Digital Currency:

The Transition to a Cashless Society

By

Kenneth Weiss

Faculty SIP Supervisor

Dr. Hannah Apps, Department of Economics and Business

A paper submitted in partial fulfillment of the requirements for the degree of Bachelor of Arts at Kalamazoo College

Fall 2015

i

Acknowledgements

First, I would like to take the time to acknowledge my family, friends, colleagues, and

various professors for contributing ideas and proofreading my research. Second, I would like to

thank Brett Scott, author of The Heretics Guide to Global Finance: Hacking the Future of

Money, for his outlook on the future of money in the world economy. Additionally, I would like

to thank him for aggregating and publishing various academic research pertaining to Bitcoin and

other digital currencies. Third, I would like to thank Val Srinivas, research leader at the Deloitte

Center for Financial Services, for his input on the Deloitte state-sponsored cryptocurrency paper.

Finally, I would like to give a special thanks to my SIP supervisor Dr. Hannah Apps for her

encouragement while I researched the new and exciting field of cryptocurrency. This study

would not have been possible without the knowledge and support from all of you.

ii

Abstract

During the 1800s, the United States banking system was undergoing a transition to

central banking. The history of the Second Bank of the United States shows that during this shift

there was a debate to determine who should control the money supply. Today, the world is

undergoing a transition to a cashless society through the use of digital currencies. On January 3,

2009, the release of Bitcoin (/BTC), the worlds first fully decentralized digital currency,

sparked a revolution. Unlike traditional currencies that are issued by central banks, Bitcoin has

no central monetary authority. Because of Bitcoins growing mainstream adoption, economists

have been exploring the viability of countries adopting centralized or decentralized digital

currencies. Based on this research, it is too early to speculate if the path toward a cashless

society will be centralized or decentralized. This is because there is no alternative digital

currency that has been implemented. As todays world is more globalized, any sort of digital

currency would have worldwide consequences. Therefore, future research regarding this

transition must be taken very seriously.

iii

Table of Contents

Acknowledgements ......................................................................................................................... i

Abstract .......................................................................................................................................... ii

Table of Contents .......................................................................................................................... iii

I. Introduction .................................................................................................................................1

II. Literature Review .......................................................................................................................3

2.1 Functions of Money ......................................................................................................3

2.2 Forms of Money ............................................................................................................5

2.3 Modern Central Banking System ..................................................................................8

2.4 Second Bank of the United States ...............................................................................11

III. Analysis ...................................................................................................................................13

3.1 Digital Currency vs. Cryptocurrency ..........................................................................13

3.2 Bitcoin: A Peer-to-Peer Electronic Cash System ........................................................14

3.3 Centralized Digital Currencies ....................................................................................21

3.4 Deloitte State-Sponsored Cryptocurrency Paper ........................................................21

3.5 Yanis Varoufakiss Future Tax Coin (FT Coin) Proposal ..........................................25

3.6 New Economics Foundation: ScotPound Proposal .....................................................27

IV. Conclusion ..............................................................................................................................31

Sources ..........................................................................................................................................34

Appendix .......................................................................................................................................37

1

I. Introduction

Technology has changed the way people live and communicate with each other.

More specifically, the rise of the internet changed the way people work, learn, build

relationships, and multi-task. For better or worse, the internet impacted many industries

in society. For instance, before the internet, established record companies controlled the

distribution of physical music product. Now, a majority of music is distributed directly to

consumers through online stores or streaming services (El Gamal, 2012). Despite the

many revolutionary changes that internet technology has brought the world, there are still

some parts of society whose structural functions have not progressed. The central

banking system is an evident example. Although consumer financial services evolved

through the internet, the core functions of how money works have remained largely

unchanged.

On January 3, 2009, the release of Bitcoin (/BTC), the first fully decentralized

digital currency, showed that it is a part of the worlds shift to a cashless society. Unlike

traditional currencies that are issued by central banks, Bitcoin has no central monetary

authority. It is maintained through a peer-to-peer computer network that operates on a

cryptographic protocol. New Bitcoins are created by miners who use special software to

solve complex mathematical problems. In exchange, they are rewarded with new units of

bitcoin. This provides an incentive for more people to mine bitcoin. Additionally, this

incentive helps maintain the integrity of this decentralized system. All transactions are

self-verified and posted to a secure public ledger known as the block chain. The invention

of a distributed ledger is revolutionary. Essentially, this technology allows value to be

exchanged safely without a middleman such as a government or a bank.

2

The development of this revolutionary technology accelerated the debate over

who should control the money supply. During the 1800s, a similar debate existed. The

United States banking system was undergoing a slow transition to central banking. The

history of the Second Bank of the United States shows there was a power struggle

between state banks and central banks over who should control the money supply. The

development of digital currencies shows that a similar debate exists between those

supporting centralized digital currencies and decentralized digital currencies.

This paper addresses whether or not any type of digital currency can fulfill the

three basic functions of money. Additionally, this paper considers the monetary policy

implications of these new currencies. Finally, this paper determines if the path toward a

cashless society will lead to a centralized or decentralized currency.

This library research paper is organized as follows. First, in the literature review,

this paper discusses the definition of money by using its main three functions. This

theoretical framework is central to determining what can be classified as money. Second,

different forms of money are explored to show how none of them is perfect. Third,

modern central banking is studied as it is an important aspect of modern monetary

systems. Fourth, the history of the Second Bank of the United States is discussed to show

the importance of who controls the money supply. Finally, analysis of Bitcoin and other

digital currencies are explored to see if they can be considered money.

3

II. Literature Review

2.1 Functions of Money

What is Money?

It is important to comprehend the basic principles of money to determine if the

path toward a cashless society will lead to a centralized or decentralized currency. These

functions are essential to concluding if digital currencies can be considered money in

their current state.

What is money? On the surface, this should be a very simple question to answer.

Everyone uses money, works for it, and thinks about it. However, unless you are an

economist, defining what money is and where it comes from can be very difficult. The

following will demystify this question by exploring the three basic functions of money.

Medium of Exchange

First, a digital currency must be a sufficient medium of exchange to be considered

money. Since ancient times, money has played an important function as a medium of

exchange in society. A medium of exchange is an intermediary instrument used to

facilitate the sale, purchase or trade of goods between parties (Nikolakopulos, 2015). For

example, producers sell their goods to vendors in exchange for money. In turn, vendors

sell these goods to consumers in exchange for money. Similarly, everyone in society sells

their services in exchange for money. With this money, people in society buy the goods

and services that they need or want.

4

Money can only operate as a medium of exchange when the general population

accepts it in that role. For example, Amy is willing to accept money for marketing

consulting if she is confident others will accept this money from her in the future.

Unit of Account

Second, a digital currency must be a sufficient unit of account to be considered

money. A unit of account is a standard monetary unit of measurement of the cost of

goods, services, or assets. Simply, prices for goods or services are quoted in terms of

money rather than in terms of other goods or services (Nikolakopulos, 2015).

