 Token Distribution
The distribution of the NEO token has been taking place in two phases. Amongst
the 100 million tokens, the first 50 million tokens were distributed proportion-
ally to supporters of NEO during crowdfunding. The remaining 50 million NEO,
managed by the NEO Council to support NEO’s long-term development, will
never enter the exchanges. There are plans to use 20 million tokens to motivate
NEO developers and members of the NEO Council, with another 15 million to be
used for cross-investment in other blockchain projects.
6.3 Architecture
NEO is a distributed and decentralised peer-to-peer (P2P) network. Nodes that
store the blockchain are called “full-node”. They establish the network and share
the blockchain amongst them using the P2P network. All nodes in the NEO net-
work are equal. They act both as a client interface and as a server.
6.3.1 Basic Structure
The NEO blockchain platform has two full-node programs, namely Neo-GUI and
Neo-CLI. The former has all the essential functions for the client including a graph-
ical interface and is intended for NEO users, while the latter provides an external
API for the required wallet functions and is intended for NEO developers. The
CLI also helps other nodes achieve consensus with the network and is involved in
generating new blocks.
The NEO network protocol provides a low-level API for some transaction types
that are not currently supported by the CLI, such as claiming GAS or sending
NEO without an open wallet. The CLI neither provides the required functionality
to switch the wallet on or off remotely nor verifies the process when opening a wal-
let. Therefore, it becomes a requirement that the wallet must be kept open all the
time to respond to the withdrawal requests of users.
The NEO blockchain supports running private networks (private chain), in
particular for writing and testing DApps and smart contracts. A private network
is a complete NEO blockchain for individuals, isolated from the public network
where the owner can spin it up quickly, claim the initial 100 million NEO and
experiment with all aspects of it.
6.3.2 Advanced Features
This blockchain has three advanced features under development. The first is NeoX
that aims to traverse blockchains. It also aims to provide the much-required pri-
vate–public blockchain linkages on the platform. The second feature is called
NeoFS. In the near future, this blockchain aims to support file and data storage
facility for its contracts. The third and final feature is called NeoQS. Possibly it is
not going to happen soon, but NEO has the plan to fight against quantum com-
puting power to protect its blockchain using this feature once the new computers
come into existence.
6.4 Consensus Mechanism: dBFT

The design of the consensus mechanism in the NEO blockchain is different from
that of Bitcoin’s and Ethereum’s where proof of work is applied. NEO uses a
custom-built algorithm called “delegated Byzantine fault tolerant” or simply
dBFT. It is a BFT consensus mechanism that enables large-scale participation
in consensus through proxy voting. The holder of the NEO token can pick the
bookkeeper it supports by voting. Then the selected group of bookkeepers reach
a consensus through the BFT algorithm and generate new blocks in this block-
chain [Zhang, 2014].
6.4.1 Algorithm
In the NEO consensus algorithm, “consensus nodes” are those who participate in
the consensus activity by verifying the validity of the transactions. These nodes are
also referred to as bookkeepers and elected by NEO token holders. During a consen-
sus activity, consensus nodes take turns assuming the following two roles: speaker,
who is responsible for transmitting a block proposal to the system, and delegates,
who are responsible for reaching a consensus on the transaction.
The dBFT algorithm ensures the security and usability of the NEO blockchain.
Because erroneous nodes in the consensus can make maximum ⌈ (n − 1)/3 ⌉ support,
the functionality and stability of the system look guaranteed. In this algorithm,
n = | R | suggests the total number of nodes joined in the consensus making, while
R stands for the set of consensus nodes. In f = ⌈ (n − 1)/3 ⌉, f stands for the maxi-
mum number of erroneous nodes allowed in the system. In fact, the total ledger is
maintained by bookkeeping nodes, while ordinary nodes do not participate in the
consensus making.
All consensus nodes are required to maintain a state table to record the current
consensus status. The dataset used for a consensus from the beginning to the end
is called a View. If consensus cannot be reached within the current View, a View
Change will be required. The algorithm identifies each View with a number v, start-
ing from 0 and it may increase until achieving the consensus.
In this algorithm, each consensus node is identified with a number, starting
from 0 making the last node numbered n − 1. For each round of consensus,
a node plays speaker of the house, while other nodes play congressmen. The
NEO ◾ 113
speaker’s number p is determined by the following formula: hypothetically, if

the current block height is h, then p = (h – v) mod n, where p’s range will be
0 ≤ p < n.
A new block will be generated with each round of consensus, with at least n – f
signatures from bookkeeping nodes. Upon the generation of a block, a new round
of consensus begins, resetting v = 0.
6.4.2 Procedure
With block generation time interval t, under normal circumstances, a node broad-
casts transaction data to the entire network with the sender signature attached. All
bookkeeping nodes monitor the broadcasted transaction data independently and
store it in memory. After time t, the speaker sends
⟨PrepareRequest, h, v, p, block, ⟨block⟩ σp⟩

Having received the proposal, congressman i sends
⟨PrepareRequest, h, v, i, block, ⟨block⟩ σi⟩
Any node receiving at least n − f block σi reaches a consensus and publishes a

full block. Following the arrival of a full block, other nodes delete the transaction
in question from their memory and begin with the next round of the consensus.
It is required that for all the consensus nodes, at least n − f nodes are in the
same original state. This is to say, for all the nodes i, the block height h and View
number v are the same.
6.4.3 Transaction Validation
Nodes, having monitored the broadcasting and received the proposal, must validate
the transactions. They cannot write an illegal transaction in the memory once one
of the reasons mentioned in the following is revealed. If the proposal contains an
illegal transaction, that round of consensus will be abandoned and the View change
will take place immediately.
A transaction is ruled illegal, if
◾◾ The data format of the transaction is not consistent with the system rules.
◾◾ The transaction is already in the blockchain.
◾◾ All the contract scripts of the transaction are not correctly executed.
◾◾ There is a multiple-spend in the transaction.
If the transaction has not been ruled illegal based on the preceding conditions,
it will be ruled legal.
6.4.4 View Change
If, after (2v + 1) × t time interval, the nodes cannot reach a consensus or should
they receive proposals that contain illegal transactions, the View Change will take
place as follows (Figure 6.1):
1. Given k = 1, vk = v + k.
2. Node i sends View Change request ⟨ChangeView, h, v, i, vk⟩
3. Once any node receives at least n − f same vk from different i, the View
Change ends. Set v = vk and the consensus begins.
4. If, after (2v + 1) × t time interval, the View Change does not complete, the k
increases and the process returns to the step 2 (Figure 6.1).
6.4.5 Fault Tolerance and Transaction Time

The dBFT provides Byzantine fault tolerance of ⌊ (n − 1)/3 ⌋ for a consensus system
consisting of n consensus nodes. This fault tolerance also includes both security
and availability, resistant to general and Byzantine failures, and is suitable for any
network environment. dBFT has good finality, meaning that once confirmations
are final, the block cannot be bifurcated, and the transaction will not be revoked
or rolled back.
In the NEO dBFT consensus mechanism, taking about 15 to 20 seconds to
generate a block, the transaction throughput is measured up to about 1000 TPS,
which is excellent performance amongst the public chains. Through appropri-
ate optimisation, there is potential to reach 10,000 TPS, allowing it to support
large-scale commercial applications.
The dBFT combines digital identity technology, meaning the bookkeepers can
be the real name of the individual or institution. Thus, it is possible to freeze,
revoke, inherit, retrieve and transfer ownership due to judicial decisions on them.
This facilitates the registration of compliant financial assets in the NEO network.
The NEO network plans to support such operations when necessary.
6.5 Smart Contracts
The NEO blockchain implements smart contracts, which is much different from
Ethereum. It currently runs its Smart Contract 2.0 that features three different
types of contracts, namely validation contracts, function contracts and application
contracts.
The NeoVM virtual machine is the contract execution environment in this
blockchain that starts up fast and uses resources efficiently. It comes with sup-
port for arrays and complex data structures and enables developers to write their
contracts in a wide range of programming languages. Unlike the native Solidity
NEO ◾ 115
1
Speaker sends the request
for confirmation to the
delegates.
Each delegate validates the

transaction and sends its
confirmation to other
delegates.
Speaker
node
3
Delegate
node
Once a delegate node receives

consensus based on the
condition set in the algorithm, it
notifies the network by
broadcasting the entire block.
4 Having received the notification

of consensus with the
completed block from a
delegate node, other nodes
delete the transaction in
question and get ready for the
next round of consensus.
Figure 6.1 NEO consensus mechanism in the presence of a no dishonest node;

hence the view change is not shown.
language in Ethereum, the NEO smart contract can be used directly by almost any
high-level programming language. The current batch of supported languages is C#,
VB.Net, F#, Java, Python, JavaScript, Go and Kotlin. NEO provides compilers and
plug-ins for these languages, which are used to compile high-level languages into
instruction sets supported by NEO virtual machines.
NEO Smart Contract 2.0 achieves a scalable approach through a combination
of high concurrency and dynamic partitioning, combined with its low-coupling
design. The low-coupling contract procedure is executed in the virtual machine and
communicates with the outside through the interactive service layer. Therefore, the
vast majority of upgrades to the smart contract function can be done through the
API of the interactive service layer.
There is a deployment fee that a developer must pay to deploy a smart contract
on the blockchain. Currently, this fee is 500 GAS. There is another cost called the
execution costs that the user pays for executing a smart contract. All operations in a
NEO blockchain incur a fee; most defaulting to 0.001 GAS with the first 10 GAS
given free. It is possible with NEO Smart Contract to achieve priority processing
by manually increasing the execution fee.
The NEO blockchain has emerged as a strong contender to Ethereum in smart
contracts. Its focus on assets and identity management further makes it unique
for those use-cases. Its ability to provide a wide range of programming language
support positions this blockchain in a favourable place amongst other smart con-
tract–supported distributed ledgers in the market. With a solid plan for moving
forward, as blockchain technology continues to grow, NEO is expected to do better
and attract more consumers who will be willing to use its smart contract in future.
6.6 Summary
This chapter presented NEO, a blockchain platform supporting smart contracts.
This new generation distributed ledger is considered one of the competitors to the
Ethereum platform; hence the emphasis was given to explain how NEO stands
out from Ethereum in the discussion. The chapter provided a brief introduction to
the NEO blockchain by describing its tokens (NEO and GAS), networks, consen-
sus mechanism and smart contract. Although the objective of the chapter was to
inform readers with the technical details of the NEO blockchain and its underly-
ing working principles, the body of the text can also help investors and investment
enthusiasts to understand the potential of this blockchain and the intrinsic value
of its token.
Chapter 7
EOS
The popularity of the smart contract in the blockchain industry attracted a good
number of platforms to provide contract supports. We have already learned about
Ethereum and NEO in the previous two chapters. This chapter takes the opportu-
nity to present EOS, another blockchain renowned for providing smart contracts.
EOS is one of the latest platforms to support some of the most cutting-edge features
for deploying smart contracts and decentralised applications. The blockchain is not
only famous for its technological excellence, but also as the most successful business
project in terms of raising funds through a crowdsale. This chapter aims to explain
EOS’ technical details as well as how it generated a hefty $4.2 billion in capital for
its operation through an initial coin offering (ICO).
7.1 What is EOS?
EOS is a blockchain protocol developed by the Cayman Islands–registered pri-
vate company Block.one. The EOS ecosystem is comprised of two components:
EOS.IO, the operating system, and Cryptocurrency EOS, its native token. The
protocol emulates most of the attributes of a real computer, including CPU and
GPU for processing, RAM and hard disk, with computing resources distrib-
uted equally amongst EOS cryptocurrency holders. EOS operates as a smart
contract platform and decentralised operating system for the deployment of
industrial-scale decentralised applications (DApps). The founders claimed that
EOS is the first decentralised operating system providing the right environment
for large-scale DApp development, although several other blockchain platforms
also claimed to provide a similar environment, if not the same, including NEO
described in the previous chapter.
117
The CTO of Block.one, Daniel Larimer, is the lead engineer of the develop-
ment team and has some original contributions in the making of this blockchain.
The delegated proof of stake (DPoS), a consensus algorithm invented by Larimer
for two of his previously founded blockchains, is used as the consensus mechanism
of EOS.
There exists no official full form for the EOS abbreviation. The founders have
decided not to formally define it themselves either.
7.2 Token: EOS
The EOS does not have the notion of “mining” but introduces a new concept called
“block producing”. A block producer generates new blocks and gets rewarded by
the creation of new EOS tokens for each block. A more detailed explanation as to
how these blocks are produced and the rewards are distributed will be covered later
while discussing the consensus mechanism and the reward distribution.
7.2.1 Initial Coin Offering

A significantly large portion of EOS tokens were pre-created, even before the
launch of the platform, and sold through an ICO. The ICO was distributed as
ERC-20 tokens by Block.one that created 1 billion tokens intending to generate an
equal amount of US dollars (USD) from the sell. The tokens were sold for almost
a year, the longest of any major blockchain project. It created a massive hype that
led to generating $4.2 billion from the sell, and by the end of April 2018, each
token hit $22.
As of December 2018, 20 people owned 60% of the total EOS tokens with 100
individuals retaining over 75% stakes [Wilmoth, 2018b] (Figure 7.1). This indicates
that the success of the blockchain as an excellent business project is down to the
Figure 7.1 As of December 2018, 100 individuals owned over 75% of the tokens
with only 20 people retaining over 60% of the total.
EOS ◾ 119
parent company Block.one who successfully targeted high net-worth individuals to

sell tokens.
Such a concentration of ownership is not good for Bitcoin-like blockchain plat-
forms, but in the case of EOS as a business project, this can be an advantage for the
future development and growth of this platform. While funds gathered from most
ICOs look scattered amongst small investors and crypto- enthusiasts, having high
net-worth individuals with big stakes on the board can potentially bring stability in
the operation. The block-building process, consensus mechanism and management
operation of the EOS blockchain have a direct relationship to individuals having
tokens (we learn about it in Section 7.4) making this platform more like a public
limited company boardroom than a new start-up company.
7.2.2 Transaction Fees
EOS does not use transaction fees to pay for infrastructure but instead uses infla-
tion. The practice is that users must deposit an amount (a stake) of tokens to use
resources. This stake remains locked up until the resources are released. Upon
releasing the resources, users get their full stake back. This approach, however, does
not mean they get to use the blockchain for free. For validating transactions and
producing blocks, a block producer receives a reward in EOS tokens that the block-
chain generates out of nowhere; hence the concept of inflation arrives. Because of
the presence of the newly generated tokens, existing EOS tokens lose value, which
is the indirect price for using the blockchain [Floyd, 2018].
7.2.3 Inflation
The EOS system creates inflation of 5% each year, although the token holders can
vote on decreasing or increasing the inflation rate. Of those, 1% is dedicated to
funding the block producers responsible for running the blockchain, while the
remaining 4% is paid into the Worker Proposal Fund (WPF). The WPF is intended
to be a source of funding for community-driven ideas that help grow the ecosystem.
The idea is anyone willing to offer a service would be able to serve the community
using this fund. It is still a matter of debate whether EOS needs this option and the
large volume of reserves kept for this fund [Yi, 2018].
7.3 Architecture
Two groups of nodes form the EOS network. The first is individuals having
EOS tokens, who have the supreme power in the network. The EOS block-
chain operates based on the selection of delegates who produce blocks. Token
holders are the entities who retain voting power and select delegates. Token
holders’ strength is determined by how many tokens they hold. This means
that nodes with greater tokens influence the network more than nodes having
fewer tokens.
The second is the block producers who run the election in a bid to becoming a
delegate. There runs a continuous approval voting system in this blockchain where
anyone may choose to participate to become a block producer. Once elected, they
are called delegates and given the opportunity to produce blocks. The election in
EOS is an open and free process where anyone can get elected provided that they
can persuade token holders to vote for their nomination.
The voting system in the EOS network works because it is able to get rid of bad
nodes quickly and at the same time appreciate new valuable members. The system is
reliant upon active voters (token holders) in the community, hence educating them
about how the system works is essential to the well-being of the blockchain.
7.4 Consensus Mechanism: DPoS

The delegated proof of stake (DPoS) was invented by Daniel Larimer who used it
for two of the blockchains he founded before EOS, namely Bitshare and Steemit. It
was no secret that Bitcoin mining is too wasteful of energy and needs alternatives.
Larimer also realised that Bitcoin mining would become centralised in the future,
with giant mining pools taking over the control of the network. Additionally, he
wanted to build a system capable of handling more than 100,000 transactions per
second, which Bitcoin or Ethereum are unable to support. These disadvantages led
him to invent this new DPoS consensus mechanism [Konstantopoulos, 2018].
7.4.1 Algorithm
DPoS runs by using reputation systems and utilises real-time voting to form a panel
of limited trusted parties. Members of this panel, known as delegates, then have
the right to create blocks that they consequently add to the blockchain. This selec-
tion process prohibits untrusted parties from participating where only the panel
of trusted parties takes turns creating blocks in a randomly assigned order that
changes with each iteration [Grigg, 2017].
It is important to realise that the selected panel does not have to be highly
trusted, as the block creators, or more appropriately delegates, can either success-
fully create or fail to create blocks. In other words, they can only insert transac-
tions to a block or fail to do so. They do not have the power of changing the
details, making them nearly harmless. In the worst case, if delegates fail to create a
block, the next delegate’s block will be twice the size or at least include the missing
transactions, and the confirmation time will be twice the regular time. Due to the
malicious delegates’ behaviour being publicly visible, the community can quickly
vote them out. If that happens, it will result in the delegate losing their income as
delegates with no potential upside; hence this discourages such an attack.
EOS ◾ 121
The EOS blockchain requires delegates to create blocks exactly every half a sec-
ond and one delegate is allowed to create a block at any given point in time. If the
delegate fails to create the block at the scheduled time, the block for that time slot
is skipped. When one or more blocks are skipped, a gap of half a second or more
becomes evident in the blockchain.
7.4.2 Procedure
DPoS runs in rounds of 126 where six blocks are produced each time with 21 del-
egates (block producers) for each block. At the beginning of each round, 21 unique
delegates get selected by the token holders through voting. The scheduling of the
delegates must be in an order agreed upon by 15 or more members of the delegate
panel (Figure 7.2).
If delegates miss a block and it turns out that they did not create any blocks
within the last 24 hours, they will be removed from further consideration until
the blockchain hears from them with an intention to start creating blocks again.
It ensures the network operates smoothly by identifying the delegates proven to be
unreliable.
Delegates
(Block Producers) Delegates produce
blocks by verifying
transactions
in rounds and earn
rewards for their work.
Interested
nodes failing to
get selected
wait for another
chance in the
next election.
Token holders select

21 delegates through
voting to produce
blocks in rounds.
Decentralised
Applications (DApps)
keep running on the
blockchain who use Token holders look
EOS.IO and generate after the process and
transactions. keep selecting
EOS Token holders delegates depending
on their activity and
behaviour.
Figure 7.2 The consensus mechanism of EOS blockchain platform.

Under normal circumstances, a DPoS blockchain does not experience any

forks because, rather than compete, the delegates cooperate to create blocks. In
the event there is a fork, consensus will automatically switch to the longest chain.
This method works because the rate at which blocks are added to a blockchain
fork is correlated to the percentage of delegates that share the same consensus. In
other words, a blockchain fork with more delegates will grow in length faster than
one with fewer delegates because the former experiences fewer missed blocks. No
delegate should be creating blocks on two forks at the same time. A delegate caught
doing so is likely be voted out. Cryptographic evidence of such double-production
is also used to remove abusers automatically.
The Byzantine fault tolerance (BFT) is added to DPoS by allowing all delegates
in a panel to sign all blocks. It makes it impossible for delegates to sign two blocks
with the same timestamp or the same block height. Once 15 delegates have signed a
block, the block is deemed irreversible. Under this model, an irreversible consensus
should be reachable within 1 second. A transaction can be considered confirmed
with 99.9% certainty after an average of one-quarter of a second from the time of
its broadcast. In addition to DPoS, EOS also adds asynchronous Byzantine fault
tolerance (aBFT) for faster achievement of irreversibility. The aBFT algorithm pro-
vides 100% confirmation of irreversibility within 1 second.
7.4.3 Reward
The block producers receive rewards in two ways. The selected 21 producers who
take part in the block-producing process receive 318 EOS per day for their service.
There is another reward for all potential block producers who take part in the elec-
tion to encourage their participation. This reward is given based on the percentage
of the vote they receive. For each 1% of the vote, a potential block producer gets
200 EOS per day. For example, if a producer gets selected as a delegate receiving
5% of the vote, then their earnings will be 318 + (5×200) EOS for a day.
A potential block procedure can deliberately ask for a pay cut to attract vot-
ers. In that case, they only receive the amount stated before the election instead
of 318 EOS, should they go on winning the election and become one of the 21
delegates.
7.5 Smart Contracts
EOS is using a WebAssembly (Wasm) virtual machine to run smart contracts. Wasm
is a web standard that defines a binary format and a corresponding assembly-like
text format for executable codes in web pages. It is meant to enable executing code
nearly as quickly as running native machine code and was developed at the World
Wide Web Consortium (W3C) with engineers from Mozilla, Microsoft, Google
and Apple. As such, the availability of Wasm in EOS.IO means programmers are
EOS ◾ 123
free to use any language that compiles into Wasm, although the recommended way
in this blockchain’s smart contract is to use the C++ library and the eosio-cpp tool.
In the EOS.IO smart contracts, the phrase Action and Transaction have special
meaning. An Action is a call to a smart contract to give the decision as to how it
should operate, while a Transaction is a collection of one or more Actions. A con-
tract and an account communicate using two communication modes: “Inline”,
which is executed with the current transaction, and “Deferred”, which gets sched-
uled later at the producer’s discretion.
7.6 EOS.IO Operating System

The development of EOS.IO identifies the gap between existing platforms pro-
viding business applications and established centralised applications such as eBay,
Uber, Airbnb and Facebook, and intends to mitigate that gap. As such, these
centralised use-cases require handling tens of millions of active daily users, and
in some instances, an application may not work unless a critical mass of users is
reached. The EOS operating system aims to provide the platform that can handle
vast numbers of users with low latency of transactions [EOS, 2018].
There are three broad categories of resources that applications can potentially
consume. They are bandwidth and log storage (Disk); computation and compu-
tational backlog (CPU); and state storage (RAM). Bandwidth and computation
have two components: instantaneous usage and long-term usage. The blockchain
maintains a log of all actions that all full nodes store. With this log, it is possible to
reconstruct the state of all applications.
Blockchain state storage is information that is accessible from application logic.
It includes information such as order books and account balances. If an application
never reads the state, then that information should not be stored.
Block producers publish their available capacity for bandwidth, computation
and state. The EOS.IO allows each account to consume a percentage of the avail-
able capacity proportional to the number of tokens held in a 3-day staking contract.
For example, if an account holds 1% of the total tokens, then that account has the
potential to utilise 1% of the state storage capacity.
7.6.1 Schema-Defined Actions and Database

In EOS.IO, Actions sent between accounts are defined by a schema which is
part of the blockchain consensus state. This schema allows seamless conversion
between binary and JSON representation of the Actions. The database state is also
defined using a similar schema. This ensures that all data stored by all applications
is in a format that can be interpreted as human readable JSON, but stored and
manipulated with the efficiency of binary. Developing smart contracts requires
a defined database schema to track, store and find data. Developers commonly
need the same data sorted or indexed by multiple fields to maintain consistency
amongst all the indices.
7.6.2 Separation of Authentication from Applications

EOS.IO separates the authentication from the applications. The authentication is a
read-only process of verifying that an Action can be applied while the applications
do the actual work. Both calculations need to be performed in real time, but once a
transaction is included in the blockchain, the authentication operation is no longer
required.
7.6.3 Inter-Blockchain Communication
EOS.IO is designed to facilitate inter-blockchain communication, another name
for cross-chain transactions, that makes transactions happen between blockchains,
moving tokens from one blockchain to another. This interoperability between
blockchains relies on a light client version of Merkle proofs, the technology at the
heart of all blockchains invented by Ralph Merkle. There are several use-cases that
could utilise EOS inter-blockchain communication and potentially make it easier
for existing DApps utilising ERC-20 tokens on the Ethereum blockchain to port
over to EOS.
7.7 Summary
This chapter presented EOS, one of the latest and most technologically developed
blockchain platforms available. The blockchain is mainly designed to support
large-scale DApps deployment with smart contract facilities; hence the chapter
emphasised on the topics that are relevant to this objective of the blockchain. It
described the architecture of the blockchain, its consensus mechanism, smart con-
tracts and the EOS operation system. The technical details are presented in such a
way that even investment enthusiasts who have little, or no knowledge of distrib-
uted systems can also comprehend the potential of this blockchain.
Part III
FINANCIAL III
NETWORKS
Chapter 8
Ripple
The book has so far discussed blockchain technology and its first applications to
Bitcoin. It went on to introduce the concept of smart contract in the second part
and explained how three new generation distributed ledgers, namely Ethereum,
NEO and EOS, extended the ability of Bitcoin beyond a currency transaction pro-
tocol. In this third part, we learn about Ripple and Stellar, two new distributed
ledgers that aim to extend the capability of Bitcoin as dynamic financial networks.
These protocols stick to Bitcoin’s original use-case of transferring funds but extend
its nature from currency to anything valuable. This chapter presents the Ripple
protocol, discusses financial aspects of its token XRP, and explains the technical
details of the architecture and the consensus mechanism as well as describes the
partnership of Ripple with various participating companies.
8.1 What is Ripple?
Ripple is a distributed payment protocol and a real-time gross settlement system.
Unlike Ethereum that extended the capability of Bitcoin across various use-cases,
Ripple sticks to the original objective of Bitcoin: decentrally transferring money
over a digital medium. In doing so, Ripple stretches the concept of money from
currency to anything valuable. It allows users to exchange their assets decentrally
over a distributed network. For example, Bob lives in London and has British
Airways frequent flyer miles that will expire soon. He wants to exchange these
miles with someone for a Netflix membership. The Ripple protocol can help Bob to
find Alice who lives in New York and has a Netflix membership for a year, but she
is rather interested in exchanging the membership for frequent flyer miles because
of the impending world tour she has planned with her friends. In this example,
instead of exchanging currency of the same or different types, Bob and Alice will
127
be able to exchange their assets. A currency, for example Bitcoin, may form a part
of the exchange if the value of the assets is not even.
From the preceding example, it is evident that Ripple needs intermediaries to
facilitate such an exchange. At this point, it moves away from the original use-case
Nakamoto created for his Bitcoin protocol, which was to transfer money with-
out the help of any institution. Ripple, instead, enables banks and even non-bank
financial service providers to allow their customers to use this protocol for instantly
transferring funds or assets globally. The role of these institutions is not to act like
a central authority in this case. Their role is merely as brokers to help customers use
Ripple. If we look at the earlier example, Bob and Alice may deposit their assets to
a facilitator who then finds a match for them and administrates the exchange.
Ripple protocol makes it possible to execute global financial transactions of any
size in exchange for a minimal fee. The protocol supports a variety of tokens repre-
senting fiat currencies, cryptocurrencies, commodities and other specialised units
(such as frequent flier miles, store-card points, mobile-phone minutes). Alongside
supporting external tokens, the protocol comes with a native cryptocurrency that
can be used in the transactions.
The US-based company Ripple Labs created the Ripple protocol in 2012. It is
built atop a distributed open-source internet protocol. At its core, the network is a
distributed shared public ledger and follows the consensus mechanism for confirm-
ing the validity of a transaction. Despite Ripple Lab creating the network, Ripple
can operate without the presence of the company. Unlike Bitcoin whose main back-
ers are crypto-enthusiasts, Ripple is heavily promoted by its parent company that
successfully managed contracts with renowned banks such as UniCredit, UBS and
Santander for using the protocol.
8.2 Token: XRP
XRP is the native currency of the Ripple protocol. It is currently divisible to six
decimal places, and the smallest unit is called a drop with 1 million drops equal-
ling 1 XRP. Users of the Ripple protocol are not required to use XRP as a store of
value or a medium of exchange. Each Ripple account, however, is required to have
a small reserve of 20 tokens.
8.2.1 Token Generation and Distribution

XRP tokens are all pre-mined at the genesis block. One hundred billion tokens
were generated at the time of the creation of this distributed ledger. The design of
this ledger does not allow coin mining; hence there will be no chance of having
more than 100 billion XRP in existence unless a hard fork enforces generation of
more coins. On the contrary, XRP has been decreasing every moment. The Ripple
protocol charges a small transaction cost. This amount is, however, not given to
Ripple ◾ 129
anyone but is rather simply destroyed. The protocol does this to prevent the net-
work from a DDoS or spam attack. This practice makes the number of XRP decline
every moment. The transaction cost is designed to increase along with the load of
the network. The current minimum cost is 0.00001 XRP for each transaction, but
it may change if the network gets congested. As of 3 December 2017, there were
99.993094043 billion XRP in existence, and the remaining got destroyed over the
last 5 years. Since no new XRP can be generated, this makes this token more scarce
and benefits its holders by making it more valuable [Ripple, 2018].
The distribution of XRP tokens has been a topic of debate since its incep-
tion. The founders of the Ripple protocol retained 20% of the total XRP tokens
for themselves and transferred the remaining 80% to Ripple Labs, which takes
responsibility to distribute these tokens phase by phase to charities and companies
using the protocol [Kurson, 2013]. When the concerns surrounding XRP supply
mounted in May 2017, Ripple Labs placed 55 billion XRP (88% of its holdings)
into a cryptographically secured escrow. The escrow allows it to use up to 1 billion
on a monthly basis. Ripple Labs returns the unused sum at the end of each month
to the escrow and starts over again the next month [Pilkington, 2017].
8.2.2 Bridge Currency
One of the functions of XRP is to bridge currencies in the absence of a direct
exchange rate, for example when transacting between two rarely traded currency
pairs where finding an exchange rate is not possible. Within the network’s currency
exchange, XRPs are traded freely against other currencies, and its market price
obtained from those trade helps to create the bridge [Liu, 2015].
8.2.3 Market Capitalisation
XRP is the second largest cryptocurrency by market capitalisation. There has been
competition between XRP and Ethereum’s ETH to take over the second spot
throughout 2018 when XRP emerged as one of the market giants (Figure 8.1). XRP
initially took the second position surpassing ETH for a brief period at the begin-
ning of 2018 but later surrendered the position when its price nosedived. As the
crypto market continued to show volatility, ETH’s price also dropped significantly
pushing it to third place. As of December 2018, XRP and ETH were very close
with Ripple’s token retaining the position just behind Bitcoin [Bambrough, 2018].
8.3 Architecture
The Ripple protocol mimics an age-old informal value transfer system commonly
known as hawala and connects financial and non-financial brokers globally to take
part in the exchange of assets. Like other protocols built around distributed ledger
Figure 8.1 The competition between Ripple (XRP) and Ethereum (ETH) between
4 December 2017 and 4 December 2018 to become the second largest cryptocur-
rency by market capitalisation after Bitcoin (BTC).
technology, Ripple is also a decentralised peer-to-peer network. Its nodes are dis-
tributed around the world and decisions are made through consensus while validat-
ing transactions.
8.3.1 Hawala
Hawala originated in the Middle East but soon became popular amongst people liv-
ing in and around the Horn of Africa, North Africa and the Indian Subcontinent.
The literal meaning of the Arabic word hawala is to assign the responsibility of
something to someone based on trust. During the early days of Islamic rule in the
Middle East, it was unsafe for travellers to carry a large sum of money or valuable
items because of the threat of theft. To prevent this problem, hawala was intro-
duced [Thompson, 2013].
According to this system, a person approaches a hawala broker in his city (let us
suppose, A) and deposits a sum of money that he instructs to hand over to someone
in another city (let us suppose, B). Along with the money, the depositor provides
a passcode that the withdrawer must present to verify his authenticity. The broker
then contacts his peer in B City and instructs him to pay the sum to the nomi-
nated person. He also passes on to his peer the passcode for the verification of the
authenticity of the withdrawer. Separately, the depositor also passes on the same
information to the withdrawer located in B City. The withdrawer finally meets the
broker in B City, proves her legitimacy by mentioning the passcode and collects the
money. An execution of a hawala transaction is shown in Figure 8.2. It is evident
from the figure that assets do not move through the transfer process. Instead, the
brokers negotiate between them to continue working as a pair and execute transac-
tions in such a way that the balance stays even on each end. The Ripple protocol
takes the concept to the next level and makes it possible to transfer assets over the
digital medium.
Ripple ◾ 131
Passcode moves,
money does not move
A B
City City
Money
A City Broker B City Broker
Passcode
Sender Receiver
Figure 8.2 The execution of a hawala transaction.
8.3.2 XRP Ledger
The Ripple protocol provides the required distributed systems to the brokers to
seamlessly transfer assets. It is comprised of server nodes connected to a peer-to-
peer network. Each server in this network acts as a broker. Brokers’ computers run
software called “rippled” (always written with a lower-case r at the beginning) that
powers them to connect with the network and take part in the exchange process.
Globally distributed rippled servers host the ledger that contains all the transactions.
Ripple uses a distributed ledger instead of a blockchain. Although its dis-
tributed ledger has many features similar to a blockchain, it is perhaps called
a ledger because of also storing state data such as accounts and balances. The
name of Ripple’s distributed ledger is XRP Ledger. It contains an index of the
ledger, a unique hash, the hash of its parent ledger, transaction hashes, state data
hashes, total ripple count, flags, and actual transactions and state data as shown in
Figure 8.3 [Ripple, 2018].
The XRP Ledger has a new ledger version every several seconds. A close anal-
ogy of a “version” can be a page of a ledger book. When the network agrees on the
contents of a specific version, it becomes validated. The contents of a validated ver-
sion of the XRP Ledger are cryptographically secured and can never be changed.
A ledger version has two identifiers. The first identifier is its ledger index, which
is a sequence number counted incrementally. For example, if the current ledger
version has a ledger index of 100, the previous ledger index should be 99 and the
next 101. The second identifier is a ledger hash generated based on the contents of
that version.
The rippled servers keep proposing transactions to apply to the ledger. In doing
so, they create several candidate ledger versions with different contents. These can-
didate versions have the same ledger index but different ledger hashes. Amongst the
candidates, only one can become validated, and the remaining are discarded; hence
there always exists exactly one validated ledger hash for each ledger index.
Unique Total XRP

hash count
Flags
Ledger
index
Timestamp
Hash of
state data Newly
Hash of applied
transaction transactions
data
Hash of
parent
ledger State data
(accounts,
balance etc.)
Validated
Figure 8.3 A page of the Ripple ledger showing its various components.
8.3.3 Transactions
In the Ripple protocol, the user-level changes to the ledger are the results of trans-
actions. Transactions may occur due to making payments, changing account set-
tings or trust lines, and offering to trade. Transactions are the only way to authorise
changes to an account or to change anything else in the ledger. Each transaction
authorises one or more changes to the ledger and is cryptographically signed by an
account owner.
Each ledger version also contains a set of transactions and metadata about those
transactions. The included transactions are those that have been applied to the
previous version to create the new instance. The set of transactions incorporated
in a version enables users to audit the ledger. For example, if an account balance
is different in ledger N+1 than that of in ledger N, this must indicate ledger N+1
contains the transactions responsible for the change.
Ripple ◾ 133
Applications working with rippled APIs must distinguish between candidate

transactions proposed for inclusion in a ledger and validated transactions which
are included in a validated ledger. Only transaction results found in a validated
ledger are immutable. A candidate transaction may or may not ever be included in
a validated ledger.
Ripple has a phenomenal transaction time giving this protocol an edge over
existing renowned blockchain platforms. As opposed to the Bitcoin transaction
time that may take up to an hour to complete a single transaction, Ripple is com-
petent in making payments in a minute.
8.4 Consensus Mechanism: RPCA

Ripple protocol uses the Ripple Protocol Consensus Algorithm (RPCA) to reach
a consensus amongst the nodes to validate the versions of the XRP Ledger. The
RPCA is a Byzantine agreement (BA) algorithm where a set of previously selected
trusted nodes communicate with each other to reach a consensus. Previously we
learned that Ripple Ledger is comprised of a series of interconnected ledger ver-
sions. Nodes running rippled decide amongst themselves using this algorithm
when to give the verdict to a version that it is validated. It cannot be changed or
modified afterwards.
8.4.1 Components
Before we discuss how the algorithm works, it is necessary that the components are
properly defined. Each node in this protocol is called a “server” that runs rippled.
It is different than Ripple’s client–server, which lets users send or receive payments
or assets. The “ledger” refers to the master ledger that keeps all the transactions. An
“open ledger” is the current operating status of a server where each maintains its open
ledger. Transactions initiated by end users of a given server are applied to that server’s
open ledger. The “last-closed ledger” means the version that got validated last.
“Unique Node List” or simply UNL is a special list maintained by each server
(let us suppose s). Only the votes of the members of the UNL of s (an arbitrary
node) will be considered when determining consensus as opposed to every node on
the network. UNL represents a subset of the network that can be considered collec-
tively ‘trusted’ from the point of view of s. It must be realised that every member of
UNL may not be trusted individually but collectively. s views those not defrauding
the network. At the beginning, Ripple provides s with a short list to start with. This
list later grows as s becomes active in the ledger validation process. Figure 8.4 shows
the initial list that Ripple provides to all new servers in a text file. Ripple keeps
changing this initial list but never disclosed the algorithm behind it or if there is
any specific method in place at all.
Figure 8.4 Unique Node List (UNL) in Ripple.
8.4.2 Consensus Process
The RPCA takes a procedural approach and helps servers to validate an open led-
ger. The consensus process in Ripple moves in rounds where each round confirms
an open ledger. Before the beginning of a new round of the consensus process, each
server takes all valid transactions it encountered but have not already been applied
to a validated ledger. This includes both new and unsuccessful transactions from a
previous consensus round.
The server then makes these transactions public in the form of a list known as
the candidate set. There is a mandatory 2-second window for all nodes to propose
their initial candidate sets in each round of consensus. It not only introduces a
lower bound for each consensus round but also guarantees all nodes with reason-
able latency to have the ability to participate in the process.
Once the participating servers propose their candidate sets, everyone amalgam-
ates the candidate sets of other servers on their UNL and votes on the correctness
of all transactions. Transactions that receive more than a minimum percentage of
yes votes are considered for the next voting phase, while transactions that do not
receive enough votes will either be discarded or included in the candidate set for
the next round.
Ripple ◾ 135
The final step of consensus goes through another voting phase for the previously
selected transactions. It requires a minimum percentage of 80% of a server’s UNL
agreeing on a transaction to get selected. All transactions that meet this require-
ment are applied to a ledger to become the last-closed ledger. Figure 8.5 shows the
consensus process of Ripple in brief [Schwartz et al., 2014].
8.4.3 Correctness
For a UNL of n nodes in the network, the consensus protocol will maintain cor-
rectness so long as f ≤ (n – 1)/5, where f is the number Byzantine failures. In fact,
even in the face of (n – 1)/5 + 1 Byzantine failures, correctness is still technically
maintained. The consensus process will fail, but it will still not be possible to con-
firm a fraudulent transaction. Indeed it would take (4n + 1)/5 Byzantine failures for
an incorrect transaction to be confirmed. The proof of the Byzantine fault tolerance
of the RPCA can be found in Schwartz et al. [2014].
As the votes are recorded in the ledger for each round of consensus, nodes can be
flagged and removed from the network for some common, easily identifiable mali-
cious behaviours. These include nodes voting no on every transaction and nodes
that consistently propose transactions which are not validated by the consensus.
N+1
+1
Proposed
transactions in
the form of
candidate sets
N+1
N-1 N +1
-1
N+1
+1
Figure 8.5 The consensus process of Ripple.

Ripple provides a curated default UNL to all new servers in a text file as shown
in Figure 8.4. Ripple keeps changing this initial list but never disclosed the algo-
rithm behind it or if there is any specific method in place at all. It, however, claimed
that this default list guarantees even a naive server to participate in the consensus
process and achieve correctness with extremely high probability.
Ripple also uses a network split-detection algorithm to avoid potential forks
in the network. While the consensus algorithm certifies that the transactions
on the last-closed ledger are correct, it does not prohibit the possibility of more
than one last-closed ledger existing on different subsections of the network
with poor connectivity. To try to identify if such a split has occurred, each
node monitors the size of the active members of its UNL. If this size suddenly
drops below a pre-set threshold, it indicates the possibility of having a split in
the network.
8.5 Codius and Interledger

Ripple Labs is the developer of the Codius smart contract platform. The develop-
ment of this smart contract was initiated in 2015 but put to a halt due to the lack of
a neutral hosting platform. Later when Interledger became available, Ripple revived
the Codius project and aims to integrate it as the smart contract platform for its
XRP Ledger. Interledger is an independent platform that enables payments across
many different types of ledgers without tying companies to a specific currency
or payment network. It perfectly suits the need for a neutral hosting platform for
Codius [Schwartz and Pestritto, 2018]. Unlike Ethereum’s smart contract, Codius
uses traditional programming languages such as C++, Java, JavaScript and C#
[Njui, 2017].
Codius operates differently than the smart contracts we saw in Ethereum or
similar blockchain platforms. The contracts run on independent hosts without an
underlying blockchain, similar to traditional hosting. This approach allows the
contracts to interact with services and APIs to read from or write to any blockchain.
Thus Codius solves the most critical challenge of smart contracts “interoperability”.
Figure 8.6 shows, with the help of Codius and Interledger, smart contracts making
calls to each other [Thomas, 2018].
8.6 Real-Time Gross Settlement System

We have learned so far how the Ripple protocol works at the low level. Although
these technical details are essential to comprehend the underlying operations of
this distributed ledger, they hardly tell us how Ripple works in the real world.
Unlike blockchain platforms focusing on smart contracts that are value-agnostic by
nature where developers decide what they should be used for, Ripple is a financial
Ripple ◾ 137
Codius
Interledger
Bitcoin Eth'eum Ripple
Figure 8.6 The cooperation between Codius and Interledger.
network and a real-time gross settlement system (RTGS). The primary objective
of the Ripple protocol is to ensure real-time gross settlements in a few minutes. In
doing so, it uses high-level components such as RippleNet, xCurrent, xRapid and
xVia. The following introduces these components and explains how they are used
in payment processing by the Ripple protocol.
8.6.1 RippleNet
The current practice of cross-border banking transactions is centralised, inefficient
and expensive. The payment networks are fragmented between transacting institu-
tions resulting in slow processing time and high fees that are ultimately passed
down to the user. Ripple identified this payment network as a clear misfit for
the growing demand for low-cost payments across the globe and came up with
RippleNet. It was conceived to tackle the inefficiencies in the existing practice and
change the landscape of cross-border international payments.
RippleNet is a global network of banks and financial institutions interested
in sending and receiving payments through the use of Ripple’s distributed finan-
cial technology. RippleNet is designed to produce real-time and low-cost payments
by acting as a decentralised global network of banks and financial institutions.
By eliminating the fragmentation in payment processing, RippleNet can deliver
a frictionless experience for global payments. Members of RippleNet using the
same technology and remaining within the same standard framework of payment
rules and standards overcome the inefficiencies that a fragmented payment system
produces.
The benefits of using RippleNet are fourfold. First, it gives access to a single
global market, meaning entering into it opens up the opportunity to send and
receive money to and from anywhere in the world using a unified framework of
standard rules, formats and governance. Second, the underlying distributed ledger
technology offered by the Ripple protocol enables RippleNet members to make
transactions within seconds rather than days. Third, the network minimises the
risk of failure and provides end-to-end transparency for every payment executed on
the platform. Fourth, RippleNet considerably reduces the settlement fees and the
overall cost of the transaction.
The RippleNet ecosystem classifies participants into two groups. The first group
is comprised of network members, i.e. banks, financial institutions and payment
providers. The second group includes network users, i.e. corporates, consumers and
other similar entities as shown in Figure 8.7. It is noted that RippleNet in the fig-
ure looks as if it is working as a centralised authority, which is not the right inter-
pretation. RippleNet merely acts as an enabling technology in this decentralised
ecosystem.
8.6.2 xCurrent
xCurrent is an enterprise solution for Ripple that is responsible for facilitating the
prompt settlement and end-to-end tracking of cross-border payments between
RippleNet members. Four key components constitute xCurrent: Messenger,
Validator, ILP Ledger and FX Ticker.
The Messenger is an API whose role is to establish links between transacting
banks to serve the beneficiaries. It is the tool that initiates a transaction by exchang-
ing beneficiary and transaction information. The role of the validator is to confirm
the success or failure of a payment request cryptographically, while the ILP Ledger
enables interoperation between different ledgers and payment networks. The last
component is the FX Ticker that provides the rate of exchange between any pair
RippleNet
Enabling technology, not a

centralised authority or a
middleman
Banks and Financial Beneficiaries

Institutions
Figure 8.7 The RippleNet Ecosystem.

Ripple ◾ 139
of ledgers. It also coordinates transfers on ILP Ledgers for settlement, ensures the
validity of an FX quote and transfers the payment amount to the beneficiary bank’s
ILP Ledger [Asolo, 2018].
8.6.3 xRapid
xRapid is another settlement solution developed by Ripple that aims to makes pay-
ment even faster. From the description of xCurrent, it is understandable that this
tool of the RippleNet does not need to use XRP cryptocurrency and is fully capable
of working directly between fiat currency pairs. The reliance on fiat currency, how-
ever, introduces a chance of delay in case of finding an appropriate match between
two rare currency pairs. The introduction of xRapid eliminates that possibility of
delay by using XRP as the bridge currency; hence this tool is considered the most
correlated aspect of Ripple protocol with XRP. The more partners use xRapid, the
usage of XRP increases.
The operation of xRapid can be explained as follows: A financial institution first
connects directly to digital asset exchanges in both the originating and destination
partners. Then the originating currency is exchanged into XRP, which provides the
necessary liquidity to power the final payment, and following the completion of
that step, in seconds the XRP is exchanged into the destination currency in the sec-
ond digital asset exchange. Once this transaction takes place, the funds are sent out
on the local rails of the destination country for payout. The transaction is tracked
end-to-end, and the result is a cross-border payment that is cheaper and faster than
even xCurrent [Brown, 2018].
8.6.4 xVia
xVia is an API tool for the Ripple protocol that connects RippleNet with Enterprise
Resource Planning (ERP), a software that allows an organisation to use a system
of integrated applications to manage the business and automate many back-office
functions related to technology, services and human resources. The tool is designed
for corporates with large offices and not intended for the use of retail customers
transferring money. It allows extending the capability of RippleNet within the eco-
system of ERP to facilitate services from both parties.
8.7 Partners
The success of RippleNet heavily depends on the participation of the partners in the
network. It is not only because they act on behalf of clients, but they acting as the
server nodes in making the Ripple protocol work and achieve consensus. Due to
this reason, Ripple Labs continuously pushes for more partners to join the network.
Table 8.1 is a list showing some of the notable partners of Ripple who have been
Table 8.1 Notable Partners of Ripple

Name Type Country xCurrent xRapid xVia
Bank of England Central bank UK Testing — —
Mitsubishi Corp. Trading Japan Testing — —
American Card USA Testing — —

Express
Western Union Transfer USA Testing Testing —
MoneyGram Transfer USA Testing Using —
Cambridge Transfer Australia Using Testing —

Global
UAE Exchange Transfer UAE Using — —
InstaRem Transfer Singapore Using — Using
Deloitte Consultancy UK Using — —
Accenture Consultancy Ireland Using — —
Bank of America Bank USA Using — —
Standard Bank UK Using — —

Chartered
MUFG Bank Bank Japan Using — —
DBS Group Bank Singapore Using — —
Santander Bank Bank Spain Using Testing —
NAB Bank Australia Using Testing —
Westpac Bank Australia Using Testing —
Bank of Bank Canada Using Testing —

Montreal
BBVA Bank Spain Using — —
Credit Agricole Bank France Using — —
Nordia Bank Sweden — Using —
Scotia Bank Bank Canada — Using —
Bank Leumi Bank Israel Using — —
(Continued )
Ripple ◾ 141
Table 8.1 (Continued) Notable Partners of Ripple

Name Type Country xCurrent xRapid xVia
Rak Bank Bank UAE Using — —
CBW Bank Bank USA Using — —
Saldo Bank Mexico Using — —
UBS Bank Switzerland Testing — —
Credit Suisse Bank Switzerland Testing — —
RBC Bank Canada Testing — —
Barclays Bank UK Testing Testing —
JP Morgan Bank Singapore Testing — —
HSBC Bank UK Testing — —
RBS Bank UK Testing — —
Commonwealth Bank Australia Testing — —

Bank
ANZ Bank Australia Testing — —
Macquarie Bank Australia — Testing —

Group
Intesa Sanpaolo Bank Italy — Testing —
FairFX, Foreign UK — — Using

RationalFX, exchange
Exchange4Free
using or testing RippleNet to send and receive money for the beneficiaries they
serve. The list specifically indicates which tool – xCurrent, xRapid or xVia – they
use while engaging in RippleNet. The list of all partners along with some vital
information regarding Ripple and XRP can be found in the portal Rippl.Info.*
8.8 Summary
This chapter presented Ripple, one of the most popular distributed ledgers avail-
able in the industry. Instead of focusing on smart contracts, the Ripple protocol
* The portal is publicly accessible using the following URL: www.rppl.info.

emphasises developing asset transferring facilities in a decentralised environment.

