04 Blockchains and Cryptocurrencies Flashcards
What is a BLockchain?
A blockchain is a ledger or list where the entitties are grouped in blocks that are cryptographically linked
* blocks are timestamped and cannot be altered once included in the chain
High level distinguish between four differetent types of tokens?
- Cryptocurrencies/ payment tokens
- Utility tokens
- Security tokens and tokenized assets
- Non-fungible tokens
What do cryptocurrencies promise?
- secure and immutable transaction
- increases in efficiency
- reduction in cost (no intermediation)
- no trust in particular authority
- financial inclusion due to lower costs and decentralization
What are the main functions of money? and fullfilled by cryptocurrencies?
- Unit of account
- Medium of exchange
- Store of value
–>No decentralized money:
* volatility is high
* acceptance is low
The two generations of blockchains/cryptocurrenices
1. Generation cryptocurrencies: Payments and store of value
2. Generation: Platform/ distributed computation tokens
What is a Stablecoin?
is a cryptocurrency where the price is linked to some other asset such as fieat currencies or a commodity
Characteristics of stable coins
- low volatility compared to other cryptocurrencies
- provide quick and relativeley safe way of entering into cryptocurrencies
- less regulation than the asset they are pegged to
- some allow for smart contracts
What is Central bank digital currencies? (CBDCs)
–>a virtuel currency representing a direct liability of a central bank, similar to banknotes and coins
The two types of Central Bank digital currencies?
- Wholesale CBDC –>used among financial intermediaries
- Retail CBDC –>used in the wider economy
What are utility tokens?
Utility tokens offer the right to a service or product
* have value and can typically be used similarly to cryptocurrencies
* some act as internal currencies for payments on a blockchain (E.g. ether)
Wider functionality of utility tokens?
- some utility tokens are “consumed” in exchange for products or services, comparable for voucher or gift gards
- othery only have to be held, for example offering voting rights
Ex:
* Golem (GNT) for renting computing power
* Filecoin (FIL) for renting storage space
* Exchange tokens like Binance coin (BNB)
What are security tokens/ tokenized assets?
Security tokesn represent blockchain-based recorded ownerships of other assets (Stocks, bonds and real estate)
–>derive value from an external asset
What are the benefits of tokenization for tradeing?
Beneifts: Allow for fractional ownership
- Equitites:
- Real Estate
* Trading costs and other fictions may be lowerr for tokenized assets
* tokenization is typically not decentralized
–>a company ususally owns the underlying asset
- The price is pegged by allowing token holders to exchange their tokens for the underlying asset
What are tokenized assets?
Tokenization of (existing) assets provides a way of recording the ownership of other types of assets on a blockchain
How can security tokens be issued?
Can be issued via decentralized ICO, but may also be issued in a more centralized way by a company
- A security token offering (STO) may be less expensive for smaller ventures as compared to an IPO
Market for security tokens and their regulation?
–>Security tokens are usually subject to the same regulation as the underlying asset
–>Market is still relatively small, but potentially impacts the way trading is organized
Benefits using security tokens for trading?
- transaction allows for fractional ownership
- Blockchain transactions are transparent
- settlement of trade substantially faster
- secondary market liquidity may (or may not) benefit
- transactions cost may be lower than on conventional exchanges
What are non-fungible tokens?
Non-fungible tokens are not interchangeable
–>usually represent digital artwork and collectibles, where the ownership is recorded on a blockchain
What is a cryptographic hash function?
= a cryptographic hash function maps an input x of any length to an output Hash(x) of fixed length
What do the two properties Deterministic, Efficient mean for Hash Functions?
Deterministic: The same input x will always give the same output
Efficient: GIven x, calculating Hash(x) is computationally easy
What do the two properties One-way, collusion resistant mean for Hash Functions?
One-way: GIven Hash(x), calculating x is computationally infeasible
Collision resistant: Finding two inputs x and y that give the same output Hash(x)=Hash(y) is infeasible
What do the two properties Avalanche-effect and Puzzle friendly mean for Hash Functions?
Avalanche-Effect: Changing x slightly changes the Output Hash(X) substantially
Puzzle Friendly: GIven Hash(x) and part of x, it is still difficult to find the rest of x
Key properties of Hash functions
- deterministic
- efficienct
- oneway
- collision resistant
- avalance effect
- puzzle friendly
What are Merkle trees and Merkle roots?
Merkle trees: are trees containing hashes of hases
–>The top has of a merkle tree is called the Merkle root
What is cryptohraphy and security?
