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G494 Team 5 Blockchain Use in Decentralized Technologies

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Bitcoin, Blockchain and Innovation Decentralized Technologies
Team 5: Shelby Barron, Daniel Casey, Patrick O’Malley
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Table of Contents
1. Abstract 3
2. The Blockchain Algorithm 4
3. Where Did Blockchain Originate? 4
4. HowDoes Blockchain...
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Blockchain Use in Decentralized Technologies
G494
10 December 2016
Abstract
This paper has sought to explain the mechani...
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G494 Team 5 Blockchain Use in Decentralized Technologies

  1. 1. 1 Bitcoin, Blockchain and Innovation Decentralized Technologies Team 5: Shelby Barron, Daniel Casey, Patrick O’Malley Institution: Kelley School of Business at Indiana University
  2. 2. 2 Table of Contents 1. Abstract 3 2. The Blockchain Algorithm 4 3. Where Did Blockchain Originate? 4 4. HowDoes Blockchain Work? 5 5. HowCan Blockchain Improve Financial Services? 5 6. Primary Blockchain Application: Bitcoin 7 7. HowDoes the Bitcoin Network Function? 7 8. Bitcoin as a Cryptocurrency 8 9. Mining 8 10. Medium ofExchange 9 11. Unit of Account 10 12. Store ofValue 10 13. Value of Bitcoin in the Market 11 14. Self-Regulation 11 15. Regulatory Action 12 16. The Double Spending Problem’s Prevalence in Cryptocurrencies 12 17. HowDoes Bitcoin Compare to Financial Intermediaries? 14 18. Ability of BitPay in Increasing Transactions 15 19. Benefits ofUsing Bitcoin 16 20. Risks ofUsing Bitcoin 18 21. Additional Blockchain Applications: Banking 20 22. Additional Blockchain Applications: Digitized Legal Contracts 23 23. Additional Blockchain Applications: Intellectual Property Rights 24 24. Conclusion 25
  3. 3. 3 Blockchain Use in Decentralized Technologies G494 10 December 2016 Abstract This paper has sought to explain the mechanics of Blockchain technology and its current and future applications. A study of the Blockchain’s principle application, Bitcoin, is provided in great detail. Bitcoin has emerged as a pioneer in the market of Cryptocurrencies and has uses the Blockchain Algorithm for its ledger system of transactions. Bitcoin’s ability to eliminate third party intermediaries provides a great advantage. However, Bitcoin’s scale and deflationary nature is investigated to determine its long-term sustainability. Blockchain technology is also evaluated to determine its potential in improving the banking industry, digitized legal services, and licensing protection. The findings in this paper show how Blockchain is a working model in eliminating the use of third parties, with implications of further decentralized services to come after the success of Blockchain’s use in Bitcoin.
  4. 4. 4 The Blockchain Algorithm Blockchain technology is complicated, but the idea is simple. At its core, the Blockchain secures trust and integrity between strangers. Blockchain is a way to organize and structure data in a public peer-to-peer distributed online database. Some insist that the Blockchain algorithm is the “first native digital medium of value, just as the internet was the first native digital medium for information.” [1] Transactions are added to chains of blocks and shared on a global digital ledger to a network of computers. No central authority has the power to alter these records in a Blockchain, thus everything in the system is deemed irreversible. Complex algorithms structure the process and prevent users from performing fraudulent activity. [2] Where did Blockchain Originate? Blockchain technology initially originated in whitepaper titled “Bitcoin: A Peer to Peer Electronic Cash System” published in November 2008 by the pseudonym Satoshi Nakamoto. The writer still remains a mystery, but the Bitcoin technology lives on. Nakamoto published the whitepaper on a popular cryptocurrency website, where it received immediate traction in the community. The term “Blockchain” is never mentioned in the paper, however the idea behind the block technology is first introduced. Nakamoto aims to eliminate the need for a third party intermediary in digital monetary transactions. The overall idea of the “Blockchain” developed further as the research behind the Bitcoin became more extensive. As the Bitcoin’s popularity grew, more individuals and institutions recognized the potential of underlying Blockchain technology to improve other industries as well. [1]Tapscott, D., & Tapscott,A.(2016, May 10). The Impact of the Blockchain Goes Beyond Financial Services. Retrieved December 9, 2016, from https://hbr.org/2016/05/the-impact-of-the-Blockchain-goes-beyond-financial- services [2]Hackett, R. (2016, May 23). Wait, What Is Blockchain? Retrieved December 9, 2016, from http://fortune.com/2016/05/23/Blockchain-definition/
  5. 5. 5 How does Blockchain Work? A Blockchain holds two types of files: individual transactions and blocks. Blocks are large, organized collections of data connected to the transactions approved within a measured time period. In the Blockchain used for Bitcoin, transactions are created whenever funds are transferred from one user’s account to another’s in the network. In another Blockchain network, such as Smart Contracts, transactions are generated whenever contracts are signed by the individual parties in the agreement. Blockchain users validate each new transaction that enters the system across the global digital ledger so that it can be timestamped and added to the next block in the chain. Blockchain approvers build new blocks and verify the new transactions added to the chain of transactions. These approvers create a permanent identification of a block when it is added to a chain, therefore it disables the the ability of tampering with data. If one party wishes to fraudulently reverse an old transaction submitted on a Blockchain, they would have to first change the specific block’s identification, which would be impractical in that successive and previous blocks would not recognize this change as valid. Some even argue no existing institution has the computing power to alter an embedded block in the chain. The sheer energy needed to change all the subsequent blocks in the chain and update the ledgers of the worldwide network is far too colossal to imagine. The airtight security of the Blockchain allows the global database to even function without the massive backup processors and storage of other entities. The Blockchain in itself exists as an enormous, inalterable record of history. How Can Blockchain Improve Financial Services? Nakamoto’s paper was published during the aftermath of the subprime mortgage financial crisis in 2008. Global recession, quantitative easing by the Federal Reserve, and the European sovereign-debt crisis were all major concerns during the period. The public’s confidence in government issued currencies deteriorated during this time, as the public lost trust in their safety and legitimacy. [3] The effects of the financial crisis still live on today, and people and institutions have turned to other options to manage their money. [3]Desjardins, J. (2014, February 23). The Definitive History of Bitcoin. Retrieved December 10, 2016, from http://www.visualcapitalist.com/the-definitive-history-of-Bitcoin/
