Numerous characteristics of this digital currency lend themselves to revolutionising the transfer of private property.
What Bitcoin Is and How It Works
Bitcoin’s Monetary Properties
In October 2008, amidst a global recession that resulted in government bailouts of the banking system, a white paper titled Bitcoin: A Peer-to-Peer Electronic Cash System was released under the pseudonym Satoshi Nakamoto. The article summarised a convergence of technologies that resulted in the development of the first successful form of digital money. These technologies were developed over four decades of failed attempts to create digital money — the following is a list of approximately 100 failed attempts:
Notable attempts to create digital money are highlighted in bold; those in italics will be discussed further in the essay.
PayPal is included on that list; their original concept was to enable cryptographic payments on mobile devices. They were unable to carry out this idea and were forced to pivot away from it. Numerous projects listed above share a similar storey of attempting to create something similar to bitcoin but falling short. In retrospect, we see that their fundamental issue was that they attempted to be a business in the first place. However, with each failure, new knowledge was gained, bringing the world closer to digital money.
Numerous attempts to create digital money were sparked by the cypherpunk movement, which began in the 1990s in tandem with the internet’s growth. Cypherpunks believed that unless defensive technologies were developed, the internet would become a government surveillance apparatus.
1999 May/June cover of Wired magazine
Prior to governments implementing national firewalls, prior to social media websites selling our personal information, prior to the NSA’s PRISM programme, and prior to big tech systematically censoring political movements, the cypherpunks were anticipating this new world. They anticipated it due to their unusual synthesis of disparate fields of knowledge — cryptography, computer science, Austrian economics, and libertarianism.
Cryptography enables digital encryption, removing the sovereign’s ability to exert control over the internet. However, an autonomous form of digital money is also required for a government-free economy. Digital money enables an encrypted online economy to conduct value transfers freely and thus organise itself freely in the digital world.
The following is a synopsis of the major events that culminated in the creation of Bitcoin:
Developed in the 1970s, public-key cryptography enabled the use of public keys over insecure communication channels. Governments attempted to exert control over this emerging technology by invoking the narrative that it would be used by criminals. They eventually lost this battle, and this technology has become a critical component of the underlying security for internet communications. It is used for encryption in a wide variety of modern technologies.
David Chaum invented digital signatures in 1989 and used them to found the company Digicash. This enabled an individual to generate a signature (similar to one found on a check) demonstrating they possessed a private key associated with a public key without disclosing the private key. This enabled individuals to independently verify that they are who they claim to be. However, Chaum’s company was unable to devise a method for verifying signatures without relying on a third party.
If digital money is nothing more than bits on a computer, what was to prevent it from being copied? Money must be scarce in order to have intrinsic value. In the real world, scarce items are extremely rare or extremely difficult to locate. In 1997, Adam Back proposed HashCash and used computational puzzles to recreate this real-world problem. While computers are adept at mathematics, there are some problems that they can only solve through guesswork. When large enough numbers are used, these problems become extremely difficult for computers to solve by guessing. By tying money creation to solutions to these difficult mathematical problems, digital money was made scarce. This is referred to as the proof-of-work consensus algorithm in Bitcoin, which requires computers, referred to as miners, to solve a computationally demanding puzzle in order to generate new bitcoin. As a result, bitcoin is expensive to produce and thus scarce.
The concept of a blockchain dates all the way back to a 1991 paper by Haber and Stornetta. The concept was for individuals to periodically send different versions of a document to a server. The server would append a hash pointer to the preceding document, a time stamp, and the server’s digital signature to ensure that the document was indeed signed by the server (i.e., verified it). This meant that the most recent version in the list was linked to its predecessor, forming a chain.
In a temporal list of documents, a hash pointer is a hash function that hashes the previous document. These functions compress large databases into text strings for storage, and any change to any part of the database is reflected in the text string. If each document created includes a hash pointer to its previous version, any changes to its lineage will be visible via a change in the current document’s hash pointer. By adding a time stamp to each document, you can create a temporal list, and then prove which server approved the document update using a digital signature. When all of these measures are combined, a verified chain of information is created in which any tampering with its history is immediately apparent.
To summarise, digital signatures establish a verifiable method for digitally confirming an identity without disclosing it. When combined with a blockchain data structure, this digital signature creates a temporally linked, immutable record of data. These technologies could be used to address inherent issues with digital money. However, the supply of that digital money had to be limited, and this problem was solved by regulating supply through computationally intensive puzzles (via hash functions).
However, none of these advancements provided a mechanism for resolving disagreements between nodes on the ledger. Bitcoin overcame these final obstacles. This may not make complete sense at the moment, but it will, so please continue reading if you are perplexed.
Bitcoin successfully created decentralised digital money for the first time in history by utilising digital signatures, the blockchain data structure, and computational puzzles.
WHAT BITCOIN IS USED FOR
What bitcoin actually does is irrelevant to why it is valuable. What distinguishes bitcoin as valuable is the network of individuals who have chosen to use it. To appreciate why these individuals chose to use it, it’s necessary to understand how it works. This can be difficult, as Bitcoin’s technology is a synthesis of technical concepts that are unfamiliar to the majority of people.
The Bitcoin protocol enables the transmission of scarce money to anyone on the planet. This ability appears straightforward, but it is extremely powerful. Call your bank immediately and request that they wire a significant sum of money to someone in another country on your behalf. Take pleasure in spending the next week attempting to accomplish that and subsequently being tracked by the government. The ability to transfer large sums of money over a digital network in a matter of minutes is unique.
What about PayPal, Venmo, or Cash App, you may ask?
These are all third parties in whom you have placed your trust, and placing your trust in third parties has consequences.
- You must adhere to their rules.
- You must inform them of your identity.
- You must trust them to keep your information secure, and you must entrust them with control of your money.
- Add the word “trustless” to my previous statement: the ability to move large amounts of value over a trustless digital network in a matter of minutes is incredibly powerful. It is trustless because no third party is required. This is possible because it is a decentralised network with no third-party intermediaries, which means that it cannot be controlled; more on this later.
In April 2020, $1.1 billion in bitcoin was transferred in a transaction that cost 68 cents and took less than a minute. This was accomplished inexpensively and efficiently, without the transactors having to follow anyone’s rules, disclose their identities to a third party, trust anyone with their information, or cede control over it. No other payment system on the planet is capable of transporting that much value, at that price, in that amount of time, without the intervention of a third party.