16.1 Setting the Stage for Digital Economies – Introduction to Cryptography with Coding Theory, 3rd Edition

16.1 Setting the Stage for Digital Economies

People have always had a need to engage in trade in order to acquire items that they do not have. The history of commerce has evolved from the ancient model of barter and exchange to notions of promises and early forms of credit (“If you give me bread today, then I’ll give you milk in the future”), to the use of currencies and cash, to the merging of currencies and credit in the form of credit cards. All of these have changed over time, and recent shifts toward conducting transactions electronically have forced these technologies to evolve significantly.

Perhaps the most dominant way in which electronic transactions take place is with the use of credit cards. We are all familiar with making purchases at stores using conventional credit cards: our items are scanned at a register, a total bill is presented, and we pay by swiping our card (or inserting a card with a chip) at a credit card scanner. Using credit cards online is not too different. When you want to buy something online from eVendor, you enter your credit card number along with some additional information (e.g., the CVC, expiration date, address). Whether you use a computer, a smartphone, or any other type of device, there is a secure communication protocol working behind the scenes that sends this information to eVendor, and secure protocols support eVendor by contacting the proper banks and credit card agencies to authorize and complete your transaction.

While using credit cards is extremely easy, there are problems with their use in a world that has been increasingly digital. The early 21st century has seen many examples of companies being hacked and credit card information being stolen. A further problem with the use of credit cards is that companies have the ability to track customer purchases and preferences and, as a result, issues of consumer privacy are becoming more prevalent.

There are alternatives to the use of credit cards. One example is the introduction of an additional layer between the consumer and the vendor. Companies such as PayPal provide such a service. They interact with eVendor, providing a guarantee that eVendor will get paid, while also ensuring that eVendor does not learn who you are. Of course, such a solution begs the question of how much trust one should place in these intermediate companies.

A different alternative comes from looking at society’s use of hard, tangible currencies. Coins and cash have some very nice properties when one considers their use from a security and privacy perspective. First, since they are physical objects representing real value, they provide an immediate protection against any defaulting or credit risk. If Alice wants an object that costs five dollars and she has five dollars, then there is no need for a credit card or an I-Owe-You. The vendor can complete the transaction knowing that he or she has definitely acquired five dollars. Second, cash and coins are not tied to the individual using them, so they provide strong anonymity protection. The vendor doesn’t care about Alice or her identity; it only cares about getting the money associated with the transaction. Likewise, there are no banks directly involved in a transaction. Currency is printed by a central government, and this currency is somehow backed by the government in one way or another.

Cash and coins also have the nice property that they are actually exchanged in a transaction. By this, we mean that when Alice spends her five dollars, she has handed over the money and she is no longer in possession of this money. This means that she can’t spend the same money over and over. Lastly, because of the physical nature of cash and coins, there is no need to communicate with servers and banks to complete a transaction, which allows for transactions to be completed off-line.

In this chapter, we will also discuss the design of digital currencies, starting from one of the early models for digital coins and then exploring the more recent forms of cryptocurrencies by examining the basic cryptographic constructions used in Bitcoin. As we shall see, many of the properties that we take for granted with cash and coins have been particularly difficult to achieve in the digital world.