  6. 6. 6 some argue the entire financial services industry must be overturned to promote higher transparency and democracy. Many people and institutions are turning to the Blockchain as a means of improving the financial services industry. Other notable technologies such as big data, the cloud, robo advising, and collaborative finance are also entering the industry, but the Blockchain has the power to make the largest impact. Alex Tapscott, CEO of Northwest Passage Ventures and author of “Blockchain Revolution”, argues the Blockchain is, “Nothing short of the second generation of the internet.” The Blockchain’s revolutionary distributed ledger and encryption can allow the banking industry to provide secure transactions in near-real time. [4] Much of the public’s distrust in the financial services industry sprouts from major scandals such as Enron, Lehman Brothers, and Fannie Mae. In September 2016, Wells Fargo was fined $185 million for assertions that bank employees opened accounts without customers’ permission. [5] This recent event calls the reliability of the financial services industry into question again. The extensive encrypted controls that Blockchain provides can help prevent many fraudulent activities from ever occurring. These controls can block financial services representatives from manipulating funds and putting clients’ accounts at risk. Blockchain encodes values and allows machines to arbitrate on the user’s behalf. Blockchain can also drastically reduce the industry players’ operating costs, as the costs of maintaining back-up processing, storage, and security are eliminated with the practice of the Blockchain hash encryptions. Faster fund transfers increase controls the functionality of Blockchain, there is also the potential to help people become financially empowered in underserved capital markets. [4]Wigmore, I. (2015, December). Blockchain Definition. Retrieved December 9, 2016, from http://whatis.techtarget.com/definition/Blockchain [5]Blake, P. (2016, November 3). Timeline of the Wells Fargo Scandal. Retrieved December 10, 2016, from http://abcnews.go.com/Business/timeline-wells-fargo-accounts-scandal/story?id=42231128
  7. 7. 7 Primary Blockchain Application: Bitcoin Bitcoin is the world’s most predominant decentralized online cryptocurrency. It operates using the Blockchain algorithm as its ledger system without a central authority power. Bitcoin is the Blockchain’s primary proof of concept. No physical Bitcoins exist. Instead, an online public ledger on the Blockchain keeps track of all the transactions in the Bitcoin community. Each user has his own private key (for security purposes) and public key (his public identifier). Each transaction is verified by the Bitcoin user community and is added to the ledger. Since Bitcoin’s launch in 2009, its value has had volatile gains and losses, reaching a high of over $1000 in late 2013 before dropping to roughly half that level. By 2016, Bitcoin has rebounded to reach of value of around $768. [6] How Does the Bitcoin Network Function? Bitcoin functions exactly like the Blockchain network detailed earlier. Transactions are issued peer to peer and the entire network is used to monitor and verify both the transfer of Bitcoins between users, and the creation of new Bitcoins through mining. [7] A ledger of all transactions is collectively maintained by all users on the platform and every new transaction is broadcasted across the entire network. Miners execute difficult and power intensive mathematics to update the new blocks added to the chain. However, the Bitcoin network has a few notable additions to its operations. Each user must have a Bitcoin “wallet”, which is basically the equivalent of a bank account. It allows the user to store Bitcoins, receive them, and send them to others. The user’s Bitcoins and secure 256 bit private key are stored inside, so it must be protected from outside infiltration. There are two main varieties of Bitcoin wallets. Many Bitcoin users opt for the “software wallet”. One must install it on his own computer and remains in total control over the security of the coins. For the Bitcoin novice, there is the “hosted wallet” that is maintained by a third party. While this is easier to use, one must trust the provider with his private information to protect his coins. [6]Bitcoin Price Index. (n.d.). Retrieved December 10, 2016, from http://www.coindesk.com/price/#2012-11- 30,2016-12-10,close,bpi,USD [7]T.S. (2011, April 11). How Does Bitcoin Work? Retrieved December 10, 2016, from http://www.economist.com/Bitcoinexplained
  8. 8. 8 Bitcoin as a Cryptocurrency Bitcoin can be described as the most successful Cryptocurrency. Bitcoin is successful from its large trading volume and market capitalization relative to other cryptocurrencies. Although not defined as a currency by the International Monetary Fund, Bitcoin is increasingly used as a medium of exchange in peer-to-peer transactions and has a greater market capitalization than currencies from some developing countries. As the shift to cashless transactions grows, cryptocurrencies have gained more presence in the markets and have influenced other countries to employ non physical money. Mining People can create Bitcoins through a mining process, using a computer and a hashrate mining software. The mining software repeats a hash function that then records hashes (outputs) of which fractions if not whole parts of Bitcoin can be found. The hashrate recognizes the mining speed of the software, and is measured in gigahashes (thousands of hashes). Once a Bitcoin is found and formed it is transferred to a wallet on a computer. The higher the hashrate being performed by the computers and mining software, the more outcome in Bitcoin. Mining was a very lucrative venture for individuals when the global hashrate was much lower than today’s value. Individuals could mine within their homes by setting up 24 hour servers that, at the time, would provide higher returns than other computing ventures. Today the global hashrate is very high. Since the supply of Bitcoin is limited to 21 million, each Bitcoin mined will progressively take more computing power to acquire. The predicted year that the last available Bitcoin will be found is in 2021. Today, if someone were to try and mine a Bitcoin themselves in their home, it would not be profitable nor feasible. The computing power is costly, the processors required are very expensive, and the time it would take is very long. Thus, the cost of running the computers would outweigh the benefits of mining. As computing power increases though, there may be more of an incentive to mine Bitcoin. Mining Pools Mining today is only feasible if there is significant enough investment to procure these Bitcoins. Mining pools have grown to take on a larger role in the supply of Bitcoin. A mining Pool is a collection of miners that run their computers simultaneously with other miners with
