The State of Cryptocurrencies, Their Issues and Policy Interactions

ABSTRACT This paper focuses on the evolution of cryptocurrencies. It traces the history of early cryptography, the 'cypherpunk' movement, and how the work of some cyber libertarians and cryptographers enabled the emergence of popular cryptocurrencies. The paper then focuses on Bitcoin. It delves into the technology behind the Bitcoin architecture and shows how exactly this technology works. The paper then does an analysis of security and regulatory considerations that affect the growth of Bitcoin-based businesses. The paper concludes with some suggestions for future work in the area. Keywords: cryptocurrency, cryptography, Bitcoin, security, IT policy, regulation. INTRODUCTION The concept of a completely anonymous and untraceable "digital cash" has existed for over two decades. In this paper we trace the evolution of cryptocurrencies, primarily focusing on Bitcoin. We then consider some of the security considerations that have been brought to the fore by cryptocurrencies. Cryptocurrencies have also come under scrutiny by governmental agencies as they can, and have enabled nefarious activities to take place by successfully hiding those transactions from the law. Given the increasing acceptance of Bitcoin, we then consider some of the policy issues and attempts that have been made to regulate cryptocurrencies. We discuss the implications of such policies, both negative and positive. We then conclude by discussing the future of cryptocurrencies, the challenges and issues and possible remedies. Background: Early work on cryptography As noted by William E. Burr, until the early 1970s, there was little commercial or academic expertise in cryptography (Burr, 2001). Cryptography and encryption were generally the preserve of defense establishments such as the military and the espionage agencies. Public awareness of cryptography in the US came with the publication of the Digital Encryption Standard (DES) on March 17, 1975 in the Federal Register (Leech & Chinworth, 2001). The origins of DES can be traced to 1971, when IBM researcher Horst Feistel, working on a project codenamed Project Lucifer, filed a patent application for a 48-bit block cipher cryptographic system (also known as the Lucifer cipher) (Feistel, 1974). The project was commissioned by Lloyds Bank for encrypting ATM transactions. In 1972, the National Bureau of Standards (NBS) identified the need for an encryption standard for encrypting unclassified but sensitive government documents, and in May 1973, solicited proposal for such a system. The NBS then chose, with the approval of the National Security Agency (NSA), a modified version of IBM's algorithm (IBM, 2012). The original algorithm was strengthened to a 56-bit block cipher by a team led by Walter Tuchman and aided by Carl Meyer (Bamford, 1982). Other members of the team were Don Coppersmith, Alan Konheim, Roy Adler, Edna Grossman, Bill Notz, Lynn Smith and Bryant Tuckerman. On January 15, 1977, DES was adopted as a standard for unclassified government documents. The publication of DES did led to many discussions and debates in the academic community and civil society. Some academics such as Martin Hellman and Whitfield Diffie at Stanford University felt that the original 56-bit block cipher was altered by IBM at NSA's behest to provide that NSA a backdoor into the cryptographic system. They also felt that the 56-bit cipher was not secure enough and could be broken with appropriate computing power--presumably available to the NSA, again enabling it to capture and decrypt messages (Blight, 2013). The controversy made the DES standard one of the most scrutinized cryptographic systems. Diffie and Hellman conducted a comprehensive analysis of the DES in 1977 (W. Diffie & Hellman, 1977). However, DES became very popular and was soon adopted internationally as the encryption standard. This period also saw further developments in cryptographic systems. …