For example, if Menelik walks into an Italian restaurant, he may see a menu that

shows that a large pizza costs $15 and a lasagna dinner costs $10. Because money is a

unit of account, he is able to compare these prices. However, if Twinkies and Ding Dongs

were used as units of account, comparing prices would be problematic. Menelik would

have a difficult time determining what costs more, a large pizza costing 10 Twinkies or a

lasagna dinner costing 15 Ding Dongs.

Store of Value

Finally, a digital currency must be a sufficient store of value to be considered

money. A store of value is any form of commodity, asset, or money that people use to

transfer purchasing power from the present to the future (Nikolakopulos, 2015).

For example, Ahmed teaches as a college professor in exchange for a salary.

Assume that he is saving five percent of his salary to go toward replacing his hat in the

coming year. In this scenario, his savings acts as a store of value. Assuming normal

5

economic conditions such as low inflation, Ahmed can choose at any time to purchase a

new hat. Conversely, Ahmed would refuse to teach if he were only paid in food. This is

because he would have to consume it before the food expires and loses its value.

Consequently, he would need to find someone willing to trade a new hat for some of his

food in the short-term.

2.2 Forms of Money

Why it matters?

It is important to understand the different forms of money that have evolved

throughout history to gain perspective on the current transition of the world toward a

cashless society. The financial system of todays world is the product of centuries of

evolution. The limitations of each incarnation of money led to new innovations. Similar

to the past, changes to money will continue to occur in response to social and

technological progress (Kolar, 1993). The following section looks at different forms of

money to demonstrate that none of them are perfect. Therefore, it is unreasonable to

believe that digital currencies can be a perfect form of money. As the history of money is

complex, this paper does not discuss a complete historical narrative of the evolution of

money.

Barter System

In prehistoric times, people lived much simpler lives by only relying on their

basic needs. Because of this, they were self-sufficient due to hunting and fishing. During

6

this time period, people had very few wants. As time progressed, these wants grew.

Naturally, human beings became incapable of satisfying all of their wants.

The barter system grew out of this reality. Scottish economist Adam Smith

explains the origin and use of money in The Wealth of Nations. Before money existed in

its current form, the world used a barter system to exchange goods or services. Bartering

is when an economic actor, such as a person, exchanges goods or services without the use

of a monetary medium (Smith, 1776). Suppose we have Tim and Hannah. Tim, a chicken

farmer, has five chickens but wants to get some pears. Hannah, a farmer, has ten pears

but wants some chickens. In the unlikely scenario that Tim and Hannah meet, Hannah

may trade some of her pears for one of Tims chickens. Although bartering is slow, it was

sufficient to satisfy some of the peoples basic wants during that time period.

Naturally, as trade became more complex, the economic problem of double

coincidence of wants became more prevalent. William Stanley Jevons explains that

double coincidence of wants is the difficulty of finding two people whose disposable

possessions mutually suit each other's wants. Although there may be many people

wanting and many possessing those things wanted, these transactions are rare because

there must be a double coincidence of wants (Jevons, 1875).

Metallic Commodity Money & Commodity-Exchange Money

As civilization progressed, metallic commodity money became widespread. Coins

made of metals like gold, silver, and copper were used in exchange for goods or services.

Coins were ideal because they can be easily handled. Smriti Chand rationalizes the

benefits of metallism being officially adopted by governments. If a government minted

7

coins, it standardized the weight and content of these metals. Because of this, they were

more easily exchanged (Chand, n.d.). For example, a $100 gold coin would have $100

worth of gold in it. Metallic money was the main form of money throughout the major

portion of recorded history.

Although metallic commodity money was more convenient than bartering, there

were still some practical issues. For example, it was dangerous to carry gold or silver

coins around. This is one of many problems that led to the creation of commodity-

exchange money. Andrew Beattie explains that as metallic commodity money became

more impractical, people started storing their gold at goldsmiths or temples in exchange

for a claim check (Beattie, n.d.). For example, if one deposits a one-ounce gold, they

would get a one-ounce gold claim check. These claim checks had the same value and

were theoretically redeemable at any time. Naturally, people began using these claim

checks as a form of money.

Fiat Money

Starting in the twentieth century, metallic commodity and commodity-exchange

money began falling out of favor. Ed Moy explains that this is especially true in the

United States during the period leading up to World War II. At this time, the global

economy was suffering from the Great Depression and the world was headed toward war.

Governments wanted more money to stimulate the economy and fund their militaries.

However, due to precious metal reserve limits, they could not print more money. Thus,

money could only be printed if they grew their precious metal reserves (Moy, 2014). As

8

mining new metals is a time-consuming process, it makes sense that these forms of

money would eventually become insufficient.

This deficiency led to the widespread adoption of fiat money. This is money that

has no intrinsic value itself. Additionally, there is no guarantee that it can be exchanged

for a valuable commodity. Simply, governments decree fiat money as legal tender. At this

time, most countries use fiat money and no longer link it to anything of value. Rather, the

value of fiat money is solely based on the confidence in the government that created it

(Gobry, 2013). Because fiat money is not linked to anything of value, more of it can be

printed. Like other evolutions of money, fiat money is not perfect. Since money can be

printed at the will of the government, inflation is always a risk.

Cryptocurrency is a new form of fiat money. Cryptocurrencies are digital

currencies that are decentralized in nature. Because they are not controlled by a central

bank, the value of cryptocurrencies is determined by market supply and demand. As a

result, Bitcoin behaves similarly to precious metals like gold and silver (Nakamoto,

2009). Proposals regarding cryptocurrencies or other digital currencies will be discussed

in greater detail in subsequent sections of this study.

2.3 Modern Central Banking System

Why Central Banking Matters?

Another factor to determining if the path toward a cashless society will lead to a

centralized or decentralized currency is to understand how the modern central banking

system works. As will be discussed, the technology behind digital currencies could

change how money is created and how monetary policy is enacted.

9

What is a Central Bank?

A central bank is an institution that is responsible for overseeing the monetary

system for a nation. From historical practice, central banks have three specific powers.

Central banks control interest rates, control the money supply, and are the lender of last

resort. In theory, these powers enable central banks to work toward policy goals. This

includes currency stability, low inflation, and full employment (Heakal, 2015). Examples

of central banks include the Federal Reserve Bank (U.S.), the European Central Bank

(EU), and the Bank of England (England).

Creation of Fiat Money

To easily comprehend how digital currencies may differ, one must understand

how new units of traditional fiat money are created. To illustrate how money is created,

the Federal Reserve Bank (Fed) will serve as an example. Suppose Congress votes to

increase the Federal debt limit to $5 billion. Congress then instructs the U.S. Treasury to

write interest-bearing bonds for this amount. Next, the Treasury offers these bonds to the

Fed against the taxpayers ability to pay. The Fed buys these bonds from the U.S.

Treasury by crediting the governments checking account. As a result, the Treasury is

able to write checks against the created credit. These checks are circulated throughout the

country and deposited into banks. Next, banks send these Treasury checks to the Fed. The

Fed debits the Treasurys account and credits the banks with the same amount.

