NEC - 2018-04-21 - Crypto-Currencies

NEW EUROPEAN COLLEGE CRYPTO-CURRENCIES
Crypto-Currencies
Impacts on Financial System and Society
Alex Gloy
Lighthouse Investment Management
April 21, 2018

1|Page
1. What is money?
2. Where does money come from?
3. Is Bitcoin money?
4. Impacts on financial system and society
2|Page
Yap Island
3|Page
Island of Stone Money
4|Page
Stone Money
5|Page
6|Page
7|Page
8|Page
9|Page
David O’Keefe (1824-1921)
• Shipwrecked
1871
• Iron tools
10 | P a g e
What is money?
1. Store of value
2. Medium of exchange
3. Unit of account
Other features
4. Divisible
5. Fungible
6. Durable
7. Transportable
8. Wide acceptance
9. Hard to counterfeit
10. Rare / limited supply
11 | P a g e
12 | P a g e
What is money?
• Coins, notes (Federal Reserve Note)
• Monetary metals
• Bank deposit?
Assets Liabilities
Cash: EUR 100 Customer deposits: EUR 100
• M0 (base money = central bank issued)

• M1 = M0 + demand deposits (checking accounts)
• M2 = M1 + savings accounts + small time deposits
• M3 = M2 + large time deposits + institutional time deposits
• MZM = money zero maturity = M1 + savings deposits + money market funds
13 | P a g e
What is money?
• Unused credit card limit?
14 | P a g e
2. Where does money come from?

• Base money (M0): coins & notes
15 | P a g e
16 | P a g e
Money creation by private sector bank:

Customer “S” sells house to buyer “B”, who finances via mortgage:
Assets Liabilities
Mortgage customer B: +100,000 Deposit customer S: +100,000
17 | P a g e
Money creation by private sector non-bank:

1. Customer buys car from dealer, who finances car with loan / lease
2. Dealer sells loan to finance company
3. Finance company bundles many car loans into an “asset-backed security”
and sells them to hedge fund
18 | P a g e
World debt: $237,000,000,000,000 (world GDP = $75 trn)
19 | P a g e
Deutsche Bank gross derivative exposure EUR 55 trillion
Equity: 50 billion
20 | P a g e
21 | P a g e
Conclusions:
• No creation of money without creation of debt
• Economy cannot grow without growth of debt
• Growth [debt] > growth [debt-bearing assets] = unsustainable
Ways to reduce debt:

• Default -> destruction of debt and savings (bank failure)
• Pay down -> recession -> debt defaults -> see above
• Inflation -> wealth transfer from savers to debtors ->
destruction of savings
22 | P a g e
There MUST be a better way to handle this
Crypto-currencies?
23 | P a g e
Digital Assets: 896 Coins ($330bn) + 689 Tokens ($50bn) = 1,585
24 | P a g e
Is Bitcoin Money?
Fiat Gold Bitcoin
Store of value Short-term Yes ?
Medium of Yes Not really* ?
exchange
Unit of account Yes Not directly* Yes
Divisible Yes Not really* Yes
Fungible Yes Mostly yes Yes
Durable Depends Yes Yes
Transportable Depends Yes Yes
Acceptance Yes Depends In future
Counterfeit Difficult Difficult No
Limited supply No Yes Yes
*) gold-backed fiat currency: yes
25 | P a g e
Creating a better monetary system

We need to:
• No hierarchy (banks) -> decentralized, without trusted 3rd party
• Cryptographic proof -> electronic signature
Solution:
• All transactions = public
• System agrees on history of transactions
• Asymmetric cryptography: hard to guess, easy to verify
• Reward for verifying transactions with $BTC and fees
• “Proof of work” -> energy needed for mining -> lost if cheating
26 | P a g e
What is Bitcoin?
It is not a coin (nor is it golden)
27 | P a g e
What is Bitcoin?
• A protocol (like http)

• A network
• A digital currency
Unit = 1 Bitcoin = 100,000,000 Satoshi
Satoshi Nakamoto wrote Bitcoin White Paper in 2008
28 | P a g e
Bitcoin Network
• Full node (download entire blockchain)

