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Effect of Bitcoin in India

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Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.

Published: Tue, 17 Oct 2017

Abstract

Bitcoin is an innovative concept of a decentralised, peer-to-peer virtual currency. Its functions are autonomous from any centralised influence. This paper discusses working of bitcoin in detail along with the method of bitcoin transaction on a network and the process of bitcoin mining. The paper also discusses the effect of bitcoin and its advantages on developing countries, centered on its effect over Indian economy and its future in the country and presenting the views of different groups of people over this new currency. The paper also provides a wide view of security issues in bitcoin with a discussion on 51% attack and presents a feasible solution to defend the attack.

Introduction

Bitcoin is a decentralized virtual cryptocurrency, launched in 2009 by an unidentified person known as Satoshi Nakamoto. It does not rely on any central services for managing the creation or flow of money. It relies on cryptographic algorithms in order to prevent abuse of the system. It is abbreviated as BTC and is powered by a peer-to-peer network in the public domain both in terms of issuing and valuation.

Until Bitcoin’s invention, online transactions always required a trusted third-party intermediary. For example, if a person A wanted to send $10 to B over the Internet, he would have had to depend on a third-party service like Citrus. Intermediaries like Citrus keep a ledger of balance of account holders. When A sends $10 to B, Citrus deducts this amount from A’s account and credits it to B’s account. The digital money could be spent more than once without such intermediaries; this problem is known as “Double Spending”9.

Bitcoins provide a solution to the double spending problem without involving any trusted third-party intermediary. It does this by distributing the transaction information among all the users on the network. Every transaction in a bitcoin economy is contained in a block which also contains the information about the previous block, forming a block chain. This block chain is available over the bitcoin network for users to verify that whether the bitcoin being transacted has been previously spent or not. The thousands of users present over the network act as the intermediary.

Terms related to Bitcoin

Bitcoin – Bitcoin is the name of the project started by Satoshi Nakamoto to create the world’s first decentralized crypto-currency. A Bitcoin is the name of a single unit of the Bitcoin currency, abbreviated as BTC.

Address – An address is a key pair, including public and private key, used by user to access their bitcoins.

Transaction – A Transaction is a single operation of moving Bitcoins from one set of one or more Addresses to another set of one or more Addresses. A Transaction is similar to a bank transfer.

Block – A Block is a package of information containing most notably all Transactions created since the previous Block, as well as reference to that preceding Block.

Block Chain – A Block Chain is a collection of linked Blocks from the most current one to the Genesis Block.

Network – The Bitcoin Network is a collective name for all applications connected together that exchange information about Bitcoin Blocks, Transactions and connected Clients.

Wallet – A Wallet is a set of Addresses created by the Client and saved locally in a file.

Miner – A Miner is a computer machine and accompanying application dedicated to creating new Blocks.

Transactions

Each user of Bitcoin owns a set of private and public key that are analogous to a bank account. In order to send someone else money, the user creates a Transaction and signs it with their private key18. Each Transaction claims a reference to a previous Transaction that credited the user, meaning that Bitcoins can’t be created out of nothing. Moreover, the same Coins can’t be spent twice. Each Transaction is broadcasted through the Bitcoin Network in order to become valid and spendable.

Every 10 minutes, all Transactions are gathered together in a Bitcoin Block, which is like a ledger. Once a Transaction is a part of a Block, it is considered safe to spent, as Blocks are hard to forge. All the Blocks are linked together to form a Block Chain. The Block Chain is a record of all Transactions that ever took place and is a definite authority over how much money users have associated to their public keys. The Block Chain is secured using cryptographic algorithms, making it impossible to alter any part of it.19

Bitcoin Mining

Bitcoin is a peer to peer network and there is no central authority like bank to control the creation of currency units or verifying the transactions, it totally depends on users present on the network, who provide their computation power to in order to verify the transactions occurring over the network. These users are termed as “miners”17 because they are rewarded for their work with newly created bitcoins. Bitcoins are “mined” or created by solving complex math problem i.e. decoding the hash present in the block of a block chain for new transactions. When a user successfully decodes a hash he obtains a bounty of bitcoins and also a transaction fee if the block was used in order to certify a transaction. As the bitcoins are mined around the world the size of the bounty reduces and the complexity of the code increases, making it more difficult to mine. Thus together these two effects reduce the rate of production of bitcoins just like gold, the more it is mined more difficult it gets to mine more. The bitcoin mining design mimics the extraction of gold or other precious metals from earth. The bitcoin mining process will not last forever. It is projected that the miners will mine the last “satoshi” (0.00000001 of a bitcoin) by 2140. As the complexity of the code increases with the mining of new bitcoins, it will be quite a challenging task to mine the last satoshi. When all the bitcoins will be mined the users will get the incentive for verifying transactions14, which will keep the network running after the last bitcoin is mined.