As such, the chapter aimed at providing descriptions of Ripples technical details
keeping this use-case in mind. The description included introducing its token XRP,
the architecture and the consensus mechanism, followed by an introduction to the
partnering companies that have been using this protocol. The discussion of how
blockchain can be used to develop alternative financial networks will continue to
the next chapter where a similar protocol, Stellar, will be discussed.
Chapter 9
Stellar
If Ethereum revolutionised the path towards the smart contract, there is no doubt
that Ripple deserves similar credit for popularising alternative and decentralised
financial networks using blockchain technology. Established atop the foundation
of Bitcoin, Ripple extended the capacity of this virtual currency by introducing
mainstream partners in the network. Stellar, originally a hard fork from Ripple’s
distributed ledger, continues to develop on the same use-case introduced by its
predecessor. The chapter presents the Stellar protocol, its native cryptocurrency
Lumens, technical details of its underlying operation and its alliance with major
industry partners. Because of the similarities between Stellar and Ripple, the
emphasis in this chapter is to frequently compare both protocols, particularly while
describing specific technical details to distinguish their performances.
9.1 What Is Stellar?
Stellar is a distributed ledger for exchanging money or tokens using blockchain tech-
nology. It aims to facilitate the cross-asset transfer of value at a fraction of a penny.
The goal of Stellar is to become an open financial system that gives people access to
low-cost financial services. Some of Stellar’s service use-cases include remittances,
micropayments, mobile branches, mobile money and distributed exchange. The
co-founder of Ripple, Jed McCaleb, and Joyce Kim founded this blockchain in
2014. The non-profit Stellar Development Foundation (SDF) is responsible for the
well-being of the Stellar ecosystem.
The Stellar protocol was originally a hard fork in the Ripple protocol. It was
a moment of turmoil and debate surrounding Ripple due to Joyce Kim claiming
to find a flaw in the initial Ripple protocol. Ripple Lab’s CTO Stefan Thomas
later contested this claim in favour of Ripple. In the wake of this drama, SDF was
143
established, and a new consensus algorithm replaced the former in the fork creating
‘Stellar-core’.
While sharing many affinities with other blockchain networks, Stellar does
operate differently. Its peer-to-peer network is comprised of multiple servers com-
municating with each other every two to five seconds. Each of these servers keeps a
copy of the public ledger that logs all transactions on the network. The ledger itself
gets updated every few seconds.
Whenever an order pops up on the network, the Stellar protocol determines the
best exchange rate for the transaction. While this could be as simple as converting
one currency to another, the algorithm is capable of creating conversions passing
through multiple currencies if the result is more beneficial for both parties. The
Stellar protocol applies a small fee for each transaction, charged in its native cryp-
tocurrency Lumens (XLM).
9.2 Token: Lumens (XLM)

Lumens, abbreviated as XLM, is the native token of Stellar. At the time of the
launch in 2014, it was called ‘stellar’ but later renamed to its current designation.
The Stellar protocol is designed to create all tokens at the genesis block; hence it is
a 100% pre-mined cryptocurrency.
9.2.1 Generation and Distribution

At the genesis block of the Stellar network, 100 billion tokens were created as speci-
fied in the protocol. SDF is given the responsibility to ensure the fair distribution
of the tokens and to look after the well-being of the network.
Following the formation, SDF was made responsible for 95 billion tokens that it
will distribute over time around the world. SDF intends to distribute XLM tokens
in the following manner:
◾◾ 50% via the Direct Sign-up Program. This program is an effort to make
Lumens easily accessible to millions of individuals and communities across
the globe. Using a simple web-based sign-up form, individuals could apply
for Lumens.
◾◾ 25% via the Partnership Program to early adopters and contributors to the
Stellar ecosystem, and to those who help extend the network’s reach to under-
served or financially excluded populations.
◾◾ 20% via the Bitcoin Program to be distributed for free to holders of Bitcoin
(19%) and XRP (1%).
SDF retains the right on the remaining 5% of tokens that it holds to support the
operational costs of the foundation and which it will not ever distribute to the public.
Stellar ◾ 145
9.2.2 Price and Market Cap

Lumens had been trading below $0.002 in the exchanges until May 2017 when
its value started to rise during the cryptocurrency bull run of the year. Initially,
the price gained by more than 400% but soon nosedived to around $0.001 despite
other major cryptocurrencies taking an active part in the rally.
The price of the XLM again started to rise in October and hit an all-time high
price of $0.85 on 4 January 2018 demonstrating an 84,900% gain in three-and-
a-half-months time. Following the cryptocurrency market crash of 2018, the price
came down to around $0.10 in twelve months (Figure 9.1).
XLM is one of the fastest growing cryptocurrencies, and despite the volatile
price, it remains one of the top 10 cryptocurrencies by market capitalisation.
9.2.3 Role of XLM in the Protocol

XLM has two roles in Stellar protocol. First, it works as a bridge currency. While
discussing the application of Stellar, we learn that this protocol can enable
multi-currency transactions in the network. Such a transaction requires a matching
pair of currencies such as USD/GBP. In the absence of such a pair, XLM can step in
and create a bridge in the form of USD/XLM and XLM/GBP to settle the payment.
The second role of XLM is to work as an anti-spam mechanism. In order to
prevent denial-of-service (DoS) attacks that would inevitably occur on the Stellar
Figure 9.1 The price chart of XLM against USD (black) and BTC (grey).
network, a small fee of 0.00001 XLM is associated with every transaction that
occurs on the network. This fee is small enough to affect the cost of a transaction
but large enough to prevent bad actors from spamming the network. This is a com-
mon practice for its predecessor Ripple as well. However, Ripple does not give this
fee to anyone; it destroys it. This makes XRP more scarce and increases the value of
this token. Stellar takes a different approach and instead of destroying the tokens,
puts it into a pool known as the ‘inflation pool’ and releases the tokens later at a rate
of 1% each year through this pool to the holders of XLM token.
9.3 Architecture
Like other distributed ledgers, Stellar is a peer-to-peer network meaning it does not
depend on any single entity. The idea is to have the participation of as many inde-
pendent servers as possible in the Stellar network so that it will still run successfully
even if some servers fail.
Stellar was a hard fork from Ripple, and therefore, the architecture looks simi-
lar. It is a distributed ledger where records are maintained like an accounting ledger
book, as we saw for Ripple in the previous chapter. The Stellar ledger records a
list of all the balances and transactions belonging to every single account on the
network. A complete copy of the global Stellar ledger is hosted on each server that
runs the Stellar software.
The architecture of this protocol is more flexible and more decentralised than its
predecessor. Unlike Ripple where servers need to go through an approval process,
any entity can join and run the Stellar server by becoming a part of the network.
9.4 Consensus Mechanism
Stellar uses a consensus mechanism known as a Federated Byzantine Agreement
(FBA). It offers four features – flexible trust, decentralised control, low latency
and asymptotic security – and aims to solve the limitations of Ripple’s Byzantine
Agreement (BA) algorithm [Mazieres, 2016].
9.4.1 Quorum and Slices

Stellar identifies a major limitation in Ripple’s BA algorithm. If we recall what we
learned in Chapter 8 (Section 8.4.2), the Ripple protocol gives a list of trusted serv-
ers, known as UNL, to each host server to get started. In the consensus process, the
host server only trusts the servers from its list. Although it is expected that the host
will expand this list as time passes, in practice, this does not often happen and the
majority of hosts stick to the list provided by the Ripple protocol. First, servers can-
not automatically join the Ripple network. They need to go through an approval
Stellar ◾ 147
process. This approach already introduces a sense of centralisation. On top of that,

when the suggested UNL becomes the de facto trusted list for the majority of hosts,
centralisation becomes a pivotal part of the process.
Stellar’s FBA algorithm aims to solve this problem by allowing servers more
flexibility. Unlike Ripple, this protocol preserves a simple entry passageway for the
servers to get into the network without going through formal approvals. Once in,
the servers then decide their group of trusted servers based on a concept called
‘quorum slice’. A quorum is said to be a set of servers (nodes) sufficient to reach an
agreement, while a quorum slice can be defined as the set of servers sufficient to
convince another server of the validity of a record. Because the latter is a subset of
the former, it is called a ‘slice’.
Figure 9.2 shows four quorums: A, B, C and D. Quorums are formed based on
the decisions of individual servers as to how they decide to trust other members. For
example, n1, n2, n3 and n4 all trust one another. So they form a quorum together
(Quorum A). Amongst the servers, n3 also trusts n10 and n11, but n1, n2 and n4 do
not directly trust these two servers; hence they are not part of the Quorum A, but
with n3 they form another quorum, D. Similarly B and C are formed.
Now let us try to understand the slices. It is easily visible from Figure 9.2 that
A has three slices: (n1, n2), n3 and n4. A slice is the intersection of two quorums
such as n3 between A and D, n4 between A and B, and n6 and n7 between B and
C. These slices play an essential role in Stellar. If we recall, in Ripple at the time of
voting, servers only accept votes from its trusted server from the UNL. However,
in Stellar, slices continue to extend the boundary of trust as the network grows. For
example, n1, n2 and n4 in quorum A do not generally trust n10 and n11. However,
Quorum A
Quorum B
n5
n1 n2
n4 n7
n6
n3 n9
n10 n8
n11
Quorum C
Quorum D
Figure 9.2 Quorum and slices as formed in the Stellar network.

as they trust n3 which trusts n10 and n11, the other servers of A now trust all serv-
ers of D.
By comparing Ripple’s UNL with the quorum slice of Stellar, we observe that
Stellar is more flexible in terms of allowing its servers to trust others. In this proto-
col, unlike Ripple, participating servers are free to decide other servers they trust,
without any restrictions. Using slices, the boundary of this trust gets bigger helping
the consensus algorithm to reach an agreement even quicker than its predecessor.
9.4.2 Agreement
An agreement in the FBA algorithm is achieved through federated voting. It is the
method by which the participating servers in Stellar agree on a decision. It begins
with initial voting, a process said to be the assurance from a server that for a specific
decision it gives an affirmative verdict with the confirmation of not voting in favour
of a contradictory decision. The server, however, can change its vote if enough of
the other participating servers that it trusts vote for another decision.
The voting may go through three other phases: (1) acceptance, a phase where a
server accepts a decision based on the decision of a contradictory statement accepted
by a server from the quorum slice; (2) ratification, where all members of a quorum
vote to accept a statement; and (3) confirmation, when the network agrees and
confirms on a decision.
Through voting, participating servers ultimately agree on a particular decision
once a sufficient threshold of messages is processed across the network. Servers
propagate acceptance messages across the network from servers within their quo-
rum. These messages could influence other servers to accept the decision even if
they had accepted a different initial message. Finally, a round of confirmation mes-
sages is broadcast to confirm the message, concluding the round of voting with an
agreement on a decision [Curran, 2018; Majuri, 2018].
9.5 Applications
Stellar is a decentralised currency transfer protocol which allows cross-border transac-
tions between any pair of currencies. This ability of Stellar helps to build a number of
use-cases involving currency transfer, foreign exchange and multi-currency transac-
tions. We have learned so far the underlying technical details of Stellar and compre-
hended its working principles. Now we see how it works with real-world applications.
9.5.1 Anchors
Before we learn some of the applications of Stellar network, it is essential to under-
stand anchors first. Anchors are entities in Stellar that people trust to hold their
deposits and issue credits into the Stellar network for those deposits. Anchors are
Stellar ◾ 149
real financial companies based in different parts of the world. SDF makes the effort
to keep partnering with anchors as the network grows. These anchors act as a bridge
between different currencies and the Stellar network. All money transactions in the
Stellar network, except XLM, occur in the form of a credit issued by anchors. The
role of anchors, therefore, is twofold:
◾◾ They take the deposit and issue the corresponding credit to the client’s
account address on the Stellar ledger.
◾◾ Clients can make withdrawals by bringing credits they issued. The distrib-
uted ledger technology provides with the trust that the anchor will honour
their deposits and withdrawals of credit it has issued.
The concept of an anchor is not new. For example, to use PayPal, users need
to deposit money from their bank account. Following the successful deposit of the
fund, PayPal gives users credits that they can use to buy products. Full or some
of the unused credit users may retreat by filing a withdrawal request to PayPal
that soon becomes real money in users’ bank account. Anchors perform the same
function in Stellar. However, the difference is that all actors (users and participat-
ing companies) including anchors are operating on the same network so that they
can all transact with one another. This ability makes it easy for people to send and
exchange different anchor credits with each other. Table 9.1 lists the anchors that
Stellar currently has a partnership with.
9.5.2 Distributed Exchange
Stellar can be used as a distributed exchange and global marketplace for providing
and accepting offers to buy and sell currencies. An offer on Stellar network can
be viewed as a public commitment to exchange one type of credit for another at a
predetermined rate. The ledger stores the offers that clients make and put it on the
market for someone else to accept if the other party agrees to accept the rate.
Stellar maintains ‘orderbooks’ for all currency–issuer pairs. Offers from clients
go to the relevant orderbooks that others can look up. For example, a client willing
to exchange GBP/Barclays for BTC/Bitstamp must look at that particular order-
book in the ledger to see what people are buying and selling. This enables people
to not only buy and sell currencies in a foreign-exchange-like manner but to also
seamlessly convert currencies during transactions.
9.5.3 Multi-Currency Transactions
The multi-currency transaction is a powerful application of Stellar. The protocol
allows its clients to send any currency they hold to anyone else in a different cur-
rency through the built-in distributed exchange. People can receive any currency
through an anchor they add.
Table 9.1 List of Anchors on the Stellar Network

Name Currency Region
Stronghold Multiple Global
TransferTo Multiple Global
Clic Multiple Global
NaoBTC BTC Global
Euro Change EUR Global
Tempo EUR Europe
Anchor CAD Canada
Novatti AUD Australia
KlickEx Multiple Pacific Region
RippleFox CNY China
Sendx SGD Singapore
Lala World SGD Singapore
Money Match RM Malaysia
Pundi Rp Indonesia
Secure LC XIM Hong Kong
Moin KRW Korea
Coins.ph PHP Philippines
Clock Pesa TZS Tanzania
Celluland NGN Nigeria
Flutter Wave GHS, KSH, NGN Ghana, Kenya, Nigeria
If someone wants to send euros (EUR) using a US dollars (USD) balance to a recipi-
ent, Stellar automatically submits an offer to the distributed exchange to perform the
underlying exchange on behalf of the client. In this operation, what Stellar is good at is
finding the best exchange rate for the transactions so that the client sending money can
enjoy the maximum benefits. Stellar performs such transactions in three possible ways:
1. Conversion through an offer: The straightforward option for Stellar is to find a direct
offer on the internal USD/EUR exchange. If someone is waiting to buy EUR for
USD, Stellar automatically makes the exchange between the two parties.
Bob
USD to AUD
London
Moscow
Paris
Toronto
New York Carol Beijing Tokyo
EUR to USD Dubai

Los Angeles Mumbai
Hong Kong
Singapore
Alice
AUD to EUR
Johannesburg
Rio de Janeiro
Sydney
Figure 9.3 Multi-currency transactions in Stellar.

Stellar ◾ 151
Table 9.2 List of Stellar Partners

Name Type Region
Inter/stellar Technology USA
IBM Technology USA
Deloitte Consultancy UK
SatoshiPay Payment processing Germany
Hijro Supply chain France
Stripe Payment processing Global
Poseidon Trading Global
Bext360 Consultancy Global
SPUR IoT Global
Misfos Software provider Global
MVP Workshop Technology Global
Blockdaemon Technology Global
Factury Consultancy Global
Wipro Consultancy Global
Rehive Consultancy Global
Telindus Financial service Europe
Moni Payment card Europe
Wanxiang Technology China
Yinbi Technology China
Distributed Lab Consultancy Ukraine
Swipe Fintech Latin America
Gramio Technology Africa
Anglo African Consultancy Africa
Oradian Software provider West Africa
NEC Payments Technology Bahrain

Stellar ◾ 153
2. Conversion through compound offers: If a direct offer does not remain available
but a compound offer can be obtained out of multiple offers, Stellar takes the
opportunity and settles the payment. Let us look at a more complex example
in Figure 9.3 showing the Stellar network across global financial hubs. The
figure shows that Alice from Sydney has an offer for EUR in exchange for
Australian dollars (AUD). Meanwhile, Bob from New York places an offer
for AUD but in exchange for USD. So in order to settle this payment, Stellar
utilises the offer from Carol who wants to buy USD in exchange for EUR.
What Stellar does next is:
– First, it sells Alice’s AUD for USD to Bob.
– Second, it sells the USD to Carol for EUR.
– Finally, it settles the EUR payment with Alice.
3. Using XLM as the bridge currency: If a direct or a compound offer cannot be
found, Stellar uses its native cryptocurrency XLM to settle the payments. For
a USD/EUR exchange, it first looks for offers on the network asking for USD
in exchange for XLM. It simultaneously looks for an offer asking for XLM in
exchange for EUR. The network makes those exchanges and completes the
currency transfer request.
9.6 Partners
The success of the Stellar ecosystem depends on the participation of financial insti-
tutions in the network. These institutions are committed to supporting this new
and inclusive global financial infrastructure.
SDF continually seeks to introduce new partners to use Stellar. Its effort saw
many reputed institutions in addition to small and emerging financial firms joining
and using the network. The network includes financial institutions, payment aggre-
gators and technical specialists. Earlier, in Table 9.1, we learned about the partner-
ship of Stellar with anchor companies. Table 9.2 lists some of the notable names
that partnered with Staller and have been using the network for making payments
and currency transactions on behalf of users or their companies.
9.7 Summary
This chapter presented Stellar, one of the leading distributed ledgers in the industry.
The description included introducing its token XLM, the architecture, consensus
mechanism, applications, and a brief introduction to the partnering companies and
entities that have been making this protocol operational. The chapter concludes the
third part of the book and wraps up the discussion of how to utilise blockchain
technology to build alternative and decentralised financial networks.
Part IV
ADVANCED IV
LEDGERS AND
APPLICATIONS
Chapter 10
Purpose-Built
Distributed Ledgers
It has been only a decade since blockchain came into being, but this technology had
evolved promptly from its origins. Distributed ledgers in the present day are very
different than what we saw in Bitcoin. The initial proposal of Nakamoto indicated
his interests in features like public availability, regulation-free and pseudonym-
ity; however, the current trend identifies them unnecessary for many applications.
Nowadays, private networks are becoming popular and industry users do not care
much about the pseudonymity of the transactions. It is rather important to them
that the blockchain ensures trust and enables applications with the traits necessary
for the use-cases. As such, the demand for purpose-built distributed ledgers tailored
to perform specific tasks is skyrocketing. This chapter takes the opportunity to
present some of those platforms that have earned a reputation from both industry
and academia. The chapter also briefly discusses some emerging blockchains that
have the potential to disrupt the industry in the future.
10.1 Purpose-Built Ledgers and Blockchains

Existing public ledgers such as Bitcoin and Ethereum are not fast enough to pro-
vide adequate support to applications that require a response in the fraction of a
second. These platforms also have scalability issues and it is difficult to browse
through their data. There are initiatives to build high-level protocols to work with
Bitcoin or similar blockchains such as Lightning Network that operate on top of
Bitcoin-like distributed ledgers to enable fast transactions between participating
nodes [Poon and Dryja, 2016]. Despite such efforts, seamless communication with
157
the blockchain and scalability remain bottlenecks. Ethereum demonstrates bet-

ter performance than Bitcoin but it still not considered good enough for many
use-cases. Storing data on these blockchains is also a key concern due to the size
and sensitivity of the materials. As blockchain has been becoming mainstream and
industries are willing to adopt this new technology, the demand for purpose-built
platforms is rising amid these problems.
A use-cases–specific distributed ledger opens the door to customising the plat-
form depending on the requirements of the distinct applications at the blockchain
level. It not only improves the performance but also allows introducing extra levels
of security and authentication to the platform. Such an approach also aids in stor-
ing and managing data on the blockchain.
In order to give readers the idea of how these purpose-built blockchains and
distributed ledgers work, the chapter identifies six areas, namely the Internet of
Things (IoT), supply chain, network connectivity, cybersecurity, private network and
blockchain framework, and discusses one platform from each area as shown next:
1. IOTA: A distributed ledger specifically designed to support IoT applications.

Although there are several distributed ledgers available in the market that
supports IoT use-cases, this ledger is chosen due to its unique nature of not
using a blockchain-like data structure, and for a consensus mechanism that is
very different from existing approaches.
2. OriginTrail: The author of its white paper claimed this platform to be the
world’s “first purpose built protocol for supply chains based on blockchain”.
It is also one of the most reputed blockchain platforms proposed for the sup-
ply chain industry. Despite having an even more popular platform support-
ing this area (VeChain), the chapter picks OriginTrail to show how multiple
mainstream blockchains can be utilised to develop purpose-built ledgers.
Its layer-based architecture is also suitable to show the interactions between
application and blockchain.
3. Moeco: This is a one-of-a-kind blockchain platform that enables network con-
nectivity for IoT devices in a unique way. There is no known reputed alterna-
tive for this platform in the market.
4. Naoris: This is perhaps the world’s first cybersecurity initiative to provide a
purpose-built application for this domain. Like Moeco, it is also one of a kind
and there are no reliable alternatives available in the market.
5. HydraChain: This is a blockchain platform used for deploying private net-
works. Created by one of the largest public blockchain projects, Ethereum, to
facilitate a permissioned blockchain, HydraChain is an excellent example of
how a private distributed ledger can be built and managed.
6. Hyperledger: This a framework to develop blockchain platforms. It is unique
in nature and focused solely on the blockchain technology instead of promot-
ing tokens. Hyperledger is an initiative that is considered highly valuable by
the industry as well as the scholarly community.
Purpose-Built Distributed Ledgers ◾ 159
The chapter, in addition to those six distributed ledgers, also briefly discusses some
emerging platforms providing support to use-cases such as medical services, drug
manufacturing and quality assurance.
10.2 Internet of Things: IOTA

IOTA is a distributed ledger designed for the Internet of Things (IoT). It provides
secure communications and payments between IoT devices and will soon have a
smart contract service called Qubic. Unlike using a Hashcash-like proof-of-work,
it uses Tangle, a consensus-building data structure made of a directed acyclic graph
(DAG). Its transactions are fast, free of cost and scalable [Popov, 2018].
10.2.1 Overview
The communication between two IoT devices in IOTA is called machine-
to-machine (M2M) communication. IOTA uses Tangle to solve the double-spend-
ing problem alongside solving both the scalability and transaction fee issues faced
by most distributed ledgers including Bitcoin. By requiring the sender in a transac-
tion to perform an approval of two transactions, IOTA turns its users into miners;
hence the act of making a transaction and verifying transactions are coupled on this
platform. There are no dedicated miners; instead, those making transactions are the
actor affecting the system. Scalability, fast transactions and the ability to validate
an unlimited number of transactions simultaneously make IOTA suitable for the
use-cases working with IoT devices. In the near future, IOTA plans to introduce
Qubic, this platform’s smart contract feature capable of providing general-purpose,
cloud or fog-based permissionless multiprocessing on Tangle.
10.2.2 Technical Details
Tangle is a consensus-building system that, instead of employing a blockchain, uses
an orderly approach of verifying transactions to reach the consensus. Each machine
(network member) in IOTA that submits a new transaction needs to verify two
other transactions on the network before it gets verified. This approach ensures
reaching the consensus out of a web of verifications.
Tangle removes the need for miners on the platform. Each machine willing to
execute a transaction must actively participate in the network consensus by approv-
ing two past transactions. This way each transaction links to the two transactions
it verified, and over time, it will be linked to future transactions that verify it as
shown in Figure 10.1. For each verification, the verifier performs a small “proof
of work” linking the transactions into the overall Tangle. This approach solves
the scalability problem, as the network no longer relies on building blocks for a
blockchain.
An actor
waiting
with a
Two potential
validations transaction
No Fees,
only 2
validations
- 100 IOTA + 100 IOTA
Figure 10.1 Tangle, consensus mechanism of IOTA.
Because every new machine on the network contributes its computing power to
the network at the time of submitting a transaction, the cost of using the network
is as good as the electricity consumed by the machine for verifying the required two
transactions. As Tangle eliminates the need for block mining, the network released
the entire volume of coins immediately after launch. Therefore, the task of verifying
transactions on IOTA has no relation to creating new tokens and the role is limited
to fulfilling the consensus condition only.
Tangle makes the IOTA network even more distributed than a blockchain
network. With blockchain, the network is distributed amongst the miners on the
blockchain, while with Tangle the network is distributed amongst every partici-
pating node. The latest addition in IOTA is Qubic, which is a protocol specify-
ing IOTA’s solution for quorum-based computations, outsourced computations
and smart contracts. This protocol is expected to empower machines operating on

IOTA with the ability to develop and run contracts.
We learned earlier that Bitcoin-like blockchain protocols are vulnerable if some-
one can accumulate 51% of the total computing power on the network. IOTA is
less secure and theoretically more vulnerable than those protocols, as it requires
only 34% or higher than one-third of the network’s computing power to launch
an attack on this platform. However, implementing a 34% attack using Tangle is
complicated, as the attacker still has to discover the next verified transactions of the
network before leveraging the 34% advantage. If the network grows big, the dif-
ficulty increases. Nevertheless, the IOTA network is not still big enough to avoid
such attacks; hence, it uses a coordinator in its initial implementation to combat this
threat and ensure the early Tangles are not compromised. IOTA plans to eliminate
the coordinator once the network becomes strong enough in future.
10.2.3 Applications
The application domain of IOTA is data communication and storage for the
Internet of Things. Most use-cases utilising this blockchain will enable IoT devices
to fetch data from the data sources and store them on this platform. It can be used
to develop applications related to smart cities, supply chains and regular monitor-
ing of use-cases. It is expected that there will be more opportunities with IOTA
in the near future when it implements smart contract functionality Qubic. This
upgrade will open the opportunity to build decentralised applications on the plat-
form. Once activated, developers will be able to host IoT applications like commu-
nications, public transport information hubs and interactive maps on the platform.
10.2.4 Alternatives: IBM Watson and Waltonchain

There are several blockchain platforms available in the market that are alternatives
to IOTA. Amongst them, IBM Watson and Waltonchain are two renowned proj-
ects. IBM Watson is a massive initiative by technology giant IBM to connect IoT
with the blockchain technology. In doing so, IBM has been using the Hyperledger
framework, another project conceived by IBM in collaboration with Linux, to build
the platform. We learn more about Hyperledger later in this chapter.
Waltonchain, on the other hand, was mainly developed to serve the supply chain
industry, but it can be used as a dedicated IoT platform as well. It is named after
Charles Walton, the inventor of RFID* technology and the project aims to advance
his vision for the ubiquitous deployment of RFID technology in the form of IoT.
* Radio frequency identification (RFID) uses electromagnetic fields to identify and track tags
containing electronically stored information attached to objects automatically.
10.3 Supply Chain: OriginTrail

OriginTrail is a decentralised and permissionless blockchain–supported
data-sharing platform for integrating blockchain technology with digital supply
chains. Working along with IoT technology, it enables the supply chain industry
with data immutability and integrity in ensuring the quality of products [Rakic
et al., 2017].
10.3.1 Overview
OriginTrail presents a stacked blockchain platform for vendors and clients involved
in supply chains to exchange data seamlessly in a trusted environment.
It connects sensors and IoT devices to work with a broader ecosystem and allows
developing DApps to read, write, access and verify facts about products and services
throughout their life cycle. The platform implements the Electronic Product Code
Information Service (EPCIS) framework to facilitate the layered, extensible and
modular design across the entire structure. Its ecosystem consists of four layers
(Figure 10.2). The first layer is called the blockchain layer that provides the neces-
sary blockchain technology support, while the second and third layers integrate
data and networking functionalities. The final layer hosts DApps to interact with
blockchain and data via the network layer.
Application
Layer
Network
Layer
Layer
Data
Blockchain
Layer
IOTA Ethereum NEO
Figure 10.2 Layers of the OriginTrail platform.

OriginTrail itself is not a fully functional blockchain, rather operating over existing
blockchains, it seeks to extend capabilities to a great extent. Early implementations
of this platform used to utilise Ethereum only. However, now OriginTrail comes
with support for a wide range of distributed ledgers including NEO and IOTA at
its blockchain layer. This layer is responsible for providing data integrity in supply
chains by incorporating blockchain as a data-sharing platform. It stores informa-
tion on the immutable ledgers in the form of data fingerprints since the arrival of
data throughout its life cycle.
An off-chain decentralised peer-to-peer network known as OriginTrail
Decentralised Network (ODN) implements the data and network layers. The nodes
in ODN are of two types: Data Creators (DC) and Data Holders (DH). DC nodes
are responsible for incorporating supply chain data into the network and replicating
it over a particular number of DH nodes, while DH nodes ensure the immutability
and storage of the corresponding data.
The current version of OriginTrail implements the proof-of-work (PoW)
mechanism that runs above the Ethereum blockchain. The consensus mechanism
involves two key aspects: maintaining accountability and matching and validating
the authenticity of the claims. The chain of accountability on this platform is main-
tained through the approval of each stakeholder by the previous and the follow-
ing supply chain stakeholders. The matching, on the other hand, is performed by
verifying dynamic batch information including batch identifiers, timestamps and
other metadata such as transactional, compliance and sensor data. The information
can also be verified by the auditing and compliance organisations providing their
confirmations.
10.3.3 Applications
OriginTrail is designed to serve the supply chain industry by providing information
about products throughout their life cycle. It can be used to develop applications
giving users information about the place, location or area from where a product
originates; hence ensuring the provenance. The application can also have informa-
tion about the product’s journey from the field or factory to the market and who are
involved in producing this product. Applications ensuring the quality of a product
can also be built using IoT devices measuring temperature and similar data to find
out if the product is still in good condition despite having a long journey from the
field and factory to the market and so on.
10.3.4 Alternatives: VeChain and OpenChain

There are several blockchain platforms available that are developed to support sup-
ply chain use-cases. For example, VeChain is a blockchain platform particularly
designed for the supply chain industry. It enables manufacturers to share product
data with vendors and consumers. It aims to inform both parties who are engaged
in bringing a product to market and who purchase it with necessary information
including the origin. OpenChain is another alternative blockchain to OriginTrail
that seeks to build trust in the supply chain industry by providing a platform that
forces participating companies of all sizes from all sectors to meet the defined
specifications.
10.4 Connectivity: Moeco
Moeco is a blockchain platform envisioned by its creator as the “DNS of things”.
This platform integrates several network standards and offers connectivity to bil-
lions of devices globally through participating gateways. It is particularly built to
suit IoT technology in a cost-efficient way. The goal of the Moeco blockchain system
is to deliver data packages. As a decentralised system, there is no central authority
ensuring the payment against any service provided by the gateway owners; hence
the need for a blockchain transpired. Moeco works as a facilitator between vendors
and gateway owners to establish connectivity for IoT data transmissions and deliv-
ering the payments [Moeco, 2018].
10.4.1 Overview
Moeco uses a crowdsourcing approach to enable existing networks and private
gateway owners in its infrastructure. Anyone having the communication connec-
tivity can become a gateway service provider. For example, someone with a wireless
router at home or a smartphone with the internet connectivity can join as a gate-
way provider and start serving vendors, who are business providers owning sensor
devices, to facilitate their sensor devices looking for connectivity. The permission-
less decentralised architecture makes Moeco convenient for its users, both gateway
owners and vendors. The platform takes care of payment and billing processes and
ensures data delivery. The vendors pay for connectivity, while the gateway owners
receive money for each connection made through their gateway.
The goal of the Moeco blockchain system is to deliver data packages. As a decen-
tralised system, there is no central authority ensuring the payment against any
service provided by the gateway owners; hence the need for a blockchain transpired.
Moeco works as a facilitator between vendors and gateway owners to establish con-
nectivity for IoT data transmissions and delivery of payments. Figure 10.3 shows
the architecture of the platform where vendors look for connectivity in exchange of
a small fee that they pay to the gateway owners. The blockchain is the technology
Bl Exo
Moeco Master Nodes oc nu
kc m
ha
in
Node A Vendor X Node
Transport
Invoice
Billing
Data
Step 1 Node B Step 2
Verification Approval
Gate Pool
Gateway
Step 3
Approved Data
Gateway
Vendor's Server,
Website, Smartphone
App etc.
Vendor X
Figure 10.3 The architecture of the Moeco platform.
that ensures this service in a decentralised way. There is no central authority, rather
the vendors themselves approve each connection and make arrangement for the
payments before sending data to their servers.
This system utilises two blockchains, namely transport blockchain and invoice
blockchain. The data package transportation and payment validation are both
taking place in the Moeco network based on the Exonum blockchain framework,
while the payment is arranged using ERC-20 Moeco tokens in the Ethereum net-
work. Because it is an overlay over Exonum, features of the parent blockchain
including the consensus mechanism get extended to Moeco.
The transport blockchain is responsible for delivering data packages in Moeco.
In doing so, a gateway creates an encrypted transaction that the vendor’s master
nodes validate, decrypt and accepts. Once some transactions get approved, a block
is signed in the transport blockchain by the majority of the master nodes. They
concurrently create a new block in the invoice blockchain that holds records rep-
resenting invoices. The gateway owners generate these invoices to the vendors for
the transport of the transactions that they expedited in the network earlier. If an
invoice has remained unpaid for more than n days (an arbitrary number of days set
by the platform), master nodes remove the specific vendor’s devices from the system
and gateways stop processing data packages for them.
10.4.3 Applications
There are many applications that can be built using this blockchain platform. The
base use-case is to provide gateways for sensors and IoT devices. This will lead to
building applications for ski resort, resource management, smart traffic flow, agri-
cultural, various smart city use-cases and so on. These use-cases do not require a
blockchain to store data but need a free flow of data from the source sensor to their
servers and applications.
10.5 Cybersecurity: Naoris
Naoris, or more formally the “Naoris Security Ecosystem”, is arguably one of the
first attempts to develop a decentralised security system. The distributed ledger
takes the initiative to standardise security-related requirements within the realm of
blockchain technology [Carvalho and Oravcova, 2018].
10.5.1 Overview
Naoris is a distributed cybersecurity platform that is agnostic to a device or operat-
ing system; hence, it works atop networked devices and their operating systems.
It starts operating by uniquely identifying devices using smart proof of existence
(SPoE). SPoE is a technique through which a cryptographically unique fingerprint
of every digital device can be generated and stored into the blockchain that for-
ever identifies those devices. Naoris is designed to run as lightly as possible across
systems as a DApp. Naoris suggests the usage of an environment where critical
domains and businesses will be able to support verifiable and trusted distributed
resilience, integrity and availability.
The goal of Naoris is to ensure cybersecurity decentrally; as such, this system
relies on identity verification through an approach known as Distributed Identity
Validation Authority (DIVA). DIVA works in cooperation with SPoE to establish
unique sources of truth to achieve genuinely attributable behaviour regarding data
sources, devices or other digital assets. Each device can easily be a participant in a
living, breathing ecosystem focusing on maintaining security and integrity of sys-
tems and digital assets across various networks (Figure 10.4).
Naoris’s virtual and hardware-based appliances may act as confederated secure
validator nodes allowing clients to participate in the effort of securing local and far
away environments. This blockchain uses the delegated proof of stake (DPoS) as
its consensus mechanism. The procedure is divided into two steps: first, electing
the block producers and, second, building the blocks. It gives each nominal token
holder the ability to observe and understand what is going on within the system
creating a demand for delegate standing or reputation. If a user does not have excel-
lent standing within the community, he is unlikely to be elected, as token holders
may attempt to elect people that operate in line with the needs of the system.
Within this principle of DPoS consensus, Naoris can build one irreversible block
every second.
Byzantine fault tolerance is introduced to classic DPoS in this blockchain by
allowing most block producers to sign all of the blocks in such a way that no single
block producer would be allowed to sign two blocks with the same timestamp
Transaction 1 Transaction 2 Transaction 3

C
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pa
ny
A
Subsidiary A
C
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pany
om
Com
pa
Application
ny
Router
B
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om
pa
Database Smartphone
ny
Su
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C
idi
ary
B
Laptop Server Cloud Service
Figure 10.4 Architecture of the Naoris blockchain ecosystem.

or the identical block elevation. Once about five manufacturers sign a block, it is
deemed irreversible. Any Byzantine producer intending to subvert the environment
would have to build and sign cryptographic proofs. However, because individual
producers are restricted to signing a limited number of blocks, such an attempt
would reveal the abuse showing repeated signing at identical timestamps or block
heights.
10.5.3 Applications
Naoris is designed to fight against cyberthreats and ensure securities of the cyber-
space of the participating organisations. Its use-cases, therefore, fall within the
cybersecurity regime covering various aspects of threats and retreat. This block-
chain ecosystem accepts inputs in the form of scripts through the API. The manage-
ment of a participating organisation can set up various rules regarding the security
strategy of the environments they want to keep track of for numerous reasons such
as compliance, best practice, patch-levels and so on.
10.6 Private Network: HydraChain

HydraChain is an open-source blockchain platform jointly developed by Brainbot
Technologies and the Ethereum project. It is an extension of the Ethereum plat-
form which adds support for creating permissioned distributed ledgers. It is particu-
larly designed to host private or consortium chains.
10.6.1 Overview
HydraChain, as an extension of the Ethereum blockchain platform, provides an
infrastructure for writing smart contracts which is fully compatible with all API
level and contract level protocols in Ethereum and extends several tools from its par-
ent blockchain to develop DApps. The blockchain bypasses the Ethereum Virtual
Machine (EVM); hence it makes native contract execution faster than Ethereum. It
offers Python as the primary programming language, but native contracts remain
inter-operable with EVM-based contracts written in the Solidity or Serpent lan-
guages and can coexist on the same chain. The benefits of using HydraChain
include significantly reduced development time and better debugging capabilities.
HydraChain provides private networks, and therefore validation is a matter of
concern in this blockchain. There is a registered accountable validator in the net-
work who is responsible for the validation of the blocks and transactions. In a
HydraChain network, all the blocks are not allowed to enter the network without
validation. It means a block will be added to the network only when the validators
sign it. Once a block enters into a network, it becomes persistent, and there will be
no reverts. Figure 10.5 shows the block-building process in HydraChain.
HydraChain has a restriction in creating blocks where new blocks are only
created if there are pending transactions necessary to be processed. It creates new
blocks when putting a transaction on hold does not remain an option. A valida-
tor needs to sign the block before it is allowed to be added to the network. As the
validators are registered, a KYC* is used for the participants to make sure that the
Users
Transaction
phase
Pending
Transaction Check KYC
Transaction
Adding Data Validator

Creates a
to the Signs the
new block
Blockchain Block
Data stays in
the blockchain
forever, immutable
Block
generation
phase
Figure 10.5 Block-building process in HydraChain.
* “Know your customer”, alternatively known as “know your client” or simply KYC, is the
process of a business verifying the identity of its clients and assessing potential risks of illegal
intentions for the business relationship.
transaction takes place between registered participants only. HydraChain provides

the ability to customised blockchain features such as transaction cost, gas limits,
genesis allocation and block time.
The average block time in an Ethereum blockchain is 10 minutes, meaning it
will take 10 minutes for a new block to be added to the blockchain. However, with
HydraChain, this block time is not applicable due to its on-demand block-building
character. So while creating a private blockchain, the administrator can set the
block time according to their need.
10.6.3 Applications
The primary use of HydraChain is to form private networks. It can be used for
developing DApps of any type as long as they stay private. It suits organisations,
companies and entities that plan to deploy DApps for their internal use. If the use
of the blockchain remains limited within a single entity, it acts as a private chain,
whereas if multiple entities share it, the nature of this distributed ledger turns to a
consortium blockchain.
10.7 Framework: Hyperledger
Hyperledger is a collaborative attempt between IBM and Linux Foundation to
build an enterprise-grade, open-source distributed ledger framework. This project
aims to provide an open standard for blockchain so that any enterprise can build
customised solutions [Hyperledger, 2018].
10.7.1 Overview
Hyperledger does not support any cryptocurrency; instead, the initiative solely focuses
on the blockchain technology. It aims to take blockchain to a different level disjointing
its relation as a token facilitator. If we recall the previous blockchain protocols from
Bitcoin to small, customised platforms mentioned earlier in this chapter, they all have
one thing in common, and that is having a native cryptocurrency. Hyperledger steps
out of that requirement and seeks to utilise the potential of blockchain technology only.
Hyperledger is an umbrella project providing a general architecture for any
project developed under this framework. As such, the rule is an individual project
can have its consensus mechanism but must follow the architecture provided by the
framework. The architecture provides the necessary APIs and provisions to fit cus-
tomised features including a consensus algorithm to make the blockchain opera-
tional. As an umbrella, several active projects are running under its hood. Fabric,
Burrow, Sawtooth, Iroha and Indy are amongst the notable projects.
Fabric is the most popular platform from this group. It is a permissioned
blockchain infrastructure with modular architecture which enables configuring
different types of consensus algorithms. It also supports execution of smart contact

(known as Chaincode in Fabric) and membership services provided by a Certificate
Authority managing X.509* certificates, which are used to authenticate the identity
of the members and their roles in the blockchain.
Amongst the other projects, Burrow provides Ethereum Virtual Machine sup-
port in Hyperledger, while Iroha focuses on mobile applications. Sawtooth, con-
ceived by another technology giant, Intel, includes a dynamic consensus enabling
hot swapping consensus algorithms in a running network. The Indy platform sup-
ports independent identities on distributed ledgers and provides the necessary tools,
libraries and reusable components for implementing digital identities rooted on
blockchains or other distributed ledgers.
Projects using Hyperledger can have an individual consensus mechanism but
need to follow the architecture defined by the framework. The architecture of
Hyperledger is arranged in layers:
1.
Consensus layer: Responsible for the agreement of nodes about how to create
and maintain the ordering of the blocks and how to confirm the correctness
of the transactions in the blockchain.
2.
Smart contract layer: Responsible for processing transaction requests and
determining if transactions are valid by executing business logic.
3.
Communication layer: Responsible for peer-to-peer message transport between
the nodes that participate in a shared ledger instance.
There are several components in this framework such as data store abstraction,
crypto abstractions, identity services, policy services and a wide range of APIs.
Amongst these components, the identity services enable the establishment of a root
of trust during setup of a blockchain instance; the enrolment and registration of
identities during network operations; and management of changes like drops, adds
and revocations. It is also responsible for providing authentication and authorisa-
tion features for the blockchain. The policy services ensure the management of
various policies specified in the system, such as the endorsement policy, consensus
policy and group management policy. Although there are a number of ongoing
Hyperledger projects, the following discusses the architecture of Fabric to show an
instance of how this framework can be used to implement a platform.
Hyperledger Fabric contains three nodes, namely the orderer node, the peer
node and the client node. Each type of node is associated with some organisation
* The X.509 is a standard defining the format of public key certificates. These certificates are
used in many Internet protocols, including TLS/SSL. They are also used in offline applica-
tions, like electronic signatures.
and has its certificates and private key. These nodes interact with each other to
maintain the network, while end users communicate with them to get in touch
with the blockchain as shown in Figure 10.6.
The client node acts on behalf of users in creating transactions. The peer node
is responsible for maintaining the ledger and receiving ordered update messages
for committing a new transaction to the ledger. There is a special type of peer
node called “endorser”, which endorses transactions by checking whether they fulfil
c
bri
Fa ents
Cl i
End-user Application Permission

Issuer
Transaction Transaction
(Invoking contracts) (Defining contracts)
Peer Peer Peer
Validating
entities
Peer Peer Peer
The Ledger
Figure 10.6 The architecture of the Hyperledger Fabric.

necessary and sufficient conditions. The orderer node provides a communication

channel to the client and peer that can be used to broadcast transactions.
Being a permissioned blockchain, Hyperledger Fabric can support a consider-
able number of transactions. The number, however, will depend on the use-case and
how it is deployed. For example, developers can use the Max Message Count to con-
trol the maximum number of transactions/messages to permit in a block. Similarly,
they can control the block size with BatchTimeout and BatchSize parameters in the
configuration file based on their use-case. Fabric uses modular architectural design
to support different consensus mechanisms to be plugged in. Currently, Fabric sup-
ports only two consensus mechanisms: SOLO and Kafka. Although Hyperledger
does not provide a token, there are provisions to implement one if need be.
10.7.3 Application
Hyperledger is a framework for creating blockchain platforms. It is possible to use
this framework for building almost anything users wish; hence it is value-agnostic
by nature. However, this distributed ledger is increasingly becoming popular for
building private networks making it suitable for hosting DApps for organisations,
companies and consortiums. IBM Watson, the blockchain platform developed to
support IoT uses-cases, is one of the most notable examples of the implementation
of the Hyperledger framework.
10.8 Emerging Distributed Ledgers

The chapter so far discusses some of the notable purpose-built distributed ledgers
available in the market. The list, however, is not limited to those only, and new
ledgers have been continuously coming. In this section, we learn about emerging
distributed ledgers that have the potential to disrupt the industry in the near future.
10.8.1 Medical Services: MediChain and MediLedger

MediChain is a purpose-built platform for the medical industry. As a medical
blockchain big data platform, it brings dispersed patient data together to improve
diagnosis and treatment for individuals and allows analysing of big data in the
search for new treatments and cures. The objective of MediChain is in twofold:
first, it gives access to medical information coming from different systems and
hospitals. It even allows individuals to view and control their own information.
Second, in addition to acting as a data placeholder, it seeks to help scientists make
important decisions as to how to prevent, treat and cure conditions that currently
remain untreatable. In doing so, MediChain aims to extract clues to medical break-
throughs hidden in the mass of data that exists about patients, treatments and
outcomes [Medichain, 2018].
MediLedger is another blockchain initiative jointly developed by LinkLab and

Chronicled. It works with pharmaceutical companies to make prescription services
easy and hassle-free for patients. The platform aims to unite rival pharmaceutical
manufacturers and wholesale dealers for improved tracking and tracing functional-
ity when it comes to making a prescription for a patient.
10.8.2 Drug Development: BlockPharma

BlockPharma is a French start-up that aims to introduce transparency and account-
ability in the drug manufacturing industry. Drugs are sensitive products that can
cause death to someone if they do not provide what they promise to. As such, this
platform uses blockchain technology to fight counterfeit drugs. It comes with an
app that helps to track the origins of a medication giving patients the liberty to
know where their medicine is produced, who produced and how it reached them.
10.8.3 Quality Assurance: Ambrosus

Ambrosus is a blockchain platform designed focusing on two industries: food and
pharma. It uses a combination of sensors, RFID chips and QR codes to track move-
ment, temperature and tampering. The data is then uploaded to the blockchain for
security and to share data amongst counterparties in a trust-minimised way. This
blockchain is expected to be used for the quality control and assurance of food,
drugs and similar products in the factories, warehouses and customer-facing outlets.
10.8.4 Sharing Economy: Slock.it

Slock.it is a platform developed atop the Ethereum blockchain aiming to establish
a genuinely decentralised sharing economy to enable direct interactions between
producers and consumers of IoT smart objects. The principle of a sharing economy
is to allow people to share their unused or rarely used physical or virtual resources,
such as rooms or flats, cars, electricity or even time, for financial incentives. The
traditional approach requires much human intervention with a big issue of trust
and transparency. The existing applications of a sharing economy such as Uber and
Airbnb are not decentralised. They rely on their monopolistic, centralised provid-
ers who charge a considerable fee, yet security, trust and transparency issues are
prevalent in such applications. Slock.it aims to address these issues by providing a
platform consisting of IoT smart objects, software and blockchain.
10.8.5 Genomic Data Collection: Nebula Genomics

Nebula Genomics is a blockchain platform to manage genomic data. Pharma and
biotech companies spend billions of dollars each year on acquiring genomic infor-
mation for scientists to determine what causes diseases and how to cure them.
However, there is not enough of this information, as it is fragmented and there are
no standards of data acquisition. This blockchain platform aims to get rid of inter-
mediaries, giving people control of their genomic data. It helps to cut the costs and
ensure data security while allowing buyers to easily acquire standardised informa-
tion from both individuals and genomic databases.
10.9 Summary
This chapter presented a wide range of purpose-built distributed ledgers available in
the industry. The goal of this chapter was to introduce readers to application-specific
ledgers and give an idea of how blockchain technology has been evolving. It dis-
cussed areas like the Internet of Things, supply chain, cybersecurity, connectivity,
private networks and blockchain frameworks, and will act as the basis of the next
chapter where the book elaborately discusses use-cases and applications of block-
chain technology.
Chapter 11
Applications of
Blockchain
The blockchain has been the subject of much debate in recent times both in and
outside the scientific community as to what can be and what cannot be done
using this disruptive technology. Interestingly, the world seems to get divided into
two while discussing blockchain. Academics, industry leaders, developers – every
group has opinions on this technology criticising or praising its ability to change
the existing digital infrastructures and practices. Many inspiring words have been
told in favour of this technology, while critics respond brutally to dissect its pos-
sible flaws and give their verdicts against its potentials. As the hype continues to
skyrocket, many of these arguments proved to be impulsive indicating that useful
use-cases can only be developed through systematic analysis of the sectors and
identifying the genuine need for this technology in making those sectors better.
This chapter takes the opportunity to look at the possibilities of how blockchain
can be turned into real applications using educated assumptions. In doing so, it
first classifies the use-cases based on roles, domains and categories, and thereaf-
ter presents detailed accounts of potential use-cases with the mention of existing
blockchains in the market.
11.1 Hype or Hope?
Is blockchain technology hype? Bitcoin was the first application developed using
this technology. This achievement encouraged researchers to move forward and
many new use-cases have been considered, and many if not all became thriving
applications. Bitcoin alone contributed to developing a series of financial services
177
that include cost-effective money transfers, payment processing using Bitcoin and
money exchanges. Once this first wave of applications became stable, develop-
ers looked for use-cases outside the financial industry. It is now anticipated that
many non-profit, government and business use-cases can benefit from the distrib-
uted ledger technology. The presence of a blockchain in a product or service could
drastically change the quality of the outcome where trust plays an important role.
As such, blockchain platforms providing the underlying trust infrastructure are
becoming popular, and industries are becoming more interested in adapting this
technology to build new products or improve their current upshots.
The question, however, remains unanswered. The popularity of blockchain does
not mean it is as good as it sounds. Any powerful application of this technology
capable of changing our lives or society is yet to be seen. The absence of such an
application does not reckon it is worthless either. When it comes to demonstrating
the tangible benefits of the blockchain technology that many expect to change the
world, it is still in its very early days of development, and the initial viable applica-
tions will likely arrive no sooner than half a decade. In fact, blockchain as a tech-
nology has just passed the peak of the Gartner hype cycle and is now progressing
towards the next phase.
The Gartner hype cycle identifies five overlapping stages in a technology’s life
cycle as shown in Figure 11.1 and described next:
1. Technology trigger
2. Peak of inflated expectations
3. Trough of disillusionment
4. Slope of enlightenment
5. Plateau of productivity
Amongst these stages, the second is the most hyped period that unnecessarily affects
the development of a new technology. Blockchain must have travelled through this
when Bitcoin reached its all-time-high price in December 2017. As Bitcoin and
other cryptocurrencies saw a sharp decline in price, most people started to lose
interest, and only those with a genuine intention of using this technology to build
exciting applications remain in the picture; hence it is in the trough of disillusion-
ment. The next period is the slope of enlightenment where we should witness the
potentially groundbreaking applications built around this technology.
Possibly the biggest irony of blockchain is that people find it difficult to put
their trust in the technology that is used to establish trust in the digital medium.
This scepticism arose partly due to the price hike of Bitcoin and its subsequent
fall. Many experts quickly compared blockchain technology with the Dutch Tulip
mania in the 17th century, the Mississippi Bubble in the 18th century, the UK
Canal and Railway mania in the 19th century and the dot-com bubble of 2000.
What seems to be very unfortunate for this technology is that most people could
not imagine blockchain beyond Bitcoin and cryptocurrencies. Even comparing
Applications of Blockchain ◾ 179
Figure 11.1 Gartner hype cycle for emerging technologies (August 2018).
Bitcoin to the dot-com bubble hardly does justice to its potential. There is no deny-
ing that many coins that arrived following the success of Bitcoin are garbage. It
takes time to find out who has got the potential and who are the jokers in the deck,
and this technology never got that time.
During the dot-com bubble, every company with a trailing dot-com in its name
started to receive huge investment. When things went out of proportion, the bubble
burst. The company that was hit hardest by the impact of the burst was Amazon. Its
share valuing $300 in 1998 came down to $6 in 2000. Once the dust settled down,
Amazon started to grow again because it indeed had an excellent use-case with
huge potential. At the time of this writing in 2018, Amazon had become the first
trillion dollar company of the world, with a share price hovering over $1500 USD,
demonstrating a massive growth of 250 times in 18 years, or in other words every
year the stock price of Amazon grew approximately 14 times on average. Amazon is
just a single example of a dot-com bubble survivor, and there are companies includ-
ing IBM, Oracle, eBay, ARM, Adobe, that have been doing well since the burst,
and the world saw the rise of many such tech companies including Google and
Facebook following the burst.
The rationale behind discussing the Gartner hype cycle and comparing the cryp-
tocurrency bull run of 2017 with the dot-com bubble is to show that regardless of its
potential, no matter what, a product or technology takes time to grow. And, block-
chain is no exception. The characteristics of distributed ledgers nowadays are no longer
what we used to see in Bitcoin or Ethereum. The technology has evolved significantly,
and industries have increasingly been seeking purpose-built and application-specific
ledgers. Technology giants such as IBM, Intel, Oracle and Microsoft, and open-
source pioneers such as Linux Foundation and World Wide Web Consortium are
collaborating and building next-generation distributed ledgers for industries. As these
collaborations continue to grow, we start to recognise the real value of this technology
and experience that blockchain is not hype but rather a hope that is full of potential
and capable of restructuring many existing use-cases. This chapter later shows the
potential of this technology and how it can fit into real applications.
11.2 Classification
Even though most initial applications developed over blockchain are financial ser-
vices, the potential of this technology is not limited to that realm. There exist many
proposals in the literature explaining how to use blockchain in building new and
out-of-the-box applications. What seems surprising is that these proposals hardly
saw the light of implementation. It is perhaps due to the lack of a systematic organ-
isation of the use-cases that makes any discussion inconsistent and incoherent.
Therefore, it is necessary that a classification of blockchain use-cases is prepared
before we move further to discuss how this innovative technology can be used in
building real-world applications.
11.2.1 Classifying the Domains

