Bitcoin, Blockchain and Innovation Decentralized Technologies

Team 5: Shelby Barron, Daniel Casey, Patrick O’Malley

Institution: Kelley School of Business at Indiana University

1

Table of Contents

1. Abstract 3

2. The Blockchain Algorithm 4

3. Where Did Blockchain Originate? 4

4. How Does Blockchain Work? 5

5. How Can Blockchain Improve Financial Services? 5

6. Primary Blockchain Application: Bitcoin 7

7. How Does the Bitcoin Network Function? 7

8. Bitcoin as a Cryptocurrency 8

9. Mining 8

10. Medium of Exchange 9

11. Unit of Account 10

12. Store of Value 10

13. Value of Bitcoin in the Market 11

14. Self-Regulation 11

15. Regulatory Action 12

16. The Double Spending Problem’s Prevalence in Cryptocurrencies 12

17. How Does Bitcoin Compare to Financial Intermediaries? 14

18. Ability of BitPay in Increasing Transactions 15

19. Benefits of Using Bitcoin 16

20. Risks of Using Bitcoin 18

21. Additional Blockchain Applications: Banking 20

22. Additional Blockchain Applications: Digitized Legal Contracts 23

23. Additional Blockchain Applications: Intellectual Property Rights 24

24. Conclusion 25

2

Blockchain Use in Decentralized Technologies

G494

10 December 2016

Abstract

This paper has sought to explain the mechanics of Blockchain technology and its current and

future applications. A study of the Blockchain’s principle application, Bitcoin, is provided in

great detail. Bitcoin has emerged as a pioneer in the market of Cryptocurrencies and has uses the

Blockchain Algorithm for its ledger system of transactions. Bitcoin’s ability to eliminate third

party intermediaries provides a great advantage. However, Bitcoin’s scale and deflationary

nature is investigated to determine its long-term sustainability. Blockchain technology is also

evaluated to determine its potential in improving the banking industry, digitized legal services,

and licensing protection. The findings in this paper show how Blockchain is a working model in

eliminating the use of third parties, with implications of further decentralized services to come

after the success of Blockchain’s use in Bitcoin.

3

The Blockchain Algorithm

Blockchain technology is complicated, but the idea is simple. At its core, the Blockchain

secures trust and integrity between strangers.  Blockchain is a way to organize and structure data

in a public peer-to-peer distributed online database. Some insist that the Blockchain algorithm is

the “first native digital medium of value, just as the internet was the first native digital medium

for information.” [1]

Transactions are added to chains of blocks and shared on a global digital ledger to a

network of computers. No central authority has the power to alter these records in a Blockchain,

thus everything in the system is deemed irreversible. Complex algorithms structure the process

and prevent users from performing fraudulent activity. [2]

Where did Blockchain Originate?

Blockchain technology initially originated in whitepaper titled “Bitcoin: A Peer to Peer

Electronic Cash System” published in November 2008 by the pseudonym Satoshi Nakamoto.

The writer still remains a mystery, but the Bitcoin technology lives on. Nakamoto published the

whitepaper on a popular cryptocurrency website, where it received immediate traction in the

community.

The term “Blockchain” is never mentioned in the paper, however the idea behind the

block technology is first introduced. Nakamoto aims to eliminate the need for a third party

intermediary in digital monetary transactions. The overall idea of the “Blockchain” developed

further as the research behind the Bitcoin became more extensive. As the Bitcoin’s popularity

grew, more individuals and institutions recognized the potential of underlying Blockchain

technology to improve other industries as well.

[1]Tapscott, D., & Tapscott, A. (2016, May 10). The Impact of the Blockchain Goes Beyond Financial Services.

Retrieved December 9, 2016, from https://hbr.org/2016/05/the-impact-of-the-Blockchain-goes-beyond-financial-

services

[2]Hackett, R. (2016, May 23). Wait, What Is Blockchain? Retrieved December 9, 2016, from

http://fortune.com/2016/05/23/Blockchain-definition/

4

How does Blockchain Work?

A Blockchain holds two types of files: individual transactions and blocks. Blocks are

large, organized collections of data connected to the transactions approved within a measured

time period. In the Blockchain used for Bitcoin, transactions are created whenever funds are

transferred from one user’s account to another’s in the network. In another Blockchain network,

such as Smart Contracts, transactions are generated whenever contracts are signed by the

individual parties in the agreement.

Blockchain users validate each new transaction that enters the system across the global

digital ledger so that it can be timestamped and added to the next block in the chain. Blockchain

approvers build new blocks and verify the new transactions added to the chain of transactions.

These approvers create a permanent identification of a block when it is added to a chain,

therefore it disables the the ability of tampering with data. If one party wishes to fraudulently

reverse an old transaction submitted on a Blockchain, they would have to first change the

specific block’s identification, which would be impractical in that successive and previous

blocks would not recognize this change as valid.

Some even argue no existing institution has the computing power to alter an embedded

block in the chain. The sheer energy needed to change all the subsequent blocks in the chain and

update the ledgers of the worldwide network is far too colossal to imagine. The airtight security

of the Blockchain allows the global database to even function without the massive backup

processors and storage of other entities. The Blockchain in itself exists as an enormous,

inalterable record of history.

How Can Blockchain Improve Financial Services?

Nakamoto’s paper was published during the aftermath of the subprime mortgage

financial crisis in 2008. Global recession, quantitative easing by the Federal Reserve, and the

European sovereign-debt crisis were all major concerns during the period. The public’s

confidence in government issued currencies deteriorated during this time, as the public lost trust

in their safety and legitimacy. [3] The effects of the financial crisis still live on today, and people

and institutions have turned to other options to manage their money.

[3]Desjardins, J. (2014, February 23). The Definitive History of Bitcoin. Retrieved December 10, 2016, from

http://www.visualcapitalist.com/the-definitive-history-of-Bitcoin/

5

some argue the entire financial services industry must be overturned to promote higher

transparency and democracy.