  9. 9. 9 more shared computing power to procure more of the currency. The amount of Bitcoin mined in a pool is distributed amongst the miners in the pool. Today, mining pools amount for the highest percentage of mined Bitcoins. A case exists that if the mining of Bitcoin is controlled by a majority of one organization or mining pool, then Bitcoin may collapse as a currency. The introduction of mining pools has caused some investors to worry about entering in the Bitcoin market. One theory, known as a 51% attack, is when one mining pool controls over 50% of the mining production of Bitcoin. The theory states that with a majority control of supply from a mining pool, the supply could be manipulated by these miners to cause a speculative attack in the market. In 2014, one mining pool, Gash.io, had achieved 50% of the mining capacity and it caused the pool to release statements promising to reduce their share. Currently 50% of the mining by pools is distributed among 4 players, while many other smaller pools make up the remaining 50%. The threat of a 51% attack is still there as mining has become more expensive and smaller players are driven out by the low returns. The mining pools seem to have enough interest in maintaining the value of Bitcoin that if an attack occurs, it can severely damage Bitcoin’s reputation as a secure cryptocurrency.[9] Medium of Exchange Defined as an instrument used to facilitate the sale, purchase or trade of goods between parties, Bitcoin meets the definition in being a Medium of Exchange. Bitcoin fits this definition in that people regularly exchange Bitcoin for other goods or currencies. Transactions regularly occur and Bitcoin is becoming a more accepted means of exchange in the online market. The lack of a physical element of Bitcoin can cause some to avoid using Bitcoin in markets, but as trends show, there is a growing presence in cashless transactions. The rise of cryptocurrencies has been responsive to a trend in cashless transactions and is a precursor to countries moving even further in the direction of cashless societies. [8]Cawrey, D. (2014, June 20). Are 51% Attacks a Real Threat to Bitcoin? Retrieved December 10, 2016, from http://www.coindesk.com/51-attacks-real-threat-Bitcoin/
  10. 10. 10 Unit of Account Unit of Account is a monetary unit used to value a good. Bitcoin is highly divisible with transaction amounts down to fractions of a Bitcoin. Each Bitcoin is worth an amount of a certain good. The exchange rate of Bitcoin is regularly updated with the speed of the internet and one can find instantaneously how much a good is worth in Bitcoin before proceeding in a transaction. Since transactions are normally occurring online, the price of a good offered in one currency can currently reflect the value in Bitcoin. There are also limits on how many Bitcoin are in circulation. Along with the restraints put on by the hash rate, the finite amount of Bitcoin that will be produced in total will limit the supply, so no mass inflow will occur that would cause a collapse of its market. If a mass inflow were to occur, it would cause a massive decrease in Bitcoin’s value as the shift in supply would devalue Bitcoin. This has happened to other cryptocurrencies as they start to gain a larger market presence. Speculation in the markets will cause drastic increases or decreases in the market value as the real value is still uncertain. As Bitcoin has established itself as the leader in the cryptocurrency market their acceptability in markets has increased and provided Bitcoin with a higher store of value. Store of Value In definition, an asset’s store of value is when an asset can be saved, retrieved and exchanged at a later time, and be predictably useful when retrieved. Bitcoin’s value is determined by a function of supply and demand. Since the supply is relatively controlled, the demand for Bitcoin is formed when it becomes a better store of value and more acceptable than other currencies. Some citizens of countries have started using Bitcoin when their currencies experience high amounts of inflation. For example, Bitcoin was used by some Argentinians in online transactions when their currency went through a period of high inflation. This has caused some concern in that Bitcoin’s value continues to increase over time, contradictory to the downward trends in the lifetime of fiat currencies. This deflationary principle would naturally deter owners of Bitcoin to spend them under Gresham’s Law. When the value is expected to increase, owners of the asset will tend to hold on to the cryptocurrency rather than spend it on goods. When periods of higher value occur, the price tends to increase dramatically relative to other currencies. After a period of holding time, Bitcoin tends to return to a constant deflationary
  11. 11. 11 growth. It is through Bitcoin’s value and acceptability in the marketplace that Bitcoin is still used in transactions. [9] Value of Bitcoin in the Market Bitcoin’s price, like other goods, is determined through supply and demand. Common transactions use only fractions of a Bitcoin and are transferred in peer-to-peer networks or through websites that accept Bitcoin as payment. Bitcoin also has a niche market, in that although everyone can potentially receive Bitcoin for goods sold or services performed, those willing to accept Bitcoin are still relatively low. Regardless, relative to other cryptocurrencies Bitcoin has a much larger trade volume than others and even has a larger market capitalization than some currencies in developing countries. Bitcoin is exchanged in place of other currencies when a home country's currency becomes unstable. This flight to safety tends to happen when global news events directly affect a home country's currency and traders find Bitcoin to have a better store of value. An example of this would be this summer during England’s Brexit from the European Union. As speculators saw a decrease in the value of the British Pound, the trading volume of Bitcoin drastically increased and the price rose accordingly. This threat of speculation has caused several governments to ban the exchange of Bitcoin or take actions to limit the trade and holding of Bitcoin. Self-Regulation There is a lack of regulation from the IMF in cryptocurrencies. Traditionally, with other currencies, the IMF would have influence in the trading of these in the FOREX market. The IMF still does analysis on cryptocurrencies and is active in monitoring trade and exchange of them. Despite the monitoring, the IMF does not actually define Bitcoin or other cryptocurrencies as actual currencies, differing from the public opinion of traders. Action from the IMF would greatly differ from Bitcoin’s purpose as a peer-to-peer currency in that a significant investment in Bitcoin could drastically affect the trade activity. As stated earlier, a control of the mining of [9] Plassaras, N. A. (2013, January 6). Regulating Digital Currencies: Bringing Bitcoin within the Reach of the IMF. Retrieved December 9, 2016, from http://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?article=1407&context=cjil Pages Used 384-389,396-402