An attempt to organise the likely use of blockchain technology requires an in-depth
analysis of what this technology can bring to a typical use-case and how its inclu-
sion enhances the quality of an application developed using a particular use-case.
In doing so, it appears to be a wise approach to identify the possible technological
overlap and high-level domains first. This can be followed by showing how all or
part of those findings can be incorporated into the use-cases.
To start, we first identify the role of blockchain in a use-case. There are other
cutting-edge technologies around blockchain, and sometimes they overlap. So our
approach will be to identify if blockchain is the leading or sole contributor to the
use-case or plays a supporting role. If the role is in a supporting capacity, we iden-
tify if that role is a joint venture. In doing so, we also identify artificial intelligence
(AI) and the Internet of Things (IoT ) as the key technologies that closely collaborate
with blockchain.
Next, we identify super domains. While playing a standalone role, blockchain
can be used for developing use-cases in citizen services, business and finance, and
marketplaces. In a joint venture, partnering with IoT, blockchain has the potential
to contribute to supply chain use-cases, while with AI, blockchain technology can
improve safety and security use-cases. In a supporting capacity, blockchain has
the ability to contribute to smart city use-cases where both AI and IoT also play a
significant role. So in summary, what we get here is as follows:
◾◾ Roles and domains

– Standalone
• Citizen services
• Business and finance
• Marketplace
– Joint venture with AI or IoT
• AI
◾◾ Safety and security
• IoT
◾◾ Supply chain
– Supporting role with AI and IoT
– Smart City
11.2.2 Classifying the Categories

Having identified the roles and domains, we have constructed the foundation of the
classification. In this section, we pick each domain and identify possible categories for
the use-cases. Figure 11.2 shows how the higher-level domains are broken into lower-
level categories. The figure demonstrates that each domain holds some categories that
we will break down further into use-cases within their realm hereafter in this chapter.
Standalone Joint venture Supporting role
with IoT
Citizen Services and AI
- eGovernance
- Healthcare
- Education
Smart City
Business and Finance
- Smart Transportation
- Financial Services
- Smart Grid
- Smart Property
- Smart Home
- Exchange and Trading
- Citizen Engagement
- Quality Control
Marketplace
- eCommerce
- Online Betting,
Gambling and Gaming
- e-Auctions and Supply Chain
Online Bidding Commertial Supply Chain - with IoT
Food Production -
Drug Manufacturing -
Safety and Security

with AI
Cybersecurity -
Physical Safety, Security -
and Tracking
Figure 11.2 A classification of blockchain domains and categories for potential

use-cases.
11.3 Citizen Services
Citizen services can be defined as the services that a state, its local offices and their
partnering organisations provide to the citizen. This domain can be divided into
three broad categories, namely e-governance, healthcare and education. It is likely
that the applications from these categories will overlap as they all intend to serve
the citizen. We learn more about this while discussing the potential use-cases soon.
11.3.1 e-Governance
The state is a complex centralised system. It is slow to react and continues to resist
change. The development of a country usually depends on the decisions originating
from the core. As such, bureaucracy plays a considerable role, often in a counter-
productive manner, in providing services related to citizen welfare. Decentralised
e-governance has the potential to overcome several hurdles that the state faces being
centralised.
Blockchain technology is competent in solving the problems of security, har-
monisation and settlement of data for the state management system. A distributed
ledger is a novel tool for the enhancement of transparency of the budgetary process
and the reduction of corruption factors. It removes the need for human involve-
ment from many areas, and the system operates within the approved terms of smart
contracts serving as the basis for operations.
Blockchain can play a pivotal role in making government decentralised, trans-
parent, more accountable and active. This technology can be used to develop
services such as generating citizen ID, marriage registration, birth certificate reg-
istration, notary, asset registration, degree validation and so on. There are already
blockchain platforms in practice providing some of these services, including, for
example, Borderless, a blockchain-based civil administration platform. e-Auction,
another blockchain platform, presents necessary assistance to process auctions for
the lease and sale of state property. The Credits platform provides the tools required
to ensure blockchain-based interaction between citizens and the state where opera-
tions can be conducted using smart contracts and native cryptocurrency.
Arguably the most revolutionary application of e-governance could be the
blockchain-based voting system, which does not exist yet. The architecture of the
blockchain is a ready-made solution for such a case because blockchain is immu-
table, and without consensus, even sitting government cannot change the outcome
of an election. The casting of votes may incorporate the use of biometric identifi-
cations such as fingerprints or retina scan, further derived from other blockchain
applications providing citizen ID cards and birth registrations (Figure 11.3).
11.3.2 Healthcare
Quality healthcare service implies ensuring patients’ health management at an
excellent level at all times. This includes both medical well-being and bureaucratic
processes. Unfortunately, in many countries regulations are making the delivery of
quality healthcare even more tedious and lengthy. The primary issue in the health-
care sector is the gap between multiple parties involved in its operation.
Generally, the healthcare system operates like a triangle, where doctors, patients
and providers occupy each of the angles. The role of doctors and medical person-
nel in this situation is solely giving the required treatments, while provider, such
as an insurance company or a government, pays for the care. The patient is the
individual who seeks medical assistance. Because patients’ data and information
remain scattered across different departments in the existing system, coordination
is a big challenge that severely affects the quality of the medical service as well. For
example, booking a pathological test or a surgery often requires the availability of
Figure 11.3 An electronic voting machine sarcastically showing the voting

options for the Sheriff of Nottingham Forest from the Robin Hood folklore. Even
the sitting Sheriff of Nottingham, the main antagonist, cannot change the out-
come of the result should blockchain technology be used in this public voting.
facilities and resources, and identifying the right patients based on their circum-
stances. Despite having computers and mobile phones at every healthcare facility
these days, exchanging the necessary data in a secure, privacy-friendly and seamless
manner to obtain the best possible results is yet to be achieved.
The situation gets even worse when the question for payment arrives, particularly
for services that are covered by private insurances. The dispute between insurance
providers and patients is arguably one of the most common medical complaints in
countries where governments do not pay for healthcare. Patients often complain
about hidden terms and conditions that deprive them of the healthcare cost. It
makes them vulnerable and helpless despite paying the premium on a regular basis.
Blockchain can produce a massive breakthrough in the healthcare ecosystem by
either solving or playing a role in the solutions to the problems mentioned earlier.
It can introduce specific changes in healthcare management that give power back
to the people. Blockchain-based data sharing enables multiple parties to securely
access and use information required to make better decisions and patients will have
control over their data.
Furthermore, insurance powered by smart contracts will remove the need for a
middleman. If a patient truly deserves to get paid, the provider will have no capac-
ity to stop the payment. The smart contract will show the terms and conditions
to the patients before the agreement gets initiated and will execute the payment
request based on what it shows, no matter if there lives a hidden condition some-
where on the paper that the provider carefully kept out of sight of the patient.
There are already many blockchain platforms available in the market that
specifically provide services related to healthcare. Some of these platforms offer
medical data-sharing services while some cover the total care system. MediChain,
TrustedHealth, Doc.AI and CareX are amongst the notable platforms already in use
in the healthcare industry.
11.3.3 Education
The existing education system is mainly scattered where educational institutions
operate standalone. They maintain an old tradition of carrying trust through
badges and certificates. It used to work when there were fewer institutions, and
people recognised the certificate issued by a specific university or school. However,
as time passed by, people started to lose faith in paper certificates due to the avail-
ability of handy technology that can produce fraudulent documents. Instead, it
became a new trend for the bearers of certificates, transcripts and other educational
records to establish the authenticity of their papers. Sometimes they need to send
documents to another school or an employer using official email of the providers,
while some test scores such as the IELTS, GRE, GMAT or TOEFL need to come
directly from the issuers by post. What seems to be the biggest irony in the educa-
tion sector is that even the educational institutions that once proudly developed the
convention of issuing certified documents now do not trust them.
In a world where trust is such a rare asset, blockchain can play an essential role
in developing applications to authorise degree certificates that others can easily
rely upon. Instead of operating individually, if the educational institutions jointly
form a consortium blockchain using Ethereum, NEO or EOS, the practice will
undoubtedly improve. If they start managing their certificates and transcripts on
the blockchain, it would be much simpler and more accessible for students to pro-
vide their credentials to another party without having to go through the issuer
again and again. Although it is yet to see institutions take such initiative, there
exists plenty of proposals of such applications in the literature.
The use of a consortium blockchain as mentioned will not be restricted to issuing
blockchain-based qualifications. The admission process at schools and universities
will have the benefit of accessing data to decide who to offer positions and in which
subjects. The current practice is very inefficient, as in most countries students need
to apply individually for the courses they like to study. As such, they may end up
applying for a degree that they do not qualify while fail to recognise a more suitable
program that matches their credentials. With the help of blockchain, a UCAS*-like
* The UCAS Tariff, formerly called UCAS Points System, is used to allocate points to post-16
qualifications. Universities and colleges may use it when making offers to applicants. A points
total is achieved by converting qualifications such as A levels (and many others) into points,
making it simpler for course providers to compare applicants.
system but more widespread, decentralised and reliable can be developed for major
levels such as undergraduate, masters and doctoral.
Blockchain technology can also be used in education for managing students
registrations, badges, identity cards and other services that involve trust and secu-
rity concerns. Last but not least, fees and funding can also be arranged using this
disruptive technology. Offering automatic bursaries based on results, confirmation
of payment of fees to clear registrations, deciding recipients of scholarships – all
could benefit from smart contracts that would reduce human resource, involve less
hassle and introduce more transparency in the process.
11.4 Business and Financial Services

The blockchain was initially conceived to develop financial applications. As such,
it is no surprise that there will be a good many use-cases covering this domain.
For the convenience of our discussion and to present the use-cases coherently, the
domain is split into three broad categories: financial services, smart property and
trading and exchange.
11.4.1 Financial Services
Traditional financial applications tend to be slow, error-prone and disjoint. This
nature often necessitates intermediaries to intervene in reconciling the process and
resolving disagreements. This practice costs stress, money and time that can be
avoided or at least mitigated using blockchain-based services.
The asset management industry where asset managers and their analyst teams
trade, balance and rebalance assets can benefit from blockchain technology. The
current practice incorporates broker, custodian and the settlement managers to
keep records, creating inefficiencies and room for error. The distributed ledger
simplifies the process and removes the need for unnecessary intermediaries; hence
speeding trading and rebalancing activities.
Insurance, where the processing of claims can be a daunting and endless pro-
cedure, could be another great use-case. Because processors must deal with a
wide range of fraudulent claims, room for error is enormous. Use-cases such as
smart city and the Internet of Things might help in establishing trust between
users and the policy providers as well as building transparent and accountable
management.
Cross-border payments, remittance, interbank money transfers and regular
payment facilities are some other applications already available in some countries.
Many blockchain platforms such as Abra, Align Commerce and Bitspark facilitate
some of these services, while Ripple and Stellar are designed to enable bank and
financial services to use blockchain technology to enhance the quality of their
services.
11.4.2 Smart Property
Smart property is a type of service powered by the smart contract features of block-
chain technology. It has the potential to revolutionise the traditional lending sys-
tem. For example, hard money lenders providing loans and mortgages to customers
with poor credit charge high interest rates to recover potential losses even before the
contract starts. It stresses borrowers and often put them into bankruptcy.
Smart property can help lenders and borrowers settle ownership using smart con-
tracts. Depending on the terms of the agreements, when borrowers pay a part of the
mortgage or the full value, the properties will be transferred to their name. This system
undercuts the risk and reduces the paperwork and bureaucratic process while allowing
strangers to avail loans at a lower rate. In this use-case, home is just an example where
the property can be a piece of land, a car, a factory, a smartphone or laptop and so on.
Ethereum, NEO and EOS can be used to develop applications based on this use-case.
11.4.3 Exchange and Trading

Money exchange and trading platforms are natural fits for blockchain technol-
ogy. These applications are part of the oldest use-case that blockchain addressed in
Bitcoin – transferring funds between parties in a decentralised environment.
The current practice in the money exchange industry is heavily centralised.
A person willing to exchange foreign currency needs to go through a broker who
acts to maximise his or her profits only. It happens because other people who want
to exchange their currency cannot see the whole network; hence they remain oblivi-
ous to potential offers that might make both parties winners. Trading of stocks and
other financial instruments similarly involve middleman in the form of intermedi-
aries, agents or brokers that costs people large fees and gives less decision-making
power when buying or selling assets.
Blockchain technology has the potential to remove the middleman and connect
these people to exchange their funds or assets at a better rate and by paying fewer
fees. There are several high-level protocols including the Lightning Network that use
Bitcoin or similar blockchain to facilitate bidirectional payment channels without
delegating custody of funds. Ripple and Stellar are two notable distributed ledgers
aim to build real-time gross settlement systems for exchanging and trading financial
assets. Hundreds of companies have already been using these services offered by these
two protocols, while many users are individually availing their services for exchang-
ing foreign currencies, assets and other financial instruments through bids and offers.
11.5 Online Marketplace
The online marketplace is an excellent example of how digital technology can
change our day-to-day practices. The products we buy from a real market can now
be purchased in a couple of mouse clicks or smartphone taps from the internet.

Because of the advancement of the supply chain industry (we learn more about this
later), delivery of that product is no longer a problem either; hence, it is no surprise
that the world’s biggest public limited company, Amazon, is an online marketplace.
Involving blockchain in this domain can significantly enhance the quality of ser-
vices. The following discusses how blockchain and marketplaces can work together
by dividing this domain into three broad categories, namely e-commerce; online
betting, gambling and gaming; and e-auctions and online bidding.
11.5.1 e-Commerce
Blockchains are a natural fit for e-commerce, as they are designed for storing trans-
actional data. This data, however, does not have to be financial. It can be any action
needing a permanent record. It may include payment, but can be extended to a
diverse range of operations involving order fulfilment.
Key advantages of using blockchain as the underlying platform for e-commerce
sites include the visibility of the operation, transparency and automated dispute res-
olution. Because each block in the blockchain links to the previous block, it creates
a visible chain of events showing the process of fulfilling past orders. Buyers can
easily identify reliable sellers, while sellers can refuse to process orders depending
on the reputation of the sellers. If a dispute still occurs, it can be resolved through
an escrow account without involving someone from outside.
For example, let’s suppose a customer places an online order on a
blockchain-powered e-commerce site. Each step in the ordering process such as
order placement, payment, fulfilment and shipping each add a new block to the
chain with the time that the action was performed. The seller, however, does not
instantly receive the payment; rather once the buyer confirms receiving the parcel
as ordered, the blockchain releases the payment to the seller; otherwise, the buyer
needs to return the parcel to get a refund.
At the moment, e-commerce sites such as Amazon, eBay and Alibaba offer an
arrangement like this, but it is not reliable and hassle-free and involves the involve-
ment of a third-party to addresses disputes adding extra costs. Blockchain, being
decentralised and immutable, demonstrates the ability to revolutionise this indus-
try by removing the need for a middleman. Contracts in Bitcoin have already
implemented a form of e-commerce although for the wrong reasons for selling
drugs, firearms and other illegal products (Chapter 16 further discusses the crimi-
nal activities of Bitcoin users). It is, however, the intention, not the technology
that is wrong. To get the best out of blockchain, smart contract-based decentral-
ised applications (DApps) will be necessary. NEO and EOS are two platforms that
from the beginning targeted the e-commerce industry and developed architecture
capable of handling thousands of transactions per second on a regular basis. It is
no exaggeration that amongst the many potential applications discussed in this
chapter, this use-case is amongst the most powerful ones.
11.5.2 Online Betting, Gambling and Gaming

The gambling industry itself has been going through a period of transformation for
the last one and half decades, and the arrival of blockchain technology could not be
better timed. As consumers continue to seek new and convenient opportunities to
play, pay and receive rewards, this disruptive technology has a lot to offer.
Many gambling websites have already started accepting Bitcoin and other
major cryptocurrencies as a form of payment alongside regular electronic options.
It not only makes the process convenient but also offers benefits that include allow-
ing users to gamble online anonymously without creating accounts or handing over
documentation, and collect winnings more securely avoiding cash.
More coins like Casinocoin made exclusively for the gambling industry are
expected to show up and offer benefits like lower fees and near-instant deposit
times. Improving the cost-efficiency of financial transfers is a direct cost-saving
for online sites that will enhance their profit margin and make players pay less by
bypassing cash-handling commissions. These benefits of the gambling industry can
be extended to the gaming and betting industry, as they generally have a common
business use-case.
Making payment convenient and anonymous is certainly a significant trans-
formation, but possibly the most prominent change expected to take place in these
industries is blockchain-based infrastructure that users can rely upon. There are
thousands of cases available where online gambling, gaming and betting compa-
nies tricked their users to gain an unfair advantage by depriving users of their
actual winnings. Due to trust playing a massive role in these industries’ online ver-
sion, blockchain can be handy to develop DApps on Ethereum, NEO or EOS that
people can trust. The popularity of such practices may lead to developing stand-
alone blockchain platforms for gambling, gaming and betting industries.
11.5.3 e-Auctions and Online Bidding

Auctions and biddings are modes of securing possessions of goods and services by
offering valid prices and challenging counter-offers with even higher but reason-
able prices. It is a practice that has been in our societies for centuries. Government
contracts given to private companies almost always go through auctions, while pri-
vate possessions are commonly sold to the public through open bidding processes.
The touch of digitisation even made the scope bigger, and now people can bid
from their homes. This paradigm shift helps us observe governmental contracts
going on e-auctions sites managed by public offices, and private properties being
sold online using bidding marketplaces such as eBay, LiveAuctioneers, eBid and
thesaleroom.com.
The general practice for governmental e-auctions is that bidders need to secretly
provide a quote for a service or contract they seek to win followed by their statement of
how they aim to achieve their goals. Amongst the viable bidders, the best quote wins.
There are many government auction portals where companies can bid to win con-
tracts for construction works, telecommunication license, communication routes
and so on. These are expensive contracts where maintaining the confidentiality of
the bid is critical; otherwise, any competitor company having information about
others’ quotes can easily win the bid by placing their price marginally higher than
the original highest bid. If such a thing happens, it is not only unfair for the par-
ticipating companies, but also for the governments or entities, who called for the
auction as they may not get the most appropriate quote from the bidders.
The eBay-like personal bidding sites also have trust issues, as it is a centralised
system and administrators and officials of the platform may have access to the
bidding information. In these systems, someone can set a maximum amount for
auto-bid that remains hidden until someone gradually moves close to it and outbid
the amount by offering counter-bids. A bidding stake smaller than auto-bid will
always be defeated. Knowing the information about this auto-bid can help to win
paying less in an unfair way.
The sensitivity of the information and a possible lack of trust in e-auction and
online bidding sites make blockchain an ideal candidate to solve their problems.
Smart contracts–based DApps can securely get the job done for governmental
e-auction without the presence of a middleman and centralised control. The block-
chain platform EOS is already providing customised support for building such
applications, while Auctionity is a real-time auction platform for selling personal
stuff that can mitigate trust issues for eBay-like platforms (Figure 11.4).
Figure 11.4 A blockchain-based auction website for individuals to buy and sell
goods through live bidding. It is an example of a decentralised bidding platform
where bidding information is secured through blockchain.
11.6 Supply Chain, Production and Provenance

Supply chain management (SCM) is the process of managing the flow of goods and
services. It involves the movement and storage of raw materials, work-in-process
inventory and finished goods from the point of origin to the point of consump-
tion. The goods can be food, medicine or even non-edible products like clothes
[Kozlenkova et al., 2015]. So we can quickly identify three broad categories form-
ing the supply chain domain: commercial supply chain, food production and drug
manufacturing.
11.6.1 Commercial Supply Chain

In the era of the international economy, carrying products and services from pro-
ducers to consumers presents a complex network of events. From electronic devices
to vehicles to food and clothing, most of the commodities we use have moved
through several countries and many providers before they reach us. This web of
transactions may abolish traces of the origin of the products, making consum-
ers unaware of the sources and selling parties of the particulars that brought the
goods from production to the retail marketplace. This lack of transparency could
be dangerous, as it can bring catastrophic outcomes, including mishandling and
fraudulent behaviour. As such, the blockchain-based supply chain could have been
an excellent solution to this problem.
Distributed ledger technology could be used in supply chain management to
reduce fraudulent transactions and optimise supply chain activities. From produc-
tion to guarantees and repairs to recalls, it helps tackle the complex interconnection
of data and puts everything into one database that can be used by all approved par-
ties to retain the accuracy of information at all times. Food safety, drug safety and
production, cold chain monitoring and origin tracking are amongst the most impor-
tant use-cases where blockchain can play an important role. Many b lockchain-based
solutions such as Skuchain, Provenance, Agri-Digital, Walmart, FishCoin and
AnyLedger have been designed to improve efficiency and transparency in this sector.
11.6.2 Food Production
Blockchain technology could play a vital role in reconstructing the food industry
by increasing efficiency, transparency and collaboration throughout the food sys-
tem. The ability to establish trust (or users’ inability to cheat) makes blockchain
an ideal technology to fit the bill for food supply chain and provenance use-cases.
When used with sensors and precision delivery systems connected to a network, as
with the Internet of Things, blockchain can be used to gather a wealth of data and
employ it in the field of tracing origins and managing food systems.
If adopted, consumers could be able to trace the source of their salad ingredients
in seconds. Shippers could see if a lorry is full before scheduling a delivery, while
Figure 11.5 Supermarkets in the United Kingdom often claim their beef is of
British and Irish origin. Using blockchain technology, this can be verified in a few
taps on smartphones.
shoppers could determine the temperature of the food during its journey. Grocery
stores could check if a carton of eggs is cage-free, while the consumer could verify
if the beef of a burger is really of the origin stated on the label. For example, burger
chains and supermarkets in the United Kingdom and Ireland claim that their beef
is of British and Irish origin (Figure 11.5). Using the blockchain technology, users
could verify this claim in seconds.
The Walmart–IBM blockchain has made many headlines in recent time claim-
ing to be the first implementation of such a system using blockchain. Although it
operates only in Walmart and more particularly with the leafy green food supply
chain, its success is likely to translate this initiative into hundreds of other foods
and products in the future. Walmart also insists that the technology will be used
to serve consumers fairly and justly. Because the technology tells the companies of
the origin of the foods, if a consumer gets sick, government investigators will have
a reliable spot to start the investigation. Instead of chasing a paper trail for months,
the authority can get to the source of a particular food within seconds. This practice
ultimately results in strict regulations, fewer sick people and more confidence in
the food system [Splitter, 2018]. OriginTrail, VeChain and Waltonchain are some of
the blockchain platforms that can be used in building applications based on this
use-case.
11.6.3 Drug Manufacturing
The pharmaceutical industry is one of those that must maintain strict quality
control regulations where blockchain can potentially play a vital role. The drug
manufacturing process begins at the research and development division of each
organisation that designs and develops new drugs before sending them for trials
on mice or suitable creatures. During the first 3 to 4 years, this process continues
to run and record the outcomes for the next phases. The second phase of drug test-
ing is commonly known as human trial. At this stage, the medicine must be safe
enough to run the trial on human subjects. How reliable a medicine is at this stage
depends on the research and experiments conducted earlier. It is therefore essential

to keep the records unaltered, and blockchain enters into the business at this point.
Because of its immutable nature, recording every step of the drug development
in blockchain ensures the medicine is adequate for human trial and subsequently
patient trial in the third phase of its life cycle [Khurana, 2018].
In the US, the Food and Drug Administration (FDA) requires a drug to go
through a further 13-month scrutiny period before it endorses it. In other parts of
the world, the practice is similar, if not exactly the same. During that period, the
authority needs to review the past trials, and blockchain data can be a good starting
point. It is not only going to increase the reliability of the data but also introduce
a high degree of transparency and accountability in the process resulting in better
drug development practice. BlockPhrama and Ambrosus are two blockchain plat-
forms that can be used for this use-case.
11.7 Safety and Security

As the physical world meets its digital counterpart, information has been turning out
to be vital assets for many organisations. Keeping this information safe, secure and
authentic is no easy job, and the challenges have been mounting every day. Where there
is business, there will be interactions; hence complete lockdown of the system remains
no longer a solution either. The following discusses how blockchain can be involved in
the mix to develop applications capable of dealing with modern security challenges and
help organisations fight back to prevent cyberattacks and possible security breaches.
11.7.1 Cybersecurity
Cyberspace is a continually changing area that is a highly disputed and one-of-a-
kind environment. It deals with a diverse range of crowds establishing interactions
between them to achieve specific goals. As such, its security involves a consider-
able amount of trust to run the system. It is, however, a fact that trust is a delicate
asset that is difficult to outsource without incurring massive risk; hence cyberspace
remains an open target for attackers who wish to gain unfair advantages by appro-
priating the loopholes of an organisation. As the amount of attacks and expertise
of malicious actors continues to increase, the need for a new paradigm of security
measures becomes paramount.
Within the context of cybersecurity, blockchain has two roles to play. First, we
already know that blockchain is immutable, or in other words, a piece of informa-
tion written in the blockchain remains there forever. This is a powerful feature
that can contribute immensely to the development of security applications. Second,
blockchain is inherently distributed and decentralised. The use of this technology
will result in breaking down the traditional centralised architecture and transform
it into a decentralised system.
A corporate or critical environment would have been an ideal model to benefit

from the blockchain technology. In a setup like this, having a central point of
governance produces the risk of the total collapse of the system, while malicious
actors may use such structure to gain access to data and information stored at a
central location. Decentralisation can play a role here by distributing access and
responsibilities amongst multiple branches but managing them through consen-
sus. Decentralised storage, record-keeping and peer-to-peer sharing would remove
the chance of central failure. Furthermore, identifying the malicious actors and
their intentions through activity tracking would help to proactively defend against
attacks on the system.
In addition to a regular company or organisation, nuclear power stations, elec-
trical infrastructure, power production units, banks and trading exchanges are
few areas that could benefit from the use of blockchain technology. Instead of
outsourcing trust, blockchain operates in a trustless environment that ensures the
exact operation of its affiliates. If anyone tries to bend the rules, it will be quick to
discover the breach and act against such exercises using this technology. Naoris,
BlockStack, MaidSafe and Safecoin are some blockchain platforms that developed
decentralised applications suitable for providing cybersecurity solutions to large
corporations and organisations.
11.7.2 Physical Safety, Security and Tracking

Safeguarding cyberspace is not always enough for many organisations that deal
with sensitive information, materials and services such as government offices, mili-
tary and police barracks, nuclear power plants, power grids, hospitals and labora-
tories. These kinds of organisations need to become proactive to protect their assets
from the outsiders as well as malicious insiders.
It is essential for organisations to ensure the safety of physical assets like paper
files, radioactive materials, firearms, lethal drugs and so on. Blockchain could
enable organisations to manage individuals’ records of activity, and access to physi-
cal assets and infrastructure in an immutable format that nobody can change or
alter, even the person having the highest authority in the organisation. It is also
vital that the movement of sensitive materials or information is also registered in
the blockchain to record their trails.
For instance, in a nuclear power plant, the radioactive materials must be taken
care off in such a way that no one can misuse them. Keeping records in a block-
chain of individuals having access to them as well as tracking information about
the materials themselves as to how and when they changed hands and form helps
identify any malicious behaviour relatively quickly. Sensitive paper files in military
and government offices or lethal drugs in a pharmaceutical laboratory can be of
similar importance where blockchain-based applications can come to the rescue.
Platforms like HydraChain, Hyperledger Fabric and Waltonchain would be suitable
for building these applications.
11.8 Smart City
The concept of a smart city has numerous definitions depending on the context
and meaning of the word smart. Sometimes it refers to being intelligent, while
occasionally it indicates the ability to generate and exchange real-time data. In
general, a smart city incorporates people, technology and data to provide better
services and living experiences for its citizens [Cocchia, 2014]. It is now widely
anticipated that the foundation of future cities will be built atop IoT, AI and block-
chain technologies.
A few years ago, technological giant Cisco envisioned a world where every object
would have connectivity and various degree of sensing ability that it named the
Internet of Things. Although that height has not been achieved yet, some 50 billion
IoT devices could be found communicating by 2020 [Cooney, 2017]. Real-time
data from IoT devices and immutable historical storage on blockchain is jointly
going to create vast opportunities for the researchers and developers who would get
an extra edge to look at the smart city use-cases from a new perspective called data-
to-decision, which ties up sensor data with AI in making real-time decisions [Miller
and Mork, 2013]. Smart Dubai is arguably the first blockchain and IoT-powered
initiative in building a city that ticks almost all boxes of a smart city, and many
other cities including Singapore, Hong Kong and several Chinese cities are ready to
follow suit [Khan et al., 2017].
The following discusses how blockchain platforms, IoT and AI will work
together to obtain decisions for making city life better for its citizens in the near
future. The discussion divides the domain into five categories, namely smart home,
smart transportation, smart grid, citizen engagement and quality control.
11.8.1 Smart Home
A smart home is a residence that incorporates advanced automation systems to
provide the occupants with monitoring and authority over the building’s functions
in the form of controlling lighting, temperature, multimedia, security, window and
door operations, and the washing machine, dishwasher and other appliances.
Smart homes make the use of IoT devices for sensing data and AI to make deci-
sions. Blockchain technology by joining the workforce of IoT–AI can play a central
role in making homes smart. A distributed ledger working as a shared data stor-
age platform can enable multiple devices and appliances to communicate with one
another and provide machine-learning algorithms with the necessary data stream
to compare and make decisions.
There are two subgroups of the smart home use-case, namely smart appliance
and smart security, that could benefit most in the presence of a blockchain. For
example, if the design of a smart home requires the washing machine to switch on
during midday when solar panels provide sufficient energy to run the appliance,
the decision-making module of the smart home looks for solar generation data
to compare with other information such as time of the day and availability of the
machine in the blockchain. A similar example can be imagined where a security
alarm decides to go off in response to a vibration that it identifies as an act of an
intruder. The decision needs to come from analysing a wide range of data that the
blockchain can provide.
11.8.2 Smart Transportation
Managing the transportation system has been a great challenge for many modern
cities. The growing population caused by births and migration from rural areas keeps
increasing the size of city communities and creates demand for more vehicles to be
deployed on the streets, making the smart management of public and private trans-
port inevitable. As such, blockchain-based and IoT-integrated transport system man-
agement certainly provide supports for better commuting and driving experience.
IoT-integrated citizen tracking in a smart city plays a pivotal role in this case.
It will be able to facilitate many applications and services to use machine-learning
algorithms in various areas such as designing timetables for metro trains and public
buses, anticipating commuter demand in different parts of the city, assigning driv-
ers’ shifts, identifying appropriate onboard advertising for public transports and so
on. Instant and pre-booked taxis, on the other hand, could also benefit from the
same data to decide where to be present in the absence of public services. Besides,
all forms of vehicles leave trails of their movement that can be captured using
off- and on-vehicle sensing devices for providing services such as real-time traffic
updates, adjusting the duration of traffic signal lights and suggesting alternative
routes. Monitoring a vehicle’s fitness, road taxes and other regulatory requirements
can also be implemented within this scope.
As IoT plays its part, blockchain can be introduced to share and access data on
the fly in the presence of the data stored in a consortium blockchain shared between
approved parties. Although many of the modern cities already have some of these
tracking and data-sharing facilities in existence, due to the presence of bureaucratic
red tape accessing this data is either difficult or expensive in the contemporary state
of affairs. Blockchain-based solutions make this process simpler, faster and easier
by moving central authority to individual stakeholders and empowering them with
the ability to register, write and access data with ease.
11.8.3 Smart Grid
The blockchain-based smart grid is a conceptual application having the real poten-
tial of changing the way we consume power. It works as if trading energy amongst
our peers rather than purchasing it from the power companies. It would track and
connect a network of electricity generation and usage through solar panels or wind-
mills, giving its customers the option of choosing the greenest energy at an afford-
able rate.
Distribution of energy through peer-to-peer sharing not only allows users to

see the origin of their power but also excessive energy from overproduction can
be fed back into the network eliminating the need for exporting to the grid at a
reduced rate. The demand for renewable energy continues to grow when people
notice, access and choose the sources of their power, making clean energy more
available to consumers.
Solar panels and energy bills are expensive, but when we remove the exploitative
structure of the energy business and the inaccessibility of clean energy, real possible
solutions start to show up. As digital and energy technologies evolve alongside one
another, consumers will have the power to take control of their energy needs.
11.8.4 Citizen Engagement
A smart city looks after its citizens not only by providing services such as transpor-
tation and utilities, it also improves citizens’ lifestyles by engaging them in activities
and recreation. Public parks, libraries, museums, sports, cinemas, shopping centres,
etc. are various forms of citizen engagement commonly found in modern cities.
The availability of real-time and historical data could improve the quality of the
citizen engagement experience and introduce new perspectives. It paves the path for
libraries to suggest books or museums to invite visitors to the collection that might
be of their interest. People visiting parks and gyms may form objective-aimed chal-
lenges between them to enhance their workout experience. Shopping centres, cin-
emas, theatres, spas, etc. could give customers more specific offers tailored to their
interests based on AI-analysed outputs from the data.
Citizen engagement is an ideal use-case for IoT and blockchain to work tightly
in achieving specific goals. The real-time data can be collected using IoT-enabled
sensors installed at public spaces, whilst blockchain provides the backbone of his-
torical information that aids machine learning or similar methods to make recom-
mendations (e.g. books, exhibitions), form groups (e.g. workout challenges), suggest
products (e.g. clothes, movies, foods) and so on.
11.8.5 Quality Control
Ensuring regulatory compliance is the key to healthy living in a city. Foods, medi-
cines, appliances, services – everything needs monitoring for quality-control pur-
poses [Garau, 2018]. Because failure to comply with the recommended standard
could potentially create health and living hazards, it is necessary that smart cities
remain in total control of continuous monitoring to identify breaches as soon as
possible. As such, smart cities can engage IoT and blockchain together to introduce
a higher degree of transparency in quality control in food and hygiene, medical and
pharmaceutical products, appliances, services and so forth.
There are strict food regulations in modern societies concerning preparation, pre-
serving, temperature control, hygiene maintenance and timely disposal of expired
food. As such, each of these activities could benefit from advanced IoT-integrated
sensor devices that are capable of monitoring temperature, humidity, availability of
unwanted foreign substances and so on. With the help of more sophisticated and
advanced technologies, medicine and medical products are now easily monitored.
There are already methods in place using sensors and robots to control the quality
of appliances such as seating chairs in cinemas and auditoriums, escalators in shop-
ping malls and similar locations, theme park equipment, etc.
Last but not least, the quality of services mainly in the absence of humans such
as ATMs and parking ticket machines are also easy to observe these days. However,
despite these technologies already being in existence, due to the lack of connec-
tivity and a seamless flow of data turned the stakeholder off and many exciting
applications remain to be implemented. Blockchain and IoT could be the much-
needed bridge between sensors and historical data for AI-powered applications to
make real-time decisions. Having choices, interests and preferences of citizens in
an immutable blockchain would enable approved parties to offer suggestions or rec-
ommendations when an individual comes across public places and passes through
IoT-integrated sensors.
There are many blockchain platforms already in operation that support various
aspects of IoT. IOTA is a blockchain platform that can hold and share data between
parties. One of the drawbacks of a public ledger is that its response time is not very
fast. In that case, a private network can effectively improve performance. There
are several private networks such as HydraChain and Hyperledger Sawtooth that
can be utilised within an urban community without using a public ledger. Moeco
is another blockchain platform that allows conventional smart devices to act as a
gateway for IoT applications and people on the go can exchange data with the help
of this blockchain.
11.9 Summary
This chapter took the opportunity to look at the possibilities of how blockchain can
be turned into real applications using educated assumptions. In doing so, it first
classified the use-cases based on roles, domains and categories, and then presented
detailed accounts of potential use-cases with the mention of existing blockchains
in the market on many occasions. With this chapter, the core technical discussions
on the blockchain technology of the book come to an end. The remainder of the
book concentrates on the social science aspects of blockchain technology but will
be developed on the foundation of these technical discussions.
Part V
CRYPTOCURRENCY V
Chapter 12
Evolution of Money:
From Barter to Bitcoin
It is a fact that all cryptocurrencies including Bitcoin are network protocols. It

might be difficult to grasp how on Earth a network protocol becomes a currency.
The answer to this question lies in the concept of money. A network protocol
becomes a currency just like a piece of paper becomes US dollar or British pound
sterling. To understand the underlying philosophy of cryptocurrency, knowing
the origin of money, its functions and the evolution of the monetary system
are essential. This chapter provides the basis for this requirement. The discus-
sion presented hereafter is not a comprehensive discourse on the mentioned
topic but will help readers relate the concept of cryptocurrency with regular
money and comprehend how the monetary system works. In addition to briefly
introducing money to readers, the chapter covers topics as early as from the
age of bartering through commodity and representative money to contemporary
money commonly known as fiat currency before introducing digital money and
cryptocurrency.
12.1 Money
Perhaps the most common element that we regularly use in our day-to-day lives
is money. Despite the Bible warning us that “the love of money is the root of all
evil”, it is no exaggeration that in modern societies “money makes the world go
round”. That said, it still seems somewhat deceptive that a piece of paper or a metal-
lic object pays more than what it is worth in the name of money. This scepticism
makes us think that there must have been a missing piece of a jigsaw puzzle hidden
201
somewhere; otherwise, the entire idea makes no sense. In reality, there is indeed one
missing piece, and that is an assurance given to the bearers confirming their ability
to avail anything of the value of the amount written on the paper or inscribed on
the metal in exchange for the object. In our contemporary world, this assurance is
actual money. A government of a country generally grants this assurance on which
people rely. Therefore, money can be defined as follows:
Any item or verifiable record accepted as payment for goods and services
and repayment of debts in a particular country or socio-economic context is
called money [Mishkin, 2007].
12.1.1 Functions of Money
English economist William Stanley Jevons in his 1875 book Money and the
Mechanism of Exchange identified four functions of money [Jevons, 2014]. Modern
economists later agreed upon those functions and authors of macroeconomics text-
books also adapted Jevons’s view. Many modern textbooks list all four functions as
Jevons stated, while some rearrange them into three [Milnes, 1919]. The following
briefly elaborate on these functions.
1. Medium of exchange: Money is a widely accepted token giving its bearer the
right to exchange for goods and services. Because of this function, money
acts as an intermediary instrument and avoids the limitations of barter that
requires one to have precisely matched goods or services with what the other
has to offer.
2. Measure of value: Money can measure the value of an item and provide the
ability to compare things against each other such as goods, services, assets,
liabilities, labour, income and expenses. This function of money is also known
as a unit of account.
3. Standard of deferred payment: Money is a widely accepted method to value a
debt; thereby allowing goods and services to be acquired now and paid for
in the future. This is the function that some textbooks incorporate into the
previous two.
4. Store of value: Money can be saved, retrieved and exchanged at a later time.
More generally, a store of value is anything that retains purchasing power into
the future.
12.1.2 Properties
The previous discussion revealed four functions of money. In order to fulfil these
functions, money needs to have some specific properties that the following attempts
to quickly review.
Evolution of Money ◾ 203
◾◾ Fungibility: It is perhaps the most important property of money. This prop-

erty implies that individual units must be capable of mutual substitution;
hence, it gives money the ability of interchangeability.
◾◾ Durability: This property means that money can be used again and again. It
is the ability to withstand repeated use. Money, regardless of its form, changes
hands and moves from one person or entity to another until the collapse of a
system or is officially terminated.
◾◾ Portability: It means money must be portable from one place and person to
another. This is the ability that allowed money to evolve from its primitive
forms.
◾◾ Divisible: Money needs to be divisible so that it can be broken into small
units. This property gives money the ability to be exchanged precisely.
◾◾ Cognisability: This property implies that the value of money must be easily
identified. When using as a medium of exchange, both parties must quickly
recognise the value without any dispute.
◾◾ Stability of value: The value of money needs to be stable so that bearers can
use it for the various functions. If the value of money remains highly volatile,
it would have been challenging to decide upon a price while purchasing or
selling goods and services.
12.1.3 Money Supply
The money supply is the total value of monetary assets available in an economy at a
specific time. There are several ways to define money, but standard measures usually
include currency in circulation and demand deposits [Brunner, 1987].*
Money supply plays an essential role in regulating and managing an economy.
For example, an increase in the money supply generally lowers interest rates, which
in turn, generates more investment and puts more money in the hands of consum-
ers, thereby stimulating spending. Businesses respond by ordering more raw mate-
rials and increasing production. The increased business activity raises the demand
for labour. The opposite can occur if the money supply falls or when its growth rate
declines.
The money supply within a jurisdiction has relation to prices as well. This rela-
tion between money and prices is historically associated with the quantity theory
of money. There is strong empirical evidence of a direct relation between money-
supply growth and long-term price inflation, at least for rapid increases in the
amount of money in the economy. For example, Zimbabwe that saw extremely
rapid increases in its money supply also saw extremely rapid increases in prices; a
phenomenon commonly known as hyperinflation. This is one of the reasons for the
reliance on a monetary policy as a means of controlling inflation.
* Demand deposits, also known as bank money or scriptural money, are funds held in demand
deposit accounts in commercial banks.
12.1.4 Central Bank
A central bank is an institution that manages the currency, money supply and inter-
est rates of a state as well as oversees the commercial banking system. In contrast
to a commercial bank, a central bank possesses a monopoly on increasing the mon-
etary base in the state and also generally controls the printing and coining of the
national currency, which serves as the state’s legal tender. A central bank also acts
as a lender of last resort to the banking sector during times of financial crisis. Most
central banks also have supervisory and regulatory powers to ensure the solvency of
commercial banks and the prevention of reckless or fraudulent behaviour of those
institutions. Functions of a central bank include:
◾◾ Implementing monetary policies

◾◾ Setting the official interest rate to manage both inflation and the country’s
exchange rate
◾◾ Controlling the nation’s entire money supply
◾◾ Playing the role of the government’s banker and the bankers’ bank, i.e. “the
lender of last resort”
◾◾ Managing the country’s foreign exchange and gold reserves and government
bonds
◾◾ Regulating and supervising the banking industry
12.2 Origin and Early Forms

Money, being an integral part of the human civilisation, has a long history of evo-
lution. Modern money that we encounter daily emerged from some very primitive
forms dating back thousands of years. Early societies traded and financially inter-
acted with one another using various forms of money and money-like systems that
eventually evolved to our present-day money.
12.2.1 Barter: The Origin of Money?

How money came into being is a matter of debate. Economists and anthropologists
have been arguing with each other for ages on this but never reached an agreement.
Economists believe there exists plenty of reason for an age-old system called barter
to be the motivation for the creation of money. Anthropologists, on the other side of
the table, deny this claim and instead blame the 18th century Scottish philosopher
and professor at the University of Glasgow Adam Smith, who is widely regarded as
the father of the modern economic theory, for popularising the barter economy as
the precursor to money, which anthropologists find a fairy tale that never existed.
If we are to accept the story told by the economist, barter was in use as long
ago as one hundred thousand years. According to this system, goods and services
are directly exchanged for other goods and services without the use of a money-like
medium of exchange. In order for an exchange to occur, participating entities must
have the need for what the other possesses. For example, if someone requires rice
and wants to exchange meat, she or he must find a suitable match looking for meat
in exchange for rice.
Although modern economists accept the fact that there remains a lack of evi-
dence for past societies being dependent on barter-like methods, the mention by
Aristotle in Politics stipulates the Greek were aware of bartering long before Adam
Smith discussed it in his book The Wealth of Nations [Plato, 2007]. Smith identi-
fied the inefficiency of bartering as the motivation for the emergence of money.
He argued that markets emerged out of the division of labour, hence individuals
began to develop specialisation. This practice resulted in a growing dependency on
one another for subsistence goods. Although goods were first exchanged by barter,
soon the limitations of this system were exposed and necessitated a replacement by
a more convenient approach [Smith, 1982].
The example of meat and rice was a classic case of barter in the early societ-
ies, but as needs turned intricate, the demand for more complex goods became
inevitable. Let suppose a man having lots of wood in his possession gets sick and
is in need of medicine. He must find an individual with the ability to treat him
with medicine, and most importantly that individual must require wood. To make
their lives more comfortable in the event of such a complicated situation, people in
early societies started stockpiling particular goods, such as salt or metal, that they
thought no one would refuse. Smith found this practice the origin of money and
claimed that because markets pre-existed the state, the creation of money was not
state-tied.
Anthropologists have a different view on the origin of money and refute Smith’s
conclusion. They are confident that money is a creation of governments because
when something resembling a barter-like system occurred in stateless societies, it
was almost always between strangers, not fellow villagers. With this argument,
anthropologists generally conclude that barter cannot be used to explain the origin
of money without the state.
French sociologist Marcel Mauss in his book The Gift strengthened this argu-
ment pointing that earlier economic contracts predating money were not to act in
one’s economic self-interest, instead the transaction was fostered through the pro-
cesses of reciprocity and redistribution, not barter. American anthropologist and
professor at the London School of Economics David Graeber in his book Debt: The
First 5,000 Years suggested that those people whom we know of using barter-like
systems were already familiar with money and such cases are not a lot in num-
ber. British anthropologist and professor at the University of Cambridge Caroline
Humphrey in one of her 1985 academic papers boldly dismissed the concept of a
barter economy stating all available ethnography suggests that there never existed a
concept like barter predating money; hence it points to governments as the creators
of this concept.
12.2.2 Commodity and Representative Money