Many people and institutions are turning to the Blockchain as a means of improving the

financial services industry. Other notable technologies such as big data, the cloud, robo advising,

and collaborative finance are also entering the industry, but the Blockchain has the power to

make the largest impact. Alex Tapscott, CEO of Northwest Passage Ventures and author of

“Blockchain Revolution”, argues the Blockchain is, “Nothing short of the second generation of

the internet.” The Blockchain’s revolutionary distributed ledger and encryption can allow the

banking industry to provide secure transactions in near-real time. [4]

Much of the public’s distrust in the financial services industry sprouts from major

scandals such as Enron, Lehman Brothers, and Fannie Mae. In September 2016, Wells Fargo was

fined $185 million for assertions that bank employees opened accounts without customers’

permission. [5] This recent event calls the reliability of the financial services industry into

question again. The extensive encrypted controls that Blockchain provides can help prevent

many fraudulent activities from ever occurring. These controls can block financial services

representatives from manipulating funds and putting clients’ accounts at risk. Blockchain

encodes values and allows machines to arbitrate on the user’s behalf.

Blockchain can also drastically reduce the industry players’ operating costs, as the costs

of maintaining back-up processing, storage, and security are eliminated with the practice of the

Blockchain hash encryptions. Faster fund transfers increase controls the functionality of

Blockchain, there is also the potential to help people become financially empowered in

underserved capital markets.

[4]Wigmore, I. (2015, December). Blockchain Definition. Retrieved December 9, 2016, from

http://whatis.techtarget.com/definition/Blockchain

[5]Blake, P. (2016, November 3). Timeline of the Wells Fargo Scandal. Retrieved December 10, 2016, from

http://abcnews.go.com/Business/timeline-wells-fargo-accounts-scandal/story?id=42231128

6

Primary Blockchain Application: Bitcoin

Bitcoin is the world’s most predominant decentralized online cryptocurrency. It operates

using the Blockchain algorithm as its ledger system without a central authority power. Bitcoin is

the Blockchain’s primary proof of concept. No physical Bitcoins exist. Instead, an online public

ledger on the Blockchain keeps track of all the transactions in the Bitcoin community. Each user

has his own private key (for security purposes) and public key (his public identifier). Each

transaction is verified by the Bitcoin user community and is added to the ledger. Since Bitcoin’s

launch in 2009, its value has had volatile gains and losses, reaching a high of over $1000 in late

2013 before dropping to roughly half that level. By 2016, Bitcoin has rebounded to reach of

value of around $768. [6]

How Does the Bitcoin Network Function?

Bitcoin functions exactly like the Blockchain network detailed earlier. Transactions are

issued peer to peer and the entire network is used to monitor and verify both the transfer of

Bitcoins between users, and the creation of new Bitcoins through mining. [7] A ledger of all

transactions is collectively maintained by all users on the platform and every new transaction is

broadcasted across the entire network. Miners execute difficult and power intensive mathematics

to update the new blocks added to the chain.

However, the Bitcoin network has a few notable additions to its operations. Each user

must have a Bitcoin “wallet”, which is basically the equivalent of a bank account. It allows the

user to store Bitcoins, receive them, and send them to others. The user’s Bitcoins and secure 256

bit private key are stored inside, so it must be protected from outside infiltration. There are two

main varieties of Bitcoin wallets. Many Bitcoin users opt for the “software wallet”. One must

install it on his own computer and remains in total control over the security of the coins. For the

Bitcoin novice, there is the “hosted wallet” that is maintained by a third party. While this is

easier to use, one must trust the provider with his private information to protect his coins.

[6]Bitcoin Price Index. (n.d.). Retrieved December 10, 2016, from http://www.coindesk.com/price/#2012-11-

30,2016-12-10,close,bpi,USD

[7]T.S. (2011, April 11). How Does Bitcoin Work? Retrieved December 10, 2016, from

http://www.economist.com/Bitcoinexplained

7

Bitcoin as a Cryptocurrency

Bitcoin can be described as the most successful Cryptocurrency. Bitcoin is successful

from its large trading volume and market capitalization relative to other cryptocurrencies.

Although not defined as a currency by the International Monetary Fund, Bitcoin is increasingly

used as a medium of exchange in peer-to-peer transactions and has a greater market

capitalization than currencies from some developing countries. As the shift to cashless

transactions grows, cryptocurrencies have gained more presence in the markets and have

influenced other countries to employ non physical money.

Mining

People can create Bitcoins through a mining process, using a computer and a hashrate

mining software. The mining software repeats a hash function that then records hashes (outputs)

of which fractions if not whole parts of Bitcoin can be found. The hashrate recognizes the mining

speed of the software, and is measured in gigahashes (thousands of hashes). Once a Bitcoin is

found and formed it is transferred to a wallet on a computer.

The higher the hashrate being performed by the computers and mining software, the more

outcome in Bitcoin. Mining was a very lucrative venture for individuals when the global hashrate

was much lower than today’s value. Individuals could mine within their homes by setting up 24

hour servers that, at the time, would provide higher returns than other computing ventures.

Today the global hashrate is very high. Since the supply of Bitcoin is limited to 21 million, each

Bitcoin mined will progressively take more computing power to acquire. The predicted year that

the last available Bitcoin will be found is in 2021. Today, if someone were to try and mine a

Bitcoin themselves in their home, it would not be profitable nor feasible. The computing power

is costly, the processors required are very expensive, and the time it would take is very long.

Thus, the cost of running the computers would outweigh the benefits of mining. As computing

power increases though, there may be more of an incentive to mine Bitcoin.

Mining Pools

Mining today is only feasible if there is significant enough investment to procure these

Bitcoins. Mining pools have grown to take on a larger role in the supply of Bitcoin. A mining

Pool is a collection of miners that run their computers simultaneously with other miners with

8

more shared computing power to procure more of the currency. The amount of Bitcoin mined in

a pool is distributed amongst the miners in the pool. Today, mining pools amount for the highest

percentage of mined Bitcoins. A case exists that if the mining of Bitcoin is controlled by a

majority of one organization or mining pool, then Bitcoin may collapse as a currency.