Consequently, these credits increase banks reserves. Finally, these reserves are used as a

base by commercial banks to lend out at interest (Kerkhoff, 2013). The diagram below

outlines this process.

10

Monetary Policy

To recognize how digital currencies can disrupt the effectiveness of central

banking, one needs to understand how monetary policy is enacted. Central banks use

several tools to control monetary policy. The Federal Reserve Bank of San Francisco

(FRBSF) discusses some of these tools. Direct policy controls are used to establish limits

on interest rates, credit, and lending. These tools include interest rate controls, credit

controls, and lending to domestic banks. Indirect policy controls, which are used more

commonly by central banks, are used to adjust liquidity conditions of monetary systems.

These tools include reserve requirements and open market operations.

The Fed uses open market operations to influence the supply of bank reserves.

Usually, this consists of purchases and sales of U.S. Treasury securities. For example,

during the Great Recession, the Fed wanted to increase liquidity conditions of the U.S.

monetary system. The Fed accomplished this by enacting a quantitative easing program.

This program is an expanded type of open market operation that targets commercial bank

11

and private sector assets. This is done with the intention of stimulating economic growth

by encouraging banks to lend money (FRBSF, 2004). The diagram below outlines this

process.

2.4 Second Bank of the United States

A historical example of the transition of money is seen in the history of the

Second Bank of the United States (SBUS). During this time period, the United States was

transitioning to a central bank in its monetary system. Unsurprisingly, there was

controversy over who should control the money supply. In this case, the debate was

between state-chartered banks and a federal-chartered central bank. Currently, the world

is transitioning to a cashless society. Bitcoin has started a debate over the use of

centralized or decentralized digital currencies. It is important to discuss SBUS to

understand the overarching significance of the worlds transition to a cashless society.

Simply understanding different digital currencies is not sufficient. The history of SBUS

helps put todays transition into perspective.

12

Before SBUS was founded, the United States economy was in shambles. First,

there was increased debt due to the War of 1812. Second, state-chartered banks

suspended specie payments of gold. Because of this economic environment, Congress

chartered SBUS for a twenty-year period. Its responsibilities were somewhat similar to

many modern central banks. Essentially, SBUS acted as a clearinghouse and an early

bank regulator. It held quantities of other banks notes in reserve. For example, if SBUS

felt any of its branches were over-issuing notes, they could threaten to redeem those

notes. This meant that these branches would have to pay SBUS in specie to cover the

notes they were issuing. This was crucial because during this time period, money was

backed by gold.

Although SBUS did a sufficient job controlling the money supply toward the end

of its charter, there were many opponents. The most vocal opponent was President

Andrew Jackson. First, he believed that SBUS trampled on states rights. Second, he felt

that too much power was being given to too few private citizens. Third, he disliked paper

money due to a bad business experience. As a result, his reelection campaign revolved

heavily around letting the banks charter expire.

After winning reelection, President Jackson ordered that federal deposits be

withdrawn from SBUS and deposited into state banks. This was done despite his

administrations criticism of this action. In response, Nicholas Biddle, the President of

SBUS, made the divisive decision to limit credit and call in loans. He hoped that by

putting pressure on financial markets, President Jackson would reconsider his decision. In

the public eye, Biddles actions helped to support Jacksons point that power was held by

too few. Due to President Jacksons veto on renewing SBUSs charter, it eventually

13

closed. It would be another 75 years until the United States made another attempt at

central banking by chartering the Federal Reserve. During this period, the financial

system had quite a few crises. It can be argued that a central bank could have prevented

them (Federal Reserve Bank of Philadelphia, 2010).

The main takeaway from the history of SBUS is that whoever controls the money

supply can determine the future of a nation. Clearly, the power struggle between these

two men caused major long-term ramifications for the United States. In todays transition

to a cashless society, digital currencies have the potential to cause major long-term

effects on the entire world. Therefore, it is vital to explore different digital currencies and

proposals to understand what the future of money may look like in a cashless society.

III. Analysis

3.1 Digital Currency vs. Cryptocurrency

Although these terms may seem interchangeable, there are important differences

that must be noted. First, a digital currency is any currency that is not printed on paper or

stamped into metal. It is considered a digital currency because it only exists in the digital

world. However, a digital currency can represent physical currency. For example, most of

the global money supply is digital and not held in physical form.

A cryptocurrency is a decentralized digital currency that uses cryptography for

security. Because of this security feature, it is very difficult to counterfeit. Specifically,

encryption techniques are used to regulate the new generation of units of currency and

verify the transfer of funds. Because of this, cryptocurrencies operate independently of a

central bank. Thus, it is theoretically immune to governmental interference. On January

14

3, 2009, the release of Bitcoin, was the worlds first fully decentralized digital currency.

From Bitcoins success, multiple altcoins, alternative cryptocurrencies, were created.

Since Bitcoin is currently the largest cryptocurrency, it will be the only one directly

referenced in this paper.

3.2 Bitcoin: A Peer-to-Peer Electronic Cash System

As previously mentioned, Bitcoin was the worlds first fully decentralized digital

currency released on January 3, 2009. It was created by a person or a group of people

under the pseudonym Satoshi Nakamoto. This group of people created the first paper

regarding this system in Bitcoin: A Peer-to-Peer Electronic Cash System.

In his introduction, Nakamoto explains that internet commerce is flawed as it

almost exclusively relies on financial institutions serving as trusted third parties to

process electronic payments. He believes that although this works for most transactions,

it still suffers from the weaknesses of the trust based model. First, due to the increasing

cost of mediating disputes, financial institutions increase transaction costs. Because of the

reliance on financial institutions, people are unable to make small non-reversible

payments for non-reversible services over the internet. Second, due to increasing dispute

costs, internet merchants are forced to ask their customers for more information to

validate transactions. With physical currency, these weaknesses can be avoided.

However, there is no mechanism to make payments over the internet without a trusted

third party (Nakamoto, 2009). Bitcoin was created in order to address these issues

without physical cash.

15

Bitcoin Transaction Example

To determine if cryptocurrencies display the three functions of money, one must

be familiar with how a transition on the Bitcoin network works.

Scott Driscoll gives a very technical explanation of how the Bitcoin system works

(Driscoll, 2013). To explain how the Bitcoin system works in a simplified manner,

assume the world only has six people. The world population consists of Bitcoin users

named Tim, Hannah, Amy, Chuck, Menelik, and Patrik. For expanded explanations of

specific Bitcoin terminology, please refer to the Appendix of this study. Note that real

Bitcoin transactions are more complicated than the example outlined below.

Hannah, an online merchant, decides to begin accepting bitcoins as payment. Tim,

a buyer, has bitcoins and wants to purchase a knitted sweater from Hannah for 5. Both

Hannah and Tim have Bitcoin wallets on their computers. Bitcoin wallets are files that

provide access to multiple Bitcoin addresses. Each specific address has its own balance of

bitcoins. In this scenario, Hannah creates a new Bitcoin address for Tim to send his

payment to. On his computer, Tim tells his bitcoin client to transfer 5 to Hannahs new

Bitcoin address. On a basic level, Tims balance goes down by 5 and Hannahs goes up

by 5. Although this is seemingly uneventful, the backend process that allowed this

transaction to take place is revolutionary.