Economists and anthropologists may not agree about the origin of money; how-
ever, they do accept that the first form of money was commodity money. It is the
type whose value comes from a commodity that it is made of. In addition to having
intrinsic value, commodity money can also have value in its use as money. It was
either for self-convenience or backed by the state; people started stockpiling valu-
able commodities having importance in the various contexts of life. Later these
commodities became mediums of exchange or money.
After the domestication of cattle and the start of cultivation of crops in 9000–
6000 BC, livestock and plant products were used as money followed by the use
of products such as salt, peppercorns, large stones, decorated belts, shells, , cocoa
beans, cowries and barley in a later period. Since the beginning of the Bronze Age
around 3300 BC, precious metals such as gold, silver and copper became popular
forms of money.
The invention of commodity money was a step forward towards the next stage
of civilisation, as it removed the need for finding an appropriate pair while trading.
Nevertheless, the system remained inconvenient because of the difficulties faced
by the bearer of money while transacting, transporting and storing commodity
money. As such, early societies worked out a method that kept the benefits of com-
modity money but introduced a convenient alternative to carry it. This new form
of money is known as representative money. It did not require the bearer to carry
the commodity while trading; rather something more convenient could be used
as a representative of the original commodity kept securely at a designated loca-
tion. Hence, representative money can be defined as a medium of exchange that
represents something of value but has little or no value of its own. In order to be
a genuine form of representative money, there must always be something valuable
supporting the face value represented.
The Mesopotamian civilisation developed a large-scale economy based on com-
modity and representative money. The city-state of Sumer around 2150 BC devel-
oped the shekel, a coin-like currency representing a weight of barley held at the
warehouse. Shekels had a variety of values depending on the era, government and
region, and ultimately represented precious metals, most notably electrum, silver
and gold (Figure 12.1). The use of shekels was so mainstream in the early societ-
ies that their mention can be found in the Hebrew Bible in the Book of Genesis
(chapter 23, verse 15–16):
Listen to me, my lord; the land is worth four hundred shekels of silver,
but what is that between you and me? Bury your dead (15). Abraham
agreed to Ephron’s terms and weighed out for him the price he had
named in the hearing of the Hittites: four hundred shekels of silver,
according to the weight current amongst the merchants. (16)
Figure 12.1 A Carthaginian shekel made of a naturally occurring alloy of gold

and silver commonly known as electrum from 310–290 BC, bearing the image of
Tanit, consort of Ba‘al Hammon, the chief god of Carthage.
12.2.3 Coinage
As the evolution of money continued, early societies that mastered metallurgy used
metal ingots, silver bullion and unmarked bars for exchange. In the Late Bronze
Age, standard-sized ingots as shown in Figure 12.2a and tokens such as knife
money were used as currency to store and transfer value, particularly in China dur-
ing the Zhou dynasty from about 1000 BC. The first manufactured coins appeared
separately in India, China and the cities around the Aegean Sea between 700 and
500 BC. While the Aegean coins were heated and hammered with insignia, the
Indian coins from the Ganges River Valley were punched metal disks, and Chinese
coins were cast bronze with holes in the centre.
Most of the early coins included no writing but had an image of a symbolic
animal. This makes the dating of these coins challenging that relies primarily on
archaeological evidence. Furthermore, early coins were not standardised in weight,
and their earliest usage was of ritual objects such as badges or medals issued by
priests, not as a currency.
The first ruler known to have officially set standards of weight and money was
Pheidon, the King of Argos in the Mediterranean. There remains sufficient evidence
that minting occurred in the late 7th century BC amongst the Greek cities of Asia
Minor, spreading to the Greek islands of the Aegean and the south of Italy by 500
BC. The first known stamped money with the mark of some authority in the form
of a picture or words is credited to an electrum stater of a turtle coin made of 67%
gold and 23% silver, manufactured at Aegina island about 700 BC. The earliest
inscribed coins are those of Phanes, dated to 625–600 BC from Ephesus in Ionia,
with the legend “I am the badge of Phanes” or just bearing the name “of Phanes” as
shown in Figure 12.2b. Some of these coins were found in the foundation deposit
of the Temple of Artemis at Ephesus, the earliest known deposit of electrum coins.
Despite the early developments of coins across Asia Minor, all modern
coins are considered to be descended from a single kingdom of this region,
the Kingdom of Lydia around 600 BC. King Alyattes of Lydia is frequently
Figure 12.2 (a) An oxhide ingot from Crete. Late Bronze Age metal ingots were
given standard shapes, such as the shape of an “ox-hide”, suggesting that they
represented standardised values. (b) The earliest inscribed coinage, an electrum
coin of Phanes from Ephesus, 625–600 BC. (c) Coin of Alyattes of Lydia (620–564
BC). (d) Gold Croeseid, minted by King Croesus circa 561–546 BC.
credited to be the originator of coinage who built a workforce skilled in met-

allurgy and circulated coins made of electrum during his rule as shown in
Figure 12.2c [Ramage, 2000].
Croesus, the son of Alyattes and the new king of Lydia following the death of
his father, introduced the world’s first bimetallic monetary system when he issued
Croeseid, as shown in Figure12.2d, the first true gold coins with a standardised
purity for general circulation [Metcalf, 2016]. Because electrum is a naturally
occurring material that contains 54–63% gold with the remainder silver, the coins
came in a variable mix of gold and silver. This unpredictability of the composition
of the coins significantly hampered development and as a solution to this problem,
pure gold and silver coins were developed. The ancient Greek historian Herodotus
wrote referring to the Lydians during the rule of Alyattes and Croesus:
“So far as we have any knowledge, they were the first people to intro-
duce the use of gold and silver coins and the first who sold goods by
retail” [Metcalf, 2016].
Cyrus the Great, who founded the Achaemenid Empire (the First Persian Empire)
in 550 BC, was unfamiliar to coinage in his realm where people were reliant on bar-
ter and silver bullions. It was only when he invaded Lydia in 546 BC and defeated
Croesus did he come across the Lydian coinage system. He quickly adapted it for
the whole empire, a move that massively helped to rapidly spread the coins in the
6th and 5th centuries BC, leading to the development of Ancient Greek coinage,
Achaemenid coinage, and further to Illyrian coinage. All modern coins are consid-
ered to be the descendants of one of these coinages.
12.2.4 Banknotes
The development of the banknote began in the Tang dynasty in China during the
7th century with local issues of paper currency. Before the use of paper money,
the Chinese used coins that were circular, with a rectangular hole in the middle
enabling several coins to be strung together on a rope. Merchants in China found
that their strings of coins were too heavy to easily carry around. They solved this
problem by leaving the coins with a trustworthy person who gave the merchants
a slip of paper recording how much money they had with that person. Someone
could regain the money by showing this paper to that person. This receipt of deposit
eventually resulted in paper money called jiaozi.
By 960 AD during the rule of the Song dynasty, due to the shortage of cop-
per for striking coins, China issued the first generally circulating notes. A note
is a promise to redeem later for some other object of value, usually spices. These
banknotes, however, were limited to regional zones of the empire due to geographic
limitations and were valid for use only in a designated and temporary limit of
3 years. The geographic limitation changed between the years 1265 and 1274 AD
when the late Southern Song government finally produced a nationwide standard
currency of paper money backed by gold or silver. Kublai Khan, the founder of
the Mongol-led Yuan dynasty, conquered the Song Empire around 1279 AD and
issued paper money known as chao. It was the first paper currency to be used as the
predominant circulating medium in the history of China (Figure 12.3).
There are mentions of the use of various forms of paper-like alternative money in
Europe as early as the 10th century. According to a travelogue of a visit to Prague in
960 AD by Ibrahim ibn Yaqub,* small pieces of cloth were used as a means of trade,
with these cloths having a set exchange rate versus silver. By the next 200 years,
* Ibrahim ibn Yaqub was a 10th century Hispano-Arabic traveller, probably a merchant, who
may have also engaged in diplomacy and espionage.
Figure 12.3 A Song dynasty jiaozi, the world’s earliest paper money (left) and a
Yuan dynasty banknote with Chinese and Mongol words (right).
the Knights Templar* started issuing banknotes to pilgrims around 1150 AD. The
practice was pilgrims needed to deposit their valuables with a local Templar precep-
tory before embarking, when they received a document indicating the value of their
deposit. They could use that document upon arrival in the Holy Land to retrieve
their funds in an amount of treasure of equal value.
Chinese paper money of Mongol became known in Europe through the
accounts of famous travellers, such as Marco Polo and William of Rubruck in
the 13th century. Marco Polo in his book The Travels of Marco Polo dedicated a
whole chapter titled “How the Great Kaan Causeth the Bark of Trees, Made Into
Something Like Paper, to Pass for Money All Over his Country” to the paper
money of the Yuan dynasty. He wrote:
All these pieces of paper are, issued with as much solemnity and author-
ity as if they were of pure gold or silver … with these pieces of paper,
made as I have described, Kublai Khan causes all payments on his own
account to be made; and he makes them to pass current universally over
all his kingdoms and provinces and territories, and whithersoever his
* The Knights Templar was a highly trained, well-equipped and highly motivated elite fighting
force from the 12th century.
power and sovereignty extends … and indeed everybody takes them

readily, for wheresoever a person may go throughout the Great Kaan’s
dominions he shall find these pieces of paper current, and shall be able
to transact all sales and purchases of goods by means of them just as
well as if they were coins of pure gold.
In medieval Italy and Flanders, because of the insecurity and impracticality of trans-
porting large sums of cash over long distances, money traders started using receipt-
like promissory notes to the original depositor. Although sometimes these receipts
are seen as a predecessor to regular banknotes in Europe, they were merely bills of
exchange.
The real need for banknotes became apparent during the mid-17th century due
to the price revolution, when relatively rapid gold inflation was causing a reassess-
ment of how money worked. The goldsmith-bankers of London began to give out
these receipts as payable to the bearer of the document rather than the original
depositor; hence the note could be used as currency based on the security of the
goldsmith, not the account holder of the goldsmith-banker.
This pivotal shift changed the simple promissory note into an agency for the
expansion of the money supply. As these receipts were increasingly used in the
money circulation system, depositors began to ask for multiple receipts to be made
out in smaller, fixed denominations for use as money. The receipt soon became a
written order to pay the amount to whoever had possession of the note that eventu-
ally became the modern banknotes.
The first short-lived attempt at issuing banknotes by a central bank was in 1661
by Stockholms Banco, a predecessor of Sweden’s central bank Sveriges Riksbank.
However, the bank went bankrupt 3 years later after rapidly increasing the artificial
money supply through the large-scale printing of paper money.
The first bank to initiate the permanent issue of banknotes was the Bank of
England, now the central bank of the United Kingdom. Established in 1694 to
raise money for the funding of the war against France, the bank began issuing notes
in 1695 with the promise to pay the bearer the value of the note on demand. They
were initially handwritten to a precise amount and issued on deposit or as a loan.
There was a gradual move towards the issuance of fixed denomination notes, and by
1745, standardised printed notes ranging from £20 to £1,000 were being printed.
Fully printed notes that did not require the name of the payee and the cashier’s
signature first appeared in 1855.
The Scottish economist John Law helped establish banknotes as a formal cur-
rency in France after the wars waged by Louis XIV left the country with a shortage
of precious metals for coinage. In the United States, there were early attempts at
establishing a central bank in 1791 and 1816, but it was only in 1862 that the fed-
eral government of the United States began to print banknotes [Weatherford, 1998;
Davies, 2002; Ferguson, 2008].
12.3 Fiat Money
Fiat money is legal tender whose value is backed by the government that issued it or
parties engaging in exchange agree on its value. The US dollar is fiat money, as are
the British pound, euro and many other major world currencies. The concept of fiat
money is very modern and was conceived less than half a century ago.
12.3.1 Gold Standard
The gold standard is when a country binds the value of its money to the amount of
gold it owns; hence it guarantees that one could redeem its currency for its value in
gold. Anyone holding that country’s paper money could present it to the govern-
ment and receive an agreed upon amount of gold from the country’s gold reserve.
That amount of gold is called “par value”.
The United States, for example, used a gold standard for most of the late 19th
and early 20th century. A person could exchange US currency – as well as many
public and even some private debts – for gold as late as 1971. This period is com-
monly known as the “gold standard era” when US dollar bills used to read
“This certificate is a legal tender in the amount thereof in payment of

all debts and dues public and privates. X dollars in gold coin payable
to the bearer on demand” (Figure 12.4).
12.3.2 US Dollar Standard

Following the two world wars, in 1944 an agreement commonly known as Bretton
Woods agreement established the rules (Bretton Woods system) for commercial
Figure 12.4 Gold standard dollar bill of 1928. The bottom reads “20 dollars in
gold coin payable to the bearer on demand.”
and financial relations amongst the United States, Canada, Western European
countries, Australia and Japan. It replaced the gold standard with the US dollar
standard and made this currency the global currency. The agreement also created
the World Bank and the International Monetary Fund to monitor the new system.
From 1944 to 1971, the Bretton Woods agreement fixed the value of US$35 to
1 troy ounce of gold. Other currencies were pegged to the US dollar at fixed rates.
The US promised to redeem dollars in gold to other central banks. Trade imbal-
ances were corrected by gold reserve exchanges or by loans from the International
Monetary Fund.
12.3.3 Nixon Shock and Creation of Fiat Money

The Bretton Woods system collapsed in what became known as the Nixon Shock, a
series of economic measures undertaken by US President Richard Nixon in 1971,
the most significant of which was the unilateral cancellation of the direct interna-
tional convertibility of the US dollar to gold.
While Nixon’s actions did not formally abolish the existing Bretton Woods
system of international financial exchange, the suspension of one of its key com-
ponents effectively rendered the Bretton Woods system inoperative. Even though
Nixon publicly stated his intention to resume direct convertibility of the dollar after
reforms to the Bretton Woods system, all attempts proved to be unsuccessful by
1973 when the system was replaced by the current regime based on freely floating
exchange rates between the major currencies. This marked the beginning of the
modern fiat currencies that are not backed by any commodity.
12.4 Digital Money
Digital money is a type of currency that is available in digital form in contrast
to physically structured money such as banknotes and coins. It is also frequently
referred to as electronic money. The classification of this type of money is compli-
cated due to the availability of a variety of money or money-like instruments in
digital and other forms. Figure 12.5 shows an attempt to do a taxonomy of money
by Morten Bech and Rodney Garratt [Bech and Garratt, 2017]. Their efforts dem-
onstrate how complex a monetary system can be and how digital money overlaps
with other forms of currencies. Thus, for the convenience of discussion, this chapter
divides digital money into two broad categories: centralised and decentralised.
12.4.1 Centralised Digital Money

This category of digital money is controlled by a centralised entity, usually a central
bank. This controlling entity retains the power to launch, abolish or alter the course of
this money. Most centralised digital monies are generally the digital identity of physical
Con
trol
Central Bank
ss Issued
ce Electronic
Ac
Virtual Peer-
Currency Central to-Peer
Bank
Universally Reserves
Accessible Bank Central Bank
Deposits Issued Local
Central currency
Cryptocurreny
Bank
(wholesale)
Digital
Curreny
Central Bank
Issued Wholesale
Cryptocurreny Crypto
(retail) currency
Crypto
currency
Cash
Commodity
Money
Figure 12.5 A taxonomy of money showing the position of cryptocurrency and

virtual currency within the major categories.
money. For example, someone may make transactions using mobile banking apps or
using banknotes. He or she is effectively using the same money in different forms.
More recently, since the inception of cryptocurrency, countries have been think-
ing of launching state-backed cryptocurrencies. Venezuela launched a cryptocur-
rency, the petro, and Sweden has been developing something similar, the e-krona,
which will be equivalent to its national currency, the krona. It is too early to predict
how these currencies will operate in the crypto-universe, but there is no doubt that
they will be regulated to some extent.
12.4.2 Decentralised Digital Money

This category of digital money stays outside the control of the central bank, a cen-
tralised authority or any influence of a body. The most famous example of such
money is the regular cryptocurrencies operated over a decentralised peer-to-peer
network and run by the principles set out inside the algorithm such as Bitcoin,
Ethereum or Ripple.
There is also another kind of decentralised digital money called virtual cur-
rency, which stays unregulated and outside the jurisdiction of the central bank. The
terms virtual currency and cryptocurrency are often used synonymously, but they
have some differences. For example, the definition of virtual currency implies that
it retains its status within its dedicated community. In that sense, cryptocurrencies
are all virtual currency. However, a condition for money to be called a virtual cur-
rency is the lack of universal accessibility. Cryptocurrencies once had this property,
but due to the establishment of trading exchanges, crypto-ATMs and so on, most
large cryptocurrencies are now easily accessible. Although hundreds of cryptocur-
rencies still cannot be easily accessed, as time passes, it is expected that cryptocur-
rencies will separate themselves from virtual currency and establish a new group by
making them more available to the people.
12.5 Cryptocurrency
Cryptocurrency is perhaps the most advanced stage of the evolution of money since
barter systems. It is digital and decentralised in nature and can act as a medium of
exchange [Chohan, 2017]. A 2018 study identified six conditions that an asset must
fulfil to be called cryptocurrency:
1. The system does not require a central authority; its state is maintained
through distributed consensus.
2. The system keeps an overview of cryptocurrency units and their ownership.
3. The system defines whether new cryptocurrency units can be created. If new
cryptocurrency units can be created, the system defines the circumstances of
their origin and how to determine the ownership of these new units.
4. Ownership of cryptocurrency units can be proved exclusively cryptographically.
5. The system allows transactions to be performed in which ownership of the
cryptographic units is changed. A transaction statement can only be issued by
an entity proving the current ownership of these units.
6. If two different instructions for changing the ownership of the same crypto-
graphic units are simultaneously entered, the system performs at most one of
them [Lansky, 2018].
Hence, a formal definition of cryptocurrency will be as follows:
A cryptocurrency is a digital money system designed to work as a medium

of exchange that uses strong cryptography to secure financial transactions,
control the creation of additional units and verify the transfer of assets
decentrally using distributed ledger technology, typically a blockchain, that
serves as a public financial transaction database.
As of December 2018, the number of cryptocurrencies available over the internet was
over 1600 and the quantity has been growing. Bitcoin is currently the largest crypto-
currency by market capitalisation followed by Ripple and Ethereum. Table 12.1 lists
Table 12.1 List of Notable Cryptocurrencies

Year Name Founder Hash Consensus
2009 Bitcoin Satoshi Nakamoto SHA256 PoW
2011 Namecoin Vincent Durham SHA256 PoW
2011 Litecoin Charlie Lee Scrypt PoW
2012 Peercoin Sunny King SHA256 PoW/PoS
2013 Dogecoin Jackson Palmer, B. Scrypt PoW

Markus
2013 Gridcoin Rob Halford Scrypt PoS
2013 Primecoin Sunny King 1CC/TWN PoW
2013 Ripple Chris Larsen, Jed ECDSA RPCA

McCaleb
2013 Nxt BCNext SHA256 PoS
2014 Auroracoin Baldur Odinsso Scrypt PoW
2014 Dash Evan Duffield, X11 PoW/Service

Kyle Hagan
2014 NEO Da Hongfei, Erik SHA256 dBFT

Zhang
2014 MazaCoin BTC Oyate SHA256 PoW

Initiative
2014 Monero Monero Core CryptoNight PoW

Team
2014 NEM UtopianFuture SHA3-512 PoI
2014 PotCoin Potcoin core dev Scrypt PoS

team
2014 Titcoin Edward Mansfield, SHA256 PoS

R. Allen
2014 Verge Sunerok Scrypt PoW
2014 Stellar Hard fork from ECDSA SCP

Ripple
2014 Vertcoin Bushido Lyra2RE PoW
(Continued )
Table 12.1 (Continued) List of Notable Cryptocurrencies

Year Name Founder Hash Consensus
2015 Ethereum Vitalik Buterin Ethash PoW
2015 Ethereum Hard fork from Ethash PoW

Classic Ethereum
2015 Tether Jan Ludovicus van Omnicore PoW

der Velde
2016 Zcash Zooko Wilcox Equihash PoW
2017 Bitcoin Cash Hard fork from SHA256 PoW

Bitcoin
2017 EOS Dan Larimer SHA256 DPoS
some notable cryptocurrencies along with information such as the founding year,
founders, hashing algorithm and consensus mechanism.
12.6 Summary
This chapter presented a brief discussion on the origin of money, its functions
and the evolution of the monetary system. The principal objective of the chap-
ter was to give readers an understanding of how money works in our society to
relate cryptocurrencies with that practice. It covered topics from the age of barter
through commodity money to modern money, commonly known as fiat currency.
It finally wrapped up with a discussion of various forms of digital money including
cryptocurrency.
Chapter 13
Cryptocurrency Mining
Cryptocurrency mining is the method of verifying transactions and adding the

records to the distributed ledger for various forms of cryptocurrency. The mining
has increased both as a topic and activity as cryptocurrency usage has grown expo-
nentially in the past few years. During the early days of Bitcoin, the use of a regular
computer was sufficient; however, as the mining difficulty starts to grow, miners uti-
lised graphics processing units (GPUs) to make the mining process faster and edge
past competitors followed by using purpose-built machines. Cryptocurrency mining
is no longer an amateurish job, rather it has become a booming industry attracting
huge investment and involving large infrastructures dedicated to one task – finding
a hash value! Chapters 3 and 4 of this book elaborated on mining algorithms and
how the process works. This chapter takes the opportunity to discuss mining basics,
hash rate, required hardware, pooled mining, reward sharing, countries famous for
mining and criticisms against the proof-of-work mining process.
13.1 Mining
Boden is a city more than 900 km north of Stockholm in Sweden. In one of its
airports, a massive aircraft hangar capable of holding a dozen helicopters is now
full of computers. Forty-five thousand of them each with a whirring fan to prevent
the internal machine from overheating. These machines have been tirelessly trying
to solve so-called mathematical puzzles that would earn them 12.5 Bitcoin for each
successful discovery. The venture is not so straightforward though, as they have to
be quick enough to solve it first ahead of tens of thousands of participants around
the world in this strange competition. Boden is just one of the many instances from
around the globe. The competition those computers have been participating in is
known as cryptocurrency mining and the computers are known as miners.
219
13.1.1 Evolution of Mining
Cryptocurrency mining is an ever-changing process that continues to evolve every
few months. The mining landscape we saw in the example of Boden was not any-
thing close to the mining practice a decade ago. It all began with central processing
unit (CPU) mining using regular desktop computers. Soon miners figured out that
graphics cards are even better at hashing; hence GPU mining kicked off.
It was still at a tiny scale, and one could run a very successful Bitcoin mining
operation from his or her bedroom. This practice continued for some time until it
was replaced by field-programmable gate arrays (FPGAs), which are integrated cir-
cuits designed to be configured by the customer or designer after manufacturing. The
days of this hardware did not last long as mining difficulty increased and was soon
replaced by a new generation of mining machines in the form of application-specific
integrated circuits, or ASICs. These are specialised and purpose-built chips designed
for hashing. The actual manufacturers of the equipment quickly realised that they
could get a slice of the pie and so began to build big farms of those specialised min-
ing rigs and some gathered miners around the world through the cloud to mine
together. A few of them even stopped selling their products outside the pool.
The evolution of mining did not stop there. It was not profitable to mine alone
from home in the current landscape. It cost money in the form of electricity consump-
tion and damaged the computer. A concept called pool mining has taken over the job
where miners share their processing power over a network to form a giant computing
platform exclusively for mining and later split the reward between them using a variety
of methods. These pools are so big that without joining one of them, earning anything
from Bitcoin or similar cryptocurrency mining is impossible in the current practice.
Each time a user makes a transaction a cryptocurrency miner is responsible for
ensuring the authenticity of information and updating the blockchain with the
transaction. The mining process itself involves competing with other miners to
solve mathematical puzzles with cryptographic hash functions associated with the
block containing the transaction data. The first miner to find the desired hash gets
the chance to build the block.
Mining is a vital condition for the survival of the blockchain. It prevents mali-
cious participants of the network from altering the blockchain data. Because of this
process, a group of miners operating decentrally in a network can collaborate and
coordinate between themselves in making key decisions such as verifying transac-
tions and building blocks.
In Bitcoin, a block is mined approximately every 10 minutes by solving a math-
ematical problem that is moderately difficult but easy to verify, based on a cryp-
tographic hashing algorithm. The answer to this problem is called the proof of
work (PoW). This proof shows that a miner did spend a significant amount of time
Cryptocurrency Mining ◾ 221
to solve the problem and is not an adversary with an intention to gain improper
benefits from the blockchain. Later altcoins and next-generation platforms such as
Ethereum adapted this approach.
13.1.3 Difficulty
The difficulty is the measure of how difficult it is to find a new block compared to
the easiest it can ever be. The rate is recalculated every 2016th block to a value such
that the previous 2016 blocks would have been generated in exactly one fortnight
(2 weeks) had everyone been mining at this difficulty. This is expected yield, on
average, one block every 10 minutes. As more miners join, the rate of block creation
increases. As the rate of block generation increases, the difficulty rises to compen-
sate, which has a balancing of effect due to reducing the rate of block creation.
13.1.4 Rewards
Mining utilises the concept of incentivisation. Because the miners act as
record-keepers by verifying the transactions, it is only fair if they get something in
return. The mining process establishes the basis for the requirements. Each time a
block is built, the quickest miner who solves the problem first receives a reward in
exchange for its service; most of the time some newly generated native currency,
fees or both. For example, each miner gets 12.5 Bitcoins (BTC) for building a block
in Bitcoin’s blockchain that is created afresh by the protocol. This reward may vary
over time depending on the algorithm of the protocol. Bitcoin is designed to half
the reward following a formula set inside its core. There will be a time when miners
will only get the transaction fees; no reward for mining Bitcoin in future.
13.2 Hash Rate
A hash is the output of a hash function. The ability to generate it fast has a knock-
on effect on the cryptocurrency mining and is considered the single most crucial
element in the mining process.
13.2.1 Understanding Hash Rate

Previously in Chapters 3 and 4, we learned that mining involves finding a hash
value associated with the block a miner builds. Tens of thousands of miners around
the globe attempt to find this hash value. They generate the hash of the block header
and compare it to see if it is the one that matches the criteria set by the protocol. If
not, they increase the “nonce” in the header and generate the hash again. This pro-
cess continues to go on until one miner discovers the hash fulfilling the conditions,
for which he or she receives the reward and has the honour to build the next block.
This process tells us that finding the hash is indicative of the ability to compute
fast; hence it is related to a parameter called hash rate. In plain words, the hash rate
is the speed at which a machine is capable of operating within the context of Bitcoin
or similar cryptocurrency, i.e. generating hashes.
13.2.2 Calculating Hash Rate

The hash rate is calculated in hashes per second (h/s). Depending on the number
of hashes, this unit is accompanied by prefixes such as mega-, giga- and tera-. For
instance, a machine having a speed of 60 h/s will be able to make 60 discoveries
each second while building a block. Kilohash (KH/s) is used for 1000 hashes, mega-
hash (MH/s) for 1000 kilohashes, gigahash (GH/s) for 1000 megahashes, terahash
(TH/s) for 1000 gigahashes, petahash (PH/s) for 1000 terahashes and so on.
It is also notable that the hash rate for a machine is not a constant parameter.
Because of the algorithmic differences leading to a different number of computing
operations in hash functions, the hash rate for a machine varies for different cryp-
tocurrencies. For example, a mining machine for Bitcoin has a different hash rate
than that of Ethereum.
13.2.3 Hash Rate and Profits

The hash rate has a direct relationship with the profits a miner can earn. For exam-
ple, while mining Bitcoin, a miner can earn 12.5 BTC until 23 May 2020. It is the
hash rate that increases the possibility of earning this reward after building each
block. Although the process does not follow a pattern and someone may discover
the desired block by calculating fewer hashes than others, the hash rate remains the
only variable in the mix that can be altered to increase the chances of winning the
next reward. Amongst a certain number of miners, it will be likely that the miner
having the greatest hash rate will win more than others.
13.3 Mining Hardware
Cryptocurrency mining is competitive and requires powerful hardware to com-
pete with other miners in the network. Due to electricity playing a pivotal role
in this process, it is a waste of energy and computer hardware to attempt to mine
Bitcoin-like cryptocurrency if one does not have the appropriate tools to get to the
battlefield of mining.
13.3.1 Non-Specialised Hardware
Non-specialised hardware is those that can be used for general-purpose comput-
ing, at least partially. Regular CPUs such as laptops and desktops; GPUs, or more
commonly graphics cards used generally in gaming computers; and FPGAs used
for designing customised devices through hardware programming are examples of
non-specialised hardware.
This non-specialised hardware is capable of generating a hash rate in the range
of mega- and gigahash for Bitcoin, but is no longer sufficient to compete with the
other Bitcoin and similar cryptocurrency miners given the difficulty level of the
mining. However, these devices are still used in Ethereum mining. If we recall from
Chapter 5, the consensus algorithm of Ethereum is designed to suit regular com-
puters rather than specialised hardware. Due to this constraint, Ethereum mining
still retains some traditional approaches at least device-wise. Nonetheless, mining
hardware companies have been trying hard to figure out how to design specialised
hardware, and some are already in the market. The success of this hardware will
depend on the level of competition they can create. If the performance remains the
same, miners will opt to buy non-specialised hardware instead of those expensive
devices.
Even though some specialised hardware is now considered less or not profitable
in the absence of cheap electricity for mining Bitcoin, profit aside, mining can also
be attempted even using small USB miners. Figure 13.1 shows four generations of
mining hardware used in Bitcoin and similar cryptocurrency mining.
Figure 13.1 Mining hardware (clockwise from top left): CPU, GPU, FPGA and
ASIC.
Table 13.1 Price and Hash Rate Comparison of

the Latest Bitcoin-Mining ASICs (as of January
2019)
Name Hash Rate Company Price
Dragonmint 16T 16.0 TH/s Halong $2729
Antminer S9 14.0 TH/s Bitmain $3000
Antminer R4 8.6 TH/s Bitmain $1000
Antminer S5+ 7.722 TH/s Bitmain $2300
13.3.2 Specialised Hardware (ASICs)

An application-specific integrated circuit (ASIC) is a specialised hardware and an
integrated circuit (IC) customised for a particular application. Examples of such
chips include a digital voice recorder, a handheld computer and special transmis-
sion protocol in addition to high-efficiency cryptocurrency miners. Although
Nakamoto intended for Bitcoin to be mined on desktop computers using CPUs,
Bitcoin miners discovered they could get more hashing power, at first from graphics
cards and then ASICs.
There are many ASIC miners available in the market made by several min-
ing-hardware producing companies (Table 13.1). Amongst them, Dragonmint
16T, Antminer S9 and Antminer R4 are the most powerful and most expen-
sive in the market (as of January 2019). More reasonably priced device includes
Antminer S7 and Antminer S5, although the latter is no longer profitable for
mining Bitcoin.
Three large companies dominate the current mining hardware market. They
are as follows:
◾◾ Halong Mining: The newcomer in the industry producing the best mining
tool available in the market. It produces Dragonmint T16, the most potent
mining hardware currently in use with a hash rate of 16 TH/s.
◾◾ Bitmain Technologies: Based in China, the most dominant ASICs-building
company in the industry. It has been producing the Antminer line for Bitcoin
mining for a long time. The company also operates a mining pool.
◾◾ Bitfury: It is one of the largest producers of Bitcoin mining hardware and
chips. Based in the US, it is also one of the largest Bitcoin pools. Its hardware,
however, is not available for purchase outside the pool as of writing.
13.3.3 Profitability Factors
It is necessary that the profitability factors are carefully analysed before buying
hardware to mine cryptocurrencies. Profitability factors give the potential miners
tentative information on how much they could earn by mining a particular crypto-
currency. The price of the hardware needs to be deducted from the earnings to get
a tentative per-year earning from the mining initiative.
For instance, if the electricity costs $0.03 per kWh and the hash rate of an ASIC is
16 TH/s and costs 1480 watts to achieve that feat, depending on the price of Bitcoin,
we can get an estimation from the Bitcoin Mining Profit Calculator.* As shown in
Figure 13.2, it is going to generate no profit if the price of Bitcoin is $3728 or less.
With our example conditions, to see a positive earning from the mining the price
needs to be at least more than $3729; this still does not give a profit as the miner needs
to subtract the cost of the device from the mining income to figure out the net profit.
13.4 Pooled Mining
Pooled mining has been a popular concept in cryptocurrency mining that helps to
tackle the growing difficulties of the mining process. It is generally organised by
a company that then makes the necessary arrangement to accumulate miners and
distribute rewards amongst them. China is the most popular destination for pooled
mining due to a large number of miners who reside there.
13.4.1 Pooled Mining Basics

Pooled mining is a mining approach where multiple generating clients contribute
to the generation of a block, and then split the block reward according to the con-
tributed processing power. Pooled mining effectively reduces the granularity of the
block-generation reward, spreading it out more evenly over time.
With increasing generation difficulty, mining with lower-performance devices
can take a very long time before block generation, on average. For example, with a
mining speed of 1000 KH/s, at a difficulty of 14484 (which was in effect at the end
of December 2010), the average time to generate a block is almost 2 years.
To provide a more inviting incentive to lower-performance miners, several min-
ing pools, using different approaches, have been created. With a mining pool, a
lot of different people contribute to generating a block, and the reward is then
split amongst them according to their processing contribution. This way, instead of
waiting for years to generate 50 BTC in a block, a smaller miner may get a fraction
* There are several mining calculators available online that can be accessed freely. The calculator
used in this book can be accessed using the following URL: www.buybitcoinworldwide.com/
mining/calculator/.
Figure 13.2 Profit estimation from Bitcoin mining.
of a Bitcoin on a more regular basis. The mining pool awards a share of the obtained
reward to the clients who can present a valid proof of work.
13.4.2 Mining Pools
The concept of pooled mining began in 2010 when Slush Pool launched the first
ever pooled mining initiative by the name “Bitcoin Pooled Mining Server”. The
company is currently owned by Satoshi Labs, a Czech-based tech company. Slush

Pool is the sixth largest pool, as of early 2019, and mined more than 15,000 blocks
in the Bitcoin network with a total hash power of about 7.3%.
In the current cryptocurrency mining landscape, most large pools are from
China with five of them grabbing the top five spots. BTC.com and AntPool are
two Beijing-based Bitcoin pools operated by the world’s largest Bitcoin hardware
manufacturer, Bitmain Technologies. Amongst the pools, they retain the top two
positions interchangeably. During early 2019, together they held more than 30%
hash power.
F2Pool, commonly known as the Discus Fish mining pool in the world of
Bitcoin mining, is the third largest pool in the Bitcoin network with 11.3% hash
power, while BTC.TOP is one of the fastest growing pools launched only in 2017
that holds the fourth spot with a hash power of 7.8%. ViaBTC is a newly launched
mining pool that mines Bitcoin, Litecoin and BitcoinCash. It takes the fifth spot
with about 7.7% hash power, although these latter positions are so close that they
frequently change over time.
Amongst the pools based outside China, Slush Pool (Czech Republic), Eligius
(US) and Bitfury (Georgia) are renowned but very small in size. Figure 13.3 shows
the standing of the pools during early 2019 based on data calculated by Blockchain.
com. The relative hash power of the pools is a rough estimation and for various
reasons will not be 100% accurate. This standing also changes over time as new
Figure 13.3 Standing of the mining pools during early 2019.

hardware hits the market and miners switch pools due to benefits and advantages.
The large portion of “Unknown” blocks are not attacks on the network but rather
indicate that the data provider was unable to determine the origin.
13.4.3 Reward Sharing
The problem with pooled mining is that steps must be taken to prevent cheating by
the clients and the server. Currently, there are several different approaches used. For
example, the slush approach, introduced by the Slush Pool, follows a score-based
method. Older shares, from the beginning of the round, have a lower weight than
more recent shares, which reduces the motivation to cheat by switching between
pools within a round.
The pay-per-share (PPS) approach offers an instant even payout for each share
that is solved. The payout is offered from the pool’s existing balance and can
be withdrawn immediately without having to wait for a block to be solved or
confirmed. The possibility of cheating the miners by the pool operator and by
timing attacks is thus eliminated. This method results in the least possible vari-
ance for miners while transferring all risk to the pool operator. The resulting
possibility of loss for the server is compensated by setting a payout lower than
the full expected value.
The full pay-per-share (FPPS) is another approach introduced by the BTC.com
team that aims to benefit miners from the high transaction fee. It calculates a stan-
dard transaction fee within a specified period and adds it into the block rewards
followed by the distribution of the total to miners according to PPS mode. This
method keeps the advantages of PPS and pays more to miners by sharing the trans-
action fees.
13.5 Mining Nations
China retains the title of the undisputed leader when it comes to cryptocur-
rency mining, notably Bitcoin. There are no other nations in the world that could
even come close to what China is capable of producing every year. A study from
Princeton University found that the country holds the mining hash power of over
70% of the total available in the network [Kaiser et al., 2018]. Most of the remain-
ing power is then shared by countries such as Iceland, Georgia, Russia, Estonia,
Canada, Venezuela and the United States [Lielacher, 2018].
The cheap and government-subsidised electricity in China makes the country
a mining paradise. The profitability factor of mining cryptocurrency in China is
unparalleled to any other country in the world; hence people find it more reward-
ing than doing other business. This practice led to establishing many large mining
pools in the country that further boosted the industry. The Chinese government,
however, is not very comfortable with this practice due to misuse of subsidised
electricity, and the crackdown on mining rigs in late 2017 was considered an action
motivated by this concern.
There is no denying that two small countries, Iceland and Georgia, are the
surprise entries in this list of mining nations. This is due to their geographical loca-
tion and weather. Russia, Canada and Northern parts of the Scandinavia are also
popular destinations for mining cryptocurrency for the same reason. It is because
of the availability of the cold weather in those regions that helps cool down the
mining rigs. It is just not the device that consumes the energy; cooling equipment
also consumes a significant portion that those regions close to the North Pole can
save. Mining sites, particularly in Iceland (Figure 13.4), also have the opportunity
to produce less pollution than the coal-burning sites located in China, for they
have access to geothermal and hydroelectric power plants, both cheaper and more
environmentally friendly alternatives to coal. These advantages have led to mining
companies relocating there from all around the globe. To put it in context, it was
reported that Iceland was set to consume more electricity by the mining companies
than households in the country in 2018 [Zuckerman, 2018].
13.6 Criticism of PoW Mining

The PoW-based cryptocurrency mining that consumes enormous energy has been
the subject of severe criticism from renewable energy experts since the early days of
Bitcoin. Although PoW is central to the security of the blockchain, it is often seen as
a colossal waste of electricity by the people outside the community [NewScientist,
2017; Coppola, 2018].
Figure 13.4 A mining farm operated by Genesis Mining in Iceland.

Experts have been trying to put the consumption in context by comparing

with known instances. In 2017, The Guardian reported that the yearly energy
consumption of Ireland is less than what the Bitcoin network consumed and pro-
duces the same annual carbon emissions as one million transatlantic flights [Hern,
2017, 2018]. Despite those comparisons, how big this waste is remains compli-
cated to express on a scale that can compare it with potentially anything. Such a
scale became available when a study published in Nature put Bitcoin mining in the
same context of precious metal mining. The study found that the amount of energy
required to mine one dollar’s worth of Bitcoin is more than twice that required to
mine the same value of copper, gold or platinum [Krause and Tolaymat, 2018].
Figure 13.5 shows the energy consumption for mining cryptocurrencies compared
to precious metals on the dollar scale.
China, being the most famous mining destination for Bitcoin, put more criti-
cism in this mix. Chinese miners often use cheap coals to mine cryptocurrency,
which severely damages the environment. Because the whole mining process is
unregulated, there is no authority to ensure the cleanliness of the energy or enforce
mining rigs to use renewable energy for these purposes.
Nevertheless, the landscape has been changing in recent times as a trend can be
observed where mining companies are willingly using renewable energy, perhaps to
reduce the cost [Kim, 2018b]. This move came amid the cracking down of mining
rigs in China by the government, which encouraged many Chinese mining pools
to move their operations to Europe. This geographical relocation was met with a
piece of good news in the form of Bitcoin’s difficulty which was set to decrease,
not increase, for the first time since December 2011. Many new cryptocurrencies,
meanwhile, avoided PoW and adopted a more energy-efficient way to establish
consensus in the network, while Ethereum, one of the largest industries for PoW
Figure 13.5 Energy consumption for mining cryptocurrencies compared to pre-

cious metals.
mining, already has been in the process of moving to an alternative consensus

mechanism with proof of stake.
13.7 Summary
This chapter presented the cryptocurrency mining from the industry and opera-
tional perspective rather than discussing algorithms. It briefly presented some
important key concepts such as mining difficulty, incentivisation, hash rate and
its relation with the choice of hardware. The chapter then went on to present the
required hardware, pooled mining approach, reward-sharing methods, mining
pools and their hash power, popular destinations for mining and criticisms of this
process due to excessive energy consumption that is often viewed as a misuse.
Chapter 14
Cryptocurrency Wallet
The concept of the cryptocurrency wallet is misleading as it never holds the token.
We already learned that Bitcoin and similar cryptocurrencies have no virtual existence;
hence they do not reside on the blockchain or our computers. The blockchain stores
only the transactions, while our computers may have the client software to interact with
the blockchain. The ownership of the tokens is determined based on the transactions
triggered by the private–public key pair. Therefore, a place to keep these key pairs can
be the closest analogy for a real wallet. This chapter takes the opportunity to discuss
various types of cryptocurrency wallets from the personal wallet to cold storage used by
exchanges. The key objectives of this chapter are to establish the importance of wallets
within the context of cryptocurrency and show why their safeguarding is necessary. The
chapter also helps users understand how to pick a suitable wallet for their tokens.
14.1 Wallet
A wallet is a place to store the required public and private key pairs that give access
to cryptocurrency. Because transactions between two or more bearers determine
the owners, the public key acts as the medium of receiving tokens, while the private
key gives the right to spend those tokens by granting access. It is, therefore, no
exaggeration to say that the keys are the actual representative of the tokens, and
losing the keys, particularly the private key, means losing the tokens.
A wallet can be of different types: software, hardware, physical or even a brain
wallet. The type of wallets might also differ depending on their actions such as a
multi-signature wallet, a receive-only wallet, a cold-storage wallet and so forth.
Wallets have been subject to various attacks since the inception of cryptocurrency
and users need to safeguard their tokens by increasing the securities of their wal-
lets. This involves encrypting keys or storing them using multiple private keys.
233
Some users keep their keys offline, while some go as far as memorising their keys
removing any form of physical or digital existence.
A wallet closely works with a piece of software that allows spending the funds.
Sometimes this software itself acts as the wallet by storing the keys, yet seldom does
its role remains limited to giving access to the blockchain. In any case, this software
lets users spend the funds, interact with the blockchain and request payments. This
software may reside on the user’s computer or can be a web application.
The public–private key pair plays a pivotal role in sending and receiving funds.
Reviewing the structures of the keys and the transaction process is essential to
understand the importance of wallets and their safeguarding.
14.1.1 Private Key and Address

In Bitcoin and similar cryptocurrencies, the address represents the hash of the pub-
lic key, while the private key is a 256-bit number. The following shows a Bitcoin and
an Ethereum address and their corresponding private key. Please note that these
are sample addresses and private key pairs. Readers must not send tokens to these
addresses as they may lose their money.
Bitcoin address and private keys:

19BEJfwj7Ej5s6uy3uiKGvRuygjrujNRhG
L1FGnCmpU9kGVHAK nU5TunkeiB7exsUdWjBKwn3cH3HsqsuUWLmS
Ethereum address and private keys:
0xC2D7CF95645D33006175B78989035C7c9061d3F9
3a1076bf45ab87712ad64ccb3b10217737f7faacbf2872e88fdd9a537d8fe266
14.1.2 Transferring Funds
The transfer of funds is achieved using the key pair. Let us retrace a bit. We learned
in Chapter 4 that Bitcoin’s address is a hash representation of a public key. It is
called “representation” because it does not contain the key, but rather its hash value
in a particular format with other metadata. Notable cryptocurrencies including
Ethereum and Ripple also follow this convention.
This address is the key to receive funds. For example, Alice requested Bob to
send her a payment using this address. Bob in response will transfer the funds to
this address by inserting it into the transaction request. Once miners verify the
transaction and include it in a block, the fund gets locked and only the private key
of the associated address can redeem it.
Alice must have the private key in her wallet that she will use to access the
transferred fund. She uses her private key to generate a digital signature where her
public key acts as the message. It accompanies a hash of the message encrypted by
the private key. Alice sends this message as an instruction to redeem the funds.
Cryptocurrency Wallet ◾ 235
The protocol then verifies the signature. A valid signature designates the public key
to be the counterpart of a private key that possibly qualifies to redeem the fund.
It is, however, not readily made available to Alice. She must pass through one last
drill. The hash of this public key is then compared with the hash of the address. If
that matches, the protocol unlocks the funds for Alice to redeem in a new transac-
tion. This example explains the importance of keeping the keys secure. It is illus-
trated in Figure 14.1 describing the steps of transferring and accessing funds.
14.2 Types of Wallets
There is no hard and fast rule for a wallet. It is just a storing place for the keys.
People can be innovative in making their wallets as long as they securely store the
keys. However, they must bring in the keys to a software wallet connected to the
Private Key
Public Key 1 Hash
5 Address
3
6
Figure 14.1 A typical fund transfer of major cryptocurrencies.

internet to interact with the blockchain and spend the funds. These kinds of wallets
are called hot wallets, while the wallets that remain offline are called cold wallets.
The following discusses some ordinary wallets that can be found in regular use.
14.2.1 Web Wallet
A web wallet is an online account with an external provider where users deposit
their keys to interact with the blockchain to access their funds. Web wallets are
also known as hosted wallets or cloud wallets. Using a web wallet requires granting
the host to manage the funds on behalf of their users. Giving the responsibility of
the private keys means conferring them with access to the funds; hence any secu-
rity breach on their server would immensely affect users. It is therefore essential to
choose the right web wallet provider that the users can trust.
One way to pick a reputed wallet provider is to examine their approval from the local
financial regulatory body. Such approval binds providers with a code of conduct that they
must practice to uphold this status. These codes of conduct generally include maintaining
high cybersecurity measures, insurance against the deposited funds and regular inspec-
tions. Table 14.1 presents the names of financial regulatory bodies of some countries and
territories that are renowned for their strict regulatory practice, and having recognition
from one or more of these bodies would indicate the provider is somewhat reliable.
Web wallets are like online banks. They require users to create one or more
forms of authentication to access their funds. It is a good practice to use two-factor
authentication for accessing web wallets, as this reduces the risk of suffering hack-
ing attacks and losing control over the account. Many web wallets connect users’
mobile phones with the account to send code using SMS that requires inserting
at the time of providing the password. Other forms of two-factor authentication
include sending emails and approval from the mobile app.
There are some benefits of using web wallets. Of course, the principal advantage
is that the keys are the responsibility of the host and in events of security threats,
insurance covers the loss. However, many of the providers are also exchanges that
can give low transactions fees, better exchange rates, and fee-free portfolios to man-
age and invest in cryptocurrencies.
Some providers store only the public keys on their servers, while users store the
private keys on their computers or in offline wallets. In this setup, usually called a
hybrid web wallet, users need to import their private keys temporarily to the server
to spend funds. It helps users to mitigate the trust and take responsibility for their
keys while using a web wallet.
14.2.2 Software Wallet
A software wallet, as the name suggests, is a desktop or smartphone application
to store the public–private key pairs on the local computer. Sometimes the block-
chain itself may provide the wallet. For instance, the Ethereum blockchain provides
Table 14.1 Major Financial Regulatory Bodies

Country Authority Abbreviation
United Kingdom The Financial Conduct Authority FCA
United States Securities and Exchange Commission SEC
Australia Australian Securities and Investments ASIC

Commission
Canada Investment Industry Regulatory IIROC

Organization of Canada
Ireland Central Bank of Ireland CBI
Germany Federal Financial Supervisory Authority BaFin
France Autorite des marches financiers AFM
Denmark Financial Supervision Authority DFSA
Austria Financial Market Authority FMA
Belgium Financial Services and Markets Authority FSMA
Netherlands Financial Markets Authority AFM
Luxembourg Commission de Surveillance du Secteur CSSF

Financier
Switzerland Financial Market Supervisory Authority FINMA
Singapore Monetary Authority of Singapore MAS
Hong Kong The Financial Commission FinCom
UAE Dubai Financial Services Authority DFSA
Cayman Islands Cayman Islands Monetary Authority CIMA
Cyprus Cyprus Securities and Exchange CySEC

Commission
Mint, a wallet application that acts as client software for Ethereum accounts and
resides on the users’ computers. Bitcoin Core, the client software for Bitcoin, also
has a wallet. Web wallet providers may also allow users to install software wallets
at their computers. Such software may store the private keys, while the web server
contains corresponding public keys and only imports private keys at the time of
spending funds.
Software wallets are subject to many security perils. These wallets usually
have internet connectivity, allowing adversaries to launch attacks from the
outside. Even if the attackers fail to seize the keys, damage to the hard drive or
losing the software database means users can no longer access the funds unless
they have the keys stored somewhere else. Unlike web wallets, these are not
protected by insurance and copies of the keys are not stored safely at multiple
locations on the server.
Software wallets, however, can be handy if managed carefully. Keeping a
backup in the form of a paper wallet (we learn about this soon) at a secure place
removes the risk of losing the keys in the event of physical damage to the computer,
while encrypting the keys using a robust algorithm can safeguard them from the
hacking attacks. One of the principal benefits of this type of wallet is the ability
to generate keys at the local machine with ease. It also assists in managing funds
locally without disclosing the keys to a third party.
14.2.3 External Storage Media

Both web wallets and software wallets are forms of hot wallets that remain con-
nected with the internet. Despite taking precautionary measures, these wallets
endure potential threats from outside attackers. One way to remove such a threat
is to use cold wallets that do not have internet connectivity. There are several cold
wallets available in practice, and external storage media is one of them.
The external storage media wallet utilises storage like USB flash drives or
optical drives. These storage media safely store private keys in a place that is
not reachable by hackers. It is still advisable to encrypt the keys on the storage
media to protect them from offline attacks like attempts to copy the keys from
the device.
The weak link of such a wallet is the moment of importing the keys to the
software or web wallet intending to spend some of the funds. To mitigate this risk,
the best practice is not to accumulate a large amount of funds under a single key;
instead, manage them separately so that later individual keys can be imported to
spend the linked funds. It alleviates the risk of losing all funds at once in the event
of an attack.
14.2.4 Paper Wallet
A paper wallet is a piece of paper where private keys are stored in printed form. It is
then kept in a safe place to prevent physical theft. A paper wallet is one of the safest
ways to deposit keys, as it not only curtails the likelihood of potential online attacks
but also eliminates the digital existence of the keys.
To distinguish the key pairs, generally, public keys are printed alongside their
corresponding private keys. Because public and private keys are long hexadecimal
numbers in the printed form, the software creating the paper wallet also generates
a QR code for the convenience of reading the number from the wallet. Figure 14.2
shows a sample paper wallet generated using www.bitaddress.org.
Figure 14.2 A typical paper wallet.
As the external storage media, keys on a paper wallet need transferring to a

software or web wallet before users can spend the funds. This process of importing
keys is a point of vulnerability that users must take care of. Storing the wallet in
a secure physical location is also of utmost necessity, otherwise the whole point of
using a paper wallet becomes worthless.
14.2.5 Hardware Wallet
A hardware wallet is a device that stores private keys and associated transactions.
These wallets offer arguably the safest possible digital option that users may avail.
Unlike an external storage medium, the private keys of a hardware wallet never
leave the device. The device of a hardware wallet is specially designed to communi-
cate with the client software of the blockchain and spends the funds by generating
the digital signature locally within the wallet; hence the hardware wallet remains
protected from attacks launched at web or software wallets.
Hardware wallets often come in the shape of flash drives with a screen to display
the transactions. These wallets utilise the USB port of computers to connect with
the client. Users can observe the transactions the wallet executes on the screen and
some sophisticated wallets may also provide extra buttons to grant further permis-
sion to proceed or abort. It is a common requirement for a hardware wallet to enter
a PIN before accessing the data. Figure 14.3 shows a hardware wallet interacting
with the Bitcoin blockchain to spend some funds.
Trezor and Ledger are the two most popular hardware wallets available in the
market. Because of the sensitivity of the data that these wallets intend to store,
manufacturers put in every effort to make them secure in every possible way. These
wallets come in a secured box having a safety seal on it confirming that the product
has not been tampered with. Inside, the device comes with a USB cable to connect
with computers, several recovery seed cards and full instructions for users as to how
to use the device to store and use private keys associated with cryptocurrencies. As
of December 2018, they cost just below $100 each.
Figure 14.3 An actual Bitcoin transaction from a web-based cryptocurrency

exchange to a hardware wallet. (Source: Image created by FlippyFlink, who
released it under the creative commons license CC BY-SA 4.0.)
14.2.6 Brain Wallet
A brain wallet is not a wallet of any form, but a technique to store private keys in
the users’ mind. A private key is a large number, for instance, the length of a Bitcoin
private key is 256 bits. It is difficult for an ordinary individual to memorise such
a long number, hence it is rarely attempted. The technique is to generate the hash
of a password in the size required. Because Bitcoin private keys are 256 bits long,
SHA256 can be utilised for this blockchain.
A brain wallet stores the password in the brain and does not require keeping
backups as long as the user can remember the passphrase. Like a paper wallet, it
does not constitute an actual wallet, and the keys need importing to a web or soft-
ware wallet for accessing funds.
The brain wallet is subject to brute-force attacks that could lead to stealing the
funds. If the password is not strong enough, this kind of wallet is as vulnerable as
a simple email password against the brute-force attacks of hackers. It is, therefore,
essential for the users to pick the password carefully with a high degree of entropy
[Goodin, 2012].
The rule of thumb for creating a strong password is to have at least 12 characters
including numbers, symbols, and lower- and upper-case letters. The password must
not have dictionary words or a combination of words that can be quickly identified,
and rely on obvious substitutions such as “H0use” for “House” [Hoffman, 2018]. A
password fulfilling these requirements is challenging for users to memorise, and a little
technique may help. In order to remember a password of that complexity, the right
way is to generate the password from a memorable sentence. For example, “The first
house I rented in Dublin is 5 Vernon Avenue in Clontarf, and the rent was $440 per
month”. We can turn this into a strong password by taking the first letter of each word.
This gives us “TfhIriDi5VAiCatrw$4pm”. It would take about 3 sextillion years for a
hacker to break this password applying a brute-force attack using a desktop computer.*
14.3 Special Wallets
There are some particular types of wallets in use that are not common amongst
regular users. Organisations such as exchanges and online sellers that deal with a
considerable amount of funds generally use these wallets. The primary objective of
these wallets is not usability but security. These wallets are designed in such a way
that stealing funds would require tremendous efforts both online and offline.
14.3.1 Multi-Signature Wallet
Multi-signature wallets are those that require multiple keys to access the funds. Let
us recap what we learned in Chapter 4. The concept of multi-signature refers to
requiring more than one key to authorise a transaction. It is available in all major
blockchains and generally used to divide up responsibility for possession of crypto-
currencies such as Bitcoin, Ether and XRP. Standard transactions on a blockchain
network are “single-signature transactions”. It is because transfers in these transac-
tions require only one signature– from the owner of the private key associated with
the token address. However, Bitcoin and most major networks support much more
complicated transactions that require the signatures of multiple people before the
funds can be transferred. These are often referred to as M-of-N transactions.
Typically, all types of multi-signature wallets require M-of-N signatures. Let’s
suppose we have configured a multi-signature wallet for 3-of-5 authorised signa-
tures. This means a transaction would only become valid when at least three out of
five authorisers sign it. Multi-signature wallets are useful to securely protect funds
and prevent loss of funds in the event of losing keys. This type of wallet is generally
used by exchanges, companies and organisations that need to store a large amount
of funds in a single wallet.
14.3.2 Cold-Storage Wallet
Cold storage in the context of cryptocurrency refers to keeping a reserve of tokens
offline. This is often a necessary security precaution, especially dealing with large
amounts of funds. For example, a cryptocurrency exchange typically offers an
instant withdrawal feature and might be a steward of hundreds of thousands of
* Interested readers may use the website www.howsecureismypassword.net to examine their

passwords.
tokens. To minimise the possibility that an intruder could steal the entire reserve
in a security breach, the operator of the exchange follows a best practice by keeping
the majority of the reserve in cold storage, or, in other words, not present on the web
server or any other computer. The only amount kept on the server is the amount
needed to cover anticipated withdrawals. The remaining amounts are kept offline.
There are several options available to implement cold storage. A paper wallet,
hardware wallet or external storage device can store the keys. This wallet is then
stored at a secured location. Deep cold storage refers to storing the offline wallet in a
safe deposit box, insured locker and so on to add a further layer of protection. Cold
storages usually contain a multi-signature wallet, making it extremely difficult for
hackers to steal the funds.
Figure 14.4, generated using bitinfocharts.com, shows the five wealthiest
Bitcoin addresses collecting tokens in December 2018 that would have been more
than $11 billion at the all-time-high price of Bitcoin. It is no surprise that all of
them are cold storage for the world’s five largest cryptocurrency exchanges, and
three out of five wallets are multi-signature.
14.3.3 Receive-Only Wallet
A receive-only wallet is a unique wallet that refers to the ability to receive funds but not
spend them. These wallets do not hold private keys; they only include the public keys
to generate addresses. This wallet is a good idea if the recipient is a seller or an exchange
where a large volume of in-flow is regularly expected. The funds of a receive-only wallet
can be transferred to a more appropriate wallet or cold storage later.
14.4 Deterministic Wallet
A deterministic wallet is a wallet that can generate many addresses and their asso-
ciated private keys from a shared private key. Deterministic wallets have several
advantages over regular wallets. For instance, regular wallets need to backup every
user who creates a new address. In contrast, a deterministic wallet requires only one
backup when the wallet is set up. The backup size of a regular wallet grows over
time as new addresses are added to it. Some wallets come with a large size – for
example, the Bitcoin Core Wallet generates 100 addresses in advance by default.
On the other hand, the backup of a deterministic wallet has a small constant size,
as only the master password needs to be backed up.
14.4.1 Type-1 Wallet
Type-1 deterministic wallets can be derived from brain wallets. The pro-
cess begins with a password and a counter. Let suppose the password is
“TfhIriDi5VAiCatrw$4pm”, which we created in the discussion of brain wallet.
Figure 14.4 The five wealthiest Bitcoin addresses. It is no surprise that all of

them are cold storage for the world’s five largest cryptocurrency exchanges.
A counter n is appended at the end of the password before hashing it to yield the
private key:
priv = H ( pw | n) (14.1)
This private key is then used to create the public key and subsequently the address:
B = priv. A modp (14.2)
The explanation of Equation 14.2 is presented in Section 2.4 in Chapter 2, where