The introduction of mining pools has caused some investors to worry about entering in

the Bitcoin market. One theory, known as a 51% attack, is when one mining pool controls over

50% of the mining production of Bitcoin. The theory states that with a majority control of supply

from a mining pool, the supply could be manipulated by these miners to cause a speculative

attack in the market. In 2014, one mining pool, Gash.io, had achieved 50% of the mining

capacity and it caused the pool to release statements promising to reduce their share. Currently

50% of the mining by pools is distributed among 4 players, while many other smaller pools make

up the remaining 50%. The threat of a 51% attack is still there as mining has become more

expensive and smaller players are driven out by the low returns. The mining pools seem to have

enough interest in maintaining the value of Bitcoin that if an attack occurs, it can severely

damage Bitcoin’s reputation as a secure cryptocurrency.[9]

Medium of Exchange

Defined as an instrument used to facilitate the sale, purchase or trade of goods between

parties, Bitcoin meets the definition in being a Medium of Exchange. Bitcoin fits this definition

in that people regularly exchange Bitcoin for other goods or currencies. Transactions regularly

occur and Bitcoin is becoming a more accepted means of exchange in the online market. The

lack of a physical element of Bitcoin can cause some to avoid using Bitcoin in markets, but as

trends show, there is a growing presence in cashless transactions. The rise of cryptocurrencies

has been responsive to a trend in cashless transactions and is a precursor to countries moving

even further in the direction of cashless societies.

[8]Cawrey, D. (2014, June 20). Are 51% Attacks a Real Threat to Bitcoin? Retrieved December 10, 2016, from

http://www.coindesk.com/51-attacks-real-threat-Bitcoin/

9

Unit of Account

Unit of Account is a monetary unit used to value a good. Bitcoin is highly divisible with

transaction amounts down to fractions of a Bitcoin. Each Bitcoin is worth an amount of a certain

good. The exchange rate of Bitcoin is regularly updated with the speed of the internet and one

can find instantaneously how much a good is worth in Bitcoin before proceeding in a transaction.

Since transactions are normally occurring online, the price of a good offered in one currency can

currently reflect the value in Bitcoin.

There are also limits on how many Bitcoin are in circulation. Along with the restraints

put on by the hash rate, the finite amount of Bitcoin that will be produced in total will limit the

supply, so no mass inflow will occur that would cause a collapse of its market. If a mass inflow

were to occur, it would cause a massive decrease in Bitcoin’s value as the shift in supply would

devalue Bitcoin. This has happened to other cryptocurrencies as they start to gain a larger market

presence. Speculation in the markets will cause drastic increases or decreases in the market value

as the real value is still uncertain. As Bitcoin has established itself as the leader in the

cryptocurrency market their acceptability in markets has increased and provided Bitcoin with a

higher store of value.

Store of Value

In definition, an asset’s store of value is when an asset can be saved, retrieved and

exchanged at a later time, and be predictably useful when retrieved. Bitcoin’s value is

determined by a function of supply and demand. Since the supply is relatively controlled, the

demand for Bitcoin is formed when it becomes a better store of value and more acceptable than

other currencies. Some citizens of countries have started using Bitcoin when their currencies

experience high amounts of inflation. For example, Bitcoin was used by some Argentinians in

online transactions when their currency went through a period of high inflation. This has caused

some concern in that Bitcoin’s value continues to increase over time, contradictory to the

downward trends in the lifetime of fiat currencies. This deflationary principle would naturally

deter owners of Bitcoin to spend them under Gresham’s Law. When the value is expected to

increase, owners of the asset will tend to hold on to the cryptocurrency rather than spend it on

goods. When periods of higher value occur, the price tends to increase dramatically relative to

other currencies. After a period of holding time, Bitcoin tends to return to a constant deflationary

10

growth. It is through Bitcoin’s value and acceptability in the marketplace that Bitcoin is still used

in transactions. [9]

Value of Bitcoin in the Market

Bitcoin’s price, like other goods, is determined through supply and demand. Common

transactions use only fractions of a Bitcoin and are transferred in peer-to-peer networks or

through websites that accept Bitcoin as payment. Bitcoin also has a niche market, in that

although everyone can potentially receive Bitcoin for goods sold or services performed, those

willing to accept Bitcoin are still relatively low. Regardless, relative to other cryptocurrencies

Bitcoin has a much larger trade volume than others and even has a larger market capitalization

than some currencies in developing countries.

        Bitcoin is exchanged in place of other currencies when a home country's currency

becomes unstable. This flight to safety tends to happen when global news events directly affect a

home country's currency and traders find Bitcoin to have a better store of value. An example of

this would be this summer during England’s Brexit from the European Union. As speculators

saw a decrease in the value of the British Pound, the trading volume of Bitcoin drastically

increased and the price rose accordingly. This threat of speculation has caused several

governments to ban the exchange of Bitcoin or take actions to limit the trade and holding of

Bitcoin.

Self-Regulation

        There is a lack of regulation from the IMF in cryptocurrencies. Traditionally, with other

currencies, the IMF would have influence in the trading of these in the FOREX market. The IMF

still does analysis on cryptocurrencies and is active in monitoring trade and exchange of them.

Despite the monitoring, the IMF does not actually define Bitcoin or other cryptocurrencies as

actual currencies, differing from the public opinion of traders. Action from the IMF would

greatly differ from Bitcoin’s purpose as a peer-to-peer currency in that a significant investment

in Bitcoin could drastically affect the trade activity. As stated earlier, a control of the mining of [9]  Plassaras, N. A. (2013, January 6). Regulating Digital Currencies: Bringing Bitcoin within the Reach of the

IMF. Retrieved December 9, 2016, from http://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?

article=1407&context=cjil

Pages Used 384-389,396-402

11

bitcoin by over 51% could cause tremendous volatility in the price of Bitcoin; large transactions

of Bitcoin also cause volatile changes in price. Insofar as there is an infrequency of large

transactions and speculative transactions, the IMF will still stay out of regulating the

cryptocurrency market.

Regulatory Actions

The only regulations made so far have been from certain countries. To counter the threat

of speculation, Russia and Bolivia have banned the exchange of their respective currencies for

Bitcoin. These legislations do not ban the use of Bitcoin in their markets, it only dissuades the

use of them. If someone is willing to accept a transaction in Bitcoin, they still can but the relative

value is small when it cannot be used to exchange for another currency in their market.

Other countries have started taxing the ownership and use of Bitcoin. While many nations

have not intervened in the Bitcoin market, developed economies like the United States, the

United Kingdom, France, Canada, and Singapore have tax legislations on the cryptocurrency.