• Lightweight node (simple payment verification, mobile, tracks only
user’s own unspent output)
• Third party API (application programming interface)
• Miners (bundling transactions into blocks)
29 | P a g e
Latest Blocks
519,162 blocks
182 - 1,708 transactions
Amount: 1,100 – 21,000 BTC
Size: 72 – 750 kB
30 | P a g e
Fees
1-2 blocks = 0.00018 BTC/KB = 0.00004 – 0.00018 BTC per transaction =

$0.32 - $1.44 (@ 8,000)
31 | P a g e
Liquidity
• Trade volume last 24 hours = 71,000 BTC = $600 million
32 | P a g e
Bitcoin Keys and Addresses
Bitcoin address = beneficiary name (doesn’t have to be a person)

Public key = bank account number
Private key = PIN or signature
33 | P a g e
Bitcoin address (single use, like throw-away email address)
34 | P a g e
Private Key
• Randomly generated
• 64 characters in hexadecimal (0-9, A-F) = 64 x 4 = 256 bits
• 2 256 = 10 77
• Number of atoms in visible universe = 10 80
Command: [getnewaddress] -> wallet generates public key and address

from stored private key
35 | P a g e
Asymmetric cryptography
• Hard to guess, easy to verify
Challenge: find 4 digits where sum = 10

Possible Solutions:
1+2+3+4
1+1+1+7
2+2+3+3
4+3+2+1
Verification: 4 + 3 + 2 + 1 = 10
36 | P a g e
Elliptic Curve Cryptography

• Trapdoor function (one-way)
• Elliptic curve function (public)
• Starting + end point public
• Number of times ‘n’ secret
• Public key = private key x “G”
• G = generator point
37 | P a g e
From Public Key to Bitcoin Address

• SHA = Secure Hash Algorithm
(NSA)
• RIPEMD = RACE Integrity
Primitives Evaluation Message
Digest
• Base58Check = compression
• Slight change in input ->
completely different output
38 | P a g e
Is Bitcoin a Bubble?
39 | P a g e
How high could Bitcoin go?
World debt = $237 trillion

Maximum Bitcoin outstanding = 21 million
237,000,000,000,000 / 21,000,000 = ~ 10 million
40 | P a g e
Conclusions
1. Crypto-currencies offer debt-free saving
2. Limited issue crypto-currencies = no inflation
3. Households, corporations, governments, countries will have
to run balances budgets
Balanced budgets, no debt

• Big draw-down on growth
• Existing debt in fiat might have to be written off
• Existing savings in fiat same
• Drastic cuts to government spending (military?)
• Natural state of economy might be deflation
41 | P a g e

NEC - 2018-04-21 - Crypto-Currencies

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NEW EUROPEAN COLLEGE CRYPTO-CURRENCIES

April 21, 2018

Island of Stone Money

David O’Keefe (1824-1921)

• M0 (base money = central bank issued)

2. Where does money come from?

Money creation by private sector bank:

Money creation by private sector non-bank:

World debt: $237,000,000,000,000 (world GDP = $75 trn)

Deutsche Bank gross derivative exposure EUR 55 trillion

Ways to reduce debt:

There MUST be a better way to handle this

Digital Assets: 896 Coins ($330bn) + 689 Tokens ($50bn) = 1,585

Creating a better monetary system

It is not a coin (nor is it golden)

• A protocol (like http)

Unit = 1 Bitcoin = 100,000,000 Satoshi

Satoshi Nakamoto wrote Bitcoin White Paper in 2008

• Full node (download entire blockchain)

1-2 blocks = 0.00018 BTC/KB = 0.00004 – 0.00018 BTC per transaction =

• Trade volume last 24 hours = 71,000 BTC = $600 million

Bitcoin Keys and Addresses

Bitcoin address = beneficiary name (doesn’t have to be a person)

Bitcoin address (single use, like throw-away email address)

Command: [getnewaddress] -> wallet generates public key and address

Challenge: find 4 digits where sum = 10

Elliptic Curve Cryptography

From Public Key to Bitcoin Address

How high could Bitcoin go?

World debt = $237 trillion

Balanced budgets, no debt

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