A is the generator of the elliptic curve, B is the public key and p is the order of the
prime field under which the elliptic curve operations are performed.
The addresses generated by a type-1 deterministic wallet are impossible to relate
to one another by anyone who does not know the master password. Like brain wal-
lets, type-1 deterministic wallets are sensitive to brute-force attacks and should not
be used unless the master password has been generated with enough entropy.
14.4.2 Type-2 Wallet
Type-2 deterministic wallets separate the roles of the generation of private keys
and the generation of addresses. Unlike type-1 wallets, it does not rely on a master
password (pw) but only rather utilises an extra component called a master private
key (mpk). These two components together generate the private key:
priv = mpk + H ( pw | n) (14.3)
This wallet splits the elliptic curve cryptography (ECC) private key into two parts:
a public key and a password:
B = privA mod p (14.4)
From Equation 14.3,
B = mpkA + H ( pw | n) A mod p (14.5)
B = Bmpk + H ( pw | n) A mod p (14.6)
Equation 14.6 shows the generation of the public key not involving the correspond-
ing private key. Instead, the process uses a master public key in combination with
a master password.
Type-2 deterministic wallets increase security because of the separation of the
roles of the mpk and the pw. The mpk is a regular ECC private key randomly gen-
erated and backed up following standard procedures. The compromise of this key
does not necessarily mean the loss of the funds, hence it can be shared amongst
many users. Businesses such as online portals with customer-facing servers can ben-
efit from the key-split. The administrator can give the servers a copy of the Bmpk and
the pw. Servers then use them to generate new addresses for receiving payments
from customers. As the servers do not keep a copy of the private keys for those
addresses, the funds will not be subject to any attack. The attacker can only identify
the location of the funds stored but not be able to steal them.
14.4.3 HD Wallet
A HD wallet, or hierarchical deterministic wallet, is a type of cryptocurrency wal-
let that is amongst the most popular wallet in use at the moment. Its popularity
is partly because of the convenience it provides and partly due to its security. Its
mathematical foundation is based on the deterministic wallets described earlier;
however, it comes with a set of extra features that enhances the security and the
usability of this wallet to a great extent.
A HD wallet derives addresses form a hierarchy starting with a secret. It follows
the convention of type-2 wallet where public and private keys are derived separately.
The novelty introduced by HD wallets is that it stores the generated addresses in a
tree structure such that a node has visibility of its descendants but not of its ascen-
dants. There are two types of nodes in the tree: private nodes that hold the private
keys to the sub-tree originating from them, and public nodes that hold only the
public keys to their sub-tree. In addition to the private and public keys, each node
includes an additional 32-byte field called the chain code. The goal of the chain
code is to add additional entropy to each node. Thus revealing an address does not
automatically reveal the tree derived from that node.
While using an HD wallet, the backing up of the seed key is mandatory. It is
also recommended that the users should keep this backup safely stored somewhere
Table 14.2 Major Wallet Providers

Name Control Anonymity Usability Type Tokens
Bitcoin Core User High Difficult Desktop BTC
Ethereum Mist User Medium Average Desktop ETH
Ledger Nano S User Medium Difficult Hardware, Most

desktop major
coins
Trezor Wallet User Medium Average Hardware, BTC, ETH,

mobile altcoins
desktop
CoinPayments Third Medium Easy Mobile All major

party coins
Guarda User High Easy Mobile, Most

web major
desktop coins
Multiwallet Third High Easy Mobile, Most

party web major
coins
Coinomi User Medium Easy Mobile Most

major
coins
Exodus User High Easy Desktop Most

major
coins
Satowallet Third Low Easy Mobile, BTC, ETH,

party web most
desktop altcoins
Jaxx User High Average Mobile, BTC, ETH,

web most
desktop altcoins
Citowise User High Easy Mobile BTC, ETH,

most
altcoins
(Continued )
Table 14.2 (Continued) Major Wallet Providers

Name Control Anonymity Usability Type Tokens
UberPay User Medium Easy Mobile BTC and

major
altcoins
KeepKey User Medium Difficult Hardware, BTC, ETH,

Wallet mobile LTC, BCH,
desktop DOGE,
DASH
Qbao User High Easy Mobile ETH,

Network ERC-20,
QTUM,
QRC20
MT Third Medium Easy Web BTC, ETH,

party MTRC
Blockchain Third Low Easy Mobile, BTC, ETH,

party web BCH
CoolWallet S User High Average Hardware, BTC, ETH,

mobile XRP, LTC,
BCH
Kimera Third High Average Web BTC, ETH,

Party XRP, XLM,
LTC, BCH,
ADA,
ERC-20
Enjin User High Easy Mobile BTC, LTC,

ETH
so that the wallet can be restored in the event of theft or damage. Moreover, the
excellence of HD wallets is that taking a backup only once allows users to recreate
all the addresses mathematically as explained earlier.
14.5 Wallet Providers
There are plenty of wallet providers available in the market. Some of them pro-
vide hardware wallets, while some offer only desktop and mobile wallets. Desktop
versions come in Windows, Linux and MacOS operating systems, while mobile
versions offer Android and iOS. However, it depends on the providers if they wish
to cover all or a part of these operating systems. The permitted coins is another cri-
terion that users must keep in mind, as not all providers allow storing all available
tokens. Some providers charge fees, while many keep the service free of charge by
monetising their business through advertisements or partnering with other services.
Many blockchains come with their wallets, for example the Bitcoin Core wallet
and Ethereum Mist wallet. These wallets are often very reliable but not user-friendly.
It is a good idea to start exploring from native wallets, but using a commercial HD
wallet will be the best option. These wallets come with many extra features and
provide user-friendly interfaces, and are often on multiple platforms allowing users
to access their funds from smartphones, laptops or desktop computers.
Comparing the underlying technology, permitted tokens and services offered
by the providers, users may pick and choose whom they want to take the wallet
from and whom they will ignore. Table 14.2 provides a list of wallet providers com-
paring them using five criteria: control, anonymity, usability, type and supported
tokens. The first two wallets on the list are the official Bitcoin and Ethereum wal-
lets, while the remaining are third-party commercial providers.
14.6 Summary
This chapter took the effort of presenting the theories and underlying principles
of cryptocurrency wallets. It offered broad discussions on how the concept of a
wallet works, various types of wallets, the construction of deterministic wallets
and recommendations for some wallet providers. One of the key objectives of the
chapter was to help readers pick a suitable wallet for their tokens for secure stor-
age to supplement the discussion of Chapter 15 that talks through the trading and
investment methods using cryptocurrencies.
Chapter 15
Cryptocurrency Trading
and Investment
A cryptocurrency is an investment instrument that investors can use to obtain a

return. Unlike a stock or a bond, it is a notably different kind of investment tool
that involves not only business and financial aspects but also a technological per-
spective. To determine how good a cryptocurrency is, understanding its underlying
principles and potential to serve specific uses-cases are essential. The first eleven
chapters of this book elaborate on this front. This chapter takes the liberty to pres-
ent the investment outlook of this technology focusing on practical aspects such
as distinguishing the asset classes and knowing the possible investment options.
The principal objective of this chapter is to provide some basic understanding of
investment so that investors having no or little prior experience can find a place to
begin. With that objective in mind, the chapter first introduces the asset classes and
continues to explain portfolios such as funds, exchange-traded funds (ETFs) and
indices before discussing the exchanges and platforms. Finally, the chapter briefly
discusses various investment strategies and possible ways to implement those in
the current landscape of the cryptocurrency market. Nevertheless, investment as a
discipline is a vast topic and it is impossible to elaborately cover everything within
a few pages; hence, this is not attempted in this chapter.
15.1 Investment
The process of investment is distributing money in the expectation of some ben-
efit in the future such as investment in financial assets, durable goods, real estate,
factories, product development or research. Amongst these, financial assets are
249
particular types of investments where the benefit is called a return. The return may
consist of a profit from the sale of property or an investment, or investment income
including dividends, interests, rental income or a combination. The projected eco-
nomic return is the appropriately discounted value of future returns [Arnold, 2014].
Investors generally expect higher returns from riskier investments, while mak-
ing a low-risk investment will usually earn a low return. In this context, the risk–
return ratio, which is a measure of return in terms of risk for a specific time period,
gives an idea about a particular investment and its associated risks. Investors who
are not experienced often seek advice from experts to adopt a particular investment
strategy and diversify their portfolio in order to statistically reduce overall risk. The
expert who builds the portfolio is known as a portfolio manager or fund manager
[Kroijer, 2017].
The types of investments are complex and challenging to group together. It is,
however, necessary to assemble various types of investments into smaller collections
so that they can be analysed carefully with a view to reducing risks and maximising
returns. As such, generally, the whole investment domain is divided into two groups,
namely traditional investments and alternative investments. Traditional investments
refer to putting money into well-known assets such as bonds, cash, real estate and
equity shares. On the other hand, alternative investments means asset classes other
than stocks, bonds and currency; hence they include tangible assets such as pre-
cious metals, art, wine, antiques, coins, and stamps, and some financial assets such
as commodities, private equity, distressed securities, hedge funds, carbon credits,
venture capital, financial derivatives and, more recently, cryptocurrencies.
There are several classifications of investment instruments available in the mar-
ket, and an investor or a portfolio manager needs to decide what to use.
The following discusses the most widely used instrument classes with a view to
identifying where cryptocurrency fits in.
15.1.1 Financial Instruments
A financial instrument is a monetary contract between multiple parties that can be
created, traded, modified and settled. Examples of financial instruments include
a contractual right to receive or deliver cash (bond) and evidence of an ownership
interest in an entity (stock/share). Bonds and stocks are collectively known as “secu-
rity” in the financial industries.
The bond is a debt security under which the issuer owes the holders a debt and,
depending on the terms of the bond, is obliged to pay the interest or to repay the
principal at a later date, termed the maturity date. Interest is usually payable at fixed
intervals: semi-annual, annual or sometimes monthly. Very often the bond is nego-
tiable; that is, the ownership of the instrument can be transferred in the secondary
market. Once the transfer agents at the bank stamp the bond, it becomes highly
liquid on the secondary market. Bonds are available to purchase from governments
Cryptocurrency Trading and Investment ◾ 251
as well as from the corporations. In that sense, the former is known as a government
bond, while the latter is called a corporate bond.
The stock of a corporation is all of the shares into which ownership of the cor-
poration is divided. In the US, the shares are commonly known as “stocks”, while
in the UK “share” is the term frequently used. A single share of stock represents
fractional ownership of the corporation in proportion to the total number of shares.
This typically entitles the stockholder to that fraction of the company’s earnings,
proceeds from the liquidation of assets after the discharge of all senior claims such
as secured and unsecured debt, or voting power, often dividing these up in propor-
tion to the amount of money each stockholder has invested. Not all stock is neces-
sarily equal, as certain classes of stock may be issued, for example, without voting
rights, with enhanced voting rights, or with an absolute priority to receive prof-
its or liquidation proceeds before or after other classes of shareholders. Stocks are
launched through a process commonly known as the initial public offering (IPO).
An IPO is underwritten by one or more investment banks that also arrange for the
shares to be listed on one or more stock exchanges; hence a privately held company
becomes a public limited company.
15.1.2 Commodities
A commodity is an economic good or service that has full or substantial fungibility,
which means the market treats instances of the good as equivalent or nearly so with
no regard to who produced it [Smith, 1982]. Most commodities are raw materi-
als, basic resources, agricultural, or mining products, such as iron, gas, petroleum,
coal, sugar, or grains like rice and wheat. Goods that are grown are called soft com-
modities, while mined commodities are known as hard commodities. Commodities
can also be mass-produced unspecialised products such as chemicals and computer
memory.
The price of a commodity good is typically determined as a function of its mar-
ket as a whole. Well-established physical commodities have actively traded spot and
derivative markets. The wide availability of commodities typically leads to smaller
profit margins and diminishes the importance of factors such as brand name other
than price.
15.1.3 Currencies
A currency in the most specific use of the word refers to money in any form when
in use or circulation as a medium of exchange, especially circulating banknotes and
coins. A more general definition is that a currency is a system of money or mon-
etary units in common use especially for people in a nation. Under this definition,
US dollars, British pounds, European euros, Russian rubles and Indian rupees are
examples of currency. These various currencies are recognised as stores of value
and are traded between nations in foreign exchange markets, which determine the
relative values of the different currencies. Currencies in this sense are defined by
governments, and each type has limited boundaries of acceptance [Peter, 1965].
15.1.4 Derivatives
A derivative is a contract that derives its value from the performance of an under-
lying entity. This underlying entity can be an asset, index, cryptocurrency and so
on. Derivatives can be used for many purposes, including insuring against price
movements (hedging), increasing exposure to price movements for speculation, or
getting access to otherwise hard-to-trade assets or markets. Some of the more com-
mon derivatives include forwards, futures, options, swaps, contracts for difference,
and variations of these such as synthetic collateralised debt obligations and credit
default swaps [Hull, 2006].
A forward contract, or simply a forward, is a “non-standardised” contract
between two parties to buy or to sell an asset at a specified future time at a price
agreed upon today. The party agreeing to buy the underlying asset in the future
assumes a long position, and the party agreeing to sell the asset in the future assumes
a short position. The price agreed upon is called the delivery price, which is equal
to the forward price at the time the contract is entered into. In contrast, a futures
contract, or simply futures, is a “standardised” forward contract, a legal agreement
to buy or sell something at a predetermined price at a specified time in the future
between parties not known to each other. The asset transacted is usually a com-
modity or financial instrument. The predetermined price the parties agree to buy
and sell the asset for is known as the forward price. The specified time in the future,
which is when delivery and payment occur, is known as the delivery date.
An option is a contract which gives the buyer, who is the owner or holder of the
option, the right but not the obligation to buy or sell an underlying asset or instru-
ment at a specified strike price prior to or on a specified date depending on the
form of the option. The strike price may be set by reference to the market price of
the underlying security or commodity on the day an option is taken out, or it may
be fixed at a discount or a premium. The seller has the corresponding obligation to
fulfil the transaction, to sell or buy, if the buyer exercises the option. An option that
conveys to the owner the right to buy at a specific price is referred to as a call, while
an option that conveys the right of the owner to sell at a specific price is referred
to as a put. A swap, on the other hand, is a derivative in which two counterparties
exchange the cash flow of one party’s financial instrument for those of the other
party’s financial instrument. The benefits in question depend on the type of finan-
cial instruments involved. For example, in the case of a swap involving two bonds,
the benefits in question can be the periodic interest payments associated with such
bonds and so on.
Finally, a contract for difference (CFD) is a contract between two parties, typi-
cally described as the “buyer” and “seller”, stipulating that the seller will pay to the
buyer the difference between the current value of an asset and its value at contract
time; however, if the difference is negative, then the buyer pays instead to the seller.
In effect, CFDs are derivatives that allow traders to take advantage of prices moving
up (known as long positions) or prices moving down (known as short positions) on
all underlying financial instruments. They are often used to speculate on markets.
A CFD is a tool of leverage with its own potential profits and losses. It allows an
investor to enter the global trading market without directly dealing with shares,
indices, commodities or currency pairs.
15.1.5 Status of Cryptocurrency
Deciding which class of investments cryptocurrency belongs to is challenging. The
status of this new instrument is disputed as there is no clear official regulation
available for most countries; various departments and authorities define it based on
their interpretation. Decisions from the courts, opinions of renowned magazines
and actions of regulatory authorities often contradict one another. Some identify
cryptocurrency as currency, while some consider it a commodity. Because there
are some similarities between IPOs and the process of raising funds for pre-mined
cryptocurrencies, known as initial coin offerings (ICOs), this new instrument is
sometimes compared to stocks as well. However, there is still no global agreement
as to where to put cryptocurrency, and it remains to be a matter of debate. Chapter
17 elaborates on this matter.
15.2 Portfolio
A portfolio is a collection of investments held by an investment company, hedge
fund, financial institution or individual. More particularly, it refers to any com-
bination of financial assets such as stocks, bonds, currencies and commodities.
A portfolio is tailor-made and can be customised. Individual investors may hold
portfolios or have them managed by financial professionals, hedge funds, banks
and other financial institutions. It is a generally accepted principle that a portfolio
is designed according to the investor’s risk tolerance, time frame and investment
objectives. The monetary value of each asset may influence the risk–return ratio of
the portfolio.
15.2.1 Funds
A fund or an investment fund is a form of investing money alongside other inves-
tors in order to benefit from the inherent advantages of working as part of a group.
These advantages include the ability to hire professional investment managers,
which may potentially be able to offer better returns and adequate risk management.
It also benefits from lower transaction costs and increases the asset diversification
to reduce some unsystematic risk. A fund can be of several types such as a mutual
fund, closed-end fund or special-purpose acquisition company (SPAC). A mutual
fund is an open-ended investment where anyone can enter or exit at anytime.
A closed-end fund, however, restricts the duration of the investment to a specific
period, while an SPAC allows investors to invest in private equities.
A fund can be constructed using any asset class such as stocks, bonds, curren-
cies, commodities or even real estate. More recently, cryptocurrency has become
a lucrative asset class, and professional fund managers have been looking at this
instrument to build funds entirely using cryptocurrencies and blockchain technolo-
gies. CryptoFundResearch is an organisation that collects and shares data related
to cryptocurrency funds. According to CryptoFundResearch, the first cryptocur-
rency fund became available in the market in 2013. Within the next 5 years, over
700 such funds were established with more than 100 new funds joining the fray in
2018 alone. Recently, Bitcoin Market Journal* surveyed those funds and published a
report along with a score out of five. Table 15.1 lists a collection of those funds with
their name, their assets under management (AUM), the founding year and the score.
15.2.2 Indices
An index is a measurement of a section of a particular financial asset such as stock.
It is usually computed from the prices of the selected assets taking a weighted
average. Indices are tools used by investors and financial managers to describe the
market and to compare the return on specific investments. Two of the primary cri-
teria of an index are that it is investable and the method of its construction should
be transparent. The American S&P 500, the Japanese Nikkei 225 and the British
FTSE 100 are some renowned stock indices.
The rise of the cryptocurrency market creates a provision for creating crypto
indices. The idea has been hovering in this industry for some time, but no serious
attempt was taken until recently. A survey in the market indicated that there are at
least four operational indices available while several are at the proposal level waiting
to be launched.
◾◾ Bloomberg Galaxy Crypto Index (BGCI): Founded by the data giant

Bloomberg, BGCI is designed to measure the performance of the largest
cryptocurrencies traded in US dollar. The index is market capitalisation
weighted and includes cryptocurrencies such as Bitcoin, Ethereum, Monero,
Ripple and Zcash. Its constituents are diversified across different categories of
digital assets, including stores of value, mediums of exchange, smart contract
protocols and private assets.
URL: www.bloomberg.com/quote/BGCI:IND
* Publicly accessible using the following URL: www.bitcoinmarketjournal.com.

Table 15.1 Renowned Cryptocurrency Funds

Name AUM Year Founded Score
Polychain Capital $1.04b 2016 4.10
Pantera Bitcoin Fund $810m 2013 4.00
Pantera Long Term ICO Fund $810m 2017 3.10
Galaxy Digital Assets $500m 2017 3.70
Alphabit Fund $480m 2017 3.00
Altana Digital Currency Fund $450m 2014 3.30
Crypto Currency Fund L.P. $200m 2017 2.70
BlockTower $150m 2017 3.00
MetaStable Capital $60m 2014 2.60
1confirmation $30m 2017 1.70
AltaIR Capital $20m 2010 3.20
Abstract Ventures $12m 2016 1.90
Amentum Investment $10m 2017 1.60

Management
Aenigma Capital $10m 2018 1.60
Source: Bitcoin Market Journal.
◾◾ Cryptocurrency Index 30 (CCi30): Launched on 1 January 2017, the CCi30

is a rules-based index designed to measure the overall growth as well as the
daily and long-term movement of the blockchain sector. By tracking the 30
largest cryptocurrencies by market capitalisation, it serves as a tool for pas-
sive investors to participate in this asset class and as an industry benchmark
for investment managers. The founders claimed that the CCi30 had been
designed with five main characteristics namely diversified, replicable, trans-
parent, providing in-depth coverage of the entire sector and presenting the
best risk-adjusted performance profile possible.
URL: www.cci30.com
◾◾ Crpto20: The index was launched by Invictus Capital in 2017 and has been
traded on a number of platforms since the beginning of 2018. It was estab-
lished through an ICO and constructed over Ethereum blockchain. The
index tracks 20 cryptocurrencies while itself an ERC-20 coin.
URL: www.crypto20.com
◾◾ CRypto IndeX (CRIX): CRIX is an academic initiative to build a compre-

hensive cryptocurrency index. Led by Professor Wolfgang Hardle from the
School of Business and Economics at Humboldt University in Berlin, the
index was constructed following the Laspeyres derivation method and holds
55 cryptocurrencies (Figure 15.1).
URL: www.thecrix.de
15.2.3 ETFs
An exchange-traded fund (ETF) is an investment fund traded on stock exchanges,
much like stocks. An ETF holds assets such as stocks, commodities or bonds, and
generally operates with an arbitrage mechanism designed to keep it trading close to
its net asset value, although deviations can occasionally occur. Most ETFs track an
index, such as a stock index or bond index. ETFs may be attractive as investments
because of their low costs, tax efficiency and stock-like features.
ETFs entirely based on cryptocurrency are a grey area that most national
authorities around the world have been against due to the volatility of these assets.
Cameron and Tyler Winklevoss* first took the initiative of creating such an ETF
when they submitted the request to register a Bitcoin-based ETF called Winklevoss
Bitcoin Trust in 2013. Despite putting tremendous effort into negotiating with the
Securities and Exchange Commission (SEC) to get the request approved, the ETF
Figure 15.1 Cryptocurrency distributions in CRIX Index.
* They are famously known as the Winklevoss twins who gained their fame during their
Harvard University time through a legal dispute with Mark Zuckerberg concerning the social
media sites ConnectU and Facebook for which they received more than $20 million in com-
pensation. They later went on to become one of the most active advocates of Bitcoin and the
underlying technologies.
Table 15.2 Renowned Blockchain ETFs

Symbol Name AUM
BLOK Amplify Transformational Data Sharing ETF $113.44m
BLCN Reality Shares Nasdaq NexGen Economy ETF $77.41m
LEGR First Trust Indxx Innovative Transaction & $41.47m

Process ETF
KOIN Innovation Shares NextGen Protocol ETF $9.83m
BKC REX BKCM ETF $5.22m
GFIN Goldman Sachs Motif Finance Reimagined ETF $5.16m
BKCH AdvisorShares Sabretooth ETF $2.70m
BCNA Reality Shares Nasdaq NexGen Economy $2.42m

China ETF
Source: Blockchain ETF List, www.etfdb.com/themes/blockchain-etfs/.
was denied in 2017. This negotiation, however, created the grounds for further dis-
cussion, and several entities including some ICOs took the opportunity to push for
launching their ETFs in the near future [Pihl, 2019].
Nevertheless, the ETFdb, a website specialised for indexing all available ETFs
around the world, identified some stock ETFs involving blockchain-related com-
panies that can be considered the closest possible investment opportunities of this
kind at the moment. Table 15.2 is prepared based on ETFdb’s listing.
15.3 Exchanges and Platforms

Unlike stocks and bonds, investing in a crypto-asset is much easier. Chapter 14
describes how cryptocurrencies can be stored in a wallet. An investor willing to
invest in a particular cryptocurrency can buy the tokens and store them in the
wallet depending on his investment strategies. However, like any other regular
product in our life, people generally randomly sell stuff in the middle of nowhere.
There needs to be a marketplace where they meet and make the trade. Trading
exchanges and platforms are places where investors can buy the desired tokens.
Nowadays, many modern exchanges also provide wallets or keep the purchased
asset at their disposal with insurance and higher security. The following intro-
duces cryptocurrency exchanges and platforms for investing in indices, funds
and derivatives.
15.3.1 Cryptocurrency Trading Exchange

A cryptocurrency exchange is a place that allows customers to trade cryptocurren-
cies for other assets, such as conventional fiat money or other digital currencies.
A cryptocurrency exchange can be a market maker taking the bid–ask spreads as
a transaction commission or may charge flat fees. The exchanges can send crypto-
currency to a user’s cryptocurrency wallet, while some can convert cryptocurrency
balances into anonymous prepaid cards which can be used to withdraw funds from
ATMs worldwide.
A regular cryptocurrency trading exchange is a typical market maker that allows
clients to join and exchange their assets. For example, Alice has some Bitcoin that
she wants to exchange for Ether, and Bob, having some Ether, wants to buy Bitcoin.
A trading exchange, acting as a middleman, can help them. Alice must first put a
bid for Ether in exchange for her Bitcoin. If Bob finds that bid reasonable enough,
he will accept the offer. The trading exchange then sends Ether to Alice and Bitcoin
to Bob. In the whole process, the exchange is likely to charge a fee. Some exchanges
do not charge fees but take a percentage from one or both parties.
There are many cryptocurrency exchanges globally operating at the moment.
Some of these exchanges are infamous for criticisms and allegations of wrongdoing,
while many operate within the regulatory norms of the countries they are based
in. Amongst the notable exchanges, the following have gained the reputation of
providing the best service to their customers.
◾◾ Binance – www.binance.com
Binance is a global cryptocurrency exchange established by Chinese-
Canadian businessman Changpeng Zhao and currently based in Malta.
It is considered the biggest cryptocurrency exchange in the world in terms
of trading volume and provides a platform for trading more than 100
cryptocurrencies.
◾◾ Bitstamp – www.bitstamp.net
Bitstamp is a UK- and Luxemburg-based exchange that primarily focuses
on the major cryptocurrencies. It allows trading using US dollars (USD),
euros (EUR), Bitcoin, Litecoin, Ethereum, Ripple, Bitcoin Cash and so on.
The exchange offers an API to allow clients using custom software to access
and control their accounts on their platform.
◾◾ Huobi – www.huobi.com
Huobi was originally founded in China by Leon Li, a Chinese business-
man and computer engineer. In 2017 when China banned cryptocurrency
exchange and ICOs, Huobi relocated its business to Singapore. It is now a
publicly listed company on the Hong Kong stock exchange.
◾◾ Coinbase – www.coinbase.com
Coinbase is a US-based exchange founded in 2012 by Brian Armstrong
and Fred Ehrsam. It is considered the most user-friendly cryptocurrency
exchange and very popular amongst new users. It offers Bitcoin, Bitcoin Cash,
Ethereum, Ethereum Classic and Litecoin with fiat currencies to exchange.
◾◾ Bittrex – www.bittrex.com
Bittrex is a US-based cryptocurrency exchange headquartered in Seattle,
Washington. Three former security professionals from Microsoft led by Bill
Shihara founded the company in 2013. It is one of the largest exchanges for
cryptocurrency trading allowing a wide range of tokens including Cardano,
ZCash, Tether, Endor, Tron, Siacoin and Komodo in addition to all the
major cryptocurrencies.
15.3.2 Derivative Trading Exchanges

A derivative trading exchange is a place (within the context of this book) where
derivative instruments related to cryptocurrencies are sold. The derivative products
that are usually traded at these exchanges are CFDs.
While investing in CFDs, an investor does not hold the underlying cryptocur-
rency but steps into a contract to get paid for the price differences between the
current price and the future price. There are two fundamental differences between
trading a real cryptocurrency and a CFD. While the former is a natural asset traded
based on the changes of its value, the latter is a leveraged product and can be pur-
chased as both a buy and sell position.
Leverage is the increased buying power allowing an investor to pay less than
full price for a trade. It is expressed as a ratio; for example a 2:1 leverage means that
an investor would be able to hold a position that is twice the value of the trading
account. If the investor has 25,000 in a trading account with 2:1leverage, he or she
would be able to purchase 50,000 worth of cryptocurrency. Nonetheless, it magni-
fies the losses on the same scale making it a very risky investment.
CFDs also allow investors to purchase either a buy or sell position. This means
a CFD product gives the opportunity to make a profit regardless of the price move-
ment of a cryptocurrency. For example, if Alice thinks that the price of Bitcoin
will go up, she may purchase a buy position for Bitcoin. If the price does go up,
she makes a profit on the differences. Similarly, if she predicts that the price will go
down, she may purchase a sell position. If the price goes down as predicted, despite
the real asset losing its value, Alice will make a profit on the differences. Figure 15.2
shows a screenshot from an exchange offering Bitcoin CFD. It provides the opportu-
nity for the investor to decide between buy and sell positions and picking a leverage.
The following are some well-known exchanges for offering cryptocurrency
CFD products.
◾◾ eToro – www.etoro.com
Founded in Israel but now registered in Cyprus and headquartered in
London, eToro is one of the most renowned exchanges for both real and CFD
products. It provides CFDs for all asset classes described earlier in addition
Figure 15.2 An exchange offering Bitcoin CFD.
to cryptocurrency. They coined the term “social trading” which allows begin-
ners to learn through discussion in a social media–like environment. They
also introduced a mechanism called “copy trading” that newcomers can use
for investment by copying (following) positions of experienced traders. The
FCA, the financial regulator of the UK, is responsible for regulating eToro in
addition to other regulators from the EU.
◾◾ BitMEX – www.bitmex.com
BitMEX is a cryptocurrency exchange that provides both real and deriva-
tive products. It was co-founded by Ben Delo, who made his fortune from
Bitcoin and is reported to be the United Kingdom’s youngest self-made bil-
lionaire [Urwin, 2018]. Unlike many other trading exchanges, BitMEX only
accepts deposits through Bitcoin, which can then be used to purchase a vari-
ety of other cryptocurrencies. BitMEX specialises in sophisticated financial
operations trading with leverage. Like many of the exchanges that operate
through cryptocurrencies, BitMEX is currently unregulated.
◾◾ Plus500 – www.plus500.co.uk/
Plus500 is an online trading exchange offering CFD products across more
than 2000 securities and multiple asset classes including cryptocurrencies. The
company is headquartered in Israel and has subsidiaries in the UK, Cyprus,
Australia and Singapore. Plus500 is regulated by the FCA and listed on the
London Stock Exchange where it is a constituent of the FTSE 250 Index.
15.3.3 Investment Platforms
An investment platform acts like an exchange, but at a greater capacity, and hosts indi-
ces, ETFs and funds. If a platform provides only indices and funds, their execution
does not happen in real-time; hence the operation differs from a regular exchange.
However, providing ETFs requires exchange-like platforms which are difficult to
distinguish from a regular exchange. Because cryptocurrency is a new product in
the market, such platforms are not very popular in this domain. The following four
platforms are mentioned as examples so that the reader may have a starting point:
◾◾ HitBTC – www.hitbtc.com
◾◾ p2pb2b – www.p2pb2b.io
◾◾ Fork Delta – www.forkdelta.app
◾◾ Dflowx – www.dflowx.com
15.4 Investment Strategy
An investment strategy is a set of rules, behaviours and procedures designed to guide an
investor to select the right investment type appropriate for an individual. Some choices
involve a trade-off between risk and return, while most investors fall somewhere in
between accepting some risk for the expectation of higher returns. The volatility of
cryptocurrency makes it a risky investment; therefore, it requires enough diversifi-
cation. The following presents some strategies that are well recognised amongst the
investment community and can be applied to cryptocurrency investments.
15.4.1 Day Trading
Trading is the process of buying and selling financial instruments to make a profit.
Traders use financial instruments such as stocks, bonds, ETFs, commodities (oil,
gas, gold and so on) and more recently cryptocurrencies to take advantage of the
gap between the buying and selling price to make a profit.
Day trading is the process of buying and selling financial instruments within the
same trading day such that all positions are closed before the market closes for the
trading day. Traders who trade in this capacity with the motive of profit use market
speculation; hence they are called speculators. The methods of quick trading con-
trast with the long-term trades underlying buy-and-hold and value-investing strate-
gies. Day traders exit positions before the market close to avoid unmanageable risks,
negative price gaps between one day’s close and the next day’s price at the open.
Day trading was once an activity that was exclusive to financial firms and
professional speculators. Many day traders are bank or investment firm employ-
ees working as specialists in equity investment and fund management. Day trad-
ing gained popularity after the deregulation of commissions in the United States
in 1975, the advent of electronic trading platforms in the 1990s, and with the
stock price volatility during the dot-com bubble. However, the rise of cryptocur-
rency makes day trading open to amateurs through exchanges dedicated to trading
cryptocurrencies.
15.4.2 Buy and Hold

Buy and hold, also called position trading, is an investment strategy where an inves-
tor buys financial instruments and holds them for a long time with the goal that it
will gradually increase in value over a long period. This approach is founded based
on the view that in the long run financial markets give a reasonable rate of return
even while taking into account a degree of volatility. Buy and hold says that inves-
tors will never see such returns if they bail out after a decline. This viewpoint holds
that market timing, the concept that one can enter the market on the lows and sell
on the highs, does not work; hence, attempting such timing gives negative results,
at least for small or unsophisticated investors. It is, therefore, better for them to buy
and hold for a more extended period.
An advantage of the buy-and-hold approach is that it is cost effective. Generally,
costs such as brokerage and bid/offer spread are incurred on all transactions sepa-
rately, and because buy and hold involves the fewest transactions for a given amount
invested in the market, it incurs fewer fees should all other conditions remain equal.
Taxation law also has some effect on this approach. Tax for long-term capital
gains may be lower in many jurisdictions, and tax may be due only when the asset
is sold and often never if the person dies. Warren Buffett, chairman of Berkshire
Hathaway and one of the three richest people in the world, is an example of a buy-
and-hold advocate who has built his fortune by investing in companies at times
when they were undervalued.
15.4.3 Value Investment
Value investment is an investment paradigm that involves buying securities that
appear underpriced by some form of fundamental analysis [Graham, 1949]. The
various forms of value investing derive from the investment philosophy first taught
by Benjamin Graham and David Dodd at Columbia Business School in 1928, and
subsequently developed in their 1934 book titled Security Analysis [Graham and
Dodd, 1934].
Warren Buffett has argued that the essence of value investing is buying stocks
at less than their intrinsic value. The discount of the market price to the intrinsic
value is what Benjamin Graham called the “margin of safety”. For the last 25 years,
under the influence of Charlie Munger, Buffett expanded the value-investing con-
cept with a focus on “finding an outstanding company at a sensible price” rather
than generic companies at a bargain price.
15.5 Investing in Cryptocurrencies
The current practice of cryptocurrency investment can be broadly divided into two
types: self-investment and guided investment. The former is the process where the
investor makes the investment decision and executes the order, while the latter
involves an expert to decide and execute the order on behalf of the investor where
an expert may mean an experienced trader, a fund manager or even an index.
15.5.1 Self-Investment
Self-investment is the most common practice in the current cryptocurrency
industry. On the contrary to the stock, bond or commodity investment where
well-established funds, ETFs and indices are available for investors to choose from,
the cryptocurrency landscape provides minimal options concerning those choices
driving investors to decide and execute investment for oneself. The self-investment
approach may involve all three strategies mentioned in Section 15.4.
◾◾ Day trading: Investors can buy and sell cryptocurrencies in the form of either
real asset or CFD products from the exchanges mentioned in Section 15.3.
Day trading involves some strategies such as trend following, contrarian invest-
ing, range trading and scalping. It is beyond the scope of this chapter to discuss
all these strategies, but interested readers may self-learn more on this using
these keywords.
Day trading is risky due to the volatility of the cryptocurrencies where
inexperience traders are likely to get caught up by the FIMO, or the fear of
missing out. When the price of a cryptocurrency keeps rising, new investors
could feel that they might be missing on the profit and make the impulse
decision of buying a stake. In most cases, following such an irrational pur-
chase, investors are likely to find themselves in a losing position as the price
starts to drop soon. The rational behaviour, however, would be the opposite:
buy when the market goes down and sell when prices rise.
Inexperienced investors also often lose money when the price drops
sharply. In those situations, they panic and sell their asset only to find that
the market reverses and they repurchase the same asset at a higher price. It is
commonly known as panic selling. Instead of making such a sale, holding on
to their asset generally earns them more profit.
◾◾ Buy and hold: Within the context of self-investment, buy and hold is an
approach where investors develop their portfolio by investing in a range of
cryptocurrency. In the current cryptocurrency landscape, finding all desired
assets in one exchange is difficult. Investors may invest through multiple
exchanges and later virtually track their portfolio using smartphone apps or
web applications independent of the exchanges.
The buy-and-hold approach requires sufficient knowledge to identify the
appropriate cryptocurrencies. This knowledge, however, cannot be developed
overnight. The skill set of investors usually gets better as they spend more
time in the industry and have more experience. In self-investment, it is neces-
sary that investors remain well informed through the reading of newspapers,
journals and relevant materials to understand the market trend and new
products.
◾◾ Value investment: This is an approach through which investors invest in
assets having the potential to grow in future. Buying tokens from ICOs can
be a way to make some value investment. As we know, all cryptocurrencies
have something to offer, a use-case. While evaluating a project before the
token sale, understanding this use-case is essential because the real potential
lies here. Moreover, due to the lack of regulations, many fraudulent actors
target this industry to make some quick money; hence, investors need to be
careful when investing through ICOs. Chapter 16 will elaborate more on the
investment and scam issues concerning ICOs.
15.5.2 Guided Investment
Guided investment is the process of employing experts to act on behalf of investors.
In the current landscape of cryptocurrency, options are limited to seek help from
an expert due to two reasons: first, the availability of such smarts is very slim and
second, there are hardly enough platforms to support funds, ETFs and indices that
the experts design and maintain. Despite those limitations, this chapter identi-
fied some investment opportunities in Section 15.2 and platforms hosting them in
Section 15.3.
◾◾ Day trading: While investing through guidance, day trading looks like an
option off the table. However, eToro makes it possible by introducing an
option called “copy trade” that allows following experience traders and copy-
ing their trading activity. For instance, Figure 15.3 shows a list of experienced
traders on the platform. Investors can look at their risk factors; returns from
the last 1, 3 or 6 months; and number of copiers to decide if they want to copy
Figure 15.3 eToro gives the option to copy experienced traders.

them. Their full portfolio is available to view (not displayed in Figure 15.3),

which can also help investors to make decisions. It is also possible for the
investors to make a portfolio of the traders they copy.
◾◾ Buy and hold: This is the approach that most fund managers take. Investors
willing to utilise this strategy can buy funds, ETFs or follow an index by
creating a portfolio on one or more exchanges. Section 15.2 gives an idea
about where to invest. Funds and ETFs are generally available to buy from
the platforms by paying a small fee, while investing in indices can be either
platform managed or self-managed. Some of the platforms mentioned ear-
lier offer C20 where investors can put their money in. However, if inves-
tors do not want to pay a fee but like to follow an index, they can create
a portfolio as mentioned in the self-investment section for themselves by
tracking an index of their choice. In this approach, they must make sure
that they keep an eye on the tracked index so that any change in the index
can be quickly introduced in the self-managed portfolio. In addition to
funds managed by specialised and independent managers, some cryptocur-
rency exchanges are now coming with their portfolios which investors may
consider investing.
◾◾ Value investment: It is a recent trend that companies are making portfolios
combining ICOs. So instead of investing in a particular ICO, experts are
gathering investments in a pool to diversify the risk by putting that money
across an extensive collection of ICOs. A similar approach can be found in
pooled mining where experts are collecting investors’ money to develop large
mining rigs and later pay investors a return monthly, bi-annually or annually.
It is challenging to find these investment approaches for new investors, but
networking with members of the community can help to get to the invest-
ment ladder.
15.6 Regulation and Tax Affairs

The cryptocurrency industry is mostly unregulated at the moment; however, regu-
lation is likely to arrive soon. It is a necessity when investing in stocks and bonds
to provide identification and proof of address in Europe, Canada, Australia, the
United Kingdom and the United States. This regulation is highly likely to be
extended for cryptocurrency in future. Many exchanges already willingly adapted
these rules and ask for identification documents, bank details and proof of address
when opening an account for trading or managing a cryptocurrency wallet.
Investments generally generate returns, and investors are liable to pay taxes on
their capital gain. Cryptocurrencies are a grey area at the moment, and many juris-
dictions have not thought out a proper tax law for the investors investing using
crypto-assets. However, cryptocurrency investment through CFD products is cov-
ered by well-established law, and investors must pay tax in due time.
Many countries provide the opportunity to make some tax-free investments,

often in the form of a threshold on the capital gain. If someone does not cross
that threshold, he or she does not have to pay taxes. Countries also offer specially
designed investment pots that are either tax-free or come with some conditions and
fulfilling those requirements gives the holder tax benefits. Examples include indi-
vidual savings accounts, or more commonly known as ISAs in the United Kingdom,
where investors are allowed to put a specific amount of money each year (declared
by the government at the beginning of each fiscal year) to trade or invest for which
they are not liable to pay taxes. This pot provides a tax-free investment opportunity
in addition to the regular tax-free threshold which is calculated on the investment
outside this container. Investors are, therefore, strongly recommended to consult a
professional accountant to discuss their tax affairs and explore the available options
open to them in their countries.
15.7 Summary
This chapter presented the investment principles and methods that can be utilised
in cryptocurrency investment. The chapter aimed to provide some basic under-
standing of investments so that investors having no or little prior experience can
find a place where they can start. It began with introducing the asset classes and
continued to explain portfolios such as funds, ETFs and indices before discussing
exchanges and platforms. Finally, the chapter discussed investment strategies and
possible ways to implement those in the current landscape of the cryptocurrency
market. The readers also must note that the literature presented in this chapter is
for guidance purposes only and is not formal investment advice. The author of this
book is not a qualified investment adviser approved by any financial conducting
authority of any jurisdiction; hence he is not legally allowed to offer investment
advice to retail clients.
Chapter 16
Initial Coin
Offerings (ICOs)
The initial coin offering, or more commonly ICO, is the established method of
securing funds for potential projects in the blockchain industry. Investors generally
put their money into a project looking at its prospects by buying pre-mined tokens
through ICOs. Although ICOs are not regulated and there is no hard and fast rule
as to how to arrange an ICO, over time the industry established some conventions
such as publishing a white paper and promoting ICOs through events. The method
worked well until 2017 when during the cryptocurrency bull run a lack of regula-
tion made ICOs a favourite tool for fraudulent actors to cheat and commit scams.
This, in turn, led regulatory authorities to intervene and crack down on projects
creating a lot of buzz and chaos making the process substantially infamous to the
public. This chapter takes the opportunity to look at the whole landscape involving
ICOs beginning with their history, how they came into being, selling of pre-mined
tokens, the advantage and disadvantages of investing through ICOs, and issues
related to regulation and scams surrounding this new crowdfunding approach.
16.1 Overview
An ICO is a type of funding using cryptocurrencies. Mostly the process is arranged
by crowdfunding, but private ICOs are becoming more common. In an ICO, a
quantity of cryptocurrency is sold in the form of tokens to venturers or investors
in exchange for fiat money or other cryptocurrencies such as Bitcoin or Ethereum.
The tokens sold are promoted as future functional units of currency if or when the
ICO’s funding goal is met, and the project launches.
267
The primary objective of investors to buy tokens through ICOs is to invest

money on the potential of a future product. Each cryptocurrency holds a use-case
that associates specific services. If the investors find the use-case lucrative enough
to become a successful product in future, they take the calculative risk of buying a
token that has just originated or not been launched yet. Once launched and popu-
lar, the token value is expected to grow giving investors their foreseen return.
16.1.1 The Creation of ICOs

It is sometimes assumed that Ripple Labs was the first company that acquired capi-
tal using the token sale, although not through a formal ICO. When Ripple Labs
developed the Ripple protocol in early 2013, 100 billion XRP tokens were created
at the genesis block. The company sold a fraction of these tokens in private to gener-
ate a working capital that helped it to survive during the early days. Nevertheless,
Ripple is not an ICO-dependent distributed ledger where selling tokens is their
vision or intention. Ripple has a defined policy of giving away tokens to charities
and partner companies instead of selling those in exchange for fiat money or another
cryptocurrency.
The first formal ICO took place in July 2013 when Mastercoin managed to
attract a good many people to buy its token MSC. Mastercoin is a successful
attempt to build a new protocol layer on top of Bitcoin. While Mastercoin allows
implementing exclusive features like design and creating contracts, the underly-
ing Bitcoin acts as the primary means of providing the foundation. The founder
of Mastercoin sold this use-case to investors who purchased MSC believing in its
potential. Some $1 million gathered from the token sale was later used to develop
the product.
Neither Ripple nor Mastercoin made ICOs famous; this is credited to Ethereum
that took the community by surprise when it raised $2.3 million (3700 BTC at that
time) in the first 12 hours of its token sale in 2014. Vitalik Buterin, the creator of
Ethereum, initially proposed changes so that Bitcoin can have a smart contract-like
feature. Failing to convince the Bitcoin community, he and a group of developers
who supported the idea arranged the crowdsale in mid-2014. Ethereum became
the centre of attention again in 2016 when a decentralised autonomous organisa-
tion called The DAO, a set of smart contracts developed on the platform, raised a
record $150 million in a crowdsale to fund the project. The event was surrounded
by controversy, dispute and scepticism as an unknown hacker took $50 million
in Ether soon after the event. It sparked a debate in the crypto-community about
whether Ethereum should perform a contentious hard fork to reappropriate the
affected funds. As a result of the dispute, the network split in two. Ethereum con-
tinued on the forked blockchain, while a new token Ethereum Classic continued
on the original blockchain.
The Ethereum blockchain went live on 30 July 2015 with 72 million coins pre-
mined, more than 70% of the total circulating supply available in 2018. Unlike
Initial Coin Offerings (ICOs) ◾ 269
Bitcoin that is a mined token, Ethereum intentionally took this path of creating
tokens in advance so that can be sold to obtain more funds for the project. This
approach is often considered greedy by the Bitcoin community, and Vitalik Buterin
is credited for popularising the pre-mining concept [Chong, 2018].
16.1.2 How Do ICOs Work?