The United States Federal Government does not recognize Bitcoin as a currency in taxation,

rather they have taxed it as property. With these regulations comes concern that the innovation of

Bitcoin may be undermined. This has been the incentive for some countries to monitor the

financial institutions and market participants who engage in transactions, rather than the miners

and transactions approvers.[10]

Double Spending Problem’s Prevalence in Cryptocurrencies

The double spending problem is defined as the ability to successfully spend a portion of

money more than once. Double spending is unique to the digital currency community because

digital information can be replicated very easily. Physical currencies cannot be easily replicated,

so they do not have this issue. The parties involved in physical currency transactions can touch

the money and witness its exchange between hands, thus there is no threat of “double spending”

the money.

[10]He, D., Habermeier, K., Leckow, R., Haksar, V., Almeida, Y., M., . . . Verdugo-Yepes, C. (2016, January).

Virtual Currencies and Beyond: Initial Considerations. Retrieved December 9, 2016, from

https://www.imf.org/external/pubs/ft/sdn/2016/sdn1603.pdf

Pages 25,42

12

Digital currency poses the risk that the holder can make a copy of an item, say a new

online currency called a digital token, and send it to another party while still retaining the

original. For example, when the token is sent to another party, the original is still saved on the

user’s computer. If the user is untrustworthy and does not delete the original file, the user has the

ability to send copies to many other people if they wish. This activity poses a high currency

valuation risk in line with Gresham’s Law, “bad money drives out the good.” Thus, if the token

is sent too many times in the network, it becomes worthless.

In order to mitigate this risk, online merchants, like Amazon, must employ third party

intermediaries, such as PayPal and Visa, to manage the exchange. These intermediaries hold

large ledgers and debit the purchaser’s account and credit the merchant’s account for the

payment agreed upon. Without this intermediary, there would be no way of preventing the payer

from buying many items without getting his account adjusted for the purchases. However, these

third party institutions charge users transaction fees, flat fees, and incidental fees. The average

credit card processing cost for online shops is roughly 2.30-2.5%.  These fees add up and can be

a significant operating cost for many businesses. [11]

How Can Bitcoin Prevent the Double Spending Problem?

Bitcoin experienced some exposure to double-spending over its history. However, the

advances of the Blockchain has helped it prevent this problem. When transactions are approved

and added to the Blockchain, they are added to its hash function. When new blocks enter the

chain, they include the previous block’s hash functions as well. Thus, a user is unable to re-spend

Bitcoins used in the original transaction, because the data is coded and confirmed across millions

of ledgers worldwide. If the user tried to double spend the Bitcoin, his ledger would be wholly

inconsistent with the entire Bitcoin network. Thus, this fraudulent transaction request would be

immediately recognized by the Bitcoin network and not authorized, preventing the double

spending from ever occurring.

[11] Dwyer, B. (n.d.). Average Credit Card Processing Fees. Retrieved December 10, 2016, from

https://www.cardfellow.com/average-fees-for-credit-card-processing/

13

How Does Bitcoin Compare to Financial Intermediaries?

Financial intermediaries attempt to verify the identities of the individuals in the

transaction to establish trust. They also use computer software to encode business logic in the

data to control its workflows. Financial intermediaries, like PayPal, are centralized. This makes

them susceptible to cyber-attacks and endangers the accounts of all their users. Intermediaries

also slow down the transaction process substantially, especially in international fund transfers.

These transactions also have many added fees. For example, at the ten largest U.S. banks, the

average cost of an outgoing domestic wire transfer is $26.40 while the average outgoing foreign

wire transfer fee is $45.50. [12] Bitcoin is different because its Blockchain database eliminates

need for the third party intermediary to establish trust in transactions. The extensive coding,

cryptography, and mass network collaboration.

Why Do Businesses Choose to Use Bitcoin as a Form of Payment?

Many small businesses recognize significant cost savings in the use of the Bitcoin. First,

the Bitcoin is cheaper to accept as a form of payment than credit cards like Visa and Mastercard.

Credit card services require the business to pay licensing fees and merchant “pay per swipe

fees”. However, there is no licensing fee necessary for the Bitcoin. The user simply creates an

account and it is ready for use. Also, the Bitcoin network charges little to no merchant fees. Most

credit card swipes cost approximately 25 cents for the business and charge 3-5% of the purchase

price. This is why many small businesses often feature signs next to their cash registers stating

phrases like, “minimum purchase for CC: $10.”. While the bulk of these merchant fees is often

passed to the seller, a portion is also passed along to the consumer. Some businesses even offer

discounts for those that use Bitcoins on purchases. Secondly, Bitcoins are much faster than

traditional electronic payment systems. There is no application process. So, businesses can start

using it right away. Also, the payments are added to the Bitcoin network almost instantaneously,

so there is no delay on the parties’ accounts being reconciled.

[12]Zhen, S. (2015, October 28). Compare the Cost of Bank Wire Transfer Fees. Retrieved December 10, 2016,

from https://www.mybanktracker.com/news/2013/04/18/wire-transfer-fees-2013/

14

However, electronic payment systems have some notable advantages over the Bitcoin.

Credit card companies charge fees because they need to be compensated for their services. First,

credit cards offer lending services. By allowing their customers to spend money they do not

have, these companies inherit significant default risks. Contrastingly, Bitcoin functions like cash.

There is no lending possible. Second, credit card companies offer insurance to their customers. If

the credit card is subject to fraud or identity theft, the unauthorized charges are reversed and the

customer is protected. Third, credit card companies allow the user to build up their credit history.

The better credit score one has, the easier it is to receive large loans in the future. Lastly, many

credit card providers offer points and rewards, such as airline miles and cash back on certain

purchases.

Ability of BitPay in Increasing Transactions

While Bitcoin is largely considered a fringe currency, mainstream entities have taken

notice and some companies have decided to become involved.  Visa is a prime example of

mainstream acceptance following their release of the Visa BitPay card in May of 2016.  By

linking the BitPay card with one’s Bitcoin wallet, individuals can convert their Bitcoins into US

dollars with ease.  Essentially functioning as a debit card, the Visa BitPay card provides

enthusiasts with a simpler method for spending their Bitcoins.