  12. 12. 12 bitcoin by over 51% could cause tremendous volatility in the price of Bitcoin; large transactions of Bitcoin also cause volatile changes in price. Insofar as there is an infrequency of large transactions and speculative transactions, the IMF will still stay out of regulating the cryptocurrency market. Regulatory Actions The only regulations made so far have been from certain countries. To counter the threat of speculation, Russia and Bolivia have banned the exchange of their respective currencies for Bitcoin. These legislations do not ban the use of Bitcoin in their markets, it only dissuades the use of them. If someone is willing to accept a transaction in Bitcoin, they still can but the relative value is small when it cannot be used to exchange for another currency in their market. Other countries have started taxing the ownership and use of Bitcoin. While many nations have not intervened in the Bitcoin market, developed economies like the United States, the United Kingdom, France, Canada, and Singapore have tax legislations on the cryptocurrency. The United States Federal Government does not recognize Bitcoin as a currency in taxation, rather they have taxed it as property. With these regulations comes concern that the innovation of Bitcoin may be undermined. This has been the incentive for some countries to monitor the financial institutions and market participants who engage in transactions, rather than the miners and transactions approvers.[10] Double Spending Problem’s Prevalence in Cryptocurrencies The double spending problem is defined as the ability to successfully spend a portion of money more than once. Double spending is unique to the digital currency community because digital information can be replicated very easily. Physical currencies cannot be easily replicated, so they do not have this issue. The parties involved in physical currency transactions can touch the money and witness its exchange between hands, thus there is no threat of “double spending” the money. [10]He, D., Habermeier, K., Leckow, R., Haksar, V., Almeida, Y., M., . . . Verdugo-Yepes, C. (2016, January). Virtual Currencies and Beyond: Initial Considerations.Retrieved December 9, 2016, from https://www.imf.org/external/pubs/ft/sdn/2016/sdn1603.pdf Pages 25,42
  13. 13. 13 Digital currency poses the risk that the holder can make a copy of an item, say a new online currency called a digital token, and send it to another party while still retaining the original. For example, when the token is sent to another party, the original is still saved on the user’s computer. If the user is untrustworthy and does not delete the original file, the user has the ability to send copies to many other people if they wish. This activity poses a high currency valuation risk in line with Gresham’s Law, “bad money drives out the good.” Thus, if the token is sent too many times in the network, it becomes worthless. In order to mitigate this risk, online merchants, like Amazon, must employ third party intermediaries, such as PayPal and Visa, to manage the exchange. These intermediaries hold large ledgers and debit the purchaser’s account and credit the merchant’s account for the payment agreed upon. Without this intermediary, there would be no way of preventing the payer from buying many items without getting his account adjusted for the purchases. However, these third party institutions charge users transaction fees, flat fees, and incidental fees. The average credit card processing cost for online shops is roughly 2.30-2.5%. These fees add up and can be a significant operating cost for many businesses. [11] How Can Bitcoin Prevent the Double Spending Problem? Bitcoin experienced some exposure to double-spending over its history. However, the advances of the Blockchain has helped it prevent this problem. When transactions are approved and added to the Blockchain, they are added to its hash function. When new blocks enter the chain, they include the previous block’s hash functions as well. Thus, a user is unable to re-spend Bitcoins used in the original transaction, because the data is coded and confirmed across millions of ledgers worldwide. If the user tried to double spend the Bitcoin, his ledger would be wholly inconsistent with the entire Bitcoin network. Thus, this fraudulent transaction request would be immediately recognized by the Bitcoin network and not authorized, preventing the double spending from ever occurring. [11] Dwyer, B. (n.d.). Average Credit Card Processing Fees. Retrieved December 10, 2016, from https://www.cardfellow.com/average-fees-for-credit-card-processing/
  14. 14. 14 How Does Bitcoin Compare to Financial Intermediaries? Financial intermediaries attempt to verify the identities of the individuals in the transaction to establish trust. They also use computer software to encode business logic in the data to control its workflows. Financial intermediaries, like PayPal, are centralized. This makes them susceptible to cyber-attacks and endangers the accounts of all their users. Intermediaries also slow down the transaction process substantially, especially in international fund transfers. These transactions also have many added fees. For example, at the ten largest U.S. banks, the average cost of an outgoing domestic wire transfer is $26.40 while the average outgoing foreign wire transfer fee is $45.50. [12] Bitcoin is different because its Blockchain database eliminates need for the third party intermediary to establish trust in transactions. The extensive coding, cryptography, and mass network collaboration. Why Do Businesses Choose to Use Bitcoin as a Form of Payment? Many small businesses recognize significant cost savings in the use of the Bitcoin. First, the Bitcoin is cheaper to accept as a form of payment than credit cards like Visa and Mastercard. Credit card services require the business to pay licensing fees and merchant “pay per swipe fees”. However, there is no licensing fee necessary for the Bitcoin. The user simply creates an account and it is ready for use. Also, the Bitcoin network charges little to no merchant fees. Most credit card swipes cost approximately 25 cents for the business and charge 3-5% of the purchase price. This is why many small businesses often feature signs next to their cash registers stating phrases like, “minimum purchase for CC: $10.”. While the bulk of these merchant fees is often passed to the seller, a portion is also passed along to the consumer. Some businesses even offer discounts for those that use Bitcoins on purchases. Secondly, Bitcoins are much faster than traditional electronic payment systems. There is no application process. So, businesses can start using it right away. Also, the payments are added to the Bitcoin network almost instantaneously, so there is no delay on the parties’ accounts being reconciled. [12]Zhen, S. (2015, October 28). Compare the Cost of Bank Wire Transfer Fees. Retrieved December 10, 2016, from https://www.mybanktracker.com/news/2013/04/18/wire-transfer-fees-2013/
  15. 15. 15 However, electronic payment systems have some notable advantages over the Bitcoin. Credit card companies charge fees because they need to be compensated for their services. First, credit cards offer lending services. By allowing their customers to spend money they do not have, these companies inherit significant default risks. Contrastingly, Bitcoin functions like cash. There is no lending possible. Second, credit card companies offer insurance to their customers. If the credit card is subject to fraud or identity theft, the unauthorized charges are reversed and the customer is protected. Third, credit card companies allow the user to build up their credit history. The better credit score one has, the easier it is to receive large loans in the future. Lastly, many credit card providers offer points and rewards, such as airline miles and cash back on certain purchases. Ability of BitPay in Increasing Transactions While Bitcoin is largely considered a fringe currency, mainstream entities have taken notice and some companies have decided to become involved. Visa is a prime example of mainstream acceptance following their release of the Visa BitPay card in May of 2016. By linking the BitPay card with one’s Bitcoin wallet, individuals can convert their Bitcoins into US dollars with ease. Essentially functioning as a debit card, the Visa BitPay card provides enthusiasts with a simpler method for spending their Bitcoins. The benefits associated with Visa’s BitPay card are relatively straightforward. The card allows users to draw funds from multiple wallets, converts said funds into US dollars, and can be used anywhere that Visa cards are accepted. What was created as an online currency can now be easily converted for use at average businesses and ATMs. No fees are charged unless the user is traveling outside the United States, where a 3% currency conversion fee is charged to the owner of the card. Bitcoin users hoping to remain completely anonymous will likely reject the card, as signing up requires the inclusion of extensive personal information including one’s address and a copy of a government-issued ID. [13] [13]Load dollars using any Bitcoin wallet, spend anywhere. (n.d.). Retrieved December 9, 2016, from https://bitpay.com/visa