When Hannah created a new Bitcoin address, she created a cryptography key pair

that consists of a private key and a public key. A private key is similar to a password one

has for their online bank account. Like an online bank account password, only the owner

knows it. The private key Hannah created will allow her to spend the bitcoins she is about

to receive from Tim. Note, that private keys are necessary to spend bitcoins in a wallet.

16

For simplicity, the public key represents Hannahs new Bitcoin address.

When Tim sent 5 to Hannahs address, also known as a public key, he used his

private key as a signature. This verified that he was the actual owner of the Bitcoin

address he was sending money from.

Although not apparent, Amy, Chuck, Menelik, and Patrik played an important

role in completing the transaction between Hannah and Tim. These four other people are

known as Bitcoin miners. Their job is to verify transactions and maintain security of the

Bitcoin network. Their computers are running free software that automatically bundles all

transactions of the past ten minutes into what is known as a block. In order to validate

these transactions or mine the block, the miners computers compete to solve a difficult

mathematical equation known as a hash function. The computer that solves the equation

first further processes that specific block. The winning miner broadcasts this proof-of-

work to the entire bitcoin network. The other miners computers double-check the

proof-of-work and the validity of the transactions. If approved, the winning miner earns a

reward of 25 newly minted bitcoins. This creates incentive for miners to provide

computing power for the network. Finally, the mined block is added to the blockchain.

In this scenario, Amy, Chuck, Menelik, and Patrik competed to solve the hash

function for the block that contained Tims transaction to Hannah. As it turned out, Patrik

was the winning miner. He broadcasted his proof-of-work to the entire network and

Amy, Chuck, and Menelik double-checked his work. As it was approved, Patrik earned

25 newly minted bitcoins in compensation for his computing power. Finally, the mined

block containing Tims transaction to Hannah is recorded on the blockchain. Since the

blockchain is unbreakable, it is proof that this transaction took place. Note, in an actual

17

bitcoin transaction, only the public keys and the amount of bitcoins sent are recorded on

the blockchain ledger. This creates a degree of privacy.

Bitcoin Analysis

For Bitcoin to serve as a sufficient medium of exchange, it must be widely

adopted. Since 2013, there has been an increase in Bitcoin adoption due to widespread

media hype over its skyrocketing value. The largest companies that accept Bitcoin are

WordPress, Dell, Namecheap, Zynga, and Microsofts search engine division, Bing

(Tanasa, 2015). Although these companies are recognizable, mass mainstream adoption

of Bitcoin has yet to be attained. According to information from Blockchain.info, Bitcoin

processes less than 200,000 transactions per day. In comparison, PayPal, a popular online

payments system processes an average of 12.4 million transactions per day (Coins, 2015).

Also, the largest four credit card companies process over 32 million transactions per day

(MasterCard, n.d.). Since Bitcoin has not been officially adopted by any country, private

enterprise will continue to be solely responsible for continued mainstream adoption. In

this case, Amy would not be willing to accept bitcoins for marketing consulting because

she would not be confident others would accept bitcoins from her in the future. As such,

for a new form of money to act as a suitable medium of exchange, there must be

widespread acceptance.

For Bitcoin to serve as a sufficient unit of account, comparing prices must be

relatively easy. Unlike most traditional currencies, Bitcoins are divisible down to eight

decimal places. For example, 1 USD could be worth 0.0043. Compared to normal

monetary units, Bitcoin prices could be very confusing for the average consumer. For

18

example, assume Menelik is an uneducated consumer. He would have difficulty

determining the price difference between a large pizza that costs 0.0645 and a lasagna

dinner that costs 0.044. Although it is possible to discern the difference of fractional

bitcoins, traditional currencies have an advantage in this scenario.

Additionally, prices would need to be relatively stable for Bitcoin to serve as a

sufficient unit of account. Because Bitcoin is not widely accepted on an official basis, its

exchange rates to traditional currencies are still important. Compared to traditional

currencies, the value of a bitcoin fluctuates greatly on a day-to-day basis. Thus,

merchants that directly accept bitcoin have to recalculate prices often. Naturally, Menelik

would be confused if one day a large pizza costs 0.0645 and then the next day it costs

0.0937.

For Bitcoin to serve as a sufficient store of value, two things must be considered.

First, one must be able to spend their bitcoins at any time. Although the Bitcoin network

itself is extremely reliable, there is an inherent weakness with how digital wallets work.

Based on the design of Bitcoin, if someone were to lose their private key for their wallet,

they would be unable to spend the bitcoins within it. Because Bitcoin has no centralized

authority, there is no one that could recover ones private key. In an ordinary banking

system, one can either deposit money at a bank or obtain physical manifestations of

money. If someone were to lose their bank account number, a bank representative could

always cross-reference your identity to give you access to your deposited money.

Conversely, physical cash is the opposite. If someone stuffed cash in their mattress and

their home burned down, their money would be gone. In this sense, bitcoins are like

digital cash.

19

Second, bitcoin must hold its value over time. As in the earlier example, Ahmed

may want to replace his hat in the future. If his salary was exclusively paid in bitcoins

there could be some issues if its value fell. Regardless if Ahmed saved his private key,

Bitcoin may remain an insufficient medium of exchange. By extension, it would be an

insufficient store of value. This is because its value is volatile in comparison to other

traditional currencies.

Although Bitcoin is revolutionary, it is evident that there are many obstacles it

must overcome to be classified as money. The issues of Bitcoin under all three functions

of money are interrelated. They show that Bitcoin must serve as a sufficient medium of

exchange before it can serve as a sufficient unit of account and store of value. As

mentioned before, commodity-exchange money is backed by gold and official fiat money

is backed by a sovereign entity. The current market value of bitcoin solely hinges on the

expectation of others willingness to accept it later at a sufficiently greater value (Lo,

2014). The speculative nature of Bitcoin seems to be a necessary evil to get widespread

acceptance. However, over the last year, Bitcoin adoption seems to have stalled (Chavez-

Dreyfuss, 2014).

Some third party companies have tried to address some of the store of value

issues to make Bitcoin a more attractive medium of exchange. For example, a merchant

wanting to accept bitcoin might consider using BitPay as a payment processor. In

exchange for a very low 1% transaction fee, BitPay allows merchants to accept bitcoin

while receiving a payout in a traditional currency. For example, if a merchant sold an

item on their website for $5, regardless of the bitcoin exchange rate, BitPay guarantees

20

that this merchant will receive a payout of $5 minus the transaction fee (Hajdarbegovic,

2014).

If someone wanted to remove the hassle of backing up their private key, they may

want to consider opening up a hosted wallet with Coinbase. With this type of service, one

trusts a private third party to keep bitcoins safe on their behalf. According to the company

website, they keep bitcoins safe by storing customers private keys in offline safe deposit

storage. Because of this, users are never given private keys to their hosted wallets as

Coinbase is solely responsible (Cawrey, 2014).