The benefits associated with Visa’s BitPay card are relatively straightforward.  The card

allows users to draw funds from multiple wallets, converts said funds into US dollars, and can be

used anywhere that Visa cards are accepted.  What was created as an online currency can now be

easily converted for use at average businesses and ATMs.  No fees are charged unless the user is

traveling outside the United States, where a 3% currency conversion fee is charged to the owner

of the card.  Bitcoin users hoping to remain completely anonymous will likely reject the card, as

signing up requires the inclusion of extensive personal information including one’s address and a

copy of a government-issued ID. [13]

[13]Load dollars using any Bitcoin wallet, spend anywhere. (n.d.). Retrieved December 9, 2016, from

https://bitpay.com/visa

15

Benefits of using Bitcoin

The advantages provided by Bitcoin are extensive enough to justify the currency’s

continued growth in popularity.  Benefits include, but are not limited to: the inability of third

parties to seize funds, freedom from taxation, the exclusion of political influence on spending,

minimal transaction costs, the acceptance of micropayments, protection against theft, and

protection against chargebacks.  It is important to note that some of these advantages are

subjective and can be viewed negatively by certain entities.  To remain consistent, we have

decided to determine advantages and disadvantages from the viewpoint of the typical Bitcoin

user.

Third Party Seizure:  

Users are able to transfer and store funds without the fear of a third party entity impeding

their ability to do so.  As reliance on physical currency continues to decrease, third party entities

such as government and financial institutions are increasingly able to control the funds of

individuals.  Bitcoin provides an escape from third party intervention and allows users to

maintain complete control over their own money.

Taxation:  

The inability of government to tax Bitcoins is largely related to their inability to freeze

funds.  The anonymity that Bitcoin provides makes identifying the owners of wallets relatively

impossible.  If the government cannot identify the owners of Bitcoins they cannot force any

individual to pay taxes on the currency.  The US government recognizes the difficult task at hand

but is still making attempts to tax users.  The IRS recently requested records from Coinbase, a

Bitcoin exchange website operated from within the United States. [14] While Coinbase has not

yet cooperated with the request, the agency’s attempt to tax users proves that Bitcoin is large

enough not to be ignored.

No Political Control:

Online transactions that utilize traditional currency can receive scrutiny from

governments who disagree with the transactions being made.  The prime example of this

involves major credit card companies and WikiLeaks.  In 2010 political pressure was placed on

major credit card companies to block transactions between customers and the WikiLeaks [14] Popper, N. (2016, November 18). Bitcoin Users Who Evade Taxes Are Sought by the I.R.S. Retrieved

December 9, 2016, from http://www.nytimes.com/2016/11/19/business/dealbook/irs-is-seeking-tax-evaders-who-

use-Bitcoin.html

16

operation.  The reasoning used was the companies’ stances against their cards being used to

purchase illegal goods or services. [15] In this case, the hacking of government files was the

illegal “service” taking place.  Users of Bitcoin and other cryptocurrencies are still able to fund

the operation due to the inability of government to influence transactions.  While WikiLeaks is

just one example, the same logic can apply to any purchase that a government classifies as

illegal.

Minimal Transaction Costs:

The costs associated with ordinary financial transactions are one of the primary

incentives for abandoning the current system in favor of Blockchain and Bitcoin.  Following its

creation, Bitcoin transaction costs were essentially non-existent.  However, as mining becomes a

more strenuous process, users have been paying transaction fees in order to have their

transactions included in the next block.  Those who do not offer to pay the additional fee risk

having to wait for longer periods before their transaction is approved.  Despite an increase in the

presence of transaction fees, the fees associated with Bitcoin are significantly less than

mainstream currencies.

Micropayments:

The costs associated with standard financial transactions are high enough to discourage

small transactions from taking place.  Transactions of all sizes are plausible between Bitcoin

users because the relatively miniscule transaction costs.

Bitcoin Theft:

In order to steal one’s Bitcoins, physical access to the user’s computer is required.  While

identity theft can cause serious financial troubles for those dealing in everyday currency, no

similar threat exists in relation to Bitcoin.  One cannot forcefully access and transfer another

user’s funds from a remote location.

[15] Greenberg, A. (2010, December 7). Visa, Mastercard Move To Choke WikiLeaks. Retrieved December 9, 2016, from

http://www.forbes.com/sites/andygreenberg/2010/12/07/visa-mastercard-move-to-choke-WikiLeaks/#204783fb4bc2

17

No chargebacks:

When transactions have been sent and approved by the Blockchain, there is no risk that

the user sending the funds will revoke them.  This guarantee is considered an advantage but it is

important to recognize the irrevocability of Bitcoins provides an opportunity for scammers.  If

the product or service purchased is of lesser quality than agreed upon, the purchaser is not

guaranteed a refund.  However, this issue has largely been resolved through the use of

intermediary exchange sites such as the previously mentioned Coinbase.  

Risks of using Bitcoin

No perfect monetary system exists—and Bitcoin is not immune to this fact.  While the

advantages provided by Bitcoin are quite appealing to its system of users, the flaws that exist

cannot be ignored.  The primary disadvantages of Bitcoins are: the vast majority of merchants

not accepting the currency, the fluctuating market value, and the susceptibility of wallets to

viruses, no buyer protection, unknown technical flaws, and a 21 million Bitcoin cap.

Not Accepted at Most Merchants:

While Bitcoin may be gaining mainstream attention, the currency is yet to be accepted by

the typical business.  The previously mentioned Visa BitPay card is an obvious remedy to this

issue.  However, a large portion of users enjoy Bitcoin for its anonymity.  Once Bitcoins are

converted into US dollars and transferred onto the BitPay card or another similar card, the

currency can be traced to the owner.  For those wishing to remain completely anonymous when

making purchases with Bitcoins, the internet remains their purchasing environment.  Even when

purchasing online, the individual or company on the receiving end of the transaction must be

willing to accept Bitcoin for the transaction to go through.

Fluctuating Market Value:

The value of Bitcoin is constantly fluctuating due to supply and demand.  The ever-

changing value places extra risk on potential investors.  While the risk of losing value exists, an

investment opportunity exists as well.  Purchasing Bitcoins at an opportune time can provide a

positive ROI for investors.