  16. 16. 16 Benefits of using Bitcoin The advantages provided by Bitcoin are extensive enough to justify the currency’s continued growth in popularity. Benefits include, but are not limited to: the inability of third parties to seize funds, freedom from taxation, the exclusion of political influence on spending, minimal transaction costs, the acceptance of micropayments, protection against theft, and protection against chargebacks. It is important to note that some of these advantages are subjective and can be viewed negatively by certain entities. To remain consistent, we have decided to determine advantages and disadvantages from the viewpoint of the typical Bitcoin user. Third Party Seizure: Users are able to transfer and store funds without the fear of a third party entity impeding their ability to do so. As reliance on physical currency continues to decrease, third party entities such as government and financial institutions are increasingly able to control the funds of individuals. Bitcoin provides an escape from third party intervention and allows users to maintain complete control over their own money. Taxation: The inability of government to tax Bitcoins is largely related to their inability to freeze funds. The anonymity that Bitcoin provides makes identifying the owners of wallets relatively impossible. If the government cannot identify the owners of Bitcoins they cannot force any individual to pay taxes on the currency. The US government recognizes the difficult task at hand but is still making attempts to tax users. The IRS recently requested records from Coinbase, a Bitcoin exchange website operated from within the United States. [14] While Coinbase has not yet cooperated with the request, the agency’s attempt to tax users proves that Bitcoin is large enough not to be ignored. No Political Control: Online transactions that utilize traditional currency can receive scrutiny from governments who disagree with the transactions being made. The prime example of this involves major credit card companies and WikiLeaks. In 2010 political pressure was placed on major credit card companies to block transactions between customers and the WikiLeaks [14] Popper, N. (2016, November 18). Bitcoin Users Who Evade Taxes Are Sought by the I.R.S. Retrieved December 9, 2016, from http://www.nytimes.com/2016/11/19/business/dealbook/irs-is-seeking-tax-evaders-who- use-Bitcoin.html
  17. 17. 17 operation. The reasoning used was the companies’ stances against their cards being used to purchase illegal goods or services. [15] In this case, the hacking of government files was the illegal “service” taking place. Users of Bitcoin and other cryptocurrencies are still able to fund the operation due to the inability of government to influence transactions. While WikiLeaks is just one example, the same logic can apply to any purchase that a government classifies as illegal. Minimal Transaction Costs: The costs associated with ordinary financial transactions are one of the primary incentives for abandoning the current system in favor of Blockchain and Bitcoin. Following its creation, Bitcoin transaction costs were essentially non-existent. However, as mining becomes a more strenuous process, users have been paying transaction fees in order to have their transactions included in the next block. Those who do not offer to pay the additional fee risk having to wait for longer periods before their transaction is approved. Despite an increase in the presence of transaction fees, the fees associated with Bitcoin are significantly less than mainstream currencies. Micropayments: The costs associated with standard financial transactions are high enough to discourage small transactions from taking place. Transactions of all sizes are plausible between Bitcoin users because the relatively miniscule transaction costs. Bitcoin Theft: In order to steal one’s Bitcoins, physical access to the user’s computer is required. While identity theft can cause serious financial troubles for those dealing in everyday currency, no similar threat exists in relation to Bitcoin. One cannot forcefully access and transfer another user’s funds from a remote location. [15] Greenberg, A. (2010, December 7). Visa, Mastercard MoveTo Choke WikiLeaks. Retrieved December 9, 2016, from http://www.forbes.com/sites/andygreenberg/2010/12/07/visa-mastercard-move-to-choke-WikiLeaks/#204783fb4bc2
  18. 18. 18 No chargebacks: When transactions have been sent and approved by the Blockchain, there is no risk that the user sending the funds will revoke them. This guarantee is considered an advantage but it is important to recognize the irrevocability of Bitcoins provides an opportunity for scammers. If the product or service purchased is of lesser quality than agreed upon, the purchaser is not guaranteed a refund. However, this issue has largely been resolved through the use of intermediary exchange sites such as the previously mentioned Coinbase. Risks of using Bitcoin No perfect monetary system exists—and Bitcoin is not immune to this fact. While the advantages provided by Bitcoin are quite appealing to its system of users, the flaws that exist cannot be ignored. The primary disadvantages of Bitcoins are: the vast majority of merchants not accepting the currency, the fluctuating market value, and the susceptibility of wallets to viruses, no buyer protection, unknown technical flaws, and a 21 million Bitcoin cap. Not Accepted at Most Merchants: While Bitcoin may be gaining mainstream attention, the currency is yet to be accepted by the typical business. The previously mentioned Visa BitPay card is an obvious remedy to this issue. However, a large portion of users enjoy Bitcoin for its anonymity. Once Bitcoins are converted into US dollars and transferred onto the BitPay card or another similar card, the currency can be traced to the owner. For those wishing to remain completely anonymous when making purchases with Bitcoins, the internet remains their purchasing environment. Even when purchasing online, the individual or company on the receiving end of the transaction must be willing to accept Bitcoin for the transaction to go through. Fluctuating Market Value: The value of Bitcoin is constantly fluctuating due to supply and demand. The ever- changing value places extra risk on potential investors. While the risk of losing value exists, an investment opportunity exists as well. Purchasing Bitcoins at an opportune time can provide a positive ROI for investors.