Although paradoxical to the main premise of Bitcoin, it is natural that private

third parties would create solutions to improve the practicality of Bitcoin as a medium of

exchange. Despite much media attention, it does not seem that Bitcoin will expand

beyond niche acceptance status at this point. The apparent failure of private third parties

making Bitcoin more mainstream from the ground up, suggests that cryptocurrencies or

other digital currencies would need to be adopted from the top down.

Additionally, Bitcoin shows that in todays world, completely decentralized

digital currencies will not be adopted as a countrys official currency. The design of

Bitcoin would render monetary policy by a central bank useless (Robleh, 2014). Unlike

traditional fiat currencies, a central bank would not be able to control the supply of

cryptocurrency in an economy. As most other countries practice some form of monetary

policy, it would not be prudent for any country to officially adopt a cryptocurrency from

this standpoint.

Despite this, there is still a possibility that other forms of cryptocurrencies will be

created in the future. As Bitcoin is open source software, developers could tweak the

21

code to make it a more attractive medium of exchange. Alternatively, more innovative

systems could be created that address many of the problems discussed above. Although

Bitcoin will probably not be the future of money, this does not mean that blockchain

technology does not have a future in a cashless society. This is evident in the creation of

centralized digital currencies.

3.3 Centralized Digital Currencies

Because of the extreme media hype surrounding Bitcoin and the technology

behind it, economists, think tanks, and private enterprises have been exploring

applications of centralized digital currencies. The following will examine Deloittes state-

sponsored cryptocurrency paper, Yanis Varoufakiss Future Tax Coin proposal, and New

Economics Foundations ScotPound proposal.

3.4 Deloitte State-Sponsored Cryptocurrency Paper

The Deloitte state-sponsored cryptocurrency paper outlines a framework of how

the United States can adopt a centralized digital currency with some cryptographic

similarities to Bitcoin. Note, the title of the paper wrongly implies it is a decentralized

digital currency that would be state-sponsored. This key difference is important to

understanding if the path toward a cashless society will lead to a centralized or

decentralized currency.

22

Deloitte Paper Transaction Example

The following is a repurposed example showing how a transaction would work in

this system. For simplicity, lets refer to money in this proposed system as a crypto-dollar.

As in the Bitcoin transaction example, Hannah decides to begin accepting crypto-dollars

as payment. Tim a buyer, has crypto-dollars and wants to purchase a knitted sweater from

Hannah for 5 crypto-dollars. In order to make this transaction, Hannah visits a registered

entity such as Bank A. Bank A obtains Hannahs Tax ID, SSN, Address, etc. in order to

verify her identity. The bank will store this information securely and confidentially. Bank

A creates and approves a cryptographic key pair consisting of a private key and a public

key for Hannah. Tim initiates a transaction to send 5 crypto-dollars to Hannahs address

by using his private key as a signature. This verifies that he is the actual owner of the

address he is sending money from. Instead of miners in the Bitcoin system, regulated

banks would compete to verify transactions. They ensure that both Hannah and Tim have

a valid private key in the ledger, as well as confirm that the sender has enough funds for

the transaction. In this case, Bank A is rewarded a small fee for verifying the transaction

first. Finally, the confirmed transaction is posted to the public ledger. This makes the

transaction transparent, auditable, and irreversible (Symes, 2015).

Deloitte Paper Analysis

The transaction process described above shows that this theoretical digital

currency would work very similar to Bitcoin. Note, that because this part of the process

would be decentralized, transactions made on this network would be irreversible.

23

Despite the many similarities, there are a few key differences. First, financial

institutions would not mine for crypto-dollars. Rather, their sole responsibility would be

to verify transactions. Second, unlike Bitcoin, there would be no cap on the money

supply of crypto-dollars. Only a central bank could add or remove crypto-dollars on this

distributed ledger. Thus, transactions in this system are verified in a decentralized manner

but the creation of new crypto-dollars is centralized. In the Bitcoin network, both

processes are completely decentralized. Third, users could deposit crypto-dollars from

their wallets to interest-bearing bank accounts insured by the FDIC. Fourth, if someone

were to lose their private key, a bank would be able to retrieve it on their behalf. Thus,

one could never lose crypto-dollars stored in their wallet. Finally, a crypto-dollar would

have the same legal tender as a physical dollar. For example, a crypto-dollar could be

exchanged for par value with a physical dollar. Thus, a crypto-dollar is not a new

unfamiliar digital currency. Rather, it is just a new medium of exchange for an existing

currency that is backed by the full faith and credit of the U.S. government.

Unlike Bitcoin, crypto-dollars would allow monetary policy to exist. In this

scenario, the Federal Reserve could expand or contact the crypto-dollar money supply

through open market operations. They could do this by transferring crypto-dollars from

their wallet using their private key to different financial institutions wallets. The

following chart from this paper shows what roles each institution would fulfill in a

potential state-sponsored cryptocurrency environment.

24

This Deloitte paper emphasizes that it is important for a digital currency to be a

sufficient medium of exchange from its inception. As crypto-dollars would be backed by

the U.S. dollar, Amy would be willing to accept them for marketing consulting because

she is confident others would accept this money from her in the future. By extension, this

proposed digital currency would be a sufficient unit of account. Since crypto-dollars

would be exchanged for par value for physical dollars, Menelik would easily know the

difference between a large pizza costing $10 and a lasagna dinner costing $15. Finally,

this proposal states that banks would provide interest-bearing accounts insured by the

FDIC. This could make crypto-currency a sufficient unit of account. In this case, Ahmed

could safely deposit crypto-dollars in a bank account with the intention of replacing his

hat later this year.

Despite this proposal addressing many of the issues of Bitcoin, it is unclear if

consumers would be comfortable using a digital currency where transactions are

irreversible. Additionally, like any other new concept, there would be a learning curve.

25

Since crypto-dollars would be used alongside traditional fiat currency, this system would

be completely voluntary. As such, the adoption rate could be slow in the consumer

segment.

This proposed framework seems better suited for business-to-business

transactions. For example, assume Company A and Company B has a strong business

relationship. In this case, both companies are unconcerned that transactions with crypto-

dollars are irreversible. The decentralized aspect of the crypto-dollar system would allow

for faster and potentially cheaper remittances than those settled through the Automated

Clearing House network (ACH). There is a clear need for this type of a system in the

private sector. For example, Bank of America recently filed a patent for a similar

cryptocurrency wire transfer system (Rizzo, 2015).

As this paper outlines the potential benefits of using a centralized digital currency

with cryptographic features as a new medium of exchange, it supports the idea that block

chain technology could be used in some form in the future. However, the concept of

digital currencies supplanting or working with traditional currencies is too new. Although

this proposed framework is intuitive, it does not answer the question whether the future

of money will be centralized or decentralized.

3.5 Yanis Varoufakiss Future Tax Coin (FT Coin) Proposal

The Greek debt crisis is another realistic example of where the technology behind

cryptocurrencies could potentially be used in a centralized digital currency. Before

explaining how this technology could be enacted, it is important to have a basic

understanding of this ongoing crisis.