An ICO is a crowdsale; hence it requires promoting the event to the right com-
munity. The team behind a new project typically announces the event on various
cryptocurrency forums, social media sites and sometimes in the mainstream media.
The announcement comes with a URL linking to the project’s website presenting
information such as a white paper of the project, goals, timeline of the development
phases, and the team involved and their experience to potential token buyers. The
promotional materials also pinpoint the key features of the product that the devel-
oper primarily sells alongside other ICO details.
Bitcoin and Ethereum are amongst the most popular methods of collecting
funds. Sometimes organisers create a global address that shows all the incoming
funds of the crowdsale. It is, however, not rare to have a separate and unique address
created for individual investors to collect the funds. The best practices dictate that
all funds ultimately be held in a publicly announced multi-signature address to
establish transparency and fairness in the process.
The duration of an ICO may vary. Generally, the crowdsale of an ICO runs for
a few weeks to raise as much money as possible. Occasionally, ICOs have a fixed cap
that requires achieving the target before the event may end. There are exceptional
cases when ICOs ran for a significantly longer period. For instance, block.one, the
company behind the EOS blockchain ran the ICO for a year raising $4 billion
using ERC-20 tokens for the project.
Once the ICO comes to an end, and the organiser launches the project, the
ICO tokens get listed at the cryptocurrency exchanges to trade against other cryp-
tocurrencies. The price of these tokens typically reflects the overall market senti-
ment of that token, the value of the product and its potential to grow.
16.2 Token Creation
ICOs come with a token (coin). The money that a project registers comes from the
sale of the token an ICO offers; hence the name “initial coin offering”. The following
discusses the nature of the token and the platforms that offer token-creation services.
16.2.1 Token
The purpose of arranging an ICO is to raise money for a future project selling its
pre-mined tokens to investors. Because the project stays at a proposal stage, by
the time the token sale takes place, usually the proposed blockchain is not ready
meaning there will be no tokens on the blockchain for sale. This situation leads
to a catch-22 problem. Luckily, there are many platforms available in the current
market that can assist the teams behind ICOs to create a temporary token and put
it on sale even before launching the native blockchain.
EOS is one of the notable examples. At the time of its ICO, the project did
not commence and, naturally, the EOS token was not ready for sale. Block.one,
the company behind the ICO, instead used the Ethereum platform for creat-
ing a token and gathered more than $4 billion from its crowdsale. When the
EOS platform became ready for operation, the token was transferred to its native
blockchain.
Possibly the next question hovering around the mind of the readers would be,
what is this temporary token? A token is a set of standards defined by the platforms
representing a value in Ethereum, Bitcoin or other cryptocurrencies. At the time
of an ICO, the project team creates this token and assigns a price tag against it.
During the crowdsale, investors can buy the token in exchange for the indicated
cryptocurrency. The token can be then stored in a wallet and kept for future usage.
Once the native blockchain is ready, the team will make the necessary arrangement
to transfer the token to its blockchain.
16.2.2 Platforms
Many platforms offer token creation; amongst them, Ethereum is the most popu-
lar. This blockchain platform not only popularised pre-mining and ICOs but
also came up with a token-creation mechanism that projects willing to offer
ICOs could easily use. The tokens that can be created on the Ethereum plat-
form are called ERC-20 tokens. “ERC-20” is basically a set of standards defining
the underlying rules of a token. These rules help to create, access and store the
token seamlessly [Blockgeeks, 2017]. These standards are elaborately described in
Chapter 5, Section 5.7.
Another popular token-creation platform is Waves. It is a cryptocurrency proj-
ect launched by the Russian entrepreneur Alexander Ivanov in 2016. The block-
chain platform itself was an ICO and raised $16 million to become one of the
largest projects in terms of funds raised through crowdfunding in 2016. Soon it
became one of the most popular ICO-hosting platforms. Tokens created on the
Waves platform need explanation as to why they were created and how they are
relevant to the project. Because no one can easily create a token on Waves and go
for an ICO, investors can rely more on these projects [Waves, 2017].
As of April 2018, 82.35% of ICOs created their tokens using the Ethereum
platform. Nearly 9% of tokens are custom-made, while 2.50% tokens are created
on Waves making it the second most used platform for ICOs. All other platforms
created 5.53% tokens combined. A small portion of tokens (0.89%) are created
using Bitcoin forks [BlockchainHub, 2018].
16.3 Understanding ICOs
The success of the Ethereum ICO made it possible to generate funds from the ini-
tial coin offerings for the development of blockchain projects by releasing some or
all of the native tokens. Because it has become a new form of investment, a grow-
ing interest in this type of investment can be observed. However, not all ICOs are
suitable for investment as many scams can be in disguise. It is therefore essential to
understand the nature and the characteristics of the ICOs to foresee the expected
growth of the investment.
16.3.1 ICOs vs IPOs
ICOs have been compared to initial public offerings (IPOs) of companies
(Table 16.1). There are some striking similarities, such as both of them are used to
sell a stake and raise money, and both have investors who see the potentials and risk
their capital to make a profit. However, there are notable differences as well. Early
supporters and enthusiasts mostly invest in ICOs. This approach makes ICOs more
like “kickstarter campaigns” with the backers having a substantial financial stake
Table 16.1 ICOs vs IPOs

ICOs IPOs
ICOs are organised by IPOs are organised by established

enthusiasts and start-ups in a companies to sell their company stocks.
bid to raise money for a new
idea or technology.
ICOs are not bound by IPOs are heavily regulated.

regulations.
ICOs are short in duration, IPOs generally take a longer time, often up
although some exceptions are to 6 months.
available such as ICO of EOS.
The team, group or company IPOs are arranged by an investment bank

behind the idea generally that also takes care of the legal and
promote and arrange the regulatory requirements tied with the
ICOs. offering.
ICOs are open to the public. IPOs are not generally open rather exclusive
in nature.
ICOs have a short, corrupt and IPOs have a solid long history dating back to
sordid history surrounded by 1602 when the Dutch East India Company
scams and frauds. offered shares of the company to the
public in order to raise capital.
in the project. ICOs are also not regulated or registered with any government, and,
generally, there exist no investor protections.
A company willing to issue an IPO must produce a legal document called a
prospectus. This document is a legal announcement that includes vital information
about the company and the IPO. There are some legal bindings that this document
needs to meet some standards of transparency. On the other hand, ICOs do not
require such legal documents. Although most ICOs publish a white paper where
everything about the project and its purpose is explained, it is not a necessity, and
groups organising the ICOs are not obligated to create this document.
The IPO is a long process taking up to 6 months in order to meet all legal
requirements. Processing ICOs can be very fast, and the duration may depend on
the nature of the project. When a company or a group issues a white paper and
a smart contract, it can start with the crowdsale. The duration of the crowdsale
depends on the project and targeted cap, and usually takes up to 1 month.
ICOs became a controversial issue in 2018 when South Korea and China
banned new offerings in their jurisdictions. It led to new ICOs to be marketed as
“crowdsales” instead of ICOs in order to avoid the legal requirements associated
with the securities sale. These ICOs use legal disclaimers and language to partici-
pants mentioning that ICOs are not securities. It is, however, unclear whether this
is sufficient for global jurisdictions to treat it differently from a securities sale and
the matter has not been prosecuted in a court of law as of this writing.
16.3.2 Signs of Good and Bad ICOs

Before investing through ICOs, investors must look out for some common signs
telling them the nature of those ICOs. There are signs warning investors to stay away
from certain ICOs that can be bad investments or scams, while some ICOs demon-
strate specific characteristics giving investors the required confidence to go ahead.
It is almost always a warning if the ICO proposal does not have a well-written and
well-documented white paper. People backing a project must know what they have
been talking about, and a good white paper will be their representative. A lack of such
a document indicates the lack of seriousness of the team for the project. And, if the
team is not serious enough, it is not worthy of placing a stake on them. Most scams set
a goal that is unrealistic and unachievable. They often fail to introduce the key people
involved in the project or the justification of their involvement or demonstrate their
experience in the areas the project is interested in. The absence of trust and transpar-
ency, and handling the token sale mysteriously are always a red alert for investors.
It is, however, not the case that all ICOs are bad. While researching for poten-
tial projects where investors can put their money, ICOs having hype and discus-
sions in the community are good to start with. Investors must also look at the
white papers and try to understand the use-case those ICOs have been addressing.
The key people backing the projects and their experiences are parameters that can
standout good ICOs. A realistic goal with a defined problem that potentially has
a robust solution is a strong indication of a good ICO. It is difficult to filter good

use-cases amongst the scams and bad ones, however, once done, investment in ICO
can be very lucrative.
16.3.3 Advantages and Disadvantages

Investing in ICOs has both advantages and disadvantages. It is essential for inves-
tors to realise the challenges and the difficulties associated with ICOs before buying
tokens. Arguably the most significant advantage of the ICO is that it is open to the
public. Anyone willing to purchase tokens can get involved without going through
much hassle. Generally, tokens are sold at a lower price giving investors the chance
to have a good return. However, some disadvantages must not be overlooked either –
for example, regulation and risk. Unlike IPOs, ICOs are not regulated, and there-
fore chances of losing the money are high. The investment itself is very risky due to
the nature of the projects and the people who run it. Enthusiasts or start-ups run
most blockchain projects, and almost always their use-cases try to solve something
new making them risky. Table 16.2 lists some key advantages and disadvantages of
investing in ICOs.
Table 16.2 Key Advantages and Disadvantages of ICOs

Advantages Disadvantages
ICOs are open to the public where It is easy to manipulate the token
anyone can invest by purchasing sale and the market as a whole.
tokens.
The process of buying tokens is simple ICOs are unregulated. It means

and straightforward. Most ICOs accept fraud can happen anytime, and
Bitcoin and Ethereum to buy tokens, people backing the project may
giving investors the freedom of staying not comply with what they
within the cryptocurrency ecosystem. promise at the time of token sale.
ICOs increase the chances of buying The unregulated token sale

tokens at a very lower price. encourages scams to get involved
more in the market.
Generally, ICOs do not have a minimum People associated with ICOs are
or maximum purchase cap, and the mostly enthusiasts with no
investors can buy the number of tokens proven track record.
of their interest.
Because start-ups and enthusiasts mostly It is risky to rely on enthusiasts

run the blockchain project, investors and the promise they make even
having a good stake can get more if they have the genuine
involved in the project and play a role intention to make the project a
in shaping the blockchain industry. success.
16.4 ICOs in Number
The first reported ICO of Mastercoin took place in 2013 followed by Ethereum and
Karmacoin in 2014 and 2015 respectively. The number of ICOs suddenly jumped
in 2016 when 54 major ICOs raised more than $103 million. In 2017, the number
of major ICOs hit 92 raising a mammoth total of $1.25 billion. The following
discusses the numbers in more detail and identifies the biggest winners and losers
from the ICOs in recent time.
16.4.1 Amount Raised
During the cryptocurrency bull run in 2017, ICOs suddenly became very popular
attracting hundreds of thousands of investors. In addition to 92 major ICOs, many
other small projects raised money throughout the year. It is anticipated that about 552
ICOs raised more than $7 billion. Amongst the most successful ICOs, Filecoin raised
$257 million, Tezos $232 million, Paragon $183 million, Finney $157 million and
Bancor $153 million. The ICO Watch List, an organisation dedicated for collecting and
providing ICO-related data, publishes all notable ICOs and the amount they register
during the crowdsale. Their data is accessible using the URL www.icowatchlist.com.
A joint report published by the consulting firm PwC and the Swiss Crypto
Valley Association stated that in 2018 despite the market crashes and price collapse,
ICOs became more popular. A total of 537 ICOs registered a volume of $13.7 bil-
lion during the year [Diemers et al., 2018]. The ICO Watch List reports EOS to be
the most successful project of the year raising $4.1 billion. The amount is by far the
most substantial sum an ICO ever registered. Amongst the other thriving ICOs,
Telegram raised $850 million, tZero $250 million and Elastos $94 million in 2018.
The United States is the jurisdiction where the largest number of ICOs are cre-
ated totalling 370 to date. Russia and the United Kingdom are the next two most
popular nations for ICOs with 231 and 187 respectively. Singapore and Switzerland
also attracted a significantly large number of projects, more than 250 ICOs between
them. Estonia, Singapore and Cyprus are the top 3 countries with most ICOs per
million people. Statistics show that in 2017, a total of $956 million was raised in
Russia, $778 million in the US, $258 million in Singapore, $131 million in the UK
and $35 million in Estonia.
There were 4 months in 2017 when the registered amount crossed the $300 mil-
lion mark with September being the most successful raising $537 million. In 2018,
the most prosperous month was June that raised $4.1 billion, although it is mainly
due to the closure of EOS that ran for almost a year.
16.4.2 Breakdown by Industry
According to the ICO Watch List, the network and telecommunication indus-
try attracted the most significant sum raised by ICOs. A total of $4.6 billion was
registered for projects proposing use-cases related to communications. Blockchain

platform and smart contract projects gathered the second largest total of $1.6 bil-
lion followed by industries like finance ($453 million), drug and health ($276 mil-
lion), payment networks and wallet providers ($262 million), and commerce/retail
($193 million).
Although the network and telecommunication industry attracted more than
half of the registered fund, only 16 projects (2.3% of the total ICOs) accumulated
that capital ensuring those companies a robust financial backing during the early
stage of their life cycles. Thirty-eight blockchain platform companies, 5.5% of the
total ICOs, claimed almost 20% funds, while the financial industry saw 84 compa-
nies (12.2%) claiming the third largest share. Table 16.3 presents the funds raised
so far according to industries.
16.4.3 Biggest Winners and Losers

The price of the token does not necessarily always reflect the real value of the
use-case, but it is indeed an indication of how a company has been doing. During
the ICOs, investors buy tokens expecting growth in future. Some projects ensure
substantial return while many fail to grow at all.
A 2018 report compiled by BlockchainHub evaluated projects that came
into being through ICOs in 2017 and found that as of 13 April Spectrecoin
was the biggest winner returning 37,175% of investors’ money. Storj.IO is
another project that saw 9822% growth followed by Qtum (5525%), Populous
(4891%) and Omisgo (4832%). Amongst the biggest losers, Useless Ethereum
Token, an ICO created to mock Ethereum, saw its value go down by 99.74%.
LevierCoin, Dimcoin, iDice and BlockCAT all lost more than 95% of their stake
[BlockchainHub, 2018].
16.5 Scams and Criticisms

The successful launch of the Ethereum platform encouraged other projects to
raise capital using ICOs. Many major blockchain platforms and companies ben-
efited from the idea and successfully secured the required funds to get started.
However, this also paved the path for bad actors in the industry having fraudu-
lent intentions to steal investors’ money. The crypto start-up Giza is one ideal
example. It raised $2.4 million using a fake ICO involving more than a thousand
investors in 2018 [McQuaid, 2018]. Other examples include the US Securities
and Exchange Commissions (SEC) freezing $15 million from PlexCoin that it
accumulated using an ICO promising a 1354% return [Palmer, 2018]. Another
blockchain platform called Benebit raised around $4 million in 2017 using fake
photos for the administrative team and just walked away with the money after-
wards [Sedgwick, 2018b].
Table 16.3 ICOs by Industry (as of 2018)

Industry % Of Projects Total Raised
Network/communications 2.32% $4,640,447,641
Blockchain platform 5.50% $1,688,474,628
Finance 12.16% $453,615,006
Drugs/health 3.76% $276,868,999
Payments/wallets 6.66% $262,955,940
Commerce/retail 5.64% $193,172,700
Content/advertising 2.75% $120,550,000
Gaming/AR/VR 4.92% $120,172,361
Media/content 3.91% $117,510,000
Data/computing/AI 4.92% $117,370,000
Social network 2.03% $112,110,000
Funding/VC 3.04% $98,920,000
Energy/utilities 2.03% $90,000,000
Security/identity 3.33% $80,060,000
Asset management 5.35% $72,916,240
IoT 3.76% $66,508,616
Prediction market 3.91% $62,703,450
Jobs/marketplace 2.75% $48,724,150
Entertainment 3.76% $36,580,000
Industry/logistics 2.32% $34,279,663
Real estate 2.75% $28,410,000
Betting/gambling 4.34% $22,370,000
Education 1.16% $13,900,000
Insurance 1.16% $7,397,480
Music/arts 0.43% $1,360,000

Scams and frauds using ICOs make regulatory bodies around the world take
strong legal actions against the companies involved. US authorities acted on more
than 750 legal cases during the first half of 2018 alone. Amongst these cases, notable
ongoing lawsuits include those against Ripple Labs alleging it raised funds through
the unregistered sale of XRP to retail investors and against UK-based Bitconnect for
failing to disclose material facts that caused its value to drop [Castillo, 2018]. Airfox
and Paragon are two companies that are currently under investigation by the SEC.
It appears that the SEC, instead of launching random crackdowns, using these two
cases to prepare future templates for ICO enforcement in the US [Palley, 2018]. The
authorities in China and South Korea banned ICOs fearing that investors in the
country would lose money to scams.
ICOs and token sales also became notoriously popular when Bitcoin and other
cryptocurrencies had a rollercoaster ride in the exchanges in 2017. At the start of
October coin sales from ICOs of that year were worth $2.3 billion, more than ten
times as much as in all of 2016. By the time the year hit November, there were
around 50 offerings a month with the highest-grossing ICO being Filecoin raising
$257 million, of which $200 million was raised within the first hour of the token
sale. Companies raised more than $7 billion via ICOs in 2017 where 20 ICOs
made 37% of that amount. By February 2018, an estimated 46% of the 2017 ICOs
had failed [Sedgwick, 2018a].
Joseph Lubin, co-founder of Ethereum, claimed during an interview with
CNBC in November 2017 that many ICOs are copycats that do not intend to offer
any real value to investors. His statement was echoed by Brad Garlinghouse, CEO
of Ripple Labs, who mentioned token sales operate in a grey area while waiting for
regulation to catch up [Choudhury, 2017]. More recently, a study conducted by the
ICO advisory firm Statis Group noticed that more than 80% of 2017 ICOs were
scams. The study took into consideration the life cycle of the project from the pro-
posal stage to the most mature phase of trading on a crypto exchange [Alexandre,
2018].
The number of scams involving ICOs became so frequent in 2017 that
internet giants Google and Facebook had to ban all advertisements concern-
ing cryptocurrencies. As of 2018, Facebook had partially lifted the ban allow-
ing only credible companies to post ads through a separate approval process
[McLean, 2018], while Google also lifted the ban but for the US and Japan
only [Marshall, 2018].
16.6 Summary
This chapter presented the whole landscape of ICOs. The goal of this chapter was
to introduce readers to this new crowdfunding process and explain how it works.
In doing so, the chapter first discussed how ICOs came into being following the
renowned pre-sell of Ethereum tokens, and how tokens are created and sold in the
absence of the proposed blockchain. It then continued to explain the differences

between IPOs and ICOs as well as the advantages and disadvantages of investing
using this method followed by discussions giving some historical breakdown of
past ICOs and how fraudulent actors have been trying to misuse this crowdfunding
technique. Along with Chapter 15, this chapter provided the basis for investing in
cryptocurrencies and blockchain projects.
Part VI
SOCIO-ECONOMIC VI
LANDSCAPE
Chapter 17
Economic Outlook
of Cryptocurrency
A striking feature of cryptocurrency is its potential to act as an alternative form of

money. Traditionally, money had either intrinsic value or derived value from government
decree that acts as its foundation. Even when people use money electronically, the use
of private ledgers and at least one trusted intermediary is necessary. Cryptocurrencies,
however, employ user agreements, a network of users and cryptographic rules to achieve
transfers of value. In this process, it uses blockchain technology to protect the public
ledgers of accounts against manipulation allowing users to make valid transfers without
a centralised and trusted intermediary. This revolutionary concept not only threatens
to rival traditional money but also challenges the conventional practices of the use of
money in our societies. This chapter presents the economic outlook of cryptocurrencies
with takes on exploring how users, merchants, regulators and experts treat this virtual
money as an economic tool. In doing so, the chapter looks at classifications, prices,
volatilities and acceptance of cryptocurrencies in the society.
17.1 Classification
Cryptocurrencies are digital assets frequently referred to as currency, digital cash,
virtual currency, electronic currency, digital gold and more commonly cryptocur-
rency. There is still no consensus as to how authorities classify them. While some
describe them as “decentralised money”, others state that they are “protocols” and
“public ledgers containing entries.” Despite these definitions having some form of
facts and descriptions of the underlying properties in part, they are not complete
reflections of cryptocurrency. This tendency of looking at cryptocurrencies from
281
multiple points of view created confusion and led authorities and investors to clas-
sify them in three broad categories: currency, commodity and stock.
17.1.1 Currency
The phrase cryptocurrency suggests that it possibly resembles currency more than
anything else. Although the question of whether Bitcoin and similar coins are cur-
rencies or not is disputed, however, The Economist magazine articulated that they
have three useful qualities as currency: they are hard to earn, limited in supply and
easy to verify [Boden, 2015]. In Chapter 12, we saw economists defining money as a
store of value, a medium of exchange and a unit of account. Cryptocurrencies have
some way to go to meet all these criteria. They do best as a medium of exchange;
by the start of 2015, the number of merchants accepting Bitcoin had already passed
half a million (Figure 17.1). All cryptocurrencies including Bitcoin, Ether and
Figure 17.1 A Bitcoin ATM at a shop in Wien Westbahnhof railway station,

Vienna.
Economic Outlook of Cryptocurrency ◾ 283
XRP have an exchange rate against most major currencies including the US dollar
(USD), British pound (GBP) and euro (EURO), and it is possible for investors to
make profits by buying and selling cryptocurrencies like other fiat currencies.
Classification of cryptocurrency by the United States government is unclear at
the time of this writing with multiple conflicting rulings. Judge Amos L. Mazzant
III of the United States District Court for the Eastern District of Texas stated in a
2013 ruling that “Bitcoin is a currency or form of money” [Hill, 2013]. However,
an opposite verdict came 3 years later, in 2016, when Judge Teresa Mary Pooler of
the Eleventh Judicial Circuit Court of Florida cleared Michell Espinoza in State
of Florida v. Espinoza for money-laundering charges he faced involving his use of
Bitcoin. Pooler stated, “Bitcoin may have some attributes in common with what
we commonly refer to as money, but differ in many important aspects, they are
certainly not tangible wealth and cannot be hidden under a mattress like cash and
gold bars” [Hurtado and Nesmith, 2016]. Later the same year, a ruling by Judge
Alison J. Nathan of the United States District Court for the Southern District of
New York contradicted the Espinoza ruling stating, “Bitcoins are funds within the
plain meaning of that term. Bitcoins can be accepted as a payment for goods and
services or bought directly from an exchange with a bank account. They therefore
function as pecuniary resources and are used as a medium of exchange and a means
of payment” [Redman, 2016].
17.1.2 Commodity
Cryptocurrencies are sometimes considered commodities. A commodity is a single
unit of a tangible asset – for example, gold, silver and oil. Commodities are dissimi-
lar to stocks or bonds on the basis that who produces them does not matter. Across
all marketplaces, such commodities remain mutually interchangeable. Further,
commodities have a limited and fixed supply because unlike a stock certificate, one
cannot just create another ton of timber. The pricing of commodities is entirely
determined by supply and demand. These qualities readily describe Bitcoin and
similar cryptocurrencies. Their algorithm has a fixed quantity at a predetermined
rate that does not alter the inherent value, and like other commodities, they need
to be sold to be profitable, implying that supply and demand determine the value
[Bitcoin Exchange Guide Team, 2018].
The US government’s Commodity Futures Trading Commission classifies
cryptocurrency as a commodity, and the Internal Revenue Service classifies it as an
asset [Redman, 2016], while the South African Revenue Service, the legislation of
Canada, the Ministry of Finance of the Czech Republic and several others classify
it as an intangible asset [Rangongo, 2018; Appel, 2014]. Leading newspapers also
took the same stance. Back in 2013, The Wall Street Journal described Bitcoin as a
commodity and Forbes described it as a digital collectable debunking its currency
status [Chapman, 2013; Woodhill, 2013]. More recently, The Guardian described
Bitcoin as digital gold [Usborne, 2017].
17.1.3 Stock
Although it is less common, many investors consider cryptocurrency as stock.
This approach was universalised by initial coin offerings (ICOs) where groups and
start-ups sell pre-mined tokens in a bid to raise working capital and in exchange
give token holders the right to participate in the administrative activities of the
blockchain. Because ICOs resemble many features that IPOs offer, they are consid-
ered similar. In reality, however, there are stark contrasts between ICOs and IPOs.
Professor Meg Luo of the Villanova University School of Business while writing for
U.S. News and World Report argued that investors buy stocks and bonds because
they bring in future cash flows, interest and principal income in the case of bonds
and dividend for stocks, and capital gains from a possible increase in price in the
future. However, cryptocurrencies can only offer a return in the price increase. Her
arguments also point to the fact that stock market prices tend to be low in volatility
to achieve overall stability. When it comes to Bitcoin and cryptocurrencies, volatil-
ity seems to be an integral part of the ecosystem making them less likely to function
similar to stocks [Luo, 2018].
17.2 Price of Bitcoin
The prices of Bitcoin and other cryptocurrencies have gone through various cycles
of appreciation and depreciation with Bitcoin leading the volatility parade. Such
behaviour of cryptocurrency pricing is referred to by many as bubbles and busts.
Forbes suggested Bitcoin is a classic bubble, while The Guardian referred to it as the
“Harlem shake of currency” stating that it is nothing but a bubble as early as in
2013 [Colombo, 2013’ Moore, 2013].
Having reached its all-time high price of nearly $20,000 in December 2017, the
value of Bitcoin sharply fell below $3000 within a year. Many pointed to this drop
as the beginning of the end of Bitcoin and other cryptocurrencies. It is, however,
interesting to find that the cryptocurrency giant had suffered even worse declines
in the past.
On 17 March 2010, the now-defunct BitcoinMarket.com exchange first offered
trading Bitcoin at $0.003. The value of Bitcoin rapidly rose in 2011 when the price
of a single token moved from about $0.30 to $32 before returning to $2 – a massive
growth of 10,566.66% followed by a 1500% decline. In the latter half of 2012 and
during the 2012–13 Cypriot financial crisis, the price began to rise again reaching
a high of $266 on 10 April 2013, before crashing to around $50. On 29 November
2013, the cost of one Bitcoin rose to an all-time peak of $1242 (2384% growth).
Some evidence suggests that part of this peak in the price of Bitcoin was due to
price manipulation [Gandal et al., 2018]. In 2014, the price fell sharply, and as of
April remained depressed at little more than half its 2013 pricing facing a decline
of about 265%. As of August 2014, Bitcoin was under $600.
In January 2015, noting that the Bitcoin price had dropped to its lowest level
since spring 2013 – around $224, losing approximately 455% of its value – The
New York Times suggested that the industry is bracing for the effects of a pro-
longed decline in prices and flashing warning signs [Ember, 2015]. The same year,
Business Insider reported that deep web drug dealers were “freaking out” as they
lost profits through being unable to convert Bitcoin revenue to cash quickly enough
as the price declined and that there was a danger that dealers selling reserves to
stay in business might force the Bitcoin price down further [Price, 2015]. Those
predictions, however, did not prove to be correct rather 2016 saw Bitcoin price
staying mostly stable between $600 and $780. As of January 2017, the price was
$800 that ultimately hit nearly $20,000 within 12 months only to drop back to
around $3000 by December 2018 where it had been hovering at the time of writ-
ing. This saw Bitcoin experiencing another massive growth of roughly 2400%
followed by 566.66% decline. Figure 17.2 shows how the price of Bitcoin moved
from 2008 to 2018.
17.3 Volatility of Bitcoin
In finance, volatility is the degree of variation of a trading price series over time
as measured by the standard deviation of logarithmic returns. The volatility of
Bitcoin’s price has been a piece of prime news ever since. It attracted prominent
figures from the financial and tech industries to comment on it. Many tried to
predict the price while others warned potential investors of their disbelief in block-
chain technology. Nevertheless, it has been observed numerous times that experts
make harsh comments about Bitcoin and write off blockchain technology follow-
ing massive crashes, but this virtual currency eventually revives and moves from
one a ll-time-high to another in the end.
According to risk management expert Professor Mark T. Williams, as of 2014,
Bitcoin has volatility 7 times greater than gold, 8 times greater than the S&P 500
and 18 times greater than the US dollar [Williams, 2014]. Attempting to explain
the high volatility, a group of Japanese scholars pointed out that having no stabi-
lisation mechanism is one of the causes behind the irregular movement of Bitcoin
and other cryptocurrency prices [Iwamura et al., 2014]. The Bitcoin Foundation
contends that high volatility is due to insufficient liquidity, while a Forbes journal-
ist claims that it is related to the uncertainty of its long-term value and the high
volatility of a start-up currency that people are still experimenting how to figure out
how useful it could be [Wilkes, 2013; Lee, 2013].
A group of pro-Bitcoin venture capitalists, in 2014, argued that significantly
increased trading volume is needed to decrease price volatility [Casey, 2014a]. This
view was echoed in a statement made by Canadian and Dutch experts who stated that
according to economic theory, the volatility of the price of Bitcoin would drop when
business and consumer usage of this virtual currency increases. It is due to the usage
Figure 17.2 The historic price movement of Bitcoin. (Image courtesy of Bitcoin

Wiki.)
for payments that reduce the sensitivity of the exchange rate to the beliefs of specula-
tors about the future value of this virtual currency [Bolt and Oordt, 2016]. According
to The Wall Street Journal, as of April 2016, Bitcoin is starting to look slightly more
stable than gold [Yang, 2016]. On 3 March 2017, the price has surpassed the value of
gold for the first time, and its price surged to an all-time high [Molloy, 2017].
A study in Electronic Commerce Research and Applications, going back through
the network’s historical data, showed the value of the Bitcoin network as measured
by the price of Bitcoins, to be roughly proportional to the square of the number of
daily unique users participating on the network. This is a form of Metcalfe’s law
and suggests that the network was demonstrating network effects proportional to
its level of user adoption [Alabi, 2017].
17.4 Historic Price Predictions

Financial journalists, analysts, economists and investors have attempted to pre-
dict the possible future value of Bitcoin on several occasions. In April 2013, John
Quiggin, professor of economics at the University of Queensland, stated in an
article he wrote for National Interest magazine, “Bitcoins will attain their true value
of zero sooner or later, but it is impossible to say when” [Quiggin, 2013]. A similar
forecast was made in November 2014 by Kevin Dowd, professor of finance and eco-
nomics at Durham University, in his article titled “Bitcoin is Bust: Why Investors
Should Abandon the Doomed Cryptocurrency” [Dowd, 2014].
Mark T. Williams, professor of finance at Boston University and an expert in
risk management, forecast in December 2013 that Bitcoin would trade for less than
$10 by mid-2014 [Williams, 2013]. In the indicated period Bitcoin exchanged as
low as $344 (April 2014) and during July 2014 the price was $609. In November
2014, David Yermack, professor of finance at New York University Stern School
of Business, forecast that in November 2015 Bitcoin may be all but worthless
[Macguire, 2014]. In the indicated period Bitcoin exchanged as low as $176.50
(January 2015) and during November 2015 Bitcoin’s lowest price was $309.90.
However, not everyone has had a sceptical view of Bitcoin while predicting its
value. In May 2013, Bank of America foreign exchange and rate strategist David
Woo forecast a maximum fair price of $1300 for each Bitcoin token [Sharf, 2013].
Investor Cameron Winklevoss stated in December 2013 that the “small bull case
scenario for Bitcoin is $40,000 a coin” [Stan, 2013]. By December 2017, Bitcoin
reached half of this value before crashing to $3000 within a year. In December
2014, a year later following his comment that Bitcoin price would go down to $10
by mid-2014, Williams stated, “The probability of success is low, but if it does hit,
the reward will be very large” [Sidel, 2014].
17.5 Price Movement of Major Cryptocurrencies

Bitcoin is the giant amongst the cryptocurrencies and tends to influence the price of
others. It is highly unlikely that when Bitcoin goes bearish, other cryptocurrencies
will not follow suit. This is the reason why experts talk about Bitcoin to indicate
the whole industry. Nevertheless, there have been some instances when other cryp-
tocurrencies tried to break away from the influence of Bitcoin and developed their
pattern; although that did not last long. The following briefly presents a commen-
tary of the price movement* of some of the major cryptocurrencies and the story
behind how they came into being.
* All prices are taken from www.coinmarketcap.com, which is free and publicly available to
access.
17.5.1 ETH
The ETH, spelt out as Ether, is the native cryptocurrency of the Ethereum plat-
form. It is the fundamental token for the operation of its distributed ledger and gas
payments.
The Ethereum platform went live on 30 July 2015 with 72 million tokens
pre-mined. This accounts for about 70% of the total circulating supply in 2018.
For the first 1½ years, Ether traded below $12. However, in May 2017, Ether
experienced massive growth of 13,000% following in the footsteps of Bitcoin
and hit its all-time-high price of about $1400 on 15 January 2018. In less than
a year its value fell by 1455% and has been trading below $90 as of December
2018.
In 2016, following the theft of $50 million worth of Ether, Ethereum encoun-
tered a hard fork, splitting into two separate blockchains – the new version became
Ethereum (ETH) with the theft reversed and the original continued as Ethereum
Classic (ETC). As of December 2018, ETC was trading below $5.
17.5.2 XRP
XRP is the native cryptocurrency of the Ripple protocol. Unlike Bitcoin, this cryp-
tocurrency along with the Ripple protocol is heavily promoted by Ripple Labs, the
company that created the network. Due to having a strong use-case focusing on
becoming a global financial network and securing a number of reputed partners
to use the system, Ripple came under the spotlight in 2017 and briefly surpassed
Ethereum to become the second largest cryptocurrency based on market capi-
talisation. Although Ethereum soon regained second place, later that year Ripple
strongly captured the position again and as of December 2018, it has been holding
on to it.
The XRP has been in the market since 2 February 2013. It was first traded in
the cryptocurrency exchange on 4 August 2013 at a price of $0.01 that reached
$0.05 on the 1 December 2013 delivering growth of 400% within 4 months of
its launch. The value of XRP, however, soon returned to $0.01 and stayed below
$0.05 for more than 3 years. On a couple of occasions, in 2013 and 2014, the
price of this cryptocurrency refused to follow Bitcoin indicating a new trend for
Ripple protocol. Despite those early signs, this did not happen until April 2017
when XRP broke away from the influence of Bitcoin and raised on its own. On
29 March 2017, XRP was traded at $0.01 and hit $3.20 on 5 January 2018. In
less than 9 months XRP experienced incredible growth of 31,900.00%. Although
this rapid growth of XRP coincided with Bitcoin’s all-time high price, it did not
strictly follow the pattern. There was a clear and unique trend for XRP that dis-
tinguished its journey than that of Bitcoin’s. The massive crash of the cryptocur-
rency market in 2018 saw the value of XRP fall below $0.50, which Ripple has
yet to recover from.
17.5.3 XLM
XLM, shorthand for Lumen, is the native token of Stellar. Originally Stellar was
created from a hard fork from the Ripple network, but soon it established itself as
one of the major cryptocurrencies. XLM was first introduced for trading by the
Brazilian Bitcoin exchange Mercado Bitcoin on 5 August 2014 and many exchanges
around the world soon follow suit. Since its inception, the price of XLM remained
below $0.003 until April 2017 when cryptocurrency markets started to experience
massive growth. Instead of following Bitcoin, XLM followed its predecessor XRP
and reached an all-time high in January 2018. As of 4 April 2017, XLM has been
trading at $0.003137, and in 9 months, it reached $0.93 experiencing an enormous
growth of 29546.15%. As of December 2018, this cryptocurrency is now steadily
trading at around $0.10.
17.5.4 NEO
NEO is the native cryptocurrency of the NEO blockchain platform. It was first
traded in the cryptocurrency exchange on 9 September 2016 at a price of $0.18 in
the name of Antshares. Later it was rebranded to its current name in June 2017. It
is a pre-mined coin, and a total of 100 million NEO were created in the genesis
block. Fifty million NEO were sold to early investors, with the remaining 50 mil-
lion NEO locked into a smart contract. Each year, 15 million NEO tokens are
unlocked for the NEO development team to fund long-term development goals
and will never enter into the exchanges for trading. NEO tokens generate a slowly
deflationary amount of GAS tokens, which are used to pay for transactions on the
network. The inflation rate of GAS is controlled with a decaying half-life algorithm
that will release 100 million GAS over approximately 22 years. More on this can
be found in Chapter 6.
As of April 2017, NEO traded at $0.18 or below, but soon it joined the cryp-
tocurrency bull movement and reached its all-time high of $196.85 on 15 January
2018. NEO is one of the few cryptocurrencies that revived close to its all-time high
following the mid-January crash. Having seen its price hovering at around $100,
NEO gained a price of approximately $160 by the end of the month. However, the
resistance this cryptocurrency showed did not last long and crashed again. Later
that year on multiple occasions, NEO again demonstrated strong resistance reject-
ing to follow the footsteps of Bitcoin, but ultimately came under the influence of
Bitcoin by the end of the year. As of December 2018, NEO has been trading at
around $7.
17.5.5 EOS
EOS is the native cryptocurrency of the EOS blockchain. It was established amid
the cryptocurrency bull run of 2017 and officially launched following a yearlong
ICO that saw 1 billion pre-created tokens sell for a total of $4.2 billion. The EOS
token was first traded at $1 but soon its value started to shoot high, and by January
2018 when all other cryptocurrencies hit their all-time high, it reached $18.16. It
was a new all-time high for EOS, but not its best.
EOS is the only dominant cryptocurrency that broke away from the influence
of Bitcoin and demonstrated its unique pattern for the first half of 2018. It is also
the only cryptocurrency that hit another all-time high of $21.46 on 29 April 2018
when all other cryptocurrencies including Bitcoin had been struggling. However,
following a series of cryptocurrency market crashes and the arrival of bad rumours
and the news of strict government regulations for the industry, the latter half of
2018 saw EOS come under the influence of Bitcoin and follow this giant’s move-
ment. As of December 2018, EOS has been trading at below $3.
17.6 Reception
The acceptance of cryptocurrency as an economic tool does not depend only at
the hands of users rather merchants who accept payments, investors who put more
money into this industry to grow it further and governments who create the envi-
ronment for everyone to use it play a vital role in this regard. The following analyses
that how these three entities have been reacting to the arrival of this new kind of
alternative money in our society.
17.6.1 Acceptance by Merchants
It has been a decade since the first cryptocurrency became available, but the use of
this new type of alternative currency is rare with merchants outside the exchanges
(Figure 17.3). Bitcoin’s nature of taking around 10 minutes to process payments
through the blockchain and hefty fees for small retail purchases makes it impracti-
cal to buy a cup of coffee or similar product on the go. The volatility of cryptocur-
rency is another challenge, as merchants frequently need to adjust the price through
conversion with a fiat currency such as the US dollar.
Contrary to common belief, during the early days of Bitcoin and other alt-
coins, merchants were more willing to accept cryptocurrency but have become
more restrictive in recent time. Statistics show that in 2017 and 2018 Bitcoin’s
acceptance amongst major online retailers included only 3 of the top 500 US online
merchants, down from five in 2016. Another report by Bloomberg stated that the
largest 17 crypto merchant-processing services handled $69 million in June 2018,
down from $411 million in September 2017 [Kharif, 2018].
Cryptocurrency seems to be more suitable for large and delay-tolerant pay-
ments. Bitcoin started to be accepted for real estate payments in late 2017 when
the first recorded sale of a house in exchange for Bitcoin happened in September.
Texas-based Kuper Sotheby’s International Realty brokered the deal using bitpay.
Figure 17.3 Bitcoin is accepted as a method of payment at a cafe in Delft, the

Netherlands.
com to process the payment. Two months later, the first recorded sale of an apart-
ment in the world and first real estate property in Europe was sold for Bitcoin in
the Czech Republic. The Czech real estate agency HOME Hunters brokered the
deal for a 3-room apartment for a Russian buyer without using payment service
providers at all [Elkins, 2018].
Despite the challenges, many online and offline merchants still accept cryptocur-
rencies as payment. For example, Microsoft has been accepting Bitcoin in its online
Xbox Store since 2014, while Purse.io is a platform that allows spending Bitcoin on
Amazon. Overstock, one of the largest US internet retailers, and Expedia, one of the
world’s largest travel agencies, accept cryptocurrency for buying products and book-
ing hotels and flights. In addition to many online merchants, there are hundreds
of thousands of offline restaurants, hotels, supermarkets, car dealers and so on that
accept cryptocurrency payment across the globe. CoinMap* in an interactive map
provider that offers users information from these outlets worldwide (Figure 17.4).
17.6.2 Acceptance by Investors
There is a division between investors as to whether to put their money in the block-
chain industry, particularly in cryptocurrencies. It looks like young and novice
* CoinMap is publicly accessible using the URL www.coinmap.org.

Figure 17.4 A map showing outlets accepting Bitcoin as a method of payment in

London (left) and New York (right).
investors are more willing to invest in blockchain than the people having more
experience. This division is echoed in the voice of Andreas Treichl, the CEO of
Erste Group Bank AG, one of the largest financial services providers in Central and
Eastern Europe, when he admitted in an interview with Bloomberg that he is not
a “believer” in this technology and prevented his children from investing money in
Bitcoin despite their strong wish. Distinguished investor Warren Buffet has been a
long-time Bitcoin sceptic who claims this virtual money not to be a value-produc-
ing asset and a “real bubble”.
Perhaps the most hostile reaction came from the CEO of JPMorgan Jamie Dimon
who called Bitcoin a “fraud” and stated that if JPMorgan traders began trading in
Bitcoin, he was going to fire them “in a second”. It was remarkable that a year later
he admitted that he regrets his comment and praised blockchain technology saying
that “the blockchain is real. You can have crypto yen and dollars and stuff like that”.
Regardless of the criticism, the blockchain industry has been experiencing
massive growth despite the huge market crash that happened throughout the year
2018. Surprisingly, more than $13 billion was invested through ICOs alone dur-
ing this period [Diemers et al., 2018]. It appears that large corporates such as IBM
and Microsoft have taken initiatives to build blockchain products, while large
exchanges such as Coinbase have recently released cryptocurrencies. It is still too
early to comment on the future of this industry, but early signs are mostly positive
outside the trading markets.
17.6.3 Acceptance by Governments
Government is perhaps the most important amongst the three entities, as their
unwillingness to support the rise of cryptocurrency will only create chaos and
turmoil. The arrival of decentralised Bitcoin was first treated as an attack on

government-controlled monetary systems. South Korea’s action on taking down
cryptocurrency exchanges and China banning cryptocurrency mining were forms
of retaliation from those governments against the revolt that Bitcoin-enthusiasts
initiated a decade ago. However, blockchain has moved on from its original forms,
and running unregulated is not the concern of most projects in recent times. The
actions South Korea and China demonstrated hardly helped to develop this tech-
nology and only increased volatility in the market followed by a series of crashes
[Kim, 2018a; Hsu, 2018].
Despite some governments taking a hard line, there are also a few nations that
are friendly with this new technology. Sweden, Switzerland, Estonia, Malta, Dubai
and Japan are jurisdictions that extended their hands to support the growth of
ICOs and exchanges. Amongst them, Estonia attempted to adapt blockchain tech-
nology even before the arrival Bitcoin, while Switzerland has an entire city in Zug
to nurture ICOs and start-ups related to this new technology. Sweden has been
in preparation for launching its own digital money, and Dubai aims to become
the first blockchain-powered government by 2020 [Adams, 2018; Billner, 2018;
Jenkinson, 2018].
Blockchain technology is going through a crucial phase as the European Union
and the United States are currently considering regulations for cryptocurrency
as an asset, and for its underlying technology. As two of the largest geographical
regions where cryptocurrency is mined, created and used, the regulations they put
forward will significantly alter the future path of this technology in future. Chapter
19 will elaborate more on the topics of government regulations, actions and willing-
ness to control this technology.
17.7 Summary
This chapter presented the economic outlook of cryptocurrencies. The ability of
these virtual currencies to act as an alternative to regular money makes it essential
to look at their utilities and acceptance in society. With that objective in mind, the
chapter presented discussion related to the classification of cryptocurrencies fol-
lowed by the movement and volatilities of prices; past predictions that ultimately
proved to be wrong; and acceptance by merchants, investors and governments
around the globe.
Chapter 18
Crime, Criminals and

Cryptocurrencies
It is an unfortunate fact that the underworld recognised the potential of Bitcoin

before learned society did. Renowned thriller writer Dan Brown in his bestsell-
ing novel Origin narrated an instance where a contract killer is contacted using a
secured network and given the assignment of killing a person for which the killer
receives payment in Bitcoin. This narrative of the novel may sound dramatic, but
the reality is that an episode like this seems to be no longer fiction. Underworld
syndicates have secured networks and a convenient payment method in Bitcoin to
turn such a tale to an actuality. Criminal organisations and underworld crime syn-
dicates have been using cryptocurrencies as early as 2011. They utilised cryptocur-
rencies like Bitcoin and altcoins to pave the path for payment in exchange for illicit
goods and services. The use of virtual currency is also involved in financial crimes,
cybercrimes and possibly the hiring of gangsters and hitmen for serious offences
like murder and abduction. This chapter seeks to gather accounts on criminal
activities using cryptocurrencies and present how criminals use this technology as
a tool for committing crimes in a wide range of wicked and unlawful exercises. The
chapter also offers some recommendations as to how such crimes can be tackled
and how cryptocurrencies can become mainstream without limiting the benefits of
blockchain technology.
18.1 Criminal Activities
Cryptocurrencies have a close tie with the underworld and crimes since their
inception. Criminals promptly liked the concept and adapted Bitcoin when it first
295
arrived, even before the learned society started releasing the true merit of this new
technology. A 2014 study from the University of Kentucky examining Google
search data found evidence that illegal activity drives interest in Bitcoin [Wilson
and Yelowitz, 2018], while a 2018 study led by the University of Sydney found that
24 million Bitcoin users accounted for illicit activities and hold $8 billion worth of
this token. This is an estimated amount of 25% of all Bitcoin users and 44% of all
Bitcoin transactions [Foley et al., 2018].
There are markets to buy and sell goods and services online that are restricted
to trade in a regular supermarket. Products like drugs, guns and fake banknotes are
not possible to buy from the local supermarket; however, current technology allows
people having Bitcoin to go online and buy stuff like this with a few mouse clicks
on their computers. The misuse of cryptocurrencies does not stop there, and people
use this technology to commit financial crimes, scams and market manipulation.
To present readers with a comprehensive but organised discussion on the
subject of criminal activities relating to cryptocurrencies, the types of crimes are
divided into three broad categories, namely darknet-based crimes, financial crimes
and fraudulent activities. Later the chapter, having provided some background on
the deep web, aims to address these categories by breaking them down further into
more elaborate subcategories. The chapter also discusses potential approaches to
preventing the misuse of cryptocurrencies.
18.2 Deep Web
It is a common criticism against Bitcoin that it acts as a method of payment for
trading goods. However, there must have been a secret online market where the
trades take place; otherwise, how does a buyer get to know about products and
whom to make the payment. Under the surveillance of government authorities
around the globe, maintaining such marketplaces seems to be impossible. Sadly,
that impossible task has become possible due to the advancement of computer com-
munication technology that enables criminals to set up black markets.
The World Wide Web (WWW, or simply the web) is not limited to what we
access, browse and use for our day-to-day activity. There exists a world that remains
unindexed by search engines and out of reach for most users; even the Google
search engine robot cannot locate that part of the web. Computer scientist Michael
K. Bergman coined a term for it – the deep web [Wright, 2009]. The contents of the
deep web are hidden behind HTTP forms and mostly include common applica-
tions such as webmail and online banking. A direct URL or IP address is generally
required to access these contents. Some of the contents need passwords or other
forms of security access approvals.
Deep inside this deep web, there exists a small part called darknet (also known
as dark web) that hosts black markets for trading illicit goods and illegal services.
Although the purpose of having the darknet is not for criminal activities but for
Crime, Criminals and Cryptocurrencies ◾ 297
people who want to stay undetected such as whistle-blowers and people sharing
contents in a secret group, it is no surprise that criminals found a sanctuary in it.
The following sections briefly describe its architecture, required protocols and how
Bitcoin became the last missing piece of a jigsaw puzzle to unleash darknet markets
to their full potential [Henderson, 2017].
18.2.1 Darknet and Dark Web

Darknet and dark web are not the same but are closely related to each other and
can be used synonymously. Darknet refers to the network, whereas the dark web
collectively denotes the websites hosted on the darknet network. Using specially
built secured communication protocols, such as Tor or I2P, users get access to the
darknet and ultimately browse through the dark web to view its contents. These
websites often require specific software, configurations and access approval.
A 2014 study at the University of Portsmouth found that the most commonly
hosted type of content on Tor is child pornography, followed by black markets.
The individual sites with the highest traffic in Tor are assigned to botnet opera-
tions where many internet-connected devices run bots to perform distributed
denial-of-service (DDoS) attacks, steal data, send spam and allow attackers to
access targeted devices. The study also noticed that darknet hosts many whistle-
blowing sites and political discussion forums [Dredge, 2014]. More recently, a
2016 study conducted at King’s College London produced a deep search in dark-
net and found that more than half of the live sites on Tor is involved in unlawful
activities [Moore and Rid, 2016].
18.2.2 Onion Routing and Tor

Onion routing provides the basis of the darknet. It is an anonymous communica-
tion method over a computer network where messages are encapsulated in layers
of encryption, analogous to layers of an onion. The encrypted data is transmitted
through a series of network nodes called onion routers, each of which “peels” away
a single layer, uncovering the next destination of the data. When the final layer is
decrypted, the message arrives at its destination. The sender remains anonymous
because each intermediary knows only the location of the nodes immediately pre-
ceding and following it [Reed et al., 2006].
Paul Syverson, Michael G. Reed and David Goldschlag at the US Naval
Research Laboratory developed onion routing in the mid-1990s to protect US
intelligence communications online. The technique was further improved by the
Defense Advanced Research Projects Agency (DARPA) and patented by the US
Navy in 1998.
Computer scientists Roger Dingledine and Nick Mathewson joined Syverson in
2002 to develop Tor (The Onion Router), the software and network protocol that
makes the largest onion-routing network. Following the release of Tor source code
under a free license by the US Navy, Tor became a non-profit organisation in 2006
with financial support from several organisations [Dredge, 2013].
Tor directs internet traffic through a free, worldwide, volunteer overlay net-
work consisting of more than 7000 relays to conceal a user’s location and usage
from anyone conducting network surveillance or traffic analysis. Although Tor’s
intended use is to protect the personal privacy of its users, as well as their freedom
and ability to conduct confidential communication by keeping their internet activi-
ties from being monitored, it is not widely used as a tool to form the largest part
of the darknet. Besides Tor, there are other anonymous communication networks
such as I2P (Invisible Internet Project), Freenet and Riffle that jointly form the
whole of the darknet.
18.2.3 Bitcoin: The Missing Piece

The principal motivation for using Bitcoin and similar cryptocurrencies by darknet
markets is perhaps their pseudonymous nature. Because Bitcoin allows its bearer to
hide behind cryptographic addresses, despite the blockchain being an open platform
where everyone can see the transfer of funds between parties, there is no way to
identify who they are unless the parties willingly disclose their identity. This feature
enables underground sellers and buyers to keep their identities private while trading
and negotiating unlawful deals. Once payment is made to an address, the person
having access to the private key of the address can only and secretly redeem the funds.
If the addressing of Bitcoin looks advantageous for trading illicit goods, the
“escrow” function of the protocol presents criminals with a perfect underground
eBay! Using the escrow, a third-party individual in disguise can step in between the
buyers and the sellers and act as a regulator to make the smooth exchange of goods
between the parties. For example, Alice purchases a gun from an underground
market in exchange for 10 Bitcoins (BTC) from Bob. Carol can be the middleman
who will have the final say on this trade. The transfer of the fund will be locked
between the trio and Bob can only redeem the tokens when Carol gives the permis-
sion. Once Alice confirms that she received delivery of the gun, Carol would use
her private key to allow Bob to redeem the tokens. In case of a dispute, the funds
remain locked on the blockchain. The script of the Bitcoin also allows for complex
operation between multiple parties in the form of an m-of-n contract. It means, to
redeem funds, out of n signatory at least m individuals must agree upon a decision
to release the funds.
Between 2006 and 2011, the darknet proliferated rapidly. When criminals
found onion routing, Tor and similar networks, they found a place to hide in ano-
nymity to discuss goods and services that they could not discuss in the real world.
They, however, still lacked the last piece of the jigsaw puzzle that they have been
solving. To make a trade happen, payment is mandatory, but there was no payment
method. Following the arrival of Bitcoin in 2009, they found the missing piece of
the puzzle, and black markets have been thriving ever since.
18.3 Darknet-Based Crimes
Darknet-based crimes are all connected to darknet markets, which are also referred
to as crypto-markets. These markets act as the middlemen for trading prohibited
goods and services in exchange for cryptocurrencies [Gayathri, 2013].
A darknet market can be more formally defined as a commercial website on
the darknet accessible through Tor or similar software. Criminals and underworld
sellers use these markets to trade illicit goods such as drugs, cyber-arms, weapons,
counterfeit currency, stolen credit card details, forged documents, unlicensed phar-
maceuticals and steroids. Modern markets even attempt to provide services such as
cyberattacks and assassinations [Beckett, 2015].
18.3.1 Silk Road
Silk Road was the first darknet market established in 2011 that developed the model
of a perfect online black market where buyers and sellers stay under the hood using
anonymous networks with payments that are taken through cryptocurrencies such
as Bitcoin as shown in (Figure 18.1). The approach became so popular that other
markets such as Agora, Utopia and Evolution were introduced with the intention
of selling illegal goods.
Figure 18.1 A flowchart depicting Silk Road’s payment system submitted as evi-
dence in a US court at the trial of the founder of Silk Road.
This market was constructed using Tor where users were able to browse the site
anonymously and securely without potential traffic monitoring. The name of the
market is inspired by the historical trading routes dating back to the Han dynasty
of the third century BC between Europe, India, China and many other countries
on the Afro-Eurasian landmass.
Silk Road was operated by the pseudonymous “Dread Pirate Roberts” who was
known for advocating libertarian ideals and criticising regulation. The involvement
of two other individuals, Variety Jones and Smedley, is considered a catalyst for
the growth and success of the site. Initially, the number of new seller accounts was
limited and allocated through auctions, however, a fixed fee was charged for each
new seller account when the market got established.
Silk Road is most famous for trading drugs; at the height of its thriving phase,
almost 70% of the total products were related to drugs [Chen, 2011]. The market used
to group these products under the headings stimulants, psychedelics, prescription,
precursors, opioids, ecstasy, dissociative and steroids/PEDs. From the inception of
Silk Road, the creator and administrators instituted terms of service that prohibited
the sale of anything whose purpose was to “harm or defraud” such as child pornog-
raphy, stolen credit cards, assassinations and weapons of any type [Gayathri, 2013].
The success of Silk Road heavily relies on Bitcoin. It is because Tor, the technology
behind the market, was already in place for some years, but buyers and sellers could
not get to manage a method for transactions that would not reveal their identities. The
arrival of Bitcoin solved that problem. Silk Road took payment in Bitcoin and took it
in an escrow until the successful delivery of the order. Meanwhile, a hedging mecha-
nism allowed sellers to opt for the value of Bitcoin held in escrow to be fixed to their
value in US dollars at the time of the sale against the price volatility. It was the respon-
sibility of Dread Pirate Roberts to cover the changes in the price during the transit.
Professor Henry Farrell, an associate professor of political science and interna-
tional affairs at George Washington University, identified the strength of Silk Road
in its payment system. He stated in an academic essay that Dread Pirate Roberts
created the market to function without government oversight but found it chal-
lenging to verify anonymous transactions. To sustain a steady stream of revenue,
the man behind the mask started increasing oversight to ensure low transaction
costs. In doing so, he added measures to ensure trustworthiness with the imple-
mentation of an automated escrow payment system and automated review system
[Farrell, 2017]. A study from Carnegie Mellon University found that an estimated
$15 million in transactions were made in 2012 in the Silk Road market. A year
later, the author of the study admitted that he would not be surprised if the volume
hit $45 million [O’Neill, 2013].
Silk Road came into prominence very quickly and earned global fame amongst
the underworld community. According to user-provided information at the time of
registering with the site, 30% were from the United States, 27% chose to be “unde-
clared”, and beyond that, in descending order of prevalence: the United Kingdom,
Australia, Germany, Canada, Sweden, France, Russia, Italy and the Netherlands.
The activities on the Silk Road made authorities around the world anxious. The
selling of illicit goods was not the only threat that this market possessed. It inspired
many other markets to come into being and start trading even more notorious
products including contract killing. This makes police and special forces in the US,
Europe and Asia desperate to shut down the operation of this marketplace.
The Federal Investigation Bureau (FBI) of the United States had been trying
to find the identity of the Dread Pirate Roberts but did not see much success after
almost 2 years of investigation. In 2013, it received a massive clue from an Internal
Revenue Service (IRS) tax inspector, Gary Alford, who while browsing through
Google noticed the name Dread Pirate Roberts in the Bitcoin forum. The person in
the forum tried to advocate for selling drugs in his post and left an email address
Ross.Ulbricht@gmail.com to contact him. Alford had previously known that the
nickname Dread Pirate Roberts is the administrator of Silk Road. He suspected
that the Dread Pirate Roberts on Bitcoin forum might be the same person, and if
so, Ross Ulbricht could have been his real name.
The tax inspector went on searching for the name and obtained the IP address
that this email account used to use. His off-duty investigation eventually led him
to a San Francisco address where a man named Ross Ulbricht resided. Initially, he
was not taken seriously, but when the FBI heard of the address that matched with
an address it found from a different source, Ross Ulbricht became the prime suspect
of being the person behind the pseudonym Dread Pirate Roberts.
Following an FBI crackdown on 2 October 2013, Ross Ulbricht was arrested
at Glen Park Library, a branch of the San Francisco Public Library and the website
was shut down. Ulbricht was indicted on charges of money laundering, computer
hacking, conspiracy to traffic narcotics and attempting to have six people killed.
Prosecutors alleged that Ulbricht paid $730,000 to others to commit the mur-
ders, although none of the murders actually occurred, and Ulbricht ultimately was
not prosecuted for any of the alleged murder attempts. He was convicted of eight
charges related to Silk Road in the US Federal Court in Manhattan and was sen-
tenced to life in prison without the possibility of parole.
18.3.2 Post-Silk Road Markets

Silk Road, as the first modern online black market, inspired other underworld syn-
dicates to found new markets in the darknet. Some markets arrived as competitors,
while many became successors once Silk Road was shut down. The following pres-
ents a brief commentary on those competitor and successor sites.
◾◾ Silk Road 2.0 and 3.0: Silk Road 2.0 came into being in November 2013 and
is considered to be the direct successor of the original website. The manage-
ment of the new market, however, had a difficult time from the beginning.
At first, a technical glitch hit the market resulting in the theft of $2.7 mil-
lion worth of Bitcoin from its escrow accounts. This vulnerability then led to
chaos and uncertainty amongst buyers, despite the site refunding at least half
of its affected users with the lost Bitcoins. Later that year, authorities includ-
ing the Federal Bureau of Investigation, Europol, and Eurojust commenced
Operation Onymous, an international law enforcement operation targeting
darknet markets and other hidden services operating on the Tor network.
The joint force as a part of this operation arrested Blake Benthall, allegedly
the owner and operator of Silk Road 2.0 under the pseudonym Defcon and
closed down the site [Cox, 2014]. Another site, Silk Road 3.0 was launched
soon to capitalise on the brand. This market is still in operation and topped
the Reddit darknet market list at the time of this writing.
◾◾ Evolution: Evolution was another Silk Road–inspired darknet market operat-
ing on the Tor network. It was founded by an individual known as “Verto”
and became one of the two largest drug markets alongside Silk Road 2.0 at
the time of its height [Greenberg, 2014a]. Evolution was notoriously infamous
for selling stolen credit cards data and other kinds of fraudulent materials
and permits including passports. WIRED magazine in 2015 wrote about this
market in the article “The Dark Web Gets Darker with Rise of ‘Evolution’
Drug Market” [Greenberg, 2014b]. There is an allegation that the growth
of this market was helped by Operation Onymous that did not target this
market. Speaking about why Evolution was not part of Operation Onymous,
head of the European police cybercrimes division could not give a proper
answer and escaped saying: “…because there’s only so much we can do on one
day” [DW-News, 2014]. In March 2015, roughly 4 months after the opera-
tion, the market went offline with administrators freezing its users’ escrow
accounts. It never came online again and later became apparent that the shut
down was an exit scam with the operators of the site stealing approximately
$12 million in Bitcoins held in its escrow [Woolf, 2015].
◾◾ Agora: Agora operated as a darknet market in the Tor network from 2013
until its closure in August 2015. It was unaffected by Operation Onymous
and had been one of the strongest competitors for the top spot amongst
darknet markets. Once Evolution was closed in an exit scam in March 2015,
Agora quickly replaced it as the largest market. In August 2015 Agora’s
admins released a PGP signed message announcing a pause of operations to
protect the site against potential attacks that they believe might be used to
deanonymise server locations. Unlike Evolution, the closure of Agora was not
an exit scam, and most activities moved over to the darknet market AlphaBay
making it the largest in the realm.
◾◾ AlphaBay: Launched in December 2014, it was the next generation of darknet
markets that became very popular. AlphaBay saw steady growth that made
darknet informer Gwern Branwen, an independent researcher who over-
sees the website Gwern,* to place it in the top tier of markets regarding the
* The site is publicly accessible using the URL www.gwern.net.

