Better Than the Digital Cash You Have Now
On his deathbed, a friend’s dad gave a strange last request. ‘Break the back wall of the chimney.’ After, my friend did what his dad asked.
Wondering why, he hit the bricks with his sledge hammer. A hollow thud betrayed a false wall which hid $500,000 in gold bars. His dad had lived through the Great Depression and had never trusted banks since.
This story got me thinking about how much I trust the bank. After poking around my own chimney (it’s a 148 year old house and maybe I’ll get lucky?), I started to realize a couple of things:
- I go to work and get paid through direct deposit
- The grocery store accepts payment through a debit card for physical food (much tastier than digital food!).
- Websites work through digital credit cards and I get something physical delivered to my door (Thanks Amazon!)
…. I never actually hold my money. I am already using a digital currency.
What is the main difference between this and Bitcoin?
Trust.
The Current Financial System
Trust makes the entire financial system work.
Anything not paid in cash is a credit (which implicitly requires trust). The shopper’s bank doesn’t ship the grocery store cash at the exact time of purchase per every transaction. They credit them an amount after the day (or whatever). Same with just about any other purchase.
Banks use fractional reserve banking which means they already don’t have enough cash on hand to cover all their debts. It’s all a highly coordinated game of trust. Banks trust on the monthly payments made on what they loan and they trust not everyone wants all their physical money at the same time.
Bitcoin, on the other hand, is completely trustless. It fills the role of cold hard cash on the internet. No third party is needed, just a decentralized network working to facilitate trades.
A purely peer to peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.
How Bitcoin Works
Bitcoin is essentially a store of value with an attached transaction history.
We define an electronic coin as a chain of digital signatures. Each owner transfers the coin to the next by digitally signing a hash of the previous transaction and the public key of the next owner and adding these to the end of the coin. A payee can verify the signatures to verify the chain of ownership.
This history allows Bitcoin to be trustless. But how? What prevents people from copy/pasting new bitcoins or just sending them to multiple people? What prevents people from just editing Bitcoin code and assigning all Bitcoins to themselves?
Bitcoin Cryptography (The Cool Stuff)
Firstly, Bitcoin uses a cryptographic trick called ‘hashing’ to condense its entire history into a single 32bit value. In fact, hashing is integrated into almost every facet of Bitcoin. Oversimplified, if any part of a Bitcoin’s history changes, it will change the hash value of the coin, letting you know someone is fiddling with your bits!
The Blockchain
Secondly, all transactions are publicly announced on the Bitcoin network (the blockchain). If the majority of the nodes on the blockchain agree that the transaction took place (and it is valid), the transaction will be written into the hash of the next transactions. This makes it impossible to go back and change history (Currently. Unless you are a nation-state. Though hopefully national governments have more to worry about than my online purchases =)).
The network knows that a transaction is valid because it is aware of all transactions. This combined with an immutable history means that the blockchain is able to detect fraudulent coins. However, the blockchain has no way to tie those transactions back to you. Unlike facebook, the blockchain is only interested in moving bitcoins around and not about selling data and ads. =)
Is Bitcoin Really Money?
Further, Bitcoin is a scarce resource. Actually, compared to physical cash, Bitcoin fits the economist version of money better in every way save for acceptability (but we’re working on that!).
Money Criteria | Bitcoin | Dollars |
| Acceptability | Coinbase has 32million accounts. Last year 19 million new accounts were open. This is growing real quick. | I’ll take whatever cash anyone wants to give me =) So would anyone. |
| Scarcity | There will only ever be 21million Bitcoin | If the government needs more to spend, it can just print more! Nothing like ditching a gold standard for faith and trust! |
| Portability | I bet I can store more bitcoin in my wallet than you can fit dollars in yours =P | |
| Durability | If the internet is destroyed, we have bigger issues than lost Bitcoin (no more memes!) | Only one house fire away from losing all the cash in your mattress. Maybe the bank can help you store it |
| Divisibility | Bitcoin can be split down to the 0.00000001 BTC. | If I only have a 20, can I rip it in half to pay $10? |
| Uniformity | The only way one bitcoin differs from another is its transaction history. | I wish all my dollars were uniform, it would make getting snacks out of the vending machine so much easier. No More Crumpled Edges! |
A Brave New Coin
As our world continues to become digitized, the need for trustless internet cash will increase. Unless Jeff Bezos wants to stop sending pictures and build a drone to come get my cash, then Bitcoin will continue to become adopted. There are some issues with bitcoin (such as lost accounts and other custodial things) but these will get better in time as more and more people start to use it.
However, the scarcity of bitcoin, its security, and its distributed network are massive advantages over the traditional banking system. Some have even argued that Bitcoin could solve the world’s debt crisis. If one thing is for sure, cryptocurrency is here to stay.
