Fundamentals of Crypto — Part 3
This is part 3 in the Fundamentals of Crypto series. To start at the beginning, visit our Intro to the series.
In Part 2: A Basic Overview of Currency, we examined the functions of a currency and compared the qualities of Commodity and Fiat Currencies, historically the two most dominant forms. In Part 3 we’ll trace back the genesis of cryptocurrencies and begin to build a rudimentary knowledge of how they work.
From the grain & livestock ledgers of Babylonia, to the myriad coins of ancient greece, to the hegemonic rule of the US dollar…Tracing the history of currency can be like reading the fossil record of some fiscal organism — a progression of mutations across generations, changes in both form and function unfolding over thousands of years. