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Cryptocurrency Explained for Beginners
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"The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. Their massive overhead costs make micropayments impossible.."
Table of Contents
Intro: Our Money is Going to Zero!
In a post from before, we have already pointed out that 2022 is (and indeed since the article’s publishing) looking like the year of cryptocurrency because of the problem of inflation.
Zooming out to look at almost a 1,000 years worth of data, we can see a more fundamental problem: The value of fiat currency is moving towards zero. That means the currency we use on a daily basis in the long term becomes valueless. Worst case scenario, this means trade or transactions of any kind may no longer be conducted swiftly and efficiently with fiat money, leading to something like whole economic collapses.
The solution to this problem is cryptocurrency. In a nutshell, cryptocurrency is a decentralized digital currency enabled by blockchain technology. A blockchain is a digital ledger where transactions are protected and stored in no one centralized location.
With this understanding in mind, we can now cover perhaps the most famous cryptocurrency of them all: Bitcoin.
In this post, we will be focusing on how did Bitcoin come into being.
We highly suggest that you read our 2 previous posts, where we go over the concept of cryptocurrency looking at it as a technology and then as a currency side.
In a subsequent post, we will explore the questions of how Bitcoin has been adopted by the world and what might be in store for Bitcoin’s future.
Bitcoin’s Cypherpunk Origins
As with every innovation, Bitcoin’s invention cannot be attributed to just one person.
Years of discoveries by multiple people led to its realization.
It started as far back as the 1980s with a group of individuals part of a movement known as the Cypherpunks. The movement was characterized by the use of strong cryptography and privacy protection technologies to drive social and political change.
In 1983, a cypherpunk called David Chaum saw the dangers behind the insecurity in using credit cards to buy things online. He decided to take action and wrote the first research paper on blockchain protocols. He also formulated a computer codebase as well. Also, based on his research, Chaum also invented the first electronic cash application Ecash where users could remain anonymous. His research is widely recognized to be the basic structure of Bitcoin.
Thanks to Chaum’s contributions, there was now a blue print for an anonymous digital cash system. However, Ecash was still reliant on a centralized bank for it to be implemented. There was still no infrastructure that could enabled these anonymous payments to be decentralized.
The Origin of Bitcoin’s Infrastructure – Proof of Work (PoW)
The late 1990s was when ideas integral to Bitcoin’s infrastructure would emerge. One such idea was the idea that solving computational puzzles (i.e. guessing computer passwords) could be something valuable. In 1997, a programmer called Adam Back would develop this idea into the Proof-of-Work (POW) Scheme. POW today is the crucial infrastructure behind all Bitcoin transactions. At the time, Back initially did not apply POW to payments but envisioned as a decentralized way to control email spam.
Crypto Architecture Starts to Take Form – Bit Gold, B-Money
Next came a computer engineer called Wei Dai who published a paper in 1998 on B-money, an anonymous, distributed electronic cash system. Dai described B-money as “money impossible to regulate” and laid out the concepts that are now core to Bitcoin:
- Requires work to solve computational puzzles
- Work done to be verified by community to update a decentralized ledger
- Workers are compensated
- Funds can be exchanged by decentralized bookkeeping and authenticated with cryptographic passwords
- Contracts are revealed publicly and transactions signed with digital signatures
The same year as Dai announced B-money, Nick Szabo, a former employee of the company servicing Chaum’s Ecash, conceptualized Bit Gold. Participants of Bit Gold would use computer power to do the work needed to solve computational puzzles. The solution extracted from the work would be then verified and be put in the next puzzle, creating a growing “blockchain”. This process enabled the system to verify and issue new coins.
The Final Missing Piece – Solving Double Spending
So with the ideas of
1) anonymity in transactions
2) solving computational problems referred to as work and rewarded and
3) a decentralised consensus-driven chain-like process for solving these problems that enabled verification and issuance of new coins,
Bitcoin was almost ready to be a reliable digital currency. However, one problem still remained.
The inherent problem with any digital currency is that it can be easily copied. This problem is known as the Double Spending problem. Easy copying of money allows users to duplicate their money and spend more than they actually are supposed to, leading to fraud. Copying physical currency or counterfeiting does still happen, but over the years has become increasingly difficult due to various elaborate devices that prove that the dollar bill is real – bills changing color as they move, watermark imprinted into the paper bill. Double spending is not a problem if there is a central authority which enforces anti-counterfeiting and maintains/updates the balances of different accounts that send and receive money from one another. It becomes a problem when you try to have to have a digital payment system that is not depend on a centralized bank.
But this last problem was also solved in 2008.
Bitcoin Takes Off in 2008
In January 2008, somebody registered a domain called bitcoin.org. In October of the same year, a user by the name of Satoshi Nakamoto uploaded a paper called ‘Bitcoin: A Peer-to-Peer Electronic Cash System [bold face hypertext] to an online mailing list used by cryptography enthusiasts. In his paper, Nakamoto added the final missing puzzle that would allow the decentralized peer-to-peer payment system concept described by Chaum, Back, Dai, and Szabo to become reality: Solution to the double spend problem.
Nakamoto then immediately went to work and created (or mined) the first ever block of the bitcoin network. He added text into the first block: The Times 03/Jan/2009 Chancellor on brink of second bailout for banks. The text was the headline of the British newspaper The Times on 3 January 2009. It has been interpreted as criticism from Nakamoto on the trouble caused by banks being able to use funds from their depositors in any way they want.
In less than a week, the code was released onto the internet that would allow anyone to enable their computer to be a Bitcoin client for transactions. In the next 3 days another cryptography enthusiast called Hal Finney became the first person to download the bitcoin software and receive 10 BTC from Nakamoto himself. Wei Dai and Nick Szabo also joined the early supporter list.
Nakamoto continued to update Bitcoin’s code and collaborated with other developers. Then in mid-2010 he transferred his control of the Bitcoin code , its network alert key, and ownership of several domains to the now Bitcoin Foundation head Gavin Andresen and others in the Bitcoin community before disappearing.
Conclusion: An anonymous peer-to-peer cash system here to stay?
The invention of the world’s first fully decentralized digital payment system was hardly an accidental or Eureka discovery, but a process that took 30 years and contributions of several cypherpunks who cared deeply about protecting online privacy. Solving the doublespend problem allowed an actual decentralized digital trustless payment system to come into being. So the obvious next question is, “what does the greater world think of Bitcoin?”
In this post, we took a close look into the history of how Bitcoin came into being.
In 2010 1 year after the Bitcoin network start, a man named Lazlo Hanyecz bought 2 pizzas for 10,000 Bitcoin or 35 USD at the time. This was reputed to be one of the first transactions in Bitcoin.
Fast forward 12 years, 10,000 BTC is equal to $230 million!
What on earth has happened in between?
What is the reason why Bitcoin is now valued 6 million times its value in 2010?
Why might Bitcoin stay despite Warren Buffet’s statement that it is a mirage?
Whether a store of value or an actual payment system, the source of value behind Bitcoin is a hotly debated topic today.
In our next post, we will focus our attention on how the world has adopted Bitcoin so far, what is the perception of Bitcoin today, and how Bitcoin might pan out in the future.
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