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P2.T9.700. What is Bitcoin and what are bitcoins? (Böhme)

Nicole Seaman

Director of FRM Operations
Staff member
Learning objectives: Describe the incentives to use virtual currency. Identify the limits of Bitcoin and the concerns that may arise from these limits.


700.1. Each of these is a feature of bitcoin EXCEPT which is not?

a. Public-private key cryptography
b. Public distributed transaction ledger; aka, the blockchain
c. Reliable authority node enables centralized governance functions such as identify verification and reversible transactions; aka, refunds
d. Decentralized miners earn new coins and transaction fees as a reward for validating and adding a transaction block to the chain approximately every ten minutes; aka, clearing

700.2. The authors review four key categories of intermediaries that have shaped Bitcoin’s evolution: currency exchanges, digital wallet services, mixers, and mining pools. Each of the intermediaries is correctly identified below EXCEPT which is incorrect?

a. Currency exchanges allow users to trade bitcoins for traditional currencies or other virtual currencies; there exist few technical barriers to setting up a bitcoin currency exchange, but there are significant regulatory requirements
b. Mining pools are bitcoin funds or syndicates of pooled bitcoin that, in many cases, represent investments by hedge funds; these pools act as "market makers" in bitcoin currency exchanges such that they increase bitcoin liquidity but expose bitcoin to episodes of speculative excess.
c. Bitcoin wallets (aka, digital wallet services) are data files that include Bitcoin accounts, recorded transactions, and private keys necessary to spend or transfer the stored value; some wallet services require users to let
the service store their private keys, which increases risk if the digital wallet service is compromised
d. Mixers let users pool sets of transactions in unpredictable combinations which improves privacy, but they create additional challenges: mixing protocols are not public so their efficacy cannot be demonstrated, mixers charge 1.0% to 3.0%, and if a mixer absconds with funds, payers have a little recourse.

700.3. Which of the following is a key limitation(s) of Bitcoin?

a. Historical bitcoin transactions are periodically archived (backed up) on distributed servers such that accessing the source (input) of a payment (output) depends on remote server uptime and effective search-and-retrieval tools
b. Bitcoin does not limit the number of new bitcoins that can be mined; this could be a problem if bitcoin experiences an unexpected surge in popularity such that the money supply increases dramatically and creates a monetary inflation or hyper-inflation
c. Because Bitcoin uses a simple consensus by majority vote of connected users to affirm a transaction (aka, one person, one vote), it is vulnerable to hackers creating multiple fake identities in order to verify fake transactions; this was the cause of Silk Road's demise
d. Bitcoin imposes no obligation for an intermediary (e.g., financial institution, payment process) to verify a user’s identity or cross-check with watch-lists or embargoed countries; and bitcoin imposes
no prohibition on sales of particular items (e..g, items that are unlawful in the place of sale)

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