26

In a nutshell, constant government borrowing over the years to fund promises by

politicians caused Greeces cash crunch. As a result, Greece defaulted on its loan from

the International Monetary Fund on June 30, 2015. This led to the discussion of whether

or not Greece would exit the Eurozone. At the time, there were a few options Greece

faced. First, they could have negotiated new bailout terms to stay in the Eurozone.

Second, they could have reached a deal for an amicable departure from the Eurozone

while remaining in the European Union. Third, Greece could have made an unplanned

exit from the Eurozone. Greece ended up negotiating new bailout terms to stay in the

Eurozone. If Greece had left the Eurozone, they could have reintroduced the drachma as

their currency.

As outlined by Yanis Varoufakis, Greeces Finance Minister at the time, the

technology behind cryptocurrency could have offered a unique medium-term solution to

this crisis. He speculated that a parallel digital currency could be created to pay

pensioners and public-sector workers. This would be done by creating a centralized

digital currency that would be backed by future tax revenues and denominated in euros.

This system could be run using cryptography to ensure safe, transparent, and efficient

transactions. In theory, this would preserve scarce euros to pay the countrys creditors

while offering much needed liquidity in the Greek economy. Most importantly, this

national supply of euros would be legal in the context of the European Unions treaties.

As such, Greece could adopt this digital currency while remaining in the Eurozone

(Varoufakis, 2014).

27

Similar proposals from Bitcoin enthusiasts suggest that Greeces illiquid assets

could be tokenized and be used to back up a parallel digital currency. In theory, the result

would be similar to Yanis Varoufakiss proposal (Kelly, 2015).

The FT Coin proposal is very similar to the crypto-dollar framework in the

Deloitte paper as it would prioritize money as a medium of exchange. However, it is

different because it would not be a voluntary form of payment. As a result, it is

reasonable to argue that it would become a sufficient medium of exchange. Varoufakiss

proposal does not make it clear if FT Coin would become a sufficient unit of account or a

sufficient store of value. However, assuming it has similar features to the crypto-dollar

framework, it could satisfy all three functions of money.

The FT Coin proposal shows that centralized digital currencies can provide a way

for countries to manage their debt. This potential use is another reason why

cryptocurrencies could play a part in a cashless society. However, at this point it is

unclear whether the future of money will be centralized or decentralized.

3.6 New Economics Foundation: ScotPound Proposal

The popularity of Bitcoin has accelerated discussions regarding the transition

toward a cashless society. However, not every innovative proposal or framework uses

Bitcoin as a template for its digital currency. It is important to examine these alterative

proposals to determine if the future of money will be centralized or decentralized.

New Economics Foundations proposal suggests that Scotland should adopt a

centralized digital currency called the ScotPound (S) alongside the existing pound

sterling. The goal of this currency would be to create an economic boost for Scotland,

lower business costs, and be socially inclusive. They propose that a new public-interest

28

institution called BancaAlba would be created. This third party would become the sole

issuer of ScotPound. Additionally, they would be responsible for managing and operating

ScotPay, the payment system that ScotPounds are transferred between individuals or

businesses.

During the implementation process, everyone on Scotlands electoral register

would have an account opened for them at BancaAlba. BancaAlba would distribute the

citizens dividend of S250 per person. Once an individual reaches the age of legal

capacity, BancaAlba would open an account on their behalf and distribute the citizens

dividend of S250. In effect, this would constantly add more units of ScotPound to the

money supply.

To incentivize businesses to accept ScotPound, the payment system itself would

be free for everyone. Transactions would be carried out using the internet or mobile

phones. The New Economics Foundation proposes that the initial operating costs of

ScotPay would be covered by the Scottish government. In order to increase acceptance of

this currency, public services would accept payments in ScotPound.

To encourage spending, one would not be able to accrue interest on saved

ScotPounds. This is because unlike traditional currencies, new units of ScotPound would

not be created from debt. Due to inflation, idle balances of ScotPound would lose value

over time. As ScotPound would not be convertible to the pound sterling, it would force

spending within Scotland. Lastly, spending ScotPound would be relatively easy as its

currency units be equal in value to the pound sterling. The following chart from this

proposal graphically depicts how this digital currency differs from traditional fiat

currencies (New Economics Foundation, 2015).

29

ScotPound Analysis

It is clear that the goals of the ScotPound proposal are very different than the

original premise of Bitcoin. The idea behind cryptocurrencies is to provide users a way to

safely, efficiently, and cheaply transfer value over the internet without a third party.

Whereas, the main goal of ScotPound would be to stimulate the Scottish economy

through the introduction of an autonomous and nonconvertible digital currency.

Essentially, this digital currency would be a new form of quantitative easing. Because

BancaAlba, a third party, would centrally control this system, they would have the power

to expand the ScotPound money supply as they see fit. In other words, during times of

30

austerity, they could distribute more dividends to eligible citizens accounts. As this

digital currency is autonomous to the pound sterling, BancaAlbas monetary policy

would not add to Scotlands debt.

Like the Deloitte paper, the ScotPound proposal emphasizes the importance of

money as a medium of exchange. First, every eligible citizen would receive an initial

dividend. Second, the free ScotPay payment system would entice companies to accept

ScotPound. These qualities could potentially make ScotPound a sufficient medium of

exchange. However, it is not clear how fast businesses would adopt ScotPay.

Additionally, as the world is globalized, people may not want to spend money

exclusively in Scotland. As a result, Amy may be willing to accept some of her salary in

ScotPay for marketing consulting because she is somewhat confident others will accept

this money from her in the future. Because this proposed digital currency would be equal

in value to the pound sterling, it would make an excellent unit of account. In this

scenario, Menelik would easily know the difference between a large pizza costing S10

and a lasagna dinner costing S15. However, because interest cannot be accrued on saved

ScotPounds, it would make an insufficient store of value. Thus, if Ahmed were only paid

in ScotPound, he would be incentivized to replace his worn out hat sooner than later.

It is unclear if the ScotPound would make a viable long-term currency. The idea

behind ScotPound seems better suited for short-term monetary policy goals. For example,

this type of digital currency could have been very effective in stimulating the economy of

the United States during the Great Recession of 2007. Assuming a third party existed and

infrastructure was in place, every eligible citizen could have received benefits without

31

adding to the United States debt. As it would be an insufficient store of value, people

would naturally move back to using the U.S. dollar as the economy improved.

This proposal outlines the potential benefits of using a third party centralized

digital currency as a medium of exchange. Although this type of system would not be

directly controlled by a central bank, it could be used in tandem with traditional

currencies and digital currencies similar to the crypto-dollar. Nevertheless, the ScotPound

proposal offers clues of how the world may transition to a cashless society.

IV. Conclusion

It is evident that none of the existing or proposed digital currencies discussed in

the analysis section are perfect. First, examining these digital currencies using the theory

of money shows that each of them have strengths and weaknesses as a medium of

exchange, unit of account, and store of value. Second, considering these currencies

impact on central banking raises the question of what role government plays in a cashless

society. Third, understanding the incentives for consumers and businesses to use these

digital currencies give clues to whether they can be feasibly adopted. At this point it is

not clear if the worlds transition to a cashless society will lead to a centralized or

decentralized currency in the long-term.