Cryptographcy used for secure communication:
* prevent third parties from reading and manipulation private messages
asymmetric (or public key) cryptography uses pairs of key:
Difference between public and private key?
Private key: is basically just a random number that is only known by the owner
Public key: is mathematically linked to private key and is known by others
–>easy to get public from private key, but not vice versa
use cases of asymmetric cryptography?
- encryption of messages with the public key, that only can be decrypted by the private key
- generation of message-specific digital signatures
–>protect against tampering and impersonation
Types of blockchains?
Public or private:
public: everyone can read, view participate by writing, and validating
private: only read after approval or some verification
Permissionless or permissioned:
permissionless: no access contral, trust-free, usually slower
permissioned: validating and wirting to the chain requires approval, usually faster, trusted authority required
Two problems that needed to be addressed by decentralized currencies?
- Only alice should be allowed to spend her coins
- the “Double spending problem”
What is the solution to Problem 1: (Only alice spend her coins?
Asymmetric Cryptography:
* all transaction are cryptographically signed by private key of that individual
* everyone can verify the signature by the public key
*
What is the solution to Problem 1: (Only alice spend her coins?
–>what are keys and addresses?
- Private keys are basically long random numbers
- Public key is easy to compute from the private key
–>Addresses are easy to compute from the public key (for bitcoin, the public key is hashed twice, and a chechsum is added)
What is the solution to Problem 2: Double spending problem
Consensus Mechanism:
–>there are different consensus mechanisms to get an agreeement on what the correct version of the ledger is
–>if temporarilty conflicting versions, in the long-run the longest version is chosen
Describition of PoW
–>including transaction on the ledger requires computational effort and thus is costly
* Miners solve cryptographic puzzle to maintain the ledger
* These puzzles consists of finding a nounce–>this is a special number that results in a hash of that block with a particular pattern
POW: What is a Nounce
Nounce= a special number that when added to the block results in the hash of that block
POW: NOunce characteristics
- the hash has to start with a certain number of zeros that depends on the difficulty of the network
—>This difficult level is adjusted automaticaöy every 2016 blocks to keep the average time between two blocks at about 10 minutes
–>finding the correct nounce is done by try and error
What is done after finding the Correct Nounce?
PoW
–>The miner broadcasts the solution to the network
* it appends the block of transatiom, including the nounce, to the ledger
* The other miners (nodes) can verify the nounce results in a correct hash is computationally easy
Describe the 51% Attack in context of blockchains bitcoin with PoW
The blocks are all cryptographically linked by including the hash of the previous block in the new block
* to make changes or minor modifications to a previous block would require to re-do all the work starting with that block
–>this can in the long run only happend if the person controls 51% of the computational power of the network
What are the two mining incentives?
-
Block rewards through newly generated coins
* successful miners receives bitcoins these reward halves rougly every four years
* in about 2140 the reward is expected to be zero -
Transaction fees from users
* capacity in each block is limited —>users can optinally pay a fee to minizers to incentivize them to include their transaction in a block
–>During times of blockchain congestion, the fees can reach very high levels
What is included in the Block header?
The Block header contains:
* Bitcoin protocol number
* CUrrent difficult level
* Timestamp
* previous block header hash
* Merkle root hash of hased transactions
* Nounce
What is Unspent Transaction Output
Nodes track unspent transaction output (UTXO)
* the bitcoin transactions list input and output addresses
–>UTXO is the output of a transaction and exists until it is used as input for another transaction
–>How many UTXTO´s reside in a given address is computed by counting all prior UXTOs that list this address as their destination
Explaing the unspent transaction output
Works like a wallet, if one has 50 BTC, 1- 30 BTC and 1-20 BTC and wants to send 35 btc
–>Will use both addresses (30 BTC and 20 BTC) and send that to the other addresses, additionally there will be a new “change address” created where the remaining “Unspent transsaction outpu” go in (30+20 - 35) = 15 BTC
What is a Mempool?
New transactions are broadcasted to the whole network, the ones that are valid wait to be included in a block
–>These waiting transactions (confiremed) are stored in the mempool
What does the Mempool mean for the transaction within?
Everyone can see the transactions in the mempool:
* Trading intentions might be revealed
* Front running poses a serious problem —> insider trading
what does the Hashrate meansure?
The Hashrate measure the computing power within the Bitcoin network
* the total network hashrate has increased tremendously
–>The mining difficulty adjust automatically, but what matters for miners is their relative share of computating power
