A revolutionary new form of currency was quietly being shaped in late 2008 under the long shadow cast by the most severe economic crisis in generations. Initially, there was no clue that an obscure form of electronic money would prove to be the most important financial innovation of the 21st century, a tool that would soon be widely adopted by people, economies, and companies all across the world. In October of that year, in a white paper issued by an anonymous person or group calling itself Satoshi Nakamoto—now known to the world as “the creator of Bitcoin”—the digital currency known as Bitcoin, and the technologies underpinning it, were laid out for the first time. There were few clues in this initial description that made anyone think Bitcoin had the power to upend and revolutionize the world’s financial system. Bitcoin’s success was far from assured.
“Every informed person needs to know about Bitcoin because it might be one of the world’s most important developments.” – Leon Luow, Nobel Peace Prize nominee
Bitcoin for the Masses
In its early days, Bitcoin was mostly seen as an oddity—something that was only around to amuse experts in cryptography. Just ten years ago, the general public was still mostly unfamiliar with cryptocurrency. It was only for specialists and eccentrics. Today, of course, Bitcoin has become a household name. It has the highest market value of any cryptocurrency. Moreover, it has drawn an enormous amount of attention to blockchain, the technology on which it is built. Blockchain was originally developed as a sort of “storage room” for Bitcoin—something that would record transactions and avoid the possibility of the currency being used inappropriately.
The mortgage crisis in 2008 shook the public’s confidence in banks, governments, and other powerful institutions. Suddenly, everything was in doubt. Entities that had been seen as rock-solid and trustworthy for generations appeared to have abruptly let us down. They had been revealed as empty facades. The emperors had no clothes. Now, the world was looking for new solutions. And into this environment, Bitcoin arrived like a magic bullet, seemingly designed to solve the very issues that had caused the financial crisis in the first place. Bitcoin would decentralize power. There would be no external arbiter or regulator that might fail us. On the contrary, the people—the users of the cryptocurrency themselves—would truly hold the power.
Bitcoin was exclusive at first, like a club that people wanted to join. It was initially introduced to a very small group of people—experts in cryptography and “tech nerds” who were obsessed with the concept of individual liberty. Gradually Bitcoin made itself more available to the masses.
For hundreds of years, central banks have been playing one of the most critical roles in the financial system by managing how much money is released into the market, and controlling when this release happens. This is true for fiat money, and also for traditional digital money. In order to be accepted as a legitimate currency, digital money needs to represent value and be able to carry value.
Digital money is merely another form of fiat money. It is, essentially, the same thing. It relies on a trusted third party to verify every transaction. Cryptocurrency, however, has no need for a third party. Another way to put this is that it cuts out the middleman. Cryptocurrencies are also different from fiat money in that they are backed up by cryptography.
What is cryptography? Cryptography is the study of secure communications techniques that allow only the sender and intended recipient of a message to view its contents. Cryptography has two critical functions, encryption, and verification, which are accomplished through coding and decoding.
Today, cryptography is widely applied in a variety of economic functions and situations. Cryptography has become especially useful in computer science, and notably in the area of Internet security. With every single browser click, we interact with pages running on a complicated system of codes. Cryptography secures the input and output of information on these pages.
Encryption is the backbone of Internet security, telecommunication, and also of cryptocurrencies like Bitcoin. In their earliest stages, the government had absolute control over encryption algorithms. The National Security Agency kept a close eye on who was using them. It was only in the 1990s that these algorithms were released to the public.
Bitcoin is the best example of the value of blockchain technology. In Satoshi’s white paper from 2008, it’s made clear that blockchain will be the backbone of the exchange system for Bitcoin users. It will be, as Satoshi puts it, “a purely peer-to-peer version of electronic cash [allowing] online payments to be sent directly from one party to another without going through a financial institution.” Using cryptographic technology to secure payment has eliminated the need for banks—or other institutions—to act as middlemen.
Cryptography & Bitcoin
A person making transactions with Bitcoin uses an electronic wallet, which has an IP address containing that person’s public “key” and other identification. It is this wallet that allows the person to send and receive Bitcoins, and to document each transaction. Besides the public key, the Bitcoin user also has her or his own private key to which only they have access. This double encryption helps users of Bitcoin to remain anonymous. In order to verify a Bitcoin transaction, users have to contribute computer power to the blockchain to achieve a consensus. Transactions are then documented into blocks spread across the entire chain. One way to think of this is that blockchain allows a permanent record to be kept of each Bitcoin transaction and eliminates the possibility of so-called double payments. Blockchain is essential to Bitcoin and is what allows for the cryptocurrency’s decentralization and disintermediation. Each block in the chain nests information that cannot be altered. Trust is created by the technology itself and the way it provides total transparency.
In the chain of blocks that is the blockchain, every block has something called a Hash Pointer, which points to and reveals the Hash Value contained in the block in the front of the chain. With this Hash Pointer in place, it is impossible to hack the blockchain. Once a block is created and accepted, it is almost impossible to alter. At the technical level, this means the blocks and the transactions they record are virtually unalterable.
For conducting any anonymous transaction there are a public key & a private key. However, it also involves a digital signature and asymmetric cryptography. The terms might sound complicated, but the concept is not hard to explain. Asymmetric cryptography gives every user two keys, a public key, and a private key. The public key presents the identification and the IP address of the account holder. It can also encrypt information. Whatever information the public key encrypts can only be decoded by the matching private key. If a user is using a private key to sign any information, only the matching public key can verify the authenticity of the signature. In this world of decentralization, there is no need for a centralized power—like a bank, or software company, or government entity—to manage or secure any user’s information. Users open their accounts and keep their private key. Bitcoin users (and users of any other cryptocurrencies) often use the word address to refer to the Hash Value of the public key. The private key stays in the control of each user. In this way, asymmetric cryptography cuts out the government and any other entities who, in the physical world, collect and manage our identification information to verify transactions.
No Longer A Science Fiction
In Micronesia, there is an island called Yap. This island has unique money. Islanders on Yap use discs made from limestone as currency. If a disc is too big to move around—as many are—the owner has only to make a mark on that stone to indicate it has been used to settle a transaction. This is actually a somewhat similar concept to Bitcoin, at least in terms of how each transaction is documented.
Marking on a Yap stone disc is not much different from keeping transaction information preserved in a blockchain. The exchange information for Bitcoins (and other cryptocurrencies) is not kept in one central server. Rather, every transaction is documented in each block of a chain. The blockchain spreads out and runs on millions of computers, which makes it hard for anyone to hack, since it is not being kept on any single large database. Rather, the information is everywhere, all at the same time. In this way, blockchain is open and accessible to everyone on the Internet at any time. Privacy—at least in terms of spending and receiving money—is protected by the use of public and private keys. So Bitcoin is the asset of choice for the Internet, and the blockchain is the backbone protecting it by documenting and securing every single transaction.
It’s been a decade since Satoshi laid down his vision for Bitcoin and Blockchain. From the early days of circulating a trendy new currency for insiders only, cryptocurrencies are now empowering the general public by providing a new way of participating in and conducting transactions. It may take a while for any cryptocurrency to rival traditional currency, but the idea is no longer science fiction. It could actually happen within our lifetimes. And if it does, we will realize new efficiencies in all kinds of transactions by undercutting third parties, creating fewer transaction costs, saving time, enjoying better security and safety, and preserving near-total anonymity. (Excerpt is from ‘Crypto Economy: How Blockchain, Cryptocurrency, and Token-Economy Are Disrupting the Financial World’ by Aries Wanlin Wang)