6-month survival probability [Branwen, 2018]. By October 2015, AlphaBay

was recognised as the largest darknet market by Dan Palumbo, research
director at Digital Citizens Alliance [SC-News, 2015]. It was the first market
that enabled contract functionality for the user to allow making engagements
and agreeing to provide services in the future according to the terms of the
contract. By the time the law enforcement authority seized this site in July
2017, AlphaBay had more than 400,000 registered users. It was ten times
larger than the original Silk Road with over 369,000 listings and facilitated
tradings worth $600,000 to $800,000 every day. It received payment in two
cryptocurrencies: Bitcoin and Monero [Popper, 2017].
◾◾ The Farmer’s Market had initially been a regular website founded in 2006
and moved to the darknet in 2010. It took payment using PayPal and
Western Union that led law enforcement authorities to track down the trad-
ing parties relatively quickly. Following a 2-year investigation, it was shut
down in 2012.
◾◾ Others: Black Market Reloaded and Atlantis were two competitor markets of
the original Silk Road. The former gained notoriety amongst users because
of not being restrictive on products like child pornography, stolen credit
cards, assassinations and weapons of any type, while the latter took its place
in history by accepting Litecoin, a cryptocurrency other than Bitcoin for
the first time. During the blooming period of these markets, a lesser known
site, Sheep Marketplace, came to prominence when its vendor stole $6 mil-
lion worth of users’ Bitcoins. The investigation to find the thief led to an
approach for fighting against crimes involving Bitcoin-like cryptocurrencies.
(The chapter later elaborates on this issue.) None of these markets is opera-
tional at the moment.
Despite the constant effort of authorities around the globe to close down
darknet markets, these websites keep coming and get bigger in size. A 2015 study
from Carnegie Mellon University claims the estimated size of the markets based
on listings in 2015 nearly reaches $300,000 per day [Soska and Christin, 2015].
Another report by the Digital Citizens Alliance shows almost $50,000 of the trad-
ing involved drugs [The Economist, 2015]. Figure 18.2 illustrates the volume of drug
sales on darknet markets from 2013 to 2015 until the rise of the AlphaBay market.
Modern darknet markets accept payment in multiple cryptocurrencies, and
many prefer the model established by AlphaBay. Amongst them, Dream, The Wall
Street, Empire and Point are a few that have been still operating. There are websites
such as Dark Web News* that gives nearly live status of existing darknet markets as
shown in Figure 18.3.
* The site is publicly accessible using the URL www.darkwebnews.com.

Figure 18.2 Digital Citizens Alliance reported that a trade volume of almost
$50,000 involved drugs in the darknet markets from 2013 to 2015 (the Y-axis
shows data in thousands).
18.3.3 Assassination Markets
An assassination is a prediction market where any party can place a bet using anon-
ymous electronic money on pseudonymous remailers about the date of death of a
given individual, and collect a payoff if they “guess” the date accurately. This would
incentivise the assassination of individuals because the assassin, knowing when the
action would take place, could profit by making an accurate bet on the time of the
subject’s death. Because the payoff is for accurately picking the date rather than
performing the action of the assassin, it is substantially more difficult to assign
criminal liability for the assassination [Harkin, 2009].
The concept originated from a broader theory called assassination politics, a
term popularised by Jim Bell in his 1995–96 essay of the same name. He wrote:
If only 0.1% of the population, or one person in a thousand, was will-

ing to pay $1 to see some government slimeball dead, that would be, in
effect, a $250,000 bounty on his head. Further, imagine that anyone
considering collecting that bounty could do so with the mathematical
Figure 18.3 There are websites such as www.darkwebnews.com that gives

nearly live status of the existing darknet markets.
certainty that he could not be identified, and could collect the reward
without meeting, or even talking to, anybody who could later identify
him. Perfect anonymity, perfect secrecy, and perfect security. And that,
combined with the ease and security with which these contributions
could be collected, would make being an abusive government employee
an extremely risky proposition. Chances are good that nobody above
the level of county commissioner would even risk staying in office.
[Greenberg, 2013]
At the time Bell wrote this, there was no technology in place to make it a real-
ity. However, the arrival of Bitcoin now made it possible. The first market titled
the “Assassination Market” came into being in 2013 when a self-described crypto-
anarchist formed it using Tor. It used Bitcoin as bounties as well as the underly-
ing prediction technology. Former US President Barack Obama, economist Ben
Bernanke and former Justice Minister of Sweden Beatrice Ask were amongst the
notables placed on the hit list. As of 2015, the site is not operational, but most of
the deposited Bitcoins remained untouched [Greenberg, 2013].
The concept of a true assassination market remains a grey area as darknet mar-
ketplaces strictly prohibited such services. The terms and condition of Silk Road
and Evolution clearly stated that services like assassinations could not be traded
on the platform and their successors also did not seem to be interested in allowing
hitmen on their platforms. Ulbricht, the founder of Silk Road, was initially charged
for attempting to have six people killed but those charges were later dropped.
Nevertheless, there is news emerging in recent times that darknet has possibly
opened doors to commit such crimes.
The existence of any such marketplace hides so deep inside the dark web that
it is difficult for a regular person to reach it. A British hacker in 2018 exposed a
hitman-hiring site called Besa Mafia in the darknet that provides assassins start-
ing from $5000 for a “basic killer”, but for $30,000 one could hire an ex-military
trained hitman with a sniper rifle on buildings [Miller, 2018]. Although there is no
known history of using the darknet to kill any notable person, recently a man from
Riverside, California, who appeared before a San Luis Obispo judge for his prelimi-
nary hearing, was charged for allegedly trying to hire a hitman from the darknet to
kill his stepmother [Julio, 2018] (Figure 18.4).
18.3.4 Cybercrimes
Darknet is considered a sanctuary for hackers who commit various cybercrimes.
This includes launching DDoS attacks, creating and spreading malware, stuffing
credentials, sniffing personal information and sending phishing emails. Although
traditionally hackers operate anonymously from the darknet to gain personal and
financial benefits, the availability of cryptocurrency now popularises a concept
Figure 18.4 A screenshot from the Tor Assassination Market showing the list-
ing of an influential person from the United States and the prize money of the
equivalent of about $1.7 million (as of December 2017). The name, picture and
information about the person is removed for safety reasons.
called hacker-for-hire. Like hitmen, hackers are now available to be hired for pro-
viding a wide range of services to their would-be buyers.
A 2018 study by researchers at Positive Technologies on 25 sites on the dark web
in Russian and English with a total registered user-base of about 3 million people
analysed more than 10,000 hack-for-hire and malware-related postings. They found
that the darknet-based cybercrime industry has been thriving with the demand for
the creation of malware three times greater than the supply [Ashford, 2018].
The same research identified that the costs of cybercrime services across the
deep web for compromising a site and obtaining full control over its web applica-
tion costs as little as $150. Nonetheless, launching an attack on an organisation
depends on the difficulty and may cost more than $4500, while the most expensive
malware was for targeting banks’ ATMs with prices starting at $1500. The lead-
ing type of malware available in the darknet is cryptocurrency miners (20% of the
total), followed by hacking utilities (19%), botnet malware (14%), remote access
Trojans (RATs) (12%) and ransomware (12%).
A less expensive but booming service is hacking social network accounts and
emails. Almost two-thirds of the total hacker-for-hire requests from would-be buy-
ers involve these requests. There are also super-cheap hacking services available such
as hacking keyloggers would cost around $2.00, WiFi $3.00, Bluetooth $3.50 and
malware for draining Bitcoin wallets $6.00.
Branded phishing attacks are by far another dominant cyberattack that enter-
prising hackers are selling. They offer pages that look like the pages of popular
brands ranging from Apple and Netflix to Walmart. These fake websites cost about
$2.00 each except for big outliers such as Apple for which darknet hackers charge
approximately $5.00 on average [Migliano, 2018].
18.4 Financial Crimes
Cryptocurrencies have been the subject of financial irregularities on several occa-
sions. Some of those instances involve actual financial crimes such as money
launderings while many include suspicious and fraudulent activities. This section
focuses on the financial activities that attempt to bend the law using cryptocur-
rency. Fraudulent activities such as scams will be discussed in the next section.
18.4.1 Money Laundering
Cryptocurrency, notably Bitcoin, is a popular choice for money laundering, the
process of concealing the origins of money obtained illegally by passing it through
a complex sequence of banking transfers or commercial transactions. Even though
this is a lousy tool for committing such a crime, there are many instances around
the world where cryptocurrencies are used in concealing the origins of money
obtained illegally. The magnitude of money laundering varies from individuals
laundering a small scale of money to as large as cryptocurrency trading exchanges
getting involved in illegally handling millions of dollars.
Authorities including the European Banking Authority, the FBI and the Financial
Action Task Force of the G7 had expressed concerns during the early days of Bitcoin
that money launders could use this cryptocurrency. Their suspicion proved to be right
when Charlie Shrem, an operator of a US Bitcoin exchange, was arrested for money
laundering using cryptocurrency and subsequently sentenced to 2 years in prison for
“aiding and abetting an unlicensed money transmitting business” in 2014.
More recently, Alexander Vinnik, wanted for money laundering by the US, France
and Russia, and an alleged owner of the cryptocurrency trading exchange BTC-e,
was arrested in Greece on $4 billion money laundering charges in 2017. This case
quickly grabbed media attention because of the involvement of multiple countries, a
plot to murder Vinnik in prison, and a report by Bloomberg finding a potential link
between Vinnik and the Russian hacking group Fancy Bear [Chrepa et al., 2018].
The exchange, BTC-e, itself was also believed to be involved in criminal activi-
ties. It was founded in 2011 with its headquarters in Russia and had been opera-
tional until the US government seized its website in 2017. As of February 2015,
this exchange handled around 3% of all Bitcoin exchange volume. It allowed trad-
ing between the US dollar, Russian ruble and euro currencies, and the Bitcoin,
Litecoin, Namecoin, Novacoin, Peercoin, Dash and Ethereum cryptocurrencies
until its closure [Guttmann, 2013].
US authorities also fined Bitfinex, one of the largest cryptocurrency exchanges
of current times in 2016 for offering illegal off-exchange financed commodity
transactions. They also found Bitfinex violating the Commodity Exchange Act by
not registering as a futures commission merchant.
Authorities, however, did not always find their job as straightforward as these
cases. They often faced difficulties dealing with this new technology as criminals
tried to bend the rule misusing a grey area of the law involving cryptocurrency. As
there is no correct definition as to if cryptocurrencies are money or not, it is some-
times difficult to convince a court of law that a crime has been committed.
A famous case, State v. Espinoza, became the topic of interest in the financial,
law and tech industries. The case traces its root to 2014 when Michell Espinoza was
unknowingly selling Bitcoin to undercover agents of the Miami Police Department
and the US Secret Service. Though one of the undercover detectives had implied
that the Bitcoin would be used to buy stolen credit card numbers, Espinoza contin-
ued with the sales charging transaction fees for the privilege. He was later charged
with money laundering and illegal money transmission. When the case moved to
court in 2016, Judge Teresa Mary Pooler of the Eleventh Judicial Circuit of Florida
dismissed those charges stating that Bitcoin is not legal money; hence Espinoza
could not be punished under existing Florida statutes. The judge stated:
Bitcoin may have some attributes in common with what we commonly

refer to as money, but differ in many important aspects, they are cer-
tainly not tangible wealth and cannot be hidden under a mattress like
cash and gold bars.
[Hurtado and Nesmith, 2016]
Interestingly, a few months later the same year, a ruling by Judge Alison J. Nathan
of the United States District Court for the Southern District of New York contra-
dicted the Espinoza ruling. The judge mentioned:
Bitcoins are funds within the plain meaning of that term. Bitcoins can
be accepted as a payment for goods and services or bought directly from
an exchange with a bank account. They therefore function as pecuniary
resources and are used as a medium of exchange and a means of payment.
[Redman, 2016]
As Bitcoin becomes mainstream, an astonishing verdict came in January 2019

from Florida’s Third District Court of Appeal. The court reversed Pooler’s ruling
on Espinoza’s motion stating that:
Based on the undisputed facts, Espinoza was acting as a payment

instrument seller or engaging in the business of a money transmitter,
either of which requires registration as a money services business under
Florida law. Given the plain language of the Florida statutes governing
money service businesses and the nature of Bitcoin and how it func-
tions, Espinoza was acting as both.
[Benson, 2019]
Despite those instances of money laundering, as authorities have more knowledge

about this technology, cryptocurrencies are now conceived less risky for such crime. It
is due to the public nature of the blockchain’s transactions and discovery of potential
methods to identify associated entities involved. A report by the UK’s Treasury and
Home Office reflected on this matter. Titled “UK National Risk Assessment of Money
Laundering and Terrorist Financing”, it identified that, of the 12 methods examined
in the report, Bitcoin carries the lowest risk of being used for money laundering with
the most common money laundering method being the banks [HM Treasury, 2017].
18.4.2 Market Manipulation
The rumours of manipulating the price of cryptocurrencies have been hovering
since the inception of Bitcoin. Because of the volatility of these virtual currencies,
it is challenging to detect if someone is actually trying to manipulate the price or
if the volatility is organic. Nevertheless, there have been multiple studies recently
that investigated past episodes and suggested that manipulation happened in part.
During the 2012–13 financial crisis in Cyprus, the Bitcoin price suddenly began
to rise. It reached a high of $266 on 10 April 2013, before crashing to around $50
only to bounce back in November to hit the then all-time peak of $1242. A study
from Tel Aviv University and the University of Tulsa found evidence that the part
of this peak in the price was due to price manipulation [Gandal et al., 2018].
Researchers from the University of Texas, Austin investigated the involvement
of the cryptocurrency exchange Bitfinex with Tether cryptocurrency in 2018. Their
findings suggested that Bitfinex played a role in rising half of the price of Bitcoin
during the bull run in late 2017. They asserted that purchases with Tether were
timed following market downturns resulting in sizeable increases in Bitcoin prices
[Griffin and Shams, 2018]. Bitfinex, however, denied this accusation.
More recently, the US Justice Department launched an investigation into pos-
sible price manipulation including the techniques of spoofing and wash trades.
Traders in the US, UK and South Korea are likely to be investigated [Cornish, 2018].
Furthermore, the Wall Street Journal reported that US federal investigators also
expressed their concern about numerous exchanges including Bitstamp, Coinbase,
itBit and Kraken, and demanded trading data. Several of the exchanges initially
refused to comply with this request but later afforded data only in limited amount.
The Commodity Futures Trading Commission then summoned the data from the
exchanges. No wrongdoing has been identified as of writing [Rubin et al., 2018].
18.5 Fraudulent Activities
Cryptocurrency has been the subject of various fraudulent activities in recent times.
When the price of Bitcoin had been increasing in 2017, even people having no or
little knowledge about the technology launched cryptocurrencies. This practice led
to the creation of more than 1600 coins by August 2018. Most of these tokens are
of little value and created with the intention of committing crooked ventures such
as scams and selling tokens through false claims. During these pursuits, an initial
coin offering (ICO) remained the principal tool for wicked actors to launch their
exploits.
18.5.1 False Claims
The founding organisations behind several cryptocurrencies tried to promote their
tokens by making false claims such as showing the potential of substantial return
and being backed by currencies or commodities to make them so-called stablecoin.*
Tether Limited, the organisation behind the cryptocurrency Tether, claimed
that fiat currencies backed its token, which was designed to always to be worth
$1.00. The claim came when it rebranded Realcoin, the precursor to Tether origi-
nally launched in 2014 on the Bitcoin blockchain using Mastercoin’s layer two
protocol and founded by Brock Pierce, Reeve Collins and Craig Sellars as a Santa
Monica–based start-up. After the rebranding, the company announced that it
was entering private beta, which supported a “Tether+ token” for three curren-
cies: USTether (US+) for US dollars, EuroTether (EU+) for euros and YenTether
(JP+) for Japanese yen. The company remarkably claimed, “Every Tether+ token
is backed 100% by its original currency and can be redeemed at any time with no
exposure to exchange risk” [Casey, 2014b]. However, following a string of criti-
cism, controversy and failure to meet all customer withdrawal requests in 2017, the
company reportedly admitted that it was no longer 100% backed by actual dollars
[Coppola, 2019]. At the time of writing, Tether was priced at $1.01 according to
the CoinMarketCap.
Petro is another cryptocurrency that was claimed to be backed by one barrel of
oil for each token. It was designed, promoted and launched by Venezuela’s govern-
ment. President Nicolas Maduro initially claimed on Twitter that the oil-backed
cryptocurrency attracted $735 during the first day of its token sale in February
2018 but 6 months later admitted that Petro’s worth might be determined solely by
the market value [Browne, 2018].
There is another case where the US Securities and Exchange Commission (SEC)
froze $15 million from PlexCoin that it accumulated using an ICO in 2017. Prior
to the ICO, PlexCoin promised that it would return 1354% of the invested money,
but it did not have any plan in place and now will be prosecuted for this false claim
[Palmer, 2018].
* Stablecoins are cryptocurrencies designed to minimise the volatility of the price of the stable-
coin, relative to some “stable” asset or basket of assets. A stablecoin can be pegged to a currency
or exchange-traded commodities such as precious metals.
18.5.2 Scams
The successful launch of the Ethereum platform encouraged many to pre-mine
tokens with a view to selling them for accumulating working capital of the respec-
tive platforms. Although it worked well for many major blockchains that emerged
as giants in the industry offering diverse use-cases, there are hundreds of small
blockchain platforms and cryptocurrencies that raised money from investors with-
out having a clear idea of what they want to do. Many had fraudulent intentions.
For example, Crypto start-up Giza raised $2.4 million using a fake ICO involving
more than a thousand investors in 2018 [McQuaid, 2018]. Another blockchain
platform called Benebit raised around $4 million in 2017 using fake administrative
team photos and just walked away with the money afterwards [Sedgwick, 2018b].
ICOs and token sales became notoriously famous when Bitcoin and other cryp-
tocurrencies had a rollercoaster ride in the exchanges in 2017. However, despite
companies raising more than $7 billion via ICOs that year, by February 2018,
an estimated 46% of those projects had failed, indicating that most of them were
worthless and full of false claims [Sedgwick, 2018a].
Joseph Lubin, co-founder of Ethereum, claimed during an interview with
CNBC in November 2017 that many ICOs are copycats that do not intend to offer
any real value to investors. His statement was echoed by Brad Garlinghouse, CEO
of Ripple Labs, who mentioned token sales operate in a grey area while waiting for
regulation to catch up [Choudhury, 2017]. More recently, a study conducted by the
ICO advisory firm Statis Group noticed that more than 80% of 2017 ICOs were
scams. The study took into consideration the life cycle of the project from the pro-
posal stage to the most mature phase of trading on a crypto exchange [Alexandre,
2018].
The number of scams involving ICOs became so frequent in 2017 that internet
giants Google and Facebook had to ban all advertisements concerning cryptocur-
rencies. As of 2018, Facebook had partially lifted the ban allowing only credible
companies to post ads through a separate approval process [McLean, 2018], while
Google also lifted the ban but for the US and Japan only [Marshall, 2018].
18.6 Prevention
The proverb “prevention is better than cure” goes hand-in-hand with cryptocurren-
cies. Taking down darknet marketplaces and cracking down over money launderers
do not help much in stopping criminal activities using virtual currency. Instead,
bringing in useful regulation can put criminals off and discourage the commis-
sion of crimes in the first place. However, it must not be forgotten that regulation
alone is not sufficient to deter crime. If the criminals leverage innovative technol-
ogy to facilitate their activities, then law enforcement must hit back to identify and
mitigate the hurdles that innovative technology may raise against them. In doing
so, this book stretches importance on three grounds: regulation, cooperation and
participation.
18.6.1 Regulation
Regulation is the first and perhaps the most important ground that helps to fight
against criminal activities involving cryptocurrency. In an unregulated environ-
ment, bad actors find sanctuary, while a regulated industry will not only ensure
removal of those unwanted actors but also restore the faith of consumers in this
technology. The following discusses how regulation plays an important role in
assisting police and security services to bring down those bad actors.
Regulation is very critical in stopping scams and fake ICOs. Unlike stocks and
bonds that are financial instruments that investors rely on, there are no such rules
in place at the moment that state how an ICO needs to be conducted, what the
project can and cannot claim, and for how long it can run. Cryptocurrencies are
defined variously at different jurisdictions making it more difficult to regulate as
a financial instrument. This representation of the industry makes it urgent that
financial authorities around the world get together to decide how cryptocurrencies
will be dealt with globally.
Regulations may solve issues in ICOs and reduce scams, but fighting against
the underworld and criminals laundering money need police and security services
to join financial authorities to work together in making regulations related to cryp-
tocurrency exchanges, trading and transactions. Contrary to popular opinion, it is
not difficult to trace the person behind a Bitcoin (or similar cryptocurrency) address
if proper regulations remain in place. A huge misconception amongst people is that
Bitcoin is anonymous, which is not true; it is rather pseudonymous. All transac-
tions to and from addresses are open and can enable authorities to link transactions
together to locate perpetrators’ addresses with the help of regulated information
such as proof of identity, address and bank details.
A classic example of identifying the culprit following this approach is the case
of the darknet market Sheep Marketplace. The market announced in 2013 that one
of the site’s vendors exploited a vulnerability to steal 5400 tokens, valued at about
$6 million at the time. However, users through discussion on the site’s forum iden-
tified that the administrator transferred 40,000 Bitcoins, seven times larger than
the claimed stolen amount, to an account and blocked withdrawing of any money
even a week before this claimed incident. Amid this discussion, when users found
the forum being taken down, they became sure that the main culprit is none other
than the administrator of the site who initiated an exit scam even before the alleged
hack took place.
Victims of the theft then attempted to identify the thief by sending “tagged”
Bitcoins to his accounts. Because of the public nature of Bitcoin transactions,
they followed this money through the blockchain record of transfers. Soon a large
amount of Bitcoin was noticed to be processed by Bitcoin Fog, a “tumbler” used
to launder Bitcoins by shuffling them between many accounts for a small fee. Not
long thereafter the last known wallet of the user who had been presumed to be the
thief was found to be a wallet owned by BTC-e, the infamous Bitcoin currency
exchange that US authorities recently seized. The money stayed in the wallet for
some time until the thief paid for an expensive house entirely in Bitcoins revealing
his identity in 2015. This led Czech police to arrest Tomas Jirikovsky, the creator
of the Sheep Marketplace, who was later sentenced to serve nine years in prison for
stealing Bitcoins from the market’s users [Aliens, 2017].
This classic example teaches that identifying someone’s address is not always
enough to unveil the person behind the disguise. It is a good starting point, but
there is a number of steps involved in finding the real person. One approach is
to wait and observe. A bunch of Bitcoin in someone’s wallet does not look like a
profitable prospect unless he or she tries to exchange the virtual currency with fiat
currency and withdraw the money from an exchange or buy something using cryp-
tocurrency. This is the Achilles heel that can be capitalised on finding the person’s
identity. Regulated cryptocurrency exchanges can give information regarding who
withdrew the money. Countries in the European Union have strong policies related
to disclosing the name, proof of address and bank details to the exchanges. The
Financial Conduct Authority (FCA) in the UK asks exchanges not only to collect
this information but to also make sure it is up to date and not older than 6 months.
Such regulations should not be a problem for investors who do not want to bend the
rules and the regulations immensely help authorities to catch the offenders.
18.6.2 Cooperation
Cooperation is possibly second to regulation in terms of importance. Without
cooperation between authorities, such an industry involving technology, finance
and social issues cannot be kept safe. It was shown in the previous section how
financial and security authorities can cooperate to make regulations to track down
criminals. This cooperation is also essential across the border between authorities
from different nations.
Because public blockchains are decentralised where transactions take place all
around the globe, this makes life difficult for authorities to keep law and order and
take actions against the offenders. Without cooperation between police and secret
service forces across jurisdictions, these modern crimes are challenging to deal
with. Operation Onymous is one of the most excellent examples of such coopera-
tion between US and European authorities that took down the pioneering darknet
market Silk Road.
These cooperations are also crucial to identify linked criminals and bring them
to justice before committing something substantially massive. The structure of
Bitcoin transactions, in this case, is a great source of clues. A darknet marketplace
escrow address or an address used extensively to commit money laundering leaves
traces of who are involved in the activities. Following the unveiling of one or a few
heads from the cluster, the task of tracking down other heads does not seem to be
difficult should the authorities have the required technology and the brainpower to
operate innovative tools. One classic example is tracking down Variety Jones and
Smedley who were the second in command of Silk Road’s “Dread Pirate Roberts”,
the pseudonym of Ross Ulbricht.
If we recall, authorities failed to identify Variety Jones and Smedley at the time
of taking down the Silk Road market. However, through linked transactions, they
kept researching into these individuals’ identities and found that Smedley’s true
identity could be Mike Wattier, an American web developer living in Thailand, and
Variety Jones could be Roger Thomas Clark, a Canadian also living in Thailand.
These findings led them to successfully arrest Clark in Thailand 2 years after seiz-
ing the marketplace. Clark has been facing extradition to the United States, while
Wattier still remains at large. This example shows how cooperation between nations
can help crack down on criminals [Cox, 2015].
18.6.3 Participation
Participation is perhaps the least most important amongst the three grounds dis-
cussed; however, it can help to restore trust amongst consumers of b lockchain-based
services and decentralised applications (DApps). Much negativity about this tech-
nology has already been spread that severely damaged its reputation. As such, con-
sumers will have their faith back when they see reputed corporations have been
using distributed ledgers either inside their business model or for their day-to-day
activity.
As we progressed through the technical details of blockchain from Chapters 1
to 11, it was evident that the idea of distributed ledgers in the present day is very
different than what Bitcoin proposed. The initial proposal of Nakamoto indicated
his interests in features like public availability, regulation free and pseudonymity;
however, the current trend identifies them as unnecessary for many applications.
Nowadays, private networks are becoming popular, while industry users do not
care much about the pseudonymity of the transactions. It is rather important to
them that the blockchain ensures trust and enables applications with the traits nec-
essary for the use-cases. IBM, Linux Foundations, Walmart and Microsoft are few
companies that have been actively getting involved in this industry.
There is another aspect where reputed entities become nodes of the distrib-
uted ledger. Ripple and Stellar are two such ledgers that operate entirely based on
approved nodes. No one can join their network without approval. This approach,
however, does not make them centralised. They are fully decentralised at their core
but allow established entities to get priorities. Large corporate and financial giants
have already joined these networks to either use or test distributed ledger technol-
ogy for their use.
The more known faces that come out and participate openly in the use of
blockchain and related services will help the technology become mainstream. Such
participation, in the end, sends a strong message that blockchain and cryptocur-
rencies are not for performing criminal and illegal activities but for improving the
quality of lives and making the world a better place.
18.7 Summary
This chapter presented the criminal activities surrounding cryptocurrencies, one
of the widely used criticisms against the blockchain technology. The chapter tried
to be neutral in presenting facts and decoupling potential misunderstandings. It
offered a thorough discussion on the activities regarding darknet markets, Silk
Road and its successors, the role of the underground in misusing cryptocurrencies,
financial and social crimes such as scams, and some recommendations as to how
to potentially fight against such crimes. The objective of this chapter was to high-
light the point that despite criminals using cryptocurrencies, it is only fair to fight
against those crimes instead of suggesting to ditch this innovative technology as
many experts and prominent figures did in the past, to be discussed in Chapter 20.
Chapter 19
Regulations, Laws
and Practices
The blockchain industry has seen rapid growth in recent times as many new
applications based on distributed ledger technology hit the market. However, the
progress has not been undisrupted but rather surrounded by indecision, chaos and
clampdowns as regulatory authorities had to deal with fraudulent and corrupt
actors in the industry in the name of initial coin offerings (ICOs) and fake start-ups
that walked away investors’ money. Mining bans and shutting down exchanges
in some countries crashed markets causing small investors to lose their stake. The
fearful environment prevented many genuine blockchain start-ups from raising
working capital to begin their product development. The state of affairs, however,
might not have been this bitter had there been specific guidelines and regulations
as to how the companies would operate. This chapter presents the current aspects of
blockchain regulations, misuse of the industry by mischievous players, and how the
industry and governments around the world have been evolving towards embracing
new laws and regulations for business focusing on delivering blockchain applica-
tions, cryptocurrencies and ICOs.
19.1 Legality of Blockchain and Cryptocurrency

The legal status of blockchain technology is somewhat ambiguous around the
globe. It is not illegal in most parts of the world, but the state of legality is not clear
either. Because of the lack of proper laws, regulatory frameworks and clear defini-
tion of this new technology, confusion has been mounting at an alarming rate.
317
To put it in perspective, Judge Amos L. Mazzant III of the United States District
Court for the Eastern District of Texas stated in a 2013 ruling that “Bitcoin is a
currency or form of money” [Hill, 2013], while his colleague Judge Teresa Mary
Pooler of the Eleventh Judicial Circuit Court of Florida cleared Michell Espinoza
in State of Florida v. Espinoza of money-laundering charges he faced involving his
use of Bitcoin on the basis that this virtual currency is not a currency. Pooler stated
that “Bitcoin may have some attributes in common with what we commonly refer
to as money, but differ in many important aspects, they are certainly not tangible
wealth and cannot be hidden under a mattress like cash and gold bars” [Hurtado
and Nesmith, 2016].
In the US, authorities sometimes consider virtual currency as a commodity,
while other departments recognise it either as currency or an asset. Many countries
in the world including China and South Korea see cryptocurrencies as a tool to
commit crimes overlooking the fact that the underlying blockchain technology has
huge potential to contribute to many sectors of society. The view of many govern-
ments, however, is not totally unjustified. While dealing with new technologies,
authorities require time to become acquainted with the applications, understand
them and decide appropriate regulations.
In the case of the blockchain, that did not happen. Because of the sudden rise
in popularity of Bitcoin and cryptocurrencies, regulatory authorities never got that
required time frame to determine guidance for this technology. This resulted in con-
fusion amongst multiple departments of government leading some to take random
and whimsical actions. However, as time passes, we can anticipate that the dust of
chaos will settle, and governments around the globe will start preparing legal frame-
works for this new and innovative technology.
19.2 Regulatory Issues
Despite the recent rapid growth of blockchain technology, blockchain-related
industries are still largely unregulated in most countries. This is not perceived as an
advantage by the people involved in the industry; rather their views are quite the
opposite. The lack of regulation is often considered a weakness because consumers
are not assured of standards. Sometimes the use of cryptocurrency is even regarded
as a device or tool to facilitate criminal activities, making conventional businesses
fearful and often unwilling to provide services using blockchain technology and
cryptocurrencies. As such, to prove their credibility, many blockchain-related busi-
nesses are seeking regulations. On the other side of the coin, people having no
genuine interest in this technology have been getting involved to make some quick
money. These people have upset many regulatory bodies and law and order enforce-
ment authorities leading to legal actions, crackdowns and potentially stricter poli-
cies for the industry.
Regulations, Laws and Practices ◾ 319
19.2.1 Misuse of Pre-Mining and ICOs

The successful launch of the Ethereum platform encouraged many to pre-mine
tokens with a view to selling them for accumulating working capital of the respec-
tive platforms. Although it worked well for many major blockchains that emerged
as giants in the industry offering diverse use-cases, there are hundreds of small
blockchain platforms and cryptocurrencies that raised money from investors with-
out having a clear idea of what they were going to do. Amongst many had fraudu-
lent intentions. For example, Crypto start-up Giza raised $2.4 million using a fake
ICO involving more than a thousand investors in 2018 [McQuaid, 2018]. The US
Securities and Exchange Commissions (SEC) has frozen $15 million from PlexCoin
that it accumulated using an ICO in 2017. Prior to the ICO, PlexCoin promised
that it would return 1354% of the invested money, but it did not have any plans in
place [Palmer, 2018]. Another blockchain platform called Benebit raised around $4
million in 2017 using fake administrative team photos and just walked away with
the money afterwards [Sedgwick, 2018b].
Scams and frauds using ICOs led regulatory bodies around the world to take
strong legal action against the companies involved. During the first half of 2018,
more than 750 legal measures had been taken against companies in the United
States. It was the most prolific 24-month period of taking legal action against
companies and individuals involved in investment and securities since the Private
Securities Litigation Reform Act was enacted in 1995. Amongst the cases, notable
ongoing lawsuits included those against Ripple Labs, alleging that the defendants
raised “hundreds of millions of dollars” through the unregistered sale of XRP to
retail investors, and against UK-based Bitconnect, alleging that the company “failed
to disclose material facts” that caused its value to drop [Castillo, 2018]. Airfox and
Paragon are two companies currently under investigation by the SEC. It appears
that the SEC, instead of launching random crackdowns, is using these two cases to
prepare future templates for ICO enforcement in the US [Palley, 2018].
During the 2017 cryptocurrency bull run, scams involving ICOs became so
frequent that internet giants Google and Facebook had to ban all advertisements
concerning cryptocurrencies. As of 2018, Facebook had partially lifted the ban
allowing only credible companies to post ads through a separate approval process
[McLean, 2018], while Google also lifted the ban but for the US and Japan only
[Marshall, 2018].
19.2.2 Crackdowns on Mining and Trading

China, the producer of the most mined Bitcoin, made newspaper headlines in
January 2018 when its government decided to crack down on miners. Although
Chinese authorities reasoned this action was to prevent misuse of electricity, China’s
central bank viewed cryptocurrency as a potential tool for committing malicious
acts like fraud and money laundering. Chinese authorities also cracked down on
thousands of criminal cases associated with cryptocurrencies such as Onecoin
and Ticcoin that they perceived as Ponzi schemes used to raise illicit funds. More
recently authorities also shut down cryptocurrency trading exchanges and banned
fundraising through ICOs in China [Hsu, 2018].
South Korea, another crypto-heaven in Asia, introduced stricter regulations for
cryptocurrency exchanges following the recent cryptocurrency bull run. Previously
individuals were allowed to make trades anonymously. This practice encouraged
criminals to quietly slip into the system and take advantage of it in committing
criminal activities and receiving payments. As of January 2018, the Korean govern-
ment has banned exchanges that allowed traders to use anonymous bank accounts.
South Korea’s chief financial regulator went on to say that it may consider shut-
ting down all domestic virtual currency exchanges. Although the threat of shutting
down all domestic exchanges has not been implemented, the statement produced a
considerable amount of noise in the cryptocurrency market causing a massive crash
[Kim, 2018a].
19.3 Current Landscape
The current landscape of cryptocurrency and the blockchain industry is unsettled
and noisy as of writing. Rumours of possible crackdowns often play an important
role in crashing the market, while a lack of regulation makes investors less inter-
ested to get involved. Nevertheless, the year 2018 following the best cryptocurrency
bull run of 2017 saw people with wicked intentions leaving the industry, paving the
path for a redevelopment of the industry where regulation can be instituted.
19.3.1 Challenges
Although the blockchain industry seems to be genuinely willing to embrace regula-
tions, the path to finding a solution is not straightforward and full of challenges.
Public ledgers like Bitcoin and Ethereum are meant to be distributed and free from
any centralised control, and having lots of strings attached to these ledgers signifi-
cantly hinders the underlying fundamentals.
Government regulations usually seek to take control of the processes introduc-
ing some degree of central association. In the recent past, actions from authorities
around the globe seemed to be random and whimsical, making the cryptocurrency
market highly volatile. Any attempt to take control of the system using strength
makes investors fearful and insecure. The role of investors is an integral part of
blockchain technology and discouraging them from staying in the mix will only
worsen the situation.
Therefore, the biggest challenge will be to find a balance between what extent
regulatory bodies can intervene and what kind of freedom the technology still
holds. Another critical challenge here is to accomplish this balance through peace-
ful conversations between the people serving the industry and government regula-
tory bodies. It is essential to avoid all unnecessary measures that could potentially
cause noise in the market. The cryptocurrency market is already considerably vola-
tile, and failure to keep it noise-free and operating normally could create additional
hurdles in the process.
19.3.2 Areas
There are three notable areas where the industry urgently needs regulations. Amongst
them, regulation for cryptocurrency usage is undeniably the most important. A
lack of regulation as to how to facilitate cryptocurrency alongside fiat currencies
prevents online portals, e-commerce sites and websites accepting cryptocurrency
payments regularly. This is also the primary obstacle to setting up cryptocurrency
kiosks in physical locations to take payments using virtual currencies. During the
early days of cryptocurrency and blockchain technology, there was a rapid growth
of the number of Bitcoin ATMs and kiosks in the US; however, as time passed,
this growth significantly slowed. Outside the US, it is now rare to encounter kiosks
taking payments in virtual currencies. One of the key reasons behind people being
hesitant in using cryptocurrency as a method of payment, either online or offline,
is this technology’s infamous popularity of being a tool to commit criminal activi-
ties. Government regulations could partially eradicate the fear and encourage both
consumers and business providers to adopt the technology.
The second most important area is ICOs. There is no denying that native tokens
play an essential role in enabling start-ups. ICOs give them the opportunity to
raise the initial funds to start with. Because of the lack of regulation and past
scams, investors may feel hesitant to put their money in new blockchain platforms.
The industry is still at a very early stage, and a lot of exciting applications are yet
to arrive. Investment in companies at this stage is crucial, and regulations could
quickly encourage new and existing investors to get more involved. Regulation is
also necessary for companies that offer ICOs. A lack of regulation also means a
lack of guidance. Unlike initial public offerings (IPOs), a company offering certain
promises while publishing white papers for their ICO does not know the potential
consequences. There have been instances where authorities charged reputed block-
chain companies following their successful launches – the case against Ripple Labs
is one of the most notable examples. If there exists a guideline explaining what a
company can mention or promise and what it cannot, people involved in ICOs
would feel more confident in describing their products to the investors.
The third area where immediate attention needs to be given is how far authori-
ties can intervene in the governance of the blockchain. For example, a smart con-
tract is meant to be free from third-party control allowing two parties to get tied up
in a deal. It is the essence of a smart contract that without the intervention of a third
entity, the contract can mature. Unnecessarily bringing in regulatory authorities in
the governing process is likely to introduce bureaucracy that the technology tries to
avoid. As such, it is imperative that regulations prescribe the design of the product
but stay away from its seamless execution.
19.3.3 Blockchain-Friendly Nations
The US, South Korea, China and Japan are amongst the nations where most
crypto-mining, trading and investment take place. This, however, does not imply
they are the most friendly nations for the blockchain industry to grow. Amongst
these four, only Japan is considered blockchain-friendly because of its existing
policies and willingness to allow this industry to flourish. Japan has shown great
support for blockchain technologies, putting it at the forefront of a technological
revolution that encourages change, trust and business dealings in the financial
and technological sectors in the country. It is no surprise that Mitsubishi UFJ
Financial Group (MUFG), one of the world’s largest banks, announced plans to
open a cryptocurrency trading department for its retail and institutional inves-
tors. MUFG also expects to introduce a native token tied to the Japanese yen
and facilitate peer-to-peer transactions, lower fees and reduce volatility. DMM
group, another Japan-based corporation specialising in electronic commerce
entertainment, launched DMM Bitcoin, a cryptocurrency exchange with sup-
port for a range of cryptocurrencies and pairs. This move came amid the changes
the Japanese government has been introducing to encourage investors and people
to get involved in blockchain technology. The changes removed unnecessary red
tape from cryptocurrency trading and made Bitcoin a legitimate currency and
payment method.
Sweden is the most friendly country for blockchain technology after Japan.
Sweden recognises cryptocurrency as a crypto-asset and encourages inves-
tors to come forward and invest. Sweden is arguably the first country to launch
exchange-traded funds (ETFs) using Bitcoin. Even the Swedish government has
plans for its own central bank electronic currency, the e-Krona, although it is antic-
ipated that the implementation of e-Krona would take several years [Billner, 2018].
Estonia, a country in Northern Europe, is often viewed as a Blockchain model
for the world. Following the collapse of the Soviet Union in 1990, Estonia emerged
as a digital society. Before the launch of Bitcoin, the Estonian government began
exploring a similar technology called “hash-linked timestamping”. As of 2012,
Estonia adopted blockchain technology in national health, judicial, legislative,
security and commercial sectors [Adams, 2018].
Venezuela is another blockchain-friendly country willing to adopt blockchain
technology. The government of Venezuela is leading the charge for the mass adop-
tion of cryptos in a bid to stabilise the Venezuelan economy and the plunging boli-
var. It issued Petro, a new cryptocurrency backed by oil. However, because of the
political unrest in the country, corruption and dictatorship, its genuine interest in
this technology remains to be examined.
The United States, United Kingdom, Canada, Germany, the Netherlands,