Views on Bitcoin

Bitcoins are a very new concept that uses concepts familiar to some people in a new way, thusly creating misconceptions quite easily20. Different group of people have different views on Bitcoin, as per their area of expertise and interests.

The IT/cryptography experts

Bitcoin has generally been very well received with the programmers and cryptography experts, the main reasons being its security, pseudonymity and innovative solution to most problems8, but at the same time pointing out its problems that it does not provide fully anonymous transactions and might not scale in future. By far now, bitcoins don’t have any concerning vulnerabilities.

The legal experts

Bitcoins to this date operate in a legal grey area15 – there have been no legal actions taken against any Bitcoin-related endeavour that reached any final conclusion, nor have there been any legislation that addresses any Bitcoin-like currencies16.

The main problem with determining the legal status of how Bitcoins should be handled is whether they are a currency, security12,2, commodity3, or something completely different. While Bitcoins are commonly referred to as a “currency” as they have many common characteristics of one, the legal definition requires a currency to be issued, used and accepted by a country2, which is not the case with Bitcoin. Another problem with bitcoins is that not all the countries have legalized its use. For consumers some countries like Australia, Canada, Finland and Germany have legalized its use and have made it clear to apply normal earned income rules on Bitcoin, while many countries have yet not made a clear statement with the legalization and use of Bitcoin. On the hand Thailand has made the use of Bitcoins illegal22. The non-uniformity in the legalization of Bitcoin in different countries is a major issue.

The economics experts

There have been surprisingly few noteworthy mentions of Bitcoins in economics circles. Professor Krugman, one of the world’s leading economists, wrote an article on Bitcoin, generally dismissing it as being just another type electronic payment system and resembling a gold standard – promoting money-hoarding, deflation and depression. Other economists similarly compare Bitcoin to a gold standard, and generally point out its flaws in comparison to traditional money – lack of a system that allows borrowing and lending11, being hard to exchange and spend6, and its built-in deflatory mechanics6.

There are also a few economists that believe a rise of currencies that are not owned by governments can be a good thing. Such currencies in the past have not experienced rampart inflation.

All in all, Bitcoins don’t appear to be on the scope of too many economists as anything more than a curiosity or a means of investment.

The common users

There have been many misconceptions among laymen about many aspects regarding Bitcoin. Even security experts claim that “the first five times you think you understand [Bitcoin], you don’t”8, which can only be truer for non-tech-savvy users.

Bitcoin is sometimes dismissed as bringing no new innovation to online payment systems. They are viewed as worthless because they are not backed by anything, or even being illegal because they are not a legal tender. Bitcoin is also compared to Liberty Dollars (a privately minted silver coin that was issued to be used alongside US Dollar, later ruled to be illegal) and called terrorism, as they might undermine the legal currency of the country10. Most often, however, Bitcoin is a misunderstood concept, mistaken to be similar to such online payment processors like PayPal.

All in all, Bitcoins aren’t popular enough to be understood by most Internet users, but more often than not with little research their perception of the project ends up pretty close to how it actually works.

Bitcoin in India

Bitcoin is a potential way to improve the basic financial services and the quality of life of the people in developing nations, which is a promising antipoverty technique17. An estimated 64% people in developing countries do not have access to these services, maybe it is because the traditional financial institutions find it very expensive to serve the poor people in rural areas. People living in such countries are reaching out to mobile banking services for their financial needs. With the adoption of Bitcoin in developing countries mobile banking services can be further supplemented. Since bitcoin is an open-system payment facility therefore it can provide access to inexpensive financial services on a global level to the people in developing nations. In countries with strict capital controls, it might provide relief to people. The total amount of bitcoin that can be mined is capped at 21 million and it cannot be manipulated. Since bitcoin is an open network therefore there is no central authority which can repeal the exchange of bitcoins between countries or reverse transactions. Thus, Bitcoin provides an emergency exit for the people in countries whose currencies are devalued. For example, some Argentines have adopted Bitcoin in response to the country’s dual burdens of strict capital controls and a 25% inflation rate 13. Due to high demand of bitcoins in Argentina, one popular bitcoin exchange is thinking of opening an Argentine office7.

India is a tech-savvy country and the rapid spread of smartphones and internet access allows for information to spread faster than ever before. In addition, several techies are investors or owners of restaurants and pubs across the country. This gives a tremendous opportunity in the entertainment businesses. One buzzing industry in India which seems to be super-excited about the usage and potential appreciation of Bitcoins is that of technology startups. A number of start-ups now favour dealing in Bitcoins while setting up a business rather cash. This is because the crypto-currency can be integrated into almost any software build that can be monetised. It can act as an alternative to gold for the purpose of investment. This can lessen the demand for gold, which ultimately can bring down imports and ameliorate the balance of payments situation. Furthermore, it is going to have a deep impact on the banking revolution.