Cryptocurrencies in their current form are far from a perfect form of money. For a

decentralized digital currency to ever be adopted at an official level, every country would

have to give up sovereignty over their own currency. At an unofficial level,

cryptocurrencies like Bitcoin could continue to exist in their current state indefinitely.

Although cryptocurrencies are unlikely to be adopted officially, it is clear that the block

32

chain technology behind it has the potential to change many industries. For example,

block chain technology can be used by stock exchanges or auditors to verify transactions

between people (Swan, 2015). The possibilities are truly endless.

The Deloitte framework shows how the technology behind Bitcoin can be used in

a centralized digital currency. On the surface, this framework is very reasonable as it

satisfies all the requirements of the theory of money. Additionally, central banking would

work similarly to todays system. Also, the framework was designed to fix many of the

practical issues of Bitcoin. However, the incentives for consumers to adopt such a

currency are dismal. Although not apparent, most money that exists today is both digital

and centralized. Perhaps, most consumers do not care or understand the implications of a

centralized digital currency. Also, it is not clear if consumers would want to use a digital

currency where they do not have the ability to get refunds or submit chargebacks. Despite

this, the Deloitte framework provides a new way for businesses to transfer money without

the need for ACH or a wire transfer.

In structure, the FT Proposal is very similar to the Deloitte framework. However,

the key difference is it would not be a voluntary medium of exchange for some

constituents. In this proposal, the Greek government would pay public servants and

pensioners with this new currency. In theory, it could work if it is implemented.

However, the lack of consumer choice could be politically problematic. This proposal

shows that a country could have the power to force a digital currency as medium of

exchange in dire circumstances. Nevertheless, it is not clear if this would happen as this

technology has never been adopted at an official level.

33

Finally, the New Economics Foundations proposal discusses a third party

centralized digital currency known as the ScotPound. As they prioritize money as a

medium of exchange, the ScotPound is an inadequate store of value. Essentially, it is a

new form of quantitative easing. Assuming the infrastructure of this payment system is

put in place, there are clear incentives for both consumers and businesses to use

ScotPound. However, it is unclear if this would work in the long term because there are

no similar digital currencies being used countrywide.

Based on these findings it is too early to speculate if the path toward a cashless

society will be centralized or decentralized. This is because no alternative digital

currency has been implemented at a national level. Despite this, a few things can be

determined from this study. The technology behind Bitcoin accelerated the debate over

the future of money. The Second Bank of the United States shows that the control of the

money supply had a significant impact on the course of American history. As todays

world is more globalized, any sort of digital currency would have worldwide

consequences. This demonstrates that the worlds transition to a cashless society must be

taken very seriously. Further research must be done to determine how future digital

currencies play a part in a cashless society. While this answer may be unsatisfying, this

unique study outlines some of the important economic questions policy makers must

consider before proposing a new digital currency.

34

Sources

1. Ali, Robleh, John Barrdear, Roger Clews, and James Southgate. "The Economics of Digital Currencies - Bank of England." 2014. Accessed October 9, 2015. http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q3digitalcurrenciesbitcoin2.pdf.

2. Beattie, Andrew. "The History Of Money: From Barter To Banknotes." Investopedia. April 17, 2007. Accessed August 15, 2015. http://www.investopedia.com/articles/07/roots_of_money.asp.

3. Cawrey, Daniel. "Should Bitcoin Users Trust Hosted Wallets?" CoinDesk. August 17, 2014. Accessed September 9, 2015. http://www.coindesk.com/bitcoin-users-trust-hosted-wallets/.

4. Chand, Smriti. "5 Stages of Evolution of Money." Your Article Library. March 19, 2014. Accessed September 8, 2015. http://www.yourarticlelibrary.com/economics/money/5-stages-of-evolution-of-money/30311/.

5. Chavez-Dreyfuss, Gertrude. "All the Rage a Year Ago, Bitcoin Sputters as Adoption Stalls." Reuters. December 11, 2014. Accessed October 20, 2015. http://www.reuters.com/article/2014/12/11/us-markets-bitcoin-adoption-analysis-idUSKBN0JP2CZ20141211.

6. Coins. "The Real Value of Bitcoin." CoinsLists. May 28, 2015. Accessed

November 7, 2015. https://coinslists.info/index.php/2015/05/28/the-real-value-of-bitcoin/.

7. Driscoll, Scott. "ImponderableThings (Scott Driscoll's Blog)." How Bitcoin Works Under the Hood. July 14, 2013. Accessed September 14, 2015. http://www.imponderablethings.com/2013/07/how-bitcoin-works-under-hood.html.

8. El Gamal, Ashraf. "The Evolution of the Music Industry in the Post-Internet Era."

Claremont College. 2012. Accessed October 9, 2015. http://scholarship.claremont.edu/cmc_theses/532/.

9. "Frequently Asked Questions." MasterCard. Accessed October 13, 2015.

http://www.mastercard.com/us/company/en/newsroom/faqs.html#q11.

10. Gory, Pascal-Emmanuel. "All Money Is Fiat Money." Forbes. January 8, 2013.

Accessed July 5, 2015. http://www.forbes.com/sites/pascalemmanuelgobry/2013/01/08/all-money-is-fiat-money/.

35

11. Hajdarbegovic, Vermin. "BitPay Now Processing $1 Million in Bitcoin Payments

Every Day." CoinDesk. May 28, 2014. Accessed October 8, 2015. http://www.coindesk.com/bitpay-now-processing-1-million-bitcoin-payments-every-day/.

12. Heakal, Reem. "What Are Central Banks?" Investopedia. November 26, 2003. Accessed November 5, 2015. http://www.investopedia.com/articles/03/050703.asp.

13. Jevons, William Stanley. "Barter." In Money and the Mechanism of Exchange,. New York: D. Appleton, 1875.

14. Kelly, Jemima. "Could a Digi-drachma Avert a Grexit?" Reuters. June 5, 2015.

Accessed October 3, 2015. http://www.reuters.com/article/2015/06/05/us-digital-currency-greece-idUSKBN0OL0JR20150605. 15. Kerkhoff, Matthew. "Fractional Reserve Banking: How to Create and Destroy

Money." Fractional Reserve Banking: How to Create and Destroy Money. December 3, 2013. Accessed July 9, 2015. http://www.financialsense.com/contributors/matthew-kerkhoff/fractional-reserve-banking-how-to-create-destroy-money.

16. Kolar, Elizabeth. "Toward a Cashless Society | Foundation for Economic

Education." Foundation for Economic Education. October 1, 1993. Accessed October 11, 2015. http://fee.org/freeman/toward-a-cashless-society/.

17. Lo, Stephanie, and Christina Wang. Bitcoin as Money? Boston: Federal Reserve Bank of Boston, 2015.

18. Moy, Ed. "At MoneyNews: Bitcoin Is the Next Chapter in the History of Money."

Edmund C. Moy. November 21, 2014. Accessed October 1, 2015. http://edmoy.com/at-moneynews-bitcoin-is-the-next-chapter-in-the-history-of-money/.