  19. 19. 19 Wallet Vulnerability: While Bitcoins are safe from being stolen electronically, they can still be lost indefinitely. If an individual’s wallet becomes infected with a virus and becomes corrupted, it is likely that the user will never recover their Bitcoins. However, the ability of individual users to control multiple wallets allows them to minimize risk by storing funds in more than one wallet and on more than one computer. No Buyer Protection: As mentioned earlier in the “No Chargebacks” section, buyers are unable to guarantee the quality of the good or service they expect to receive after making a purchase with Bitcoin. Third party intermediary websites exist that specialize in Bitcoin transactions. For a small percentage of the price paid, the intermediary will act to guarantee both parties receive what is expected from the transaction. However, one of the primary benefits of Blockchain and Bitcoin is the lack of a third party intermediary which lowers transaction costs. The users must decide if this tradeoff is worth accepting for the extra protection provided. Unknown Technical Flaws: As a relatively new form of cryptocurrency, unknown technical flaws and risks may exist in the Bitcoin network that have not yet been exposed. If an individual or group of users become aware of such a flaw, there will be an opportunity for them to expose it. Luckily, the complexity of the transaction approval process is a natural defense against fraud. 21 Million Capacity: The built-in cap on the amount of Bitcoins that can be mined creates current difficulties and an uncertain future. The Bitcoins yet to be mined are becoming increasingly hard to produce. The amount of computer power required to mine each additional coin is on the rise. The users in the system who choose to mine must dedicate more time and electricity costs for each additional Bitcoin. The increasing effort required is one of the primary causes of increasing transaction costs. The finite supply also causes natural deflation. When the limit is eventually reached, it is uncertain how investors and miners will react.
  20. 20. 20 Bitcoin Black Market Bitcoin should not be described without including its darker implications. The anonymity associated with Bitcoin and other cryptocurrencies has opened up the opportunity for individuals to utilize Bitcoins in the online black market. The inability of government to identify users has made the sale of drugs, weapons, and other illegal products and services much simpler online. Not only has Bitcoin stifled the government’s ability to tax users, it has also created another obstacle in regulating the sale of goods and services. Possibly the most famous example of this is the website known as the Silk Road. The primary purpose of the website was to purchase illegal substances online. While the website has been taken down numerous times since its creation, the Silk Road rose to great heights largely thanks to Bitcoin. [16] Cryptocurrencies have filled a void online that has existed since the internet’s inception—the ability to purchase goods and services online with the same anonymity that paper currency provides. Additional Blockchain Applications Banking While many governments are not fond of Bitcoin, they still consider Blockchain as an opportunity to improve their central banks. The Blockchain formula provides an opportunity for banks to both decrease costs and increase the speed of transactions—all while maintaining increased oversight. The United Kingdom is among the countries most intrigued by the potential of the new technology. With multiple research papers released on the topic, it is clear the United Kingdom wants to remain up-to-date with the potential of Blockchains, as opposed to playing catch up later. The UK’s central bank, the Bank of England, believes adopting a system similar to Blockchain will increase the country’s yearly economic output by 3%. [17] If true, such a substantial improvement is not to be ignored. Blockchain’s ability to maintain a verifiable record of transactions also helps protect financial institutions against cyber-attacks and technical flaws. Even if the computing system of a central bank were to fail, the record of all transactions [16] Wong, J. I. (2014, October 6). Dark Markets Grow Bigger and Bolder in Year Since Silk Road Bust. Retrieved December 9, 2016, from http://www.coindesk.com/dark-markets-grow-bigger-bolder-year-since-silk-road-bust/ [17] Higgins, S. (2016, July 18). Central Bank Digital Currencies Could Boost GDP, Bank of England Says. Retrieved December 10, 2016, from http://www.coindesk.com/central-bank-digital-currencies-boost-gdp-bank-england-says/
  21. 21. 21 could still be accessed and verified. Utilizing Blockchain for financial transactions began largely as an outlet to escape banks and government entities. Ironically, Blockchain may end up making the banks stronger than ever. Wall Street If central banks have picked up on the potential of Blockchain then many businesses were likely to precede them. Companies specializing in financial transactions have known of Blockchain’s advantages for many years now and have been researching ways to capitalize on it. The amount of administrative costs and time spent on financial transactions is immense. A group of over 50 financial institutions have been collaborating in order to establish their own ledger technology that could increase the efficiency of their operations. R3 is the financial firm currently partnering with these institutions with the intention of creating a global ledger. The first ledger to be established and accepted will likely be too valuable for major companies not to adopt or at least experiment with. [18] The Decentralized Autonomous Organization Blockchain has provided a pathway for the world’s first decentralized autonomous organization, abbreviated as DAO. Where a typical company requires leadership to make decisions, a DAO is controlled by a software. A DAO functions by programming a software to complete predetermined tasks while adhering to a set of rules that have been written in computer code. Such tasks can include funding projects in order to generate revenue. Blockchain is utilized by the DAO to verify all decisions made by the software are within the predetermined rules. Having software in charge of the DAO does not mean that humans cannot benefit from the organization. Investing in a DAO provides an opportunity for humans to receive payments when the company produces profit. Earlier in 2016 the world’s first DAO crowdfunded 117 [18]About R3. (n.d.). Retrieved December 9, 2016, from http://www.r3cev.com/about/