Bitcoins are fast gaining favour in India. According to SourceForge, there have been about 36,000 downloads in India since the launch of Bitcoins on 9 November 2008. Experts estimate there are 2 to 3 users for every download. Of these, close to 70%, or 24,723 downloads, took place in 2013. In October, there were about 2,100 downloads of Bitcoin and moving India’s ranking one place up to 1620.

It’s a bit strange that a currency which is slowly becoming so popular in the country and is increasingly being used by more and more people has no standing as far as legality is concerned. Till now, the Indian Government has only been watching and studying how virtual currencies work. By the looks of it, probably they are going to be patient and will wait to see how the developed economies respond to it before adopting crypto-currency as it straddles two very radical and dynamic topics– economy and technology. The Reserve Bank of India (RBI) issued an advisory to public not to buy and sell virtual currency Bitcoins. The biggest fear of the RBI, and the income tax department is that Bitcoins will help to circulate black money internationally because of the simplicity with which the digital currency can be transacted as opposed to doing it through banks which is unregulated and unacceptable in Indian financial system as of now.21

The Bitcoin community in India wants the RBI to step in, not just to create policies to enhance safety of the consumer and impose a strict Know Your Customer system to circumvent its use for black money but also to establish its own exchange and influence all Bitcoin traders to use its own setup to make payments.

Bitcoin network security

Despite the benefits that Bitcoin presents there are concerns whether hacking could compromise the bitcoin economy. One very large flaw in the design of Bitcoin is the probability of occurrence of 51% attack. In the further section we describe the 51% attack and propose a solution to defend against it.

51% Attack

The security of a block chain in bitcoin depends upon the total processing power of all the users present on the network. The 51% attack5 assumes that at a given time if a malicious miner contributed the majority i.e. more than 50% of the networks mining hash rate, then he would have a full control over the network and would be able to manipulate the block chain.

A 51% attack is theoretically possible as the network is free and open, so if someone was to have enough computational power they can get control over the network, as there is no bitcoin authority to stop them. But in order to get such computational power the attacker would have to invest a huge amount of money in the hardware for computing, which makes this attack less feasible. There are only a couple of things that an attacker can do with 51% attack. They can prevent any transaction of their choice from gaining any confirmation and thus making them invalid. They can reverse their transactions during the time they are in control of the network i.e. they can double spend bitcoins and prevent other miners from finding any block for a short period of time while in control of the network.

The attacker though cannot double spend the coins created before, create new coins or steal coins from other user’s wallets. They can cause some serious mayhem for a very short period of time but cannot completely cripple the network with 51% attack.

With the rise of mining pools i.e. groups of people mining together as a single unit a 51% attack is possible, however the potential damage one can cause is very small, but enough to create panic among the users which would put the use of bitcoin as an online currency in jeopardy. With the current difficulty levels of block hash not even large-scale enterprises or governments can easily create a 51% attack. Though being physically possible a 51% attack is not feasible, as the amount of hardware required for controlling more than half of the network’s mining hash rate can only be acquired with an investment of a huge sum.

Defending a 51% attack

In an unlikely event of 51% attack the user can defend against it by ignoring a longer chain (i.e. the new chain created by the malicious attacker) which does not include the current best chain, if the sum of the priorities of all the transactions included in the new chain is less than the sum of the priorities of all the transactions which are a part of the current best chain and are not included in the new chain. This means that if the total priority of all the transactions present in the current best chain which is present on the network is greater than the total priority of all the transactions present in the new chain, then the new chain is easily identifiable as a malicious chain.

In order to avoid this method of identification of a malicious chain, the 51% attacker would need lots of computational power (which would require a huge amount of money) as well as lots of old, high priority bitcoins to avoid a transaction-denial-service attack. The high priority bitcoins are required to increase the priority of the transactions present in the new longer chain. Since, the attacker would run out of old, high priority bitcoins pretty quickly, thus will be forced to include the transactions of other users present on the network or have their chain rejected.

The bitcoin code has a concept of “bitcoin priority” which prevents transaction spams i.e. sending numerous numbers of tiny transactions to oneself, so as to keep everyone else on the network busy with the work of verifying and storing them. Extending this concept of “bitcoin priority” we can support this method of chain-fork-selection.

Conclusion

Every new currency has to face an uphill battle legally and technically. The value of Bitcoins will depend upon the ever-fluctuating market value, if the system gets widely adopted. Bitcoins need to be accepted as a placeholder by the merchants for goods and services, just like any other currency. This has been a challenge to other digital cash options, so it is hard to say if bitcoin will be ready to face these barriers. In views of many, there has always been a need of a decentralized currency system and bitcoin surely is a huge step towards censorship-resistant digital currency.


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