18

Wallet Vulnerability:

While Bitcoins are safe from being stolen electronically, they can still be lost indefinitely.

If an individual’s wallet becomes infected with a virus and becomes corrupted, it is likely that

the user will never recover their Bitcoins.  However, the ability of individual users to control

multiple wallets allows them to minimize risk by storing funds in more than one wallet and on

more than one computer.

No Buyer Protection:  

As mentioned earlier in the “No Chargebacks” section, buyers are unable to guarantee the

quality of the good or service they expect to receive after making a purchase with Bitcoin.  Third

party intermediary websites exist that specialize in Bitcoin transactions.  For a small percentage

of the price paid, the intermediary will act to guarantee both parties receive what is expected

from the transaction.  However, one of the primary benefits of Blockchain and Bitcoin is the lack

of a third party intermediary which lowers transaction costs.  The users must decide if this

tradeoff is worth accepting for the extra protection provided.

Unknown Technical Flaws:

As a relatively new form of cryptocurrency, unknown technical flaws and risks may exist

in the Bitcoin network that have not yet been exposed.  If an individual or group of users become

aware of such a flaw, there will be an opportunity for them to expose it.  Luckily, the complexity

of the transaction approval process is a natural defense against fraud.

21 Million Capacity:  

The built-in cap on the amount of Bitcoins that can be mined creates current difficulties

and an uncertain future.  The Bitcoins yet to be mined are becoming increasingly hard to

produce.  The amount of computer power required to mine each additional coin is on the rise.

The users in the system who choose to mine must dedicate more time and electricity costs for

each additional Bitcoin.  The increasing effort required is one of the primary causes of increasing

transaction costs.  The finite supply also causes natural deflation.  When the limit is eventually

reached, it is uncertain how investors and miners will react.

19

Bitcoin Black Market

Bitcoin should not be described without including its darker implications.  The

anonymity associated with Bitcoin and other cryptocurrencies has opened up the opportunity for

individuals to utilize Bitcoins in the online black market.  The inability of government to identify

users has made the sale of drugs, weapons, and other illegal products and services much simpler

online.  Not only has Bitcoin stifled the government’s ability to tax users, it has also created

another obstacle in regulating the sale of goods and services.

Possibly the most famous example of this is the website known as the Silk Road. The

primary purpose of the website was to purchase illegal substances online.  While the website has

been taken down numerous times since its creation, the Silk Road rose to great heights largely

thanks to Bitcoin. [16] Cryptocurrencies have filled a void online that has existed since the

internet’s inception—the ability to purchase goods and services online with the same anonymity

that paper currency provides.

Additional Blockchain Applications

Banking

While many governments are not fond of Bitcoin, they still consider Blockchain as an

opportunity to improve their central banks.  The Blockchain formula provides an opportunity for

banks to both decrease costs and increase the speed of transactions—all while maintaining

increased oversight.  The United Kingdom is among the countries most intrigued by the potential

of the new technology. With multiple research papers released on the topic, it is clear the United

Kingdom wants to remain up-to-date with the potential of Blockchains, as opposed to playing

catch up later.  The UK’s central bank, the Bank of England, believes adopting a system similar

to Blockchain will increase the country’s yearly economic output by 3%. [17] If true, such a

substantial improvement is not to be ignored.  Blockchain’s ability to maintain a verifiable

record of transactions also helps protect financial institutions against cyber-attacks and technical

flaws.  Even if the computing system of a central bank were to fail, the record of all transactions

[16] Wong, J. I. (2014, October 6). Dark Markets Grow Bigger and Bolder in Year Since Silk Road Bust. Retrieved December 9,

2016, from http://www.coindesk.com/dark-markets-grow-bigger-bolder-year-since-silk-road-bust/

[17] Higgins, S. (2016, July 18). Central Bank Digital Currencies Could Boost GDP, Bank of England Says. Retrieved December

10, 2016, from http://www.coindesk.com/central-bank-digital-currencies-boost-gdp-bank-england-says/

20

could still be accessed and verified.  Utilizing Blockchain for financial transactions began largely

as an outlet to escape banks and government entities.  Ironically, Blockchain may end up making

the banks stronger than ever.  

Wall Street

If central banks have picked up on the potential of Blockchain then many businesses were

likely to precede them.  Companies specializing in financial transactions have known of

Blockchain’s advantages for many years now and have been researching ways to capitalize on it.

The amount of administrative costs and time spent on financial transactions is immense.  A

group of over 50 financial institutions have been collaborating in order to establish their own

ledger technology that could increase the efficiency of their operations.  R3 is the financial firm

currently partnering with these institutions with the intention of creating a global ledger. The

first ledger to be established and accepted will likely be too valuable for major companies not to

adopt or at least experiment with. [18]

The Decentralized Autonomous Organization

Blockchain has provided a pathway for the world’s first decentralized autonomous

organization, abbreviated as DAO.  Where a typical company requires leadership to make

decisions, a DAO is controlled by a software.  A DAO functions by programming a software to

complete predetermined tasks while adhering to a set of rules that have been written in computer

code.  Such tasks can include funding projects in order to generate revenue. Blockchain is

utilized by the DAO to verify all decisions made by the software are within the predetermined

rules.

Having software in charge of the DAO does not mean that humans cannot benefit from

the organization.  Investing in a DAO provides an opportunity for humans to receive payments

when the company produces profit.  Earlier in 2016 the world’s first DAO crowdfunded 117

[18]About R3. (n.d.). Retrieved December 9, 2016, from http://www.r3cev.com/about/

21

million dollars from intrigued investors—a large portion of which was made in

Cryptocurrencies. [20] In return, investors receive digital tokens that represent shares in the

company.  The concept is still in development and yet to be tested in the real world, but the

overwhelming excitement is apparent through the massive amount of funds raised.

The benefit of a company with no human leadership is the removal of human flaws.

