Cryptocurrency - How to Store and Use Bitcoin

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Note: This is a reading note of chapter 4 in the book Bitcoin and Cryptocurrency Technology.

This chapter does not contain many technical details about Bitcoin storage so we just list the topics covered in this chapter. It's relatively easy to find detailed information online.

Outline

Splitting and Sharing Keys

It's interesting to know Lagrange interpolation can be used in this way. The objective of splitting a key is to store and key in \(N\) places and we need to collect at least \(K\) of them to construct the original key. The idea is simple: with \(K\) data, we could construct a polynomial \(P\) of degree \(K-1\). For example, if we select a polynomial of degree \(K-1\) such that \(p(0) = \textrm{key}\) then we could store \(P(1), P(2), ..., P(N)\) in different places. If we collect \(K\) among the \(N\) parts, then we could construct the original \(P\) and calculate \(P(0)\).

This approach still has a single point of failure because at some point we have all \(K\) pieces in one place. If that place is compromised then we will lose the Bitcoin. To solve this, there is a technique called Threshold Cryptography, which essentially provides the support of partial signatures.

Market Supply and Demand

It's surprising to know that the balance of an account in a Bitcoin exchange is only a promise from the exchange that later it will redeem the amount. This makes Bitcoin exchanges similar to traditional banks and this arrangement has implications on the supply of Bitcoins. Banks are regulated by government and they need to maintain a minimum reserve of the deposits. This creates Money Supply Multiplier Effect. For example, suppose we make a $10 deposits and the bank only needs to maintain $1 reserve. If the bank spends the other $9 then there will be $19 in the circulation.

On paper, there is a limit of 21 millions Bitcoins supply; however as the Bitcoin exchanges are not regulated, we don't really know how many Bitcoins are actually in circulation.

Another interesting observation described in the book is that the volume of the Bitcoin payments (not the trading volume for speculation) has an impact on the Bitcoin price. The reason is actually very simple: participants of a Bitcoin payments need to hold some Bitcoins for a period of time to mediate the transaction. Therefore they need to buy Bitcoins from others and this creates a demand. As there is only a limited supply of Bitcoins, an increase in the volume of the Bitcoin payments will likely leads to an increase of the Bitcoin price.

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