France, Russia, Singapore, Hong Kong, South Korea and China are not amongst
the most friendly nations for blockchain technology, but they are not blockchain-
sceptics either. Their actions against this technology came primarily to safeguard
their citizens from fraud and potential crimes. There is no denying that most inves-
tors are coming from these nations and building exciting applications using this
technology is likely to happen in these countries in the near future. The sooner these
nations adopt regulations, the better for the growth of the blockchain industry.
19.4 Regulations for Blockchain Technology

and Cryptocurrency
The regulatory scenario of blockchain was chaotic worldwide as of December 2018.
The technology is still unregulated in most of the world. Hope, however, has been
coming from smaller nations and territories that have been proactively dealing with
blockchain start-ups for the last couple of years. Some bigger countries also have
put forth proposals for regulations in 2018 that could be implemented by 2020. The
following describes the legislative and regulatory outlook of blockchain technology,
loosely based by continent.
19.4.1 The Americas
The situation regarding blockchain and cryptocurrency in the US is complicated.
Although it is legal to use virtual currencies, their status remains confusing. The
interpretation of the underlying technology powering cryptocurrency and block-
chain platforms varies from agency to agency. As we have seen in Chapter 15, recent
multiple judicial verdicts contradict one another other. US courts have sometimes
referred to cryptocurrency as an asset and sometimes likened it to fiat currency;
hence there lacks a clear definition to determine the true nature of the applications
of this technology. The practice in the US at the moment is that the SEC requires
registration of any virtual currency traded in the US if it is classified as a security
and of any trading platform that meets its definition of an exchange. The Internal
Revenue Service (IRS) treats virtual currency as property and requires the calcula-
tion of gains or losses upon exchange for tax purposes. There is no specific law to
define ICOs in the US, but it looks like the SEC is set to prepare guidelines for
companies willing to create ICOs.
Canada seemed to be ahead of its neighbour in preparing a draft regulation for
blockchain technology companies, as the federal government had listened to many
comments and opinions from the people involved in this technology before mak-
ing the regulations. However, in August 2018, Canada postponed the announce-
ment of regulations until the next year. The Canadian Blockchain Association took
this move positively, commenting that because of the complexities of this new and
evolving sector, the government’s decision to move slowly will be beneficial for
Canadian blockchain and cryptocurrency space [Willms, 2018].
On the south side of the US border, Mexico published a legal framework pass-
ing a law for fintech companies that includes cryptocurrencies in September 2018.
The central bank, Bank of Mexico, is the regulatory authority of crypto-space in
the country. The new law defines cryptocurrencies as virtual assets and gives the
Bank of Mexico the right to determine which cryptocurrencies are appropriate for
companies to offer, run and deal with. The framework states that companies willing
to carry out transactions involving cryptocurrencies needs to request authorisa-
tion from the Bank of Mexico so that they can use those technologies associated
with any of the virtual assets. The president of National Banking and Securities
Commission (CNBV) of Mexico, Bernado Gonzalez, stated that the rules would
apply to crowdfunded companies, online payments and cryptocurrencies. He went
on asserting that the move would open the possibility for small- and medium-sized
companies to obtain financing from the public through a collective funding plat-
form without having to go to a traditional credit institution, indicating ICOs. In
addition to these fintech regulations, Mexico is also due to publish general provi-
sions for cryptocurrencies in 2019 [Helms, 2018b].
Venezuela is another nation in the region that has drafted regulations for
blockchain technology and cryptocurrency. The Ministry for Communication and
Information reported in November 2018 that the National Assembly of Venezuela
approved a bill on cryptocurrency regulation and it is due to be passed in early
2019. The law validates Petro, Venezuela’s oil-backed cryptocurrency, as a unit of
commercial exchange within the country, and states that goods and services can
also be purchased using this cryptocurrency [Berman, 2018].
Amongst the other Latin American countries, Argentina, Chile, Costa Rica,
Paraguay, Panama and Uruguay do not have legal frameworks to regulate block-
chain applications and cryptocurrencies. In Brazil, although there are no official
regulations regarding cryptocurrencies, a legislative bill project is in development
where cryptocurrencies are treated similarly to air-mile programs referring to them
as “payment arrangements”. The Colombian Central Bank warned investors against
cryptocurrencies, and the Colombian Superintendency of Finance banned finan-
cial entities from operating using virtual currencies. Despite its efforts, Colombia
remains one of the top four countries in Latin America with the highest blockchain
operation volume. Other countries in that region are considered crypto-sceptics,
as their government and authorities continuously warn investors to stay away from
virtual currencies and blockchain applications [Kelemen, 2018].
19.4.2 Europe
In Europe, it is surprising that instead of so-called financial powerhouse nations,
smaller countries and territories have been doing better in adapting blockchain
technologies. Amongst them, Switzerland has already established itself as a world

leader. As one of the most blockchain-friendly nations in the world, the Swiss gov-
ernment has been developing a blockchain space in Zug, dubbed Crypto Valley,
for the last few years [Williams-Grut, 2018]. The country already regulates the
use of cryptocurrency using anti-money laundering laws allowing citizens to make
payments using cryptocurrency. Now regulatory bodies have been looking at ICOs
and other blockchain-related areas. FINMA, Switzerland’s independent financial-
markets regulator, is working towards drafting guidelines and has already pub-
lished a framework for ICOs [Keskin, 2018a]. Meanwhile, the State Secretariat
for International Financial Matters (SIF) established a blockchain/ICO working
group in collaboration with the Federal Office of Justice (FOJ). They are commis-
sioned to review all legal frameworks, identify any need for action with FINMA
and people involved in the blockchain industry, and to finalise a regulation soon
[Keskin, 2018b].
Estonia, another blockchain-friendly nation in Europe, has been exploring
opportunities related to this technology even before the arrival of Bitcoin. Eventually,
its form of blockchain, commonly known as hash-linked timestamping, and the
conventional type merged together creating a world-famous start-up ecosystem.
Estonia already has a highly regulated financial sector supervised by the Estonian
Financial Supervision Authority (EFSA), locally known as Finantsinspektsioon.
EFSA is tolerant to not only cryptocurrencies but also a diverse range of blockchain
applications. It has recently published a comprehensive legal framework overview of
ICOs in Estonia. EFSA perceives that tokens might be considered securities accord-
ing to the definition outlined in the state’s existing Securities Market Act as well
as in the Law of Obligations Act. In any case, they consider every ICO unique and
assesses them by their characteristics [Liive, 2018].
Malta, the Southern European island country in the Mediterranean Sea, is also
amongst the nations that have been trying to come to the forefront of blockchain
technology and is already at a mature stage of implementing regulations in the
state. The Cabinet of Malta has approved the Virtual Financial Assets Bill, provid-
ing a regulatory framework for cryptocurrencies and ICOs. Although the bill is
due to be debated in the parliament before it gets passed, the Maltese government
meanwhile launched the Malta Digital Innovation Authority in February 2018 to
provide legal clarity for companies developing blockchain applications, cryptocur-
rencies and ICOs. These proactive moves of the lawmakers of the country have
attracted blockchain companies to the jurisdiction; for example in March 2018,
Binance, the largest cryptocurrency exchange by volume, announced its willing-
ness to move a part of its operations to Malta [Nakamura, 2018].
Gibraltar, a British overseas territory, is one of the few jurisdictions in the
world to have a regulatory framework already in place. The regulations are specially
designed to improve blockchain businesses including cryptocurrency exchanges,
wallet service providers and any company that stores or transmits value belonging
to others using distributed ledger technology. The government of Gibraltar decided
to regulate the blockchain industry in 2014 and invited private companies to work
with the designated unit of the government to identify what the most appropriate
form of regulation should be. This initiative led to delivering a principles-based
regulatory framework appropriate for blockchain and cryptocurrency businesses
that flexible enough to remain relevant as new technologies develop within the ter-
ritory. The Gibraltar Financial Services Commission (GFSC) regulates the sector,
having a team dealing exclusively with blockchain sectors.
On the western flank of Europe, the United Kingdom has the reputation of
being one of the leaders in fintech innovation with its capital London as one of the
most regulated, friendly and safe places to establish businesses. This reputation of
the UK somehow does not go hand-in-hand when it comes to the cryptocurrency
regulation. The country seems to be lagging compared to its European, Asian
and North American competitors. The Financial Conduct Authority (FCA) regu-
lates the financial industry in the UK. The FCA initially denied that it was the
regulator for the blockchain technology, stating that the design of a crypto-asset
primarily as a means of payment or exchange would not generally sit within the
scope of FCA and whether an ICO falls within its administrative boundaries
can only be decided case by case. However, it later partially changed its position,
and as of July 2018, announced the acceptance of 29 companies in its regulatory
sandbox; of those 11 are blockchain start-ups. This move by FCA is undoubtedly
a positive sign for the UK that is expected to deliver required legal frameworks
and regulations in the future [Stankovic, 2018]. The Netherlands, Germany and
France are amongst the other European nations that have been planning to fol-
low suit.
19.4.3 Asia
Most Asian nations seem to be blockchain sceptics, including almost all Persian
Gulf nations, South Asia and many countries in Southeast Asia. Although
Southeast Asia is one of the most active regions for cryptocurrency mining and
trading, countries like China and South Korea have not put forth any clear regu-
lations rather than their recent actions regarding clamping down on mining and
exchanges, which made the market more volatile [Pavesic, 2018].
Surrounded by sceptical neighbours, only a few Asian countries have shown a
keen interest in creating a blockchain-friendly ecosystem that will help start-ups,
ICOs and trading exchanges to grow. One of those nations is Singapore, which
does not have a regulation in place for blockchain technology at the moment, and
surprisingly it does not want to constitute anything soon. Authorities in Singapore
perceive regulations as red tape and intend to avoid having regulations as much as
possible. The head of the Monetary Authority of Singapore (MAS), which serves
as the central bank and financial regulator of Singapore, stated in a 2017 interview
with Bloomberg that MAS would keep “an open mind” with no plans of regulat-
ing cryptocurrencies. Meanwhile, the government had already declared Bitcoin as
a commodity and outlined the tax issues related to cryptocurrency trading and
investment in the country [Chanjaroen et al., 2017].
Japan, being one of the most friendly blockchain nations, is also keen to estab-
lish a regulatory framework in the state. The Financial Services Agency (FSA), the
financial regulator of Japan, published a draft report in December 2018 outlining
new cryptocurrency regulations. The report contains measures in areas that are
not currently addressed in existing laws such as hacking incidents, self-regulation,
deemed dealers, privacy coins and margin trading [Helms, 2018a].
Another jurisdiction in Asia that is eager to become a crypto-friendly envi-
ronment is the Chinese autonomous territory of Hong Kong. The Securities and
Futures Commission (SFC), the regulator for securities in the region, stated in
November 2018 that it has been setting guidelines for funds dealing with cryp-
tocurrency with the intention to ultimately establish a formal regulatory environ-
ment for cryptocurrencies in Hong Kong [Suberg, 2018]. Amongst the Persian Gulf
nations, only Dubai in the UAE has plans to develop a blockchain-friendly incuba-
tor for start-ups. In 2016, it established the DubaiCoin crypto-exchange making
cryptocurrencies transactions and tradings legal. Now, it is possible to buy luxury
cars and apartments using Bitcoin in the emirate. Nevertheless, Dubai has even
bigger plans to become the first blockchain-powered government by 2020, and its
authorities have been working on regulatory frameworks expected to become law
by 2019 [Jenkinson, 2018].
19.4.4 Australia and Africa

Australia seems genuinely willing to provide the blockchain industry with the nec-
essary conditions to grow. In 2018, the Australian government passed new laws
for Digital Currency Exchange (DCE) providers. The laws were then enforced by
AUSTRAC, Australia’s financial intelligence agency and anti-money laundering
and counter-terrorism financing (AML/CTF) regulator. These new AML/CTF
laws for the first time cover regulation of service providers of Bitcoin and other
cryptocurrencies. Nicole Rose, the CEO of AUSTRAC, following the implementa-
tion of this law, stated that the laws would strengthen the agency’s compliance and
intelligence capabilities to help DCEs implement systems and controls that can
minimise the risk of criminals using them for money laundering, terrorism financ-
ing and cybercrime. Effective immediately, DCEs with a business operation located
in Australia must now register with AUSTRAC and meet the government’s AML/
CTF compliance and reporting obligations.
On the African continent, cryptocurrencies have legal but unregulated status
in South Africa, but the law of the state restricts their use. Because South African
law only distinguishes currencies that exist in a physical form as legal tenders, pay-
ment transactions using cryptocurrencies are not plausible. The South African
Reserve Bank (SARB), the central bank, has been formulating policies with regard
to digital currencies. It published a white paper clarifying the possible status of
cryptocurrency as “stores of value”. If it becomes law in the future, this could con-
vert cryptocurrency to legal tender; hence opening its usage to a greater extent. Any
earnings from virtual currencies are taxable in South Africa, and investors need to
ensure compliance with tax laws. In other African countries including Kenya and
Nigeria, regulations do not recognise cryptocurrency as legal tender, and central
banks usually do not encourage its citizens to invest in this industry due to the
speculative nature of cryptocurrencies.
19.5 Summary
This chapter presented the current regulatory landscape of blockchain technology,
cryptocurrency and ICOs around the globe. It briefly outlines how fraudulent actors
misuse the system in the absence of a regulatory framework leading to government
crackdowns and market crashes. The chapter then pointed out the challenges and
areas needing urgent attention followed by identifying b lockchain-friendly nations
of the world. The chapter finally concluded with commentary on proposed regula-
tory frameworks and plans by governments of many countries that have been keen
to establish an ecosystem within their jurisdiction to nurture this new and innova-
tive technology.
Chapter 20
Criticism, Scepticism
and Support
Blockchain technology has been the subject of critical discussions since its incep-
tion, with its first application Bitcoin being the primary target. Experts from both
finance and tech industries, economists, academics, investors, journalists and public
figures from various areas openly expressed their opinions against or in favour of this
technology. During the 2017 cryptocurrency bull run, every day hundreds of news
and opinion articles from around the globe used to arrive explaining flaws and pos-
sibilities of this technology. People predicted the values of Bitcoin and explained the
similarities of its price hike with the Dutch Tulip mania to label it a bubble. Many
of those comments proved to be wrong, while a large number of predictions are yet
to be confirmed. This chapter aims to accumulate those criticisms, scepticism and
supporting comments of blockchain technology with a view to present readers an
orderly commentary aligned with the rise and fall of the price of Bitcoin. Although
unsurprisingly, a large lump of these comments discussed Bitcoin and cryptocurren-
cies, efforts are also given to incorporate comments and criticisms on blockchain as
a host of futuristic applications. Unlike the previous chapters, it is not written in a
formal structure; rather the comments are organised as stated over the last decade.
20.1 Before It All Started

Nobel laureate in economics Milton Friedman made a remarkable prediction in
1999, a decade before the launch of the Bitcoin network. He stated:
“The internet is going to be one of the major forces for reducing the
role of government. The one thing that’s missing, but that will soon be
329
developed, is a reliable e-cash: a method whereby on the internet you

can transfer funds from A to B without A knowing B or B knowing
A – the way in which I can take a $20 bill and hand it over to you, and
there’s no record of where it came from.” – Milton Friedman
Date: 21/06/1999
Bitcoin Price: $0.00
Stance: Supportive
20.2 Early Days of Bitcoin

The price of Bitcoin remained below $20 until 2012. During this period, the dis-
cussion about the technology and this cryptocurrency was mostly confined amongst
developers and enthusiasts. Later that year when the price began to rise, more people
gathered, new cryptocurrencies were launched and people outside the community
started to take an interest in the blockchain technology, particularly in Bitcoin. By the
start of 2013, the price of Bitcoin hit more than $200, Litecoin and Ripple arrived on
the landscape, and critics and sceptics began to become furious about this technology.
If Friedman noticed something coming that was going to change the world, his
fellow Nobel laureate Paul Krugman saw evil in Bitcoin in December 2013 when
the price hit more than $700.
“Bitcoin is evil. So far almost all of the Bitcoin discussion has been
positive economics – can this actually work? And I have to say that I’m
still deeply unconvinced.” – Paul Krugman, Professor of Economics,
City University of New York
Date: 28/12/2013
Stance: Critical
By the time we reached the year 2014, Bitcoin’s price had begun to fall from its
peak and undergone some severe volatile periods. Despite those agitations, lead-
ers from tech industry giants overwhelmingly praised the underlying principles of
blockchain technology.
“… (Bitcoin) is a remarkable cryptographic achievement. The ability

to create something which is not duplicable in the digital world has
enormous value.” – Eric Schmidt, Chairman, Google (Alphabet Inc.)
Date: 03/03/2014
Stance: Supportive
Criticism, Scepticism and Support ◾ 331
“Bitcoin as a currency is working. There may be other currencies like

it that may be even better. But in the meantime, there’s a big industry
around Bitcoin. People have made fortunes off Bitcoin; some have lost
money. It is volatile, but people make money off of volatility, too.” –
Richard Branson, Founder and CEO, Virgin Group
Date: 10/09/2014
Stance: Supportive
“Bitcoin is exciting because it shows how cheap it can be. Bitcoin is

better than currency in that you don’t have to be physically in the same
place and, of course, for large transactions, currency can get pretty
inconvenient.” – Bill Gates, Founder and Chairman, Microsoft
Date: 02/10/2014
Stance: Supportive
20.3 Bitcoin Grabs Attention

The years 2015 and 2016 are when blockchain technology started to grab atten-
tion. The arrival of Ethereum and smart contracts opened a new era that many
other platforms decided to follow. This is the period when central banks around the
world became concerned about the potential of cryptocurrency. Authorities from
two Asian financial giants, Japan and Singapore, made thoughtful comments amid
the continued volatility of the cryptocurrency market.
“Whether digital currencies will take off in a big way remains to be

seen. But it is a phenomenon that many central banks are watching
closely, including MAS. And if they do take off, one cannot rule out
central banks themselves issuing digital currencies some day!” – Ravi
Menon, Managing Director, Monitory Authority of Singapore
Date: 29/06/2015
Stance: Supportive
“Given that the development of financial services has been supported

by ledgers as the basic infrastructure for information, the dramatic
changes in how ledgers are kept may have the potential of signifi-
cantly changing the structure of financial services.”– Haruhiko Kuroda,
Governor, Bank of Japan
Date: 23/08/2016
Stance: Supportive
20.4 Beginning of the Bull Run

The year 2017 is the most successful year for cryptocurrencies to date. The price of
Bitcoin hit nearly $20,000 making people crazy about commenting on this topic.
Remarks were launched from all possible directions from both critics and support-
ers. Critics and sceptics became extremely critical about this technology, while the
“believers” praised its potential as usual.
(Addressing the audience at a cryptocurrency conference) “I’m a believer.

… I’m one of the few standing before you today from a large financial-
services company that has not given up on digital currencies.” – Abigail
Johnson, CEO, Fidelity Investment
Date: 23/05/2017
Stance: Supportive
“Digital currencies are nothing but an unfounded fad (or perhaps even
a pyramid scheme), based on a willingness to ascribe value to some-
thing that has little or none beyond what people will pay for it. They
are not real. Nobody has been able to make sense to me of these cur-
rencies.” – Howard Marks, Co-Chairman and Co-Founder, Oaktree
Capital Group
Date: 26/07/2017
Stance: Critical
“It’s a fraud. If a JPMorgan trader began trading in Bitcoin I’d fire

them in a second. For two reasons: It’s against our rules, and they’re
stupid. And both are dangerous.” – Jamie Dimon, CEO, JPMorgan

Chase & Co
Date: 12/09/2017
Stance: Critical
“China doesn’t recognize cryptocurrency as payment and forbids ICOs.

… Our views are absolutely similar. In our view, it’s a sort of a finan-
cial pyramid that may collapse at any moment.” – Elvira Nabiullina,
Governor, Bank of Russia
Date: 14/09/2017
Stance: Critical
“Bitcoin is a sort of tulip. It’s indeed an instrument of speculation for

those that want to bet on something that can go up and down 50 or 40
percent in a few days but certainly not a currency, and certainly we don’t
see it as a threat to central banking or monetary policy, that’s for sure.”
– Vitor Constancio, Vice President, European Central Bank
Date: 22/09/2017
Stance: Critical
“This is going to be the largest bubble of our lifetimes. … Prices are

going to get way ahead of where they should be. You can make a whole
lot of money on the way up, and we plan on it.” – Mike Novogratz,
Former macro manager, Fortress Investment Group
Date: 26/09/2017
Stance: Sceptical
“(Bitcoin is) certainly something more than just a fad … The concept
of anonymous currency is a very interesting concept – interesting for
the privacy protections it gives people, interesting because what it says
to the central-banking system about controlling that.” – James Gorman,

CEO, Morgan Stanley
Date: 27/09/2017
Stance: Supportive
“Not so long ago, some experts argued that personal computers would
never be adopted and that tablets would only be used as expensive
coffee trays. So I think it may not be wise to dismiss virtual curren-
cies. Countries with weak institutions and unstable national curren-
cies may see growing use.” – Christine Lagarde, Managing Director,
International Monetary Fund
Date: 29/09/2017
Stance: Supportive
20.5 Crazy Price Hike

It is notable at this stage that in September 2017, when the bull market began
to jump at a great pace, authorities from several central banks and international
organisations, who used to play the role of the observer, started to express their con-
cerns. The centre of their criticisms was surrounded by possible money laundering
allegations and criminal activities that news outlets had been breaking at a regular
interval during that period.
“Bitcoin just shows you how much demand for money laundering there
is in the world.” – Larry Fink, CEO, BlackRock Financial Management
Date: 03/10/2017
Stance: Sceptical
“Bitcoin’s value is a function of supply and demand; it doesn’t really do

anything else. Blockchain is a great platform for future applications.”–
Mark Cuban, Billionaire venture capitalist
Date: 03/10/2017
Stance: Supportive
“I think it will be an asset class that will work over time. … I feel like
it’s a bit of a mania at the moment, but I think in the long term, it’s a
viable asset class.” – Kyle Bass, Founder, Hayman Capital Management
Date: 06/10/2017
Stance: Supportive
“People are more curious than really willing to invest. I don’t think
there’s any meaningful desire by high net worth individuals to take
big bets on this kind of phenomenon.” – Sergio Ermotti, CEO, UBS
Group AG
Date: 10/10/2017
Stance: Critical
20.6 To Invest or Not to Invest?

As the price got beyond $5000, CEOs of the biggest investment banks were
found divided in their opinions. While many decided to take a strong position
against this technology, some openly expressed their support, and a few took a
cautious stance indicating that they might not invest at that moment but had
their faith in it.
“Bitcoin is an attempt to replace fiat currency and evade regulation and

government intervention. I don’t think that’s going to be a success.” –
Ben Bernanke, Former Chairman, Federal Reserve
Date: 17/10/2017
Stance: Critical
“Bitcoin critics are underestimating it. … It’s like a reserve form of

money, it’s like gold and it’s just a store of value. You don’t need to use
it to make payments.” – Peter Thiel, Co-Founder, PayPal
Date: 26/10/2017
Stance: Supportive
“There ought to be a hard look at the policy of anonymous currencies,

because the ability to track information of money flowing is one we
use seriously against terrorism and as (a tool) against improper, illegal
behavior.” – Brian Moynihan, CEO, Bank of America Corp.
Date: 26/10/2017
Stance: Critical
“People get excited from big price movements, and Wall Street accom-
modates. You can’t value Bitcoin because it’s not a value-produc-
ing asset. It’s a real bubble.” – Warren Buffett, Chairman and CEO,
Berkshire Hathaway Inc.
Date: 29/10/2017
Stance: Critical
“I don’t have an investment in it, but I’m not willing to pooh-pooh it,
and that’s why I say I’m open to it.” – Lloyd Blankfein, CEO, Goldman
Sachs Group Inc.
Date: 02/11/2017
Stance: Supportive
“From what we can identify, the only reason today to buy or sell Bitcoin
is to make money, which is the very definition of speculation and the very
definition of a bubble.” – Tidjane Thiam, CEO, Credit Suisse Group AG
Date: 02/11/2017
Stance: Critical
“I don’t see why there is all this hostility to it. Bitcoin is not much
different than gold because it doesn’t have liability attached to it, by
definition, like a security” – Jeff Currie, Global Head of Commodities
Research, Goldman Sachs Group Inc.
Date: 29/11/2017
Bitcoin Price: $10,193.45
Stance: Supportive
20.7 $10K and Counting

Many critics of Bitcoin did not expect it to hit $10,000. While numerous support-
ers of the technology indicated that the price of the cryptocurrency is not what
they looked at but rather the potential of the underlying technology, critics kept
their focus on the price hike as criticisms continued to arrive starting the so-called
potential bubble.
“In terms of Bitcoin, I would be pretty cautionary about it. I think that
it’s not a stable store of value … I would be, at this point, pretty skepti-
cal of Bitcoin. I think it’s really more of a speculative activity.”– William
Dudley, President, Federal Reserve Bank of New York
Date: 29/11/2017
Stance: Critical
“Bitcoin is successful only because of its potential for circumvention,

lack of oversight, so it seems to me it ought to be outlawed. It doesn’t
serve any socially useful function.” – Joseph Stiglitz, Nobel Prize–
Winning Professor of Economics, Columbia University
Date: 29/11/2017
Stance: Critical
“We will discover that behind this Bitcoin scam, some funds were
channeled maybe to finance terrorism and at that point, we will wake
up and realize that this is not appropriate.” – Lorenzo Bini Smaghi,
Chairman, Societe Generale SA
Date: 30/11/2017
Stance: Critical
“Digital currency is disruptive, it has a lot of potential but that

doesn’t tell us a lot about what these actual instruments are worth.
Even the insiders in that industry don’t really know where it’s going
and it’s going to take some time. And for the average investor, you
know, buyer beware because you need to do your homework and it’s
tough; there’s a very high learning curve to figure out exactly what
this all means.” – Jurrien Timmer, Director of Global Macro, Fidelity

Investments
Date: 30/11/2017
Stance: Sceptical
“I’m not a Bitcoin believer. My kids think I’m really stupid … they
could have made a lot of money and I didn’t allow them to invest in
it … It’s fascinating but it will make central banks lose control, and
they are not going to let this happen. At some point in time, maybe
at $20,000, $25,000, $30,000, somebody will say ‘Stop!’” – Andreas
Treichl, CEO, Erste Group Bank AG
Date: 30/11/2017
Stance: Critical
“It is not a stable store of value, and it doesn’t constitute legal tender. It
is a highly speculative asset, and the Fed doesn’t really play any regula-
tory role with respect to Bitcoin other than assuring that banking orga-
nizations that we do supervise are attentive that they’re appropriately
managing any interactions they have with participants in that market.”
– Janet Yellen, Chair, Federal Reserve
Date: 13/12/2017
Stance: Sceptical
20.8 Nosedive
All major cryptocurrencies reached their all-time high either in December 2017 or
January 2018. Bitcoin hit nearly $20,000 spot before it started to nosedive. The free
fall of the cryptocurrency leader was soon followed by all other members, and the
market met with a series of crashes throughout the year. Most comments arrived
this year were of negative attitude, but some positive signs also shined sporadically.
“Having no clear fundamental value and largely unregulated markets,

coupled with a storyline conducive to delusions of grandeur, makes this
more than anything we can find in the history books the very essence
of a bubble.” – Jeremy Grantham, Co-Founder and Chief Investment

Strategist, GMO
Date: 03/01/2018
Stance: Critical
Amongst the positives, the most remarkable comment was made by the JPMorgan
CEO who previously called Bitcoin “a fraud” and stated he would not delay fir-
ing people in his organisation should he find them investing in this crypto-asset.
Jamie Dimon considered changing his position about the blockchain technology
and stated:
“I regret making comments saying Bitcoin is a fraud. The blockchain is

real. You can have crypto yen and dollars and stuff like that.” – Jamie
Dimon, CEO, JPMorgan Chase & Co.
Date: 09/01/2018
Stance: Supportive
“The cryptocurrency trading that’s going on actually worries me a

little bit. I think it’s going to end very badly, I really do. Some people
are going to lose a lot of money and there’s no reason that the prices
should be going up at the rate that they’re going up. There’s no funda-
mental economic reason.” – F. William McNabb, Chairman, Vanguard
Group Inc.
Date: 17/01/2018
Stance: Critical
“I believe that we are heading into a new age in which blockchain tech-
nology is going to provide a significant level of a digital currency that
is going to have a consumer application. And I believe that Starbucks
is in a unique position to take advantage of that.” – Howard Schultz,
Founder and Chairman, Starbucks
Date: 25/01/2018
Stance: Supportive
“Cryptocurrencies like Bitcoin, we should be looking at these very seri-

ously precisely because of the way they can be used, particularly by
criminals.” – Theresa May, Prime Minister, United Kingdom
Date: 25/01/2018
Stance: Critical
“We need better cross-border payments, … because it’s good for develop-
ment, it’s good for financial inclusion. So Bitcoin can help us, it can pay us
a service by forcing us to upgrade our systems. That’s a positive lesson. The
international community still needs to understand and control these gate-
ways between the shadow-currency universe and the regular financial sys-
tem.” – Benoit Coeure, Member of Executive Board, European Central Bank
Date: 26/01/2018
Stance: Supportive
As Bitcoin lost nearly half of its value within a short span of time, heads of many
central banks or similar organisation quickly became very critical about cryptocur-
rencies and the technology empowering them.
“(Cryptocurrencies) … are not really currencies at all. One should really,

really be careful and be mindful of the fact that this is more like par-
ticipating in a lottery or going to the casino. This is not banking as we
know it.” – Stefan Ingves, Governor, Riksbank (Central Bank of Sweden)
Date: 29/01/2018
Stance: Critical
“(Bitcoin is) … a purely speculative asset. … in no way a currency, or even

a cryptocurrency. It is a speculative asset. Its value and extreme volatility
have no economic basis, and they are nobody’s responsibility. The Banque
of France reminds those investing in Bitcoin that they do so entirely at
their own risk.” – Francois Villeroy De Galhau, Governor, Bank of France
Date: 30/01/2018
Stance: Critical
“We will not create a market because the mandate of Euronext is to

power pan-European capital markets to finance a real economy, and
Bitcoins have nothing to do with the real economy. Bitcoin is, at best,
a crypto asset … just like a piece of art, just like a diamond, just like
a Pokemon card. Today people buy it because it goes up and because
it’s not as transparent as other assets.” – Stephane Boujnah, CEO,
Euronext NV
Date: 30/01/2018
Stance: Critical
“India doesn’t consider cryptocurrencies legal tender and will take all
measures to eliminate use of these crypto-assets in financing illegiti-
mate activities or as part of the payment system while exploring the
use of blockchain technology.” – Arun Jaitley, Finance Minister, India
Date: 01/02/2018
Stance: Critical
Soon after the price of Bitcoin fell below $10,000, economists and investment per-
sonnel became vocal to point out that it was a bubble and it had burst. As the price
continued to drop, harsh comments showered the news outlets.
“Bitcoin is the mother of all bubbles and is also the biggest bubble in
human history if you compare it to, say, the Mississippi bubble or the
tech bubble or tulip mania or South Sea Bubble. Now it has crashed
by about 60 percent compared to the peak of mid-December. It has
crashed 30 percent in the last week and 10 percent today, and the fun-
damental value of Bitcoin is zero.” – Nouriel Roubini, Chief Economist
and Co-Founder, Roubini Global Economics Chairman
Date: 02/02/2018
Stance: Critical
“We have seen historical instances where such a rush into certain invest-
ments has benefitted our economy and those investors who backed the
right ventures. But when our laws are not followed, the risks to all
investors are high and numerous – including risks caused by or related
to poor, incorrect or non-existent disclosure, volatility, manipulation,

fraud and theft.” – Jay Clayton, Chairman, US Securities and Ex-
change Commission
Date: 06/02/2018
Stance: Sceptical
“I never considered for one second having anything to do with it.

I detested it the moment it was raised. It’s just disgusting. Bitcoin
is noxious poison.” – Charles Munger, Vice Chairman, Berkshire
Hathaway Inc.
Date: 14/02/2018
Stance: Critical
“For many reasons the crypto-assets in your digital wallets are unlikely
to be the future of money. But that is not meant to dismiss them. Their
core technology is already having an impact. Bringing crypto-assets
into the regulatory tent could potentially catalyze innovations to serve
the public better.” – Mark Carney, Governor, Bank of England
Date: 02/03/2018
Stance: Sceptical
“Cryptocurrencies are just Candy Crush. There are now more than
1,300, and it seems reasonable to assume all 1,300 are not of equal
quality … the return-on-investment could be considerably lower than
investors currently expect” – Richard Bernstein, CEO, Richard Bern-
stein Advisors LLC
Date: 18/04/2018
Stance: Critical
“Bitcoin is a scam. In my opinion, it’s a colossal pump-and-dump

scheme, the likes of which the world has never seen. Cryptocurrency is
best-suited for one use: Criminal activity. Because transactions can be
anonymous – law enforcement cannot easily trace who buys and sells
– its use is dominated by illegal endeavors.” – Bill Harris, Founding

CEO, PayPal
Date: 24/04/2018
Stance: Critical
By the time Bitcoin’s price reached $6000, people started to lose interest in the
topic. It was a period when most ICOs conceived the previous year had failed, and
fraudulent actors in the industry began to leave. The frequency of comments about
blockchain technology also got significantly reduced.
“Blockchain technology could change our world more than people

imagine. … Bitcoin, however, could be a bubble.” – Jack Ma, Founder
and Chairman, Alibaba Group Holding
Date: 25/06/2018
Stance: Sceptical
“I think of Bitcoin as a remarkable social phenomenon. It’s an epidemic

of enthusiasm. It is a speculative bubble. That doesn’t mean that it
will go to zero. Speculative bubbles recur. We had a bubble in Bitcoin
in 2013, and it looked like it was done – it fell from 1,000 to 200 –
but now look, it comes back.” – Robert Shiller, Nobel Prize–Winning
Professor of Economics, Yale University
Date: 26/06/2018
Stance: Critical
(Announcing that CFA institute will add topics on cryptocurrencies and

blockchain to its Level I and II curriculums in 2019) “We saw the field
advancing more quickly than other fields, and we also saw it as more
durable. … This is not a passing fad.” – Stephen Horan, Managing
Director, CFA Institute
Date: 16/07/2018
Stance: Supportive
The announcement from the CFA Institute was a huge boost for the blockchain
industry. This is the institute that offers CFA Charter, the most valued qualification
in the investment industry and the institute itself is famous for overseeing the ethi-
cal issues and standards of the industry. Its decision to include blockchain technol-
ogy in its curriculum cannot be an impulse move; rather it indicates the need for
such a technology in future.
20.9 Summary
This chapter took the initiative of accumulating most major criticisms and support
of cryptocurrency and blockchain technology received over its lifetime. It is quite
evident from the commentary presented here that most comments are concentrated
around the latest price hike of Bitcoin. This was the period when blockchain tech-
nology became the centre of attention to a wide range of experts, and media cover-
age was at its best to complement the scenario. Nevertheless, the discussion also
tried to assemble comments from the early years and late 2018 to give readers a
complete understanding of the criticisms, scepticisms and support that the technol-
ogy receives from around the world.
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Index
A transactions, 132–133
XRP ledger, 131–132
Altcoins, 86–87 Stellar, 146
Dash (Digital Cash), 88–89
Litecoin (LTC), 87–88
Namecoin (NMC), 87 B
Nxt (NXT), 88 BA algorithm, see Byzantine agreement
Peercoin (PPC), 88 algorithm
Ambrosus, 174 BCH, see Bitcoin Cash
Applications BFT, see Byzantine fault tolerance
bitcoin (BTC), 23 Bitcoin (BTC)
of blockchains, 23, 25 $10K and counting, 337–338
HydraChain, 170 applications, 23
Internet of Things (IoT), 161 before bitcoin, 63–64
Moeco, 166 blockchain data, 66–67
Naoris, 168 block header, 67
OriginTrail, 163 genesis block, 68–69
Stellar hash generation, 68
anchors, 148–149 Merkle tree, 67–68
distributed exchange, 149 timestamp, 67
multi-currency transactions, 149–153 crazy price hike, 334–335
Architecture definition of, 4–5, 61–63
centralised client-server, 10 double-spending problem, 5–6
centralised vs. decentralised architecture, early days of, 330–331
10–11 era, 64
characteristics, 13–14 vs. Ethereum, 107
EOS, 119–120 grabs attention, 331–332
Ethereum history of, 63
account, 100–101 investment, 335–336
address, 101 mining and supply, 65
Ethereum virtual machine (EVM), mysterious scientist, 4
99–100 Nakamotos solution, 6–7
Mist, 101–102 nosedive, 338–344
NEO price of, 332–334
advanced features, 111–112 transactions, 73–74
basic structure, 111 contracts, 79–80
peer-to-peer (P2P) network, 11–13 generation transaction, 79
Ripple, 129–130 input and output, 74–77
hawala, 130–131 multi-signature, 78–79
355
356 ◾ Index
redeeming tokens, 77–78 proof of work (PoW), 57–58

storing data, 79 consortium, 21–22
units of, 66 definition of, 8
Bitcoin address, 69–71 distributed ledger, 8–9
address structure, 72–73 hybrid blockchains, 22
formats, 71–72 immutability of
hash generation, 72 block and block header, 44
Bitcoin Cash (BCH), 85 building the chain, 45–47
Bitcoin Gold (BTG), 85–86 cryptographic applications, 36–40
Bitcoin Private (BTCP), 86 cryptography, 27–30
Block elliptic curve cryptography (ECC),
genesis block, 16 41–44
identifier and height, 15–16 Merkle tree, 45
structure, 14–15 modern cryptography, 30–36
Blockchains timestamp, 44–45
19th century, general ledger from the, 9 motivation, 7–8
applications of, 23, 25 properties, 9
citizen engagement, 197 public and private blockchains, 21
citizen services, 182–186 shared ledger, 21–22
classification, 180–182 sidechain, 21–22
commercial supply chain, 191 types of, 21
cybersecurity, 193–194 Block header, 67
drug manufacturing, 192–193 BlockPhrama, 174
e-auctions, 189–190 Brain wallet, 240–241
e-commerce, 188 BTC, see Bitcoin
exchange and trading, 187 BTCP, see Bitcoin Private
financial services, 186 BTG, see Bitcoin Gold
food production, 191–192 Byzantine agreement (BA) algorithm, 133
gambling and gaming, 189 Byzantine fault tolerance (BFT), 55–56
online betting, 189 Byzantine Generals Problem, 53–55
online bidding, 189–190
online marketplace, 187–188 C
physical safety, 194
quality control, 197–198 Classical cryptography, 28
safety and security, 193 Codius and Interledger, Ripple Labs, 136
security and tracking, 194 Coinbase, 69, 79
smart city, 195 Cold-storage wallet, 241–242
smart grid, 196–197 Cold wallets, 236
smart home, 195–196 Commercial supply chain, 191
smart property, 187 Communication layer, 171
smart transportation, 196 Consensus mechanisms, 51–52
supply chain management (SCM), 191 alternative consensus algorithms, 19–20
technology hype, 177–180 Blockchains
comparison, 22–24 BFT in, 58–59
consensus mechanisms of Byzantine Generals Problem, 52–56
BFT in, 58–59 distributed systems and consensus,
Byzantine Generals Problem, 52–56 49–52
distributed systems and consensus, double-spending problem, 59–60
49–52 hashcash proof of work (PoW)
double-spending problem, 59–60 algorithm, 56–57
hashcash proof of work (PoW) proof of work (PoW), 57–58
algorithm, 56–57 comparison, 20–21
Index ◾ 357
EOS economic outlook of

algorithm, 120–121 classification, 281–282
procedure, 121–122 commodity, 283
reward, 122 currency, 282–283
NEO stock, 284
algorithm, 112–113 exchanges and platforms
fault tolerance, 114 cryptocurrency trading exchange,
procedure, 113 258–259
transaction time, 114 derivative trading exchanges, 259–260
transaction validation, 113 investment platforms, 260–261
view change, 114 financial crimes
proof of work (PoW), 18–19 cooperation, 314–315
Ripple Protocol Consensus Algorithm false claims, 311
(RPCA) market manipulation, 310–311
components, 133–134 money laundering, 308–310
consensus process, 134–135 participation, 315–316
correctness, 135–136 prevention, 312–313
Stellar regulation, 313–314
agreement, 148 scams, 312
quorum and slices, 146–148 hash rate
Consensus layer, 121 calculation, 222
Coordination and agreement, 50–51 and profits, 222
Crazy price hike, 334–335 understanding, 221–222
Cryptocurrency, 201, 215–217 historic price predictions, 287
acceptance investment strategy
by governments, 292–293 buy and hold, 262
by investors, 291–292 commodities, 251
by merchants, 290–291 currencies, 251–252
bitcoins day trading, 261
The Missing Piece, 298 derivatives, 252–253
price of, 284–285 financial instruments, 250–251
volatility of, 285–286 guided investment, 264–265
blockchain technology self-investment, 263–264
Africa, 327–328 status of, 253
Americas, 323–324 value investment, 262
Asia, 326–327 legality of blockchain, 317–318
Australia, 327–328 mining
Europe, 324–326 difficulty, 221
criminal activities, 295–296 evolution of, 220
current landscape process, 220–221
areas, 321–322 rewards, 221
blockchain-friendly nations, 322–323 mining hardware
challenges, 320–321 application-specific integrated circuit
darknet-based crimes (ASIC), 224
assassination markets, 304–306 non-specialised hardware, 222–224
cybercrimes, 306–307 profitability factors, 225
post-silk road markets, 301–304 mining nations, 228–229
silk road, 299–301 pooled mining
deep web, 296–297 AntPool, 227
darknet, 297 basics, 225–226
dark web, 297 F2Pool, 227
onion routing and Tor, 297 reward sharing, 228
358 ◾ Index
Slush Pool, 226 Delegated proof of stake (DPoS), 120, 167

portfolio Deterministic wallet, 242–246
exchange-traded fund (ETF), 256–257 HD wallet, 244–246
funds, 253–254 type-1 wallet, 242–243
indices, 254–256 type-2 wallet, 243–244
PoW mining, 229–231 Digital Cash, see Dash; Digital money
price movement Digital currency, see Dash; Digital money
EOS, 289–290 Digital money, 6, 95
ETH, 288 centralised digital money, 213–214
NEO, 289 decentralised digital money, 214–215
XLM, 289 Digital signature, 38–40
XRP, 288 Distributed application (DApp), 50
regulation, 265–266 Distributed Identity Validation Authority
regulatory issues (DIVA), 167
ICOs, 319 Distributed systems, 50
mining and trading, 319–320 DIVA, see Distributed Identity Validation
misuse of pre-mining, 319 Authority
tax affairs, 265–266 Double-spending problem, 5–6, 26
wallet DPoS, see Delegated proof of stake
brain wallet, 240–241
cold-storage wallet, 241–242 E
deterministic wallet, 242–246
external storage media, 238 e-auctions, 189–190
hardware wallet, 239–240 ECC, see Elliptic curve cryptography
multi-signature wallet, 241 e-commerce, 188
paper wallet, 238–239 Elliptic curve cryptography (ECC)
private key and address, 234 basic concept, 41–42
receive-only wallet, 242 public and private keys, 42–43
software wallet, 236–238 vs. RSA, 43–44
special wallets, 241 Emerging distributed ledgers
transferring funds, 234–235 drug development, 174
types of, 235–236 genomic data collection, 174–175
wallet providers, 246–247 medical services, 173–174
web wallet, 236 quality assurance, 174
Cryptography sharing economy, 174
background, 28–29 Encryption, 29
basic concepts, 29–30 Enterprise Resource Planning (ERP), 139
and cryptanalysis, 28 EOS
hash function, 37–38 definition of, 117–118
Cybersecurity, 166, 193–194 EOS.IO operating system
database, 123–124
D inter-blockchain communication, 124
schema-defined actions, 123–124
DApp, see Distributed application separation of authentication, 124
Darknet-based crimes token
assassination markets, 304–306 inflation, 119
cybercrimes, 306–307 initial coin offering (ICO), 118–119
post-silk road markets, 301–304 transaction fees, 119
silk road, 299–301 ERC standards see Ethereum Request for
Dash (Digital Cash), 88–89 Comment standards
dBFT, 112 ERP see Enterprise Resource Planning
Decryption, 29 ETH, see Ether
Index ◾ 359
Ether (ETH) I
pre-mining, 97–98
price, 98 ICOs, see Initial coin offerings
units, 98–99 Initial coin offerings (ICOs), 97
Ethereum, 96–97; see also Ether; advantages and disadvantages, 273
Smart contracts creation of, 268–269
gas, 104 good and bad, 272–273
high-level languages, 104–105 vs. initial public offerings (IPOs), 271–272
transactions, 103–104 in number
Ethereum blockchain amount raised, 274
block-generation rate, 103 breakdown by industry, 274–275
mining process, 102–103 winners and losers, 275
rewards, 103 platforms, 270
Ethereum Request for Comment (ERC) scams and criticisms, 275–277
standards token, 269–270
ERC-20, 105–106 understanding, 271
ERC-223, 106 working procedure, 269
ERC-721, 106 Initial public offerings (IPOs), 271–272
ERC-777, 107
Ethereum Virtual Machine (EVM), K
99–100, 168
EVM, see Ethereum Virtual Machine Kautiliyam, 28
External storage media, 238
L
F Litecoin (LTC), 87–88
Fiat money LTC, see Litecoin
gold standard, 212
Nixon Shock and creation, 213 M
US Dollar Standard, 212–213
Forks MediChain, 173–174
occurrence, 17 MediLedger, 173–174
types of, 18 Merkle tree, 67–68
Mining
consensus, 16–17
G definition of, 16
Genesis block, 16, 68–69 Ethereum blockchain
block-generation rate, 103
mining process, 102–103
H rewards, 103
Hard fork, 18 incentivisation, 17
Hardware wallet, 239–240 method, 80–82
Hash generation, 68, 72 process, 84
Hawala transaction, 131 proof of work (PoW), 82–83
HydraChain target and difficulty, 83–84
applications, 170 Mist, 101–102
overview, 168 Modern cryptography
technical details, 168–170 public-key cryptography, 33–36
Hyperledger symmetric-key cryptography, 31–33
application, 173 Moeco
overview, 170–171 applications, 166
technical details, 171–173 overview, 164
360 ◾ Index
technical details, 164–166 PPC, see Peercoin

Money; see also Digital money; Fiat money Private key and address, 234
banknotes, 209–211 Private network, 168
central bank, 204 Proof of capacity (PoC), 20
coinage, 207–209 Proof of space (PoSpace), 20
commodity and representative, 206–207 Purpose-built distributed ledgers
functions of, 202 and blockchains, 157–159
origin of, 204–205 Internet of Things (IoT)
properties, 202–203 applications, 161
supply, 203–204 IBM Watson and Waltonchain, 161
Mulavediya, 29 overview, 159
Multi-signature technical details, 159–161
cold storage, 78–79
escrow, 78 R
wallet, 241
Real-Time Gross Settlement System, 136–137
N RippleNet, 137–138
xCurrent, 138–139
Namecoin (NMC), 87 xRapid, 139
Naoris xVia, 139
applications, 168 Receive-only wallet, 242
overview, 166 Ripple
technical details, 167–168 consensus process of, 135
Nebula Genomics, 174–175 definition of, 127–128
NEO ledger, 132
consensus mechanism, 112–114 notable partners of, 140–141
definition of, 109–110 token, XRP
and GAS bridge currency, 129
token distribution, 111 market capitalisation, 129
token generation, 110 token generation and distribution,
NMC, see Namecoin 128–129
Nxt (NXT), 88 Unique Node List (UNL) in, 134
RippleNet Ecosystem, 138
O Ripple Protocol Consensus Algorithm (RPCA)
components, 133–134
Online betting, 189 consensus process, 134–135
Online bidding, 189–190 correctness, 135–136
Online marketplace, 187–188 RPCA, see Ripple Protocol Consensus
OriginTrail, 162 Algorithm
P S
P2P, see Peer-to-peer network SCM, see Supply chain management
Paper wallet, 238–239 Secure Sockets Layer (SSL), 36–37
Partners Slock.it, 174
RippleNet, 139–141 Smart contracts
Stellar, 153 Bit gold, 95–96
Peercoin (PPC), 88 EOS, 122–123
Peer-to-peer (P2P) network, 11–13 in Ethereum
Plaintext, 29 gas, 104
PoC, see Proof of capacity high-level languages, 104–105
PoSpace, see Proof of space transactions, 103–104
Index ◾ 361
layer, 171 Transferring funds, 234–235

NEO, 114–116 Transport Layer Security (TLS), 36–37
Szabo, Nick, 95–96 Two Generals Paradox, 52–53
Turing-completeness, 96
vending machine analogy, 94–95 U
Soft fork, 18
Software wallet, 236–238 Unspent Transaction Outputs (UTXOs), 100
Special wallets, 241 UTXOs, see Unspent Transaction Outputs
Split coins
Bitcoin Cash (BCH), 85 V
Bitcoin Gold (BTG), 85–86
Bitcoin Private (BTCP), 86 Virtual currency, 215
SSL, see Secure Sockets Layer
Stellar W
definition of, 143–144
Lumens (XLM) Wallet
generation and distribution, 144 brain wallet, 240–241
price and market cap, 145 cold-storage wallet, 241–242
role of, 145–146 deterministic wallet, 242–246
Supply chain external storage media, 238
commercial, 191 hardware wallet, 239–240
OriginTrail multi-signature wallet, 241
applications, 163 paper wallet, 238–239
overview, 162 private key and address, 234
technical details, 163 receive-only wallet, 242
VeChain and OpenChain, 163–164 software wallet, 236–238
Supply chain management (SCM), 191 special wallets, 241
transferring funds, 234–235
T types of, 235–236
wallet providers, 246–247
Temporary fork, 18 web wallet, 236
TLS, see Transport Layer Security Web wallet, 236

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Inside Blockchain, Bitcoin,

© 2020 by Taylor & Francis Group, LLC

No claim to original U.S. Government works

Printed on acid-free paper

International Standard Book Number-13: 978-1-138-61815-2 (Hardback)

Visit the Taylor & Francis Web site at

and the CRC Press Web site at

Section I BLOCKCHAIN AND BITCOIN

1.7 Consensus Mechanisms....................................................................18

3.2.2 Byzantine Generals Problem................................................53

4.8 Split Coins and Altcoins...................................................................85

Section II SMART CONTRACTS

5.8 Comparison to Bitcoin...................................................................107

Section III FINANCIAL NETWORKS

8.2.1 Token Generation and Distribution...................................128

Section IV ADVANCED LEDGERS AND APPLICATIONS

10.2.2 Technical Details............................................................... 159

11.4.2 Smart Property..................................................................187

15 Cryptocurrency Trading and Investment............................................249

Section VI SOCIO-ECONOMIC LANDSCAPE

19 Regulations, Laws and Practices......................................................... 317

Figure 1.1 Centralised and decentralised currency transfer................................5

Figure 4.11 The number of miners throughout 2018........................................82

Figure 10.2 Layers of the OriginTrail platform..............................................162

Table 1.1 Consensus Mechanism Comparison.................................................20

Dr Niaz Chowdhury is a postdoctoral researcher working with blockchain tech-

1.1 The Birth of Bitcoin

1.1.1 A Mysterious Scientist

- 100 USD - 100 BTC

+ 100 USD + 100 BTC

Money Transfer Bitcoin Transfer

Figure 1.1 Centralised and decentralised currency transfer.

is technically and technologically possible. In fact, Bitcoin transfers money using a

A copy of the same

a magic trick, Nakamoto’s magic trick must be the underlying blockchain. It

A blockchain is an immutable distributed ledger secured by cryptographic

◾◾ A blockchain is open, verifiable and permanent by nature. Data of a block-

1.3.1 Centralised vs Decentralised Architecture

Client/Server Client/Server Client/Server Client/Server

Figure 1.5 A blockchain over a peer-to-peer network is an example of a decen-

Figure 1.6 A peer-to-peer network.

Figure 1.7 A blockchain over a P2P network is an example of a decentralised

blockchain, despite being decentralised, it remains immutable without the coop-

1.4.2 Block Identifier and Height

1.6.1 When Does a Fork Occur?

1.7.1 Proof of Work (PoW)

1.7.2 Alternative Consensus Algorithms

kWh to mine 1 Bitcoin. By burning 10 Bitcoins or consuming 488,000 kWh and

Proof of work Not sustainable High High

Proof of stake Sustainable Low Medium

Proof of burn Partially sustainable High High

Proof of space Sustainable High Medium

Proof of authority Sustainable Low Low

1.8.1 Public and Private Blockchains

1.8.2 Consortium, Shared Ledger, Sidechain

private blockchains operated by a group or consortium. Shared ledgers are usually

Figure 1.9 Types of major and customised blockchains.

Access Open Restricted Controlled Controlled Controlled Restricted

Speed Slow Fast Fast Slower Slower Fast

Security Consensus Pre-approval Pre-approval Pre-approval Pre-approval Pre-approval

Section I BLOCKCHAIN AND BITCOIN

Section II SMART CONTRACTS

Section III FINANCIAL NETWORKS

Section IV ADVANCED LEDGERS AND APPLICATIONS

Section VI SOCIO-ECONOMIC LANDSCAPE

Figure 1.1 Centralised and decentralised currency transfer................................5

Figure 4.11 The number of miners throughout 2018........................................82

Figure 10.2 Layers of the OriginTrail platform..............................................162

Table 1.1 Consensus Mechanism Comparison.................................................20

1.1 The Birth of Bitcoin

1.1.1 A Mysterious Scientist

1.3.1 Centralised vs Decentralised Architecture

1.4.2 Block Identifier and Height

1.6.1 When Does a Fork Occur?

1.7.1 Proof of Work (PoW)

1.7.2 Alternative Consensus Algorithms

1.8.1 Public and Private Blockchains

1.8.2 Consortium, Shared Ledger, Sidechain

1.10 Revisiting the Double-Spending Problem

2.1.1 What Are Cryptography and Cryptanalysis?

2.3.1 TLS and SSL

2.3.2 Cryptographic Hash Function

2.4 Elliptic Curve Cryptography (ECC)

2.4.2 Public and Private Keys

2.4.3 How Does ECC Compare to RSA?

2.5 Making Blockchain Immutable

2.5.1 Block and Block Header

2.5.4 Building the Chain

3.1 Distributed Systems and Consensus

3.1.2 Coordination and Agreement

3.2 Byzantine Generals Problem