10.3 Cryptocurrencies and blockchain technology

Cryptocurrencies and blockchain technology revolutionize finance and data management. These digital currencies use cryptography for security, operating independently of central banks. Blockchain, the underlying tech, creates a decentralized, tamper-resistant ledger for recording transactions and data.

This topic explores how cryptocurrencies work, from mining to wallets, and dives into blockchain's core components. We'll look at security measures, privacy concerns, and real-world applications beyond finance. Understanding these concepts is crucial for grasping modern cryptography's impact on society.

Cryptocurrency Fundamentals

Digital Currency Basics

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• Cryptocurrencies function as digital or virtual currencies leveraging cryptography for security
• Operate independently of central banks or authorities
• Utilize public-key cryptography securing transactions
  • Users possess a public key (address) for receiving funds
  • Private key signs transactions and proves ownership
• Cryptocurrency wallets store public and private keys
  • Enable sending and receiving digital currency
  • Allow users to monitor their balance
• Concept of finite supply limits total units created
  • Bitcoin caps at 21 million coins
  • Ethereum has no fixed limit but controlled inflation

Decentralization and Mining

• Decentralization forms core principle of cryptocurrencies
• Rely on distributed ledger technology (typically blockchain) recording and verifying transactions
• Mining creates new cryptocurrency units and verifies transactions
  • Often employs Proof-of-Work (PoW) consensus mechanism
  • Miners solve complex mathematical puzzles
  • First to solve adds new block to the chain
  • Receives newly minted coins as reward (Bitcoin, Litecoin)
• Alternative consensus mechanisms exist
  • Proof-of-Stake (PoS) selects validators based on coin ownership (Ethereum 2.0, Cardano)
  • Delegated Proof-of-Stake (DPoS) allows token holders to vote for block producers (EOS)

Cryptocurrency Features and Goals

• Aim to provide pseudonymity in transactions
  • Addresses not directly linked to real-world identities
  • Transactions visible but parties remain pseudonymous
• Offer transparency of all transactions on the blockchain
  • Anyone can view full transaction history
  • Enhances accountability and reduces fraud
• Resist censorship or manipulation by central authorities
  • No single point of failure or control
  • Transactions cannot be easily blocked or reversed
• Facilitate cross-border transactions
  • Enable fast and low-cost international transfers
  • Bypass traditional banking systems and intermediaries

Blockchain Technology Foundations

Cryptographic Building Blocks

• Cryptographic hash functions create unique, fixed-size data block representations
  • Ensure data integrity and immutability
  • Examples include SHA-256 (Bitcoin) and Keccak-256 (Ethereum)
• Digital signatures authenticate and verify transaction origins
  • Based on public-key cryptography
  • Prove ownership and authorize transfers
• Merkle trees summarize all transactions in a block
  • Allow efficient verification of large datasets
  • Enable lightweight clients to verify transactions without downloading entire blockchain

Consensus Mechanisms and Network Security

• Consensus mechanisms achieve agreement on blockchain state across distributed network
  • Proof-of-Work (PoW) uses computational puzzles
  • Proof-of-Stake (PoS) selects validators based on coin holdings
  • Byzantine Fault Tolerance (BFT) algorithms handle malicious nodes
• Time-stamping proves data existed at specific time
  • Enhances chronological integrity of the ledger
  • Prevents double-spending and transaction manipulation
• 51% attacks pose theoretical threat to blockchain security
  • Entity controlling majority of network's mining power could manipulate blockchain
  • More difficult on larger, established networks (Bitcoin, Ethereum)

Privacy-Enhancing Techniques

• Zero-knowledge proofs verify transactions without revealing sensitive information
  • zk-SNARKs used in privacy-focused cryptocurrencies (Zcash)
  • Allow validation of computations without disclosing inputs
• Ring signatures enhance transaction privacy
  • Obscure sender's identity within a group of possible signers
  • Implemented in privacy coins (Monero)
• Stealth addresses generate one-time addresses for each transaction
  • Prevent linking multiple transactions to same recipient
  • Improve overall anonymity of the system

Cryptocurrency Security and Privacy

Transaction Privacy and Anonymity

• Pseudonymous nature provides degree of privacy
  • Transactions linked to addresses, not real-world identities
  • Does not guarantee complete anonymity due to public blockchain
• Privacy coins enhance transaction confidentiality
  • Monero uses ring signatures and stealth addresses
  • Zcash implements zk-SNARKs for shielded transactions
• Mixing services aim to obfuscate transaction trails
  • CoinJoin protocol combines multiple transactions
  • Raises concerns about facilitating illicit activities

Security Measures and Threats

• Cryptocurrency exchanges and wallets potential hacking targets
  • Require robust security measures protecting user assets
  • Examples of major hacks (Mt. Gox, Coincheck)
• Hardware wallets and cold storage enhance cryptocurrency holdings security
  • Keep private keys offline and protected from malware
  • Popular options include Ledger, Trezor, and paper wallets
• Immutability of blockchain transactions serves as security feature and privacy concern
  • Fraudulent or erroneous transactions difficult to reverse
  • Enhances trust but complicates error correction

Regulatory and Compliance Challenges

• Tension between financial privacy and regulatory compliance
  • Anti-money laundering (AML) regulations require transaction monitoring
  • Know-your-customer (KYC) policies mandate user identification
• Balancing anonymity with legal requirements poses ongoing challenge
  • Some jurisdictions ban privacy coins or anonymous transactions
  • Exchanges implement varying levels of user verification
• Tax implications of cryptocurrency transactions
  • Many countries treat crypto as property for tax purposes
  • Reporting requirements vary by jurisdiction

Blockchain Applications and Limitations

Smart Contracts and Decentralized Applications

• Smart contracts self-execute with terms directly written into code
  • Enable automated, trustless agreements
  • Power decentralized applications (DApps) on platforms like Ethereum
• Decentralized finance (DeFi) recreates traditional financial systems
  • Lending platforms (Aave, Compound)
  • Decentralized exchanges (Uniswap, SushiSwap)
  • Yield farming and liquidity provision
• Non-fungible tokens (NFTs) represent unique digital assets
  • Digital art, collectibles, and virtual real estate
  • Built on blockchain standards (ERC-721, ERC-1155)

Enterprise and Government Applications

• Supply chain management leverages blockchain for transparency
  • Tracks goods from manufacturer to consumer
  • Examples include IBM Food Trust and TradeLens
• Voting systems explore blockchain to enhance security and transparency
  • Pilot projects in various countries (Estonia, Switzerland)
  • Challenges include voter privacy and system scalability
• Healthcare applications improve medical records security and interoperability
  • Patient data sharing with granular access control
  • Drug supply chain verification and clinical trial management

Technical and Adoption Challenges

• Scalability limits transaction throughput and increases costs
  • Bitcoin processes ~7 transactions per second
  • Ethereum faces high gas fees during network congestion
• Energy consumption poses environmental concerns
  • Bitcoin's annual energy use comparable to small countries
  • Drives research into more efficient consensus mechanisms
• Interoperability between blockchain networks remains challenging
  • Cross-chain communication protocols in development (Polkadot, Cosmos)
  • Integration with existing systems requires standardization efforts
• User experience and education barriers hinder mainstream adoption
  • Complex wallet management and key security
  • Lack of consumer protection and recourse in decentralized systems