Human leaders can be corrupt and make poor decisions.  Ideally, the DAO would only act in

ways that benefit the investors.  Investors agree to the predetermined set of rules and the

Blockchain technology takes care of the rest.  The first attempt at a decentralized autonomous

organization does not lack its fair share of critics.  Many people familiar with Blockchain fear

investments in the first DAO may be going to waste as there is no guarantee that the concept will

be successful.  Some individuals believe it foolish to believe that the software could make better

investment decisions than humans who have been educated and trained for that purpose.  

“Unbanked” Populations

Access to financial services is not readily available worldwide. Approximately 2.5 billion

people globally are “unbanked” without access to a formal banking account. [24] The unbanked,

defined those who do not have access to banks and credit cards, may be the next large market for

cryptocurrencies based on Blockchain. The great mobility, accessibility, and scalability of

Blockchain can help financial institutions reach these unbanked areas of the world through

technology. Additionally, the Blockchain will increase transparency and trust in transactions.

The dramatic rise in the mobile money industry in emerging markets like East Africa is a strong

signal that these populations could also benefit from Blockchain. Mobile services, such as M

Pesa, are currently addressing the need.  Currently, there is a lack of penetration in the mobile

banking arena by branded financial institutions. Instead many small mobile network providers,

MNOs, offer stored value accounts that facilitate person-to-person payments through their

intermediary services. [23]

[20]Prisco, G. (2016, May 16). The DAO Raises More Than $117 Million in World's Largest Crowdfunding to

Date. Retrieved December 9, 2016, from https://Bitcoinmagazine.com/articles/the-dao-raises-more-than-million-in-

world-s-largest-crowdfunding-to-date-1463422191  

[22]Hayes, A. (2016, February 29). Decentralized Autonomous Organizations: IoT of Today. Retrieved December 8, 2916, from

http://www.investopedia.com/articles/investing/022916/decentralized-autonomous-organizations-iot-today.asp

22

Also, an eminent benefit Blockchain can provide to the unbanked is its relatively low

transaction fee made possible by Blockchain technology. In areas with high rates of poverty,

such as Sub-Saharan Africa, this could make a dramatic impact on economic development. Many

of the world’s unbanked population rely on money transferring entities and traditional companies

charge much higher fees to process transactions.  Consumers are not the only ones who would

benefit from lower transaction fees.  Small businesses around the globe have difficulty

competing with global organizations.  One of the obstacles the small businesses face is the high

cost of doing international business due to the complexity of foreign currency transactions.

Blockchain provides an opportunity for small business owners to eliminate the high transaction

fees associated with international business.

Contracts and Legal Framework

Smart Contracts

When a transaction enters a Blockchain, it is there permanently and cannot be tampered

with. Currently, software exists through DocuSign signatures, where someone can electronically

submit a signature online and avoid face to face interaction. As firms and consumers enter into

more contracts, databases are naturally made of the contracts with many signatures. A

Blockchain of specific contracts could be observed and analyzed by a firm and serves as legal

confirmation when the contract is approved by both parties. This entrance of a Blockchain to

commercial and personal contracts would eliminate the legal problem of backdating in

electronically signed documents, where someone can electronically forge a prior date on a signed

document.

Digital Notaries

Similarly, when an item is added to the block, it has to be approved by the users in the

network. With total approvals, an item can be added and verified to a chain. This applies to

notary services as well, where, until the Blockchain a notary public would be paid to recognize a

contract is valid. Currently, the Blockchain approval process in Bitcoin’s ledger system is similar [23]Galant, P. (2012, April 26). Mobile Money: A Path for Increasing Financial Inclusion. Retrieved December 10,

2016, from https://www.fdic.gov/about/comein/2012/2012-04-26_presentation_galant.pdf

[24]Who are the Unbanked. (n.d.). Retrieved December 10, 2016, from

http://siteresources.worldbank.org/EXTGLOBALFIN/Resources/8519638-1332259343991/world_bank3_Poster.pdf

23

to a notary service. With quicker availability of notaries through applying Blockchain, it would

increase the availability of approved notaries and decrease the transaction costs that are

associated with high, in person notary fees.

Intellectual Property Database

Blockchain has the ability to fundamentally restructure the way we share intellectual property

around the world. The predominance of the internet has made the sharing of information easier

than ever, but it also has imposed massive ramifications on those who hold intellectual property.

Digital content can be copied and freely distributed on the internet, and often the ownership

rights are neglected. A Blockchain infrastructure containing the minimum viable data of the

information could control who accesses it and assign value to the owners. This practice could

help a wide array of individuals and businesses owning entities such as titles, deeds, scientific

discoveries, patents, and research journals. Blockchain can also even assist artists in the film, art,

music industries. To provide an in-depth analysis of this broad idea, the music industry case is

analyzed below.

Blockchain Case for the Music Industry

Blockchain has the potential to revolutionize the music industry and its intellectual

property database. Currently, no central database exists in the world to track the ownership rights

of music. Songs often have multiple writers, performers, publishers, and licenses. A single

song’s collective ownership rights can span across different organizations and countries. In

addition, music pirating remains a pervasive problem in the industry. Many artists and

collaborators do not receive anywhere near to the amount they are entitled. Artists are said to

lose up to 86% of the proceeds from their music. [25]

A world-wide distributed Blockchain database for the music industry could solve these

issues. This database would allow the artists to directly represent themselves and have a peer-to-

peer relationship with their fans. The smart contract feature of Blockchain could also help artists

receive immediate payment for their work when it is purchased and distributed. The unique

micropayments capability of Bitcoin supported by the Blockchain network would make these

payments much more fluid and transparent. [25]Chester, J. (2016, September 16). How Blockchain Startups Are Disrupting the $15 Billion Music Industry.

Retrieved December 10, 2016, from http://www.forbes.com/sites/jonathanchester/2016/09/16/how-Blockchain-

startups-are-disrupting-the-15-billion-music-industry/#41ff8229652c

24

Conclusion:

From the study of Blockchain’s applicability above, this paper concludes the findings that

the Blockchain Algorithm is a functional tool in decentralizing decision processes within other

applications. A study of the Blockchain’s principle application, Bitcoin, is provided in great

detail. Bitcoin has emerged as a pioneer in the market of Cryptocurrencies and has used the

Blockchain Algorithm for its ledger system of transactions. Bitcoin’s ability to eliminate third

party intermediaries provides a great advantage. However, Bitcoin’s scale and deflationary

nature is investigated to determine its long-term sustainability. Blockchain technology was also

evaluated in this paper for other uses, seeking to determine its uses in the banking industry,

digitized legal services, and licensing protection. This paper concludes how Blockchain is a

working model in eliminating the use of third parties, with implications of further decentralized

services to come after the success of Blockchain’s use in successful Cryptocurrencies.