  22. 22. 22 million dollars from intrigued investors—a large portion of which was made in Cryptocurrencies. [20] In return, investors receive digital tokens that represent shares in the company. The concept is still in development and yet to be tested in the real world, but the overwhelming excitement is apparent through the massive amount of funds raised. The benefit of a company with no human leadership is the removal of human flaws. Human leaders can be corrupt and make poor decisions. Ideally, the DAO would only act in ways that benefit the investors. Investors agree to the predetermined set of rules and the Blockchain technology takes care of the rest. The first attempt at a decentralized autonomous organization does not lack its fair share of critics. Many people familiar with Blockchain fear investments in the first DAO may be going to waste as there is no guarantee that the concept will be successful. Some individuals believe it foolish to believe that the software could make better investment decisions than humans who have been educated and trained for that purpose. “Unbanked” Populations Access to financial services is not readily available worldwide. Approximately 2.5 billion people globally are “unbanked” without access to a formal banking account. [24] The unbanked, defined those who do not have access to banks and credit cards, may be the next large market for cryptocurrencies based on Blockchain. The great mobility, accessibility, and scalability of Blockchain can help financial institutions reach these unbanked areas of the world through technology. Additionally, the Blockchain will increase transparency and trust in transactions. The dramatic rise in the mobile money industry in emerging markets like East Africa is a strong signal that these populations could also benefit from Blockchain. Mobile services, such as M Pesa, are currently addressing the need. Currently, there is a lack of penetration in the mobile banking arena by branded financial institutions. Instead many small mobile network providers, MNOs, offer stored value accounts that facilitate person-to-person payments through their intermediary services. [23] [20]Prisco, G. (2016, May 16). The DAO Raises More Than $117 Million in World's Largest Crowdfunding to Date. Retrieved December 9, 2016, from https://Bitcoinmagazine.com/articles/the-dao-raises-more-than-million-in- world-s-largest-crowdfunding-to-date-1463422191 [22]Hayes, A. (2016, February 29). Decentralized Autonomous Organizations: IoT of Today. Retrieved December 8, 2916, from http://www.investopedia.com/articles/investing/022916/decentralized-autonomous-organizations-iot-today.asp
  23. 23. 23 Also, an eminent benefit Blockchain can provide to the unbanked is its relatively low transaction fee made possible by Blockchain technology. In areas with high rates of poverty, such as Sub-Saharan Africa, this could make a dramatic impact on economic development. Many of the world’s unbanked population rely on money transferring entities and traditional companies charge much higher fees to process transactions. Consumers are not the only ones who would benefit from lower transaction fees. Small businesses around the globe have difficulty competing with global organizations. One of the obstacles the small businesses face is the high cost of doing international business due to the complexity of foreign currency transactions. Blockchain provides an opportunity for small business owners to eliminate the high transaction fees associated with international business. Contracts and Legal Framework Smart Contracts When a transaction enters a Blockchain, it is there permanently and cannot be tampered with. Currently, software exists through DocuSign signatures, where someone can electronically submit a signature online and avoid face to face interaction. As firms and consumers enter into more contracts, databases are naturally made of the contracts with many signatures. A Blockchain of specific contracts could be observed and analyzed by a firm and serves as legal confirmation when the contract is approved by both parties. This entrance of a Blockchain to commercial and personal contracts would eliminate the legal problem of backdating in electronically signed documents, where someone can electronically forge a prior date on a signed document. Digital Notaries Similarly, when an item is added to the block, it has to be approved by the users in the network. With total approvals, an item can be added and verified to a chain. This applies to notary services as well, where, until the Blockchain a notary public would be paid to recognize a contract is valid. Currently, the Blockchain approval process in Bitcoin’s ledger system is similar [23]Galant, P. (2012, April 26). Mobile Money: A Path for Increasing Financial Inclusion. Retrieved December 10, 2016, from https://www.fdic.gov/about/comein/2012/2012-04-26_presentation_galant.pdf [24]Who are the Unbanked. (n.d.). Retrieved December 10, 2016, from http://siteresources.worldbank.org/EXTGLOBALFIN/Resources/8519638-1332259343991/world_bank3_Poster.pdf
  24. 24. 24 to a notary service. With quicker availability of notaries through applying Blockchain, it would increase the availability of approved notaries and decrease the transaction costs that are associated with high, in person notary fees. Intellectual Property Database Blockchain has the ability to fundamentally restructure the way we share intellectual property around the world. The predominance of the internet has made the sharing of information easier than ever, but it also has imposed massive ramifications on those who hold intellectual property. Digital content can be copied and freely distributed on the internet, and often the ownership rights are neglected. A Blockchain infrastructure containing the minimum viable data of the information could control who accesses it and assign value to the owners. This practice could help a wide array of individuals and businesses owning entities such as titles, deeds, scientific discoveries, patents, and research journals. Blockchain can also even assist artists in the film, art, music industries. To provide an in-depth analysis of this broad idea, the music industry case is analyzed below. Blockchain Case for the Music Industry Blockchain has the potential to revolutionize the music industry and its intellectual property database. Currently, no central database exists in the world to track the ownership rights of music. Songs often have multiple writers, performers, publishers, and licenses. A single song’s collective ownership rights can span across different organizations and countries. In addition, music pirating remains a pervasive problem in the industry. Many artists and collaborators do not receive anywhere near to the amount they are entitled. Artists are said to lose up to 86% of the proceeds from their music. [25] A world-wide distributed Blockchain database for the music industry could solve these issues. This database would allow the artists to directly represent themselves and have a peer-to- peer relationship with their fans. The smart contract feature of Blockchain could also help artists receive immediate payment for their work when it is purchased and distributed. The unique micropayments capability of Bitcoin supported by the Blockchain network would make these payments much more fluid and transparent. [25]Chester, J. (2016, September 16). How Blockchain Startups Are Disrupting the $15 Billion Music Industry. Retrieved December 10, 2016, from http://www.forbes.com/sites/jonathanchester/2016/09/16/how-Blockchain- startups-are-disrupting-the-15-billion-music-industry/#41ff8229652c
  25. 25. 25 Conclusion: From the study of Blockchain’s applicability above, this paper concludes the findings that the Blockchain Algorithm is a functional tool in decentralizing decision processes within other applications. A study of the Blockchain’s principle application, Bitcoin, is provided in great detail. Bitcoin has emerged as a pioneer in the market of Cryptocurrencies and has used the Blockchain Algorithm for its ledger system of transactions. Bitcoin’s ability to eliminate third party intermediaries provides a great advantage. However, Bitcoin’s scale and deflationary nature is investigated to determine its long-term sustainability. Blockchain technology was also evaluated in this paper for other uses, seeking to determine its uses in the banking industry, digitized legal services, and licensing protection. This paper concludes how Blockchain is a working model in eliminating the use of third parties, with implications of further decentralized services to come after the success of Blockchain’s use in successful Cryptocurrencies.