19. Nakamoto, Satoshi. "Bitcoin: A Peer-to-Peer Electronic Cash System." Bitcoin.org. November 1, 2008. Accessed July 10, 2015. https://bitcoin.org/bitcoin.pdf.

20. Nikolakopulos, Alia. "What Is the Purpose of a Medium of Exchange and How Does It Work?" Cron. Accessed September 5, 2015. http://smallbusiness.chron.com/purpose-medium-exchange-work-35271.html.

21. Rizzo, Pete. "Bank of America Files Patent for Cryptocurrency Wire Transfer System." CoinDesk. September 21, 2015. Accessed October 24, 2015. http://www.coindesk.com/bank-of-america-cryptocurrency-wire-transfer-patent/.

36

22. "ScotPound: Digital Money for the Common Good." September 9, 2015. Accessed September 13, 2015. http://neweconomics.org/publications/entry/scotpound-digital-currency-for-the-common-good.

23. Smith, Adam, and Edwin Cannan. An Inquiry into the Nature and Causes of the Wealth of Nations. Canaan ed. New York: Modern Library, 1937.

24. Swan, Melanie. "Top 5 Immediate Money-Making Applications of Blockchain

Technology." February 23, 2015. Accessed October 5, 2015. http://ieet.org/index.php/IEET/more/swan20150223.

25. Symes, Frances. "State-Sponsored Cryptocurrency: Adapting the Best of Bitcoins Innovation to the Payments Ecosystem." Deloitte. 2015. Accessed November 5, 2015. http://www2.deloitte.com/content/dam/Deloitte/us/Documents/strategy/us-cons-state-sponsored-cryptocurrency.pdf.

26. Tans, Cristian. "Top 5 Companies That Accept Bitcoin As Payment Method." Crypto News 247 Bitcoin News. August 1, 2015. Accessed October 12, 2015. http://247cryptonews.com/top-5-companies-that-accept-bitcoin-as-payment-method/.

27. "The Second Central Bank of the United States: A Chapter in the History of Central Banking." December 1, 2010. Accessed September 9, 2015. http://www.philadelphiafed.org/publications/economic-education/second-bank.pdf.

28. "U.S. Monetary Policy: An Introduction." Federal Reserve Bank of San Francisco. Accessed September 17, 2015. http://www.frbsf.org/us-monetary-policy-introduction/.

29. Varoufakis, Yanis. "BITCOIN: A Flawed Currency Blueprint with a Potentially

Useful Application for the Eurozone." Yanis Varoufakis. February 15, 2014. Accessed October 8, 2015. http://yanisvaroufakis.eu/2014/02/15/bitcoin-a-flawed-currency-blueprint-with-a-potentially-useful-application-for-the-eurozone/.

37

Appendix

The following are common Bitcoin vocabulary sourced from Bitcoin.org:

Address -

A Bitcoin address is similar to a physical address or an email. It is the only information

you need to provide for someone to pay you with Bitcoin. An important difference,

however, is that each address should only be used for a single transaction.

Bit -

Bit is a common unit used to designate a sub-unit of a bitcoin - 1,000,000 bits is equal to

1 bitcoin (BTC or B ). This unit is usually more convenient for pricing tips, goods and services.

Bitcoin -

Bitcoin - with capitalization, is used when describing the concept of Bitcoin, or the entire

network itself. e.g. "I was learning about the Bitcoin protocol today."

bitcoin - without capitalization, is used to describe bitcoins as a unit of account. e.g. "I

sent ten bitcoins today."; it is also often abbreviated BTC or XBT.

Block -

A block is a record in the block chain that contains and confirms many waiting

transactions. Roughly every 10 minutes, on average, a new block including transactions

is appended to the block chain through mining.

Block Chain -

The block chain is a public record of Bitcoin transactions in chronological order. The

block chain is shared between all Bitcoin users. It is used to verify the permanence of

Bitcoin transactions and to prevent double spending.

38

BTC -

BTC is a common unit used to designate one bitcoin (B ). Confirmation -

Confirmation means that a transaction has been processed by the network and is highly

unlikely to be reversed. Transactions receive a confirmation when they are included in a

block and for each subsequent block. Even a single confirmation can be considered

secure for low value transactions, although for larger amounts like 1000 US$, it makes

sense to wait for 6 confirmations or more. Each confirmation exponentially decreases the

risk of a reversed transaction.

Cryptography -

Cryptography is the branch of mathematics that lets us create mathematical proofs that

provide high levels of security. Online commerce and banking already uses cryptography.

In the case of Bitcoin, cryptography is used to make it impossible for anybody to spend

funds from another user's wallet or to corrupt the block chain. It can also be used to

encrypt a wallet, so that it cannot be used without a password.

Double Spend -

If a malicious user tries to spend their bitcoins to two different recipients at the same

time, this is double spending. Bitcoin mining and the block chain are there to create a

consensus on the network about which of the two transactions will confirm and be

considered valid.

Hash Rate -

The hash rate is the measuring unit of the processing power of the Bitcoin network. The

Bitcoin network must make intensive mathematical operations for security purposes.

39

When the network reached a hash rate of 10 Th/s, it meant it could make 10 trillion

calculations per second.

Mining -

Bitcoin mining is the process of making computer hardware do mathematical calculations

for the Bitcoin network to confirm transactions and increase security. As a reward for

their services, Bitcoin miners can collect transaction fees for the transactions they

confirm, along with newly created bitcoins. Mining is a specialized and competitive

market where the rewards are divided up according to how much calculation is done. Not

all Bitcoin users do Bitcoin mining, and it is not an easy way to make money.

P2P -

Peer-to-peer refers to systems that work like an organized collective by allowing each

individual to interact directly with the others. In the case of Bitcoin, the network is built

in such a way that each user is broadcasting the transactions of other users. And,

crucially, no bank is required as a third party.

Private Key -

A private key is a secret piece of data that proves your right to spend bitcoins from a

specific wallet through a cryptographic signature. Your private key(s) are stored in your

computer if you use a software wallet; they are stored on some remote servers if you use

a web wallet. Private keys must never be revealed as they allow you to spend bitcoins for

their respective Bitcoin wallet.

40

Signature -

A cryptographic signature is a mathematical mechanism that allows someone to prove

ownership. In the case of Bitcoin, a Bitcoin wallet and its private key(s) are linked by

some mathematical magic. When your Bitcoin software signs a transaction with the

appropriate private key, the whole network can see that the signature matches the bitcoins

being spent. However, there is no way for the world to guess your private key to steal

your hard-earned bitcoins.

Wallet -

A Bitcoin wallet is loosely the equivalent of a physical wallet on the Bitcoin network.

The wallet actually contains your private key(s) which allow you to spend the bitcoins

allocated to it in the block chain. Each Bitcoin wallet can show you the total balance of

all bitcoins it controls and lets you pay a specific amount to a specific person, just like a

real wallet. This is different to credit cards where you are charged by the merchant.