25

Works Cited[1]Tapscott, D., & Tapscott, A. (2016, May 10). The Impact of the Blockchain Goes Beyond Financial Services.

Retrieved December 9, 2016, from https://hbr.org/2016/05/the-impact-of-the-Blockchain-goes-beyond-financial-

services

[2]Hackett, R. (2016, May 23). Wait, What Is Blockchain? Retrieved December 9, 2016, from

http://fortune.com/2016/05/23/Blockchain-definition/

[3]Desjardins, J. (2014, February 23). The Definitive History of Bitcoin. Retrieved December 10, 2016, from

http://www.visualcapitalist.com/the-definitive-history-of-Bitcoin/

[4]Wigmore, I. (2015, December). Blockchain Definition. Retrieved December 9, 2016, from

http://whatis.techtarget.com/definition/Blockchain

[5]Blake, P. (2016, November 3). Timeline of the Wells Fargo Scandal. Retrieved December 10, 2016, from

http://abcnews.go.com/Business/timeline-wells-fargo-accounts-scandal/story?id=42231128

[6]Bitcoin Price Index. (n.d.). Retrieved December 10, 2016, from http://www.coindesk.com/price/#2012-11-

30,2016-12-10,close,bpi,USD

[7]T.S. (2011, April 11). How Does Bitcoin Work? Retrieved December 10, 2016, from

http://www.economist.com/Bitcoinexplained

[8]Cawrey, D. (2014, June 20). Are 51% Attacks a Real Threat to Bitcoin? Retrieved December 10, 2016, from

http://www.coindesk.com/51-attacks-real-threat-Bitcoin/

[9]  Plassaras, N. A. (2013, January 6). Regulating Digital Currencies: Bringing Bitcoin within the Reach of the

IMF. Retrieved December 9, 2016, from http://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?

article=1407&context=cjil

Pages Used 384-389,396-402

[10]He, D., Habermeier, K., Leckow, R., Haksar, V., Almeida, Y., M., . . . Verdugo-Yepes, C. (2016, January).

Virtual Currencies and Beyond: Initial Considerations. Retrieved December 9, 2016, from

https://www.imf.org/external/pubs/ft/sdn/2016/sdn1603.pdf

Pages 25,42

[11] Dwyer, B. (n.d.). Average Credit Card Processing Fees. Retrieved December 10, 2016, from

https://www.cardfellow.com/average-fees-for-credit-card-processing/

[12]Zhen, S. (2015, October 28). Compare the Cost of Bank Wire Transfer Fees. Retrieved December 10, 2016,

from https://www.mybanktracker.com/news/2013/04/18/wire-transfer-fees-2013/

[13]Load dollars using any Bitcoin wallet, spend anywhere. (n.d.). Retrieved December 9, 2016, from

https://bitpay.com/visa

[14] Popper, N. (2016, November 18). Bitcoin Users Who Evade Taxes Are Sought by the I.R.S. Retrieved

December 9, 2016, from http://www.nytimes.com/2016/11/19/business/dealbook/irs-is-seeking-tax-evaders-who-

use-Bitcoin.html

[15] Greenberg, A. (2010, December 7). Visa, Mastercard Move To Choke WikiLeaks. Retrieved December 9, 2016, from

http://www.forbes.com/sites/andygreenberg/2010/12/07/visa-mastercard-move-to-choke-WikiLeaks/#204783fb4bc2

26

Works Cited[16] Wong, J. I. (2014, October 6). Dark Markets Grow Bigger and Bolder in Year Since Silk Road Bust. Retrieved December 9,

2016, from http://www.coindesk.com/dark-markets-grow-bigger-bolder-year-since-silk-road-bust/

[17] Higgins, S. (2016, July 18). Central Bank Digital Currencies Could Boost GDP, Bank of England Says. Retrieved December

10, 2016, from http://www.coindesk.com/central-bank-digital-currencies-boost-gdp-bank-england-says/

[18]About R3. (n.d.). Retrieved December 9, 2016, from http://www.r3cev.com/about/

[19]Bannon, S. (2016, May 16). The Tao of "The DAO" or: How the autonomous corporation is already here.

Retrieved December 9, 2016, from http://www.citationmachine.net/apa/cite-a-website/manual

[20]Prisco, G. (2016, May 16). The DAO Raises More Than $117 Million in World's Largest Crowdfunding to

Date. Retrieved December 9, 2016, from https://Bitcoinmagazine.com/articles/the-dao-raises-more-than-million-in-

world-s-largest-crowdfunding-to-date-1463422191  

[21]Prisco, G. (2016, May 16). The DAO Raises More Than $117 Million in World's Largest Crowdfunding to Date. Retrieved

December 9, 2016, from https://Bitcoinmagazine.com/articles/the-dao-raises-more-than-million-in-world-s-largest-

crowdfunding-to-date-1463422191

[22]Hayes, A. (2016, February 29). Decentralized Autonomous Organizations: IoT of Today. Retrieved December 8, 2916, from

http://www.investopedia.com/articles/investing/022916/decentralized-autonomous-organizations-iot-today.asp

[23]Galant, P. (2012, April 26). Mobile Money: A Path for Increasing Financial Inclusion. Retrieved December 10,

2016, from https://www.fdic.gov/about/comein/2012/2012-04-26_presentation_galant.pdf

[24]Who are the Unbanked. (n.d.). Retrieved December 10, 2016, from

http://siteresources.worldbank.org/EXTGLOBALFIN/Resources/8519638-1332259343991/world_bank3_Poster.pdf

[25]Chester, J. (2016, September 16). How Blockchain Startups Are Disrupting the $15 Billion Music Industry.

Retrieved December 10, 2016, from http://www.forbes.com/sites/jonathanchester/2016/09/16/how-Blockchain-

startups-are-disrupting-the-15-billion-music-industry/#41ff8229652c

27