  26. 26. 26 Works Cited [1]Tapscott, D., & Tapscott,A.(2016, May 10). The Impact of the Blockchain Goes Beyond Financial Services. Retrieved December 9, 2016, from https://hbr.org/2016/05/the-impact-of-the-Blockchain-goes-beyond-financial- services [2]Hackett, R. (2016, May 23). Wait, What Is Blockchain? Retrieved December 9, 2016, from http://fortune.com/2016/05/23/Blockchain-definition/ [3]Desjardins, J. (2014, February 23). The Definitive History of Bitcoin. Retrieved December 10, 2016, from http://www.visualcapitalist.com/the-definitive-history-of-Bitcoin/ [4]Wigmore, I. (2015, December). Blockchain Definition. Retrieved December 9, 2016, from http://whatis.techtarget.com/definition/Blockchain [5]Blake, P. (2016, November 3). Timeline of the Wells Fargo Scandal. Retrieved December 10, 2016, from http://abcnews.go.com/Business/timeline-wells-fargo-accounts-scandal/story?id=42231128 [6]Bitcoin Price Index. (n.d.). Retrieved December 10, 2016, from http://www.coindesk.com/price/#2012-11- 30,2016-12-10,close,bpi,USD [7]T.S. (2011, April 11). How Does Bitcoin Work? Retrieved December 10, 2016, from http://www.economist.com/Bitcoinexplained [8]Cawrey, D. (2014, June 20). Are 51% Attacks a Real Threat to Bitcoin? Retrieved December 10, 2016, from http://www.coindesk.com/51-attacks-real-threat-Bitcoin/ [9] Plassaras, N. A. (2013, January 6). Regulating Digital Currencies: Bringing Bitcoin within the Reach of the IMF. Retrieved December 9, 2016, from http://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?article=1407&context=cjil Pages Used 384-389,396-402 [10]He, D., Habermeier, K., Leckow, R., Haksar, V., Almeida, Y., M., . . . Verdugo-Yepes, C. (2016, January). Virtual Currencies and Beyond: Initial Considerations.Retrieved December 9, 2016, from https://www.imf.org/external/pubs/ft/sdn/2016/sdn1603.pdf Pages 25,42 [11] Dwyer, B. (n.d.). Average Credit Card Processing Fees. Retrieved December 10, 2016, from https://www.cardfellow.com/average-fees-for-credit-card-processing/ [12]Zhen, S. (2015, October 28). Compare the Cost of Bank Wire Transfer Fees. Retrieved December 10, 2016, from https://www.mybanktracker.com/news/2013/04/18/wire-transfer-fees-2013/ [13]Load dollars using any Bitcoin wallet, spend anywhere. (n.d.). Retrieved December 9, 2016, from https://bitpay.com/visa [14] Popper, N. (2016, November 18). Bitcoin Users Who Evade Taxes Are Sought by the I.R.S. Retrieved December 9, 2016, from http://www.nytimes.com/2016/11/19/business/dealbook/irs-is-seeking-tax-evaders-who- use-Bitcoin.html [15] Greenberg, A. (2010, December 7). Visa, Mastercard MoveTo Choke WikiLeaks. Retrieved December 9, 2016, from http://www.forbes.com/sites/andygreenberg/2010/12/07/visa-mastercard-move-to-choke-WikiLeaks/#204783fb4bc2
  27. 27. 27 Works Cited [16] Wong, J. I. (2014, October 6). Dark Markets Grow Bigger and Bolder in Year Since Silk Road Bust. Retrieved December 9, 2016, from http://www.coindesk.com/dark-markets-grow-bigger-bolder-year-since-silk-road-bust/ [17] Higgins, S. (2016, July 18). Central Bank Digital Currencies Could Boost GDP, Bank of England Says. Retrieved December 10, 2016, from http://www.coindesk.com/central-bank-digital-currencies-boost-gdp-bank-england-says/ [18]About R3. (n.d.). Retrieved December 9, 2016, from http://www.r3cev.com/about/ [19]Bannon, S. (2016, May 16). The Tao of "The DAO" or: How the autonomous corporation is already here. Retrieved December 9, 2016, from http://www.citationmachine.net/apa/cite-a-website/manual [20]Prisco, G. (2016, May 16). The DAO Raises More Than $117 Million in World's Largest Crowdfunding to Date. Retrieved December 9, 2016, from https://Bitcoinmagazine.com/articles/the-dao-raises-more-than-million-in- world-s-largest-crowdfunding-to-date-1463422191 [21]Prisco, G. (2016, May 16). TheDAO Raises MoreThan $117 Million in World's Largest Crowdfunding to Date. Retrieved December 9, 2016, from https://Bitcoinmagazine.com/articles/the-dao-raises-more-than-million-in-world-s-largest- crowdfunding-to-date-1463422191 [22]Hayes, A. (2016, February 29). Decentralized Autonomous Organizations: IoT of Today. Retrieved December 8, 2916, from http://www.investopedia.com/articles/investing/022916/decentralized-autonomous-organizations-iot-today.asp [23]Galant, P. (2012, April 26). Mobile Money: A Path for Increasing Financial Inclusion. Retrieved December 10, 2016, from https://www.fdic.gov/about/comein/2012/2012-04-26_presentation_galant.pdf [24]Who are the Unbanked. (n.d.). Retrieved December 10, 2016, from http://siteresources.worldbank.org/EXTGLOBALFIN/Resources/8519638-1332259343991/world_bank3_Poster.pdf [25]Chester, J. (2016, September 16). How Blockchain Startups Are Disrupting the $15 Billion Music Industry. Retrieved December 10, 2016, from http://www.forbes.com/sites/jonathanchester/2016/09/16/how-Blockchain- startups-are-disrupting-the-15-billion-music-industry/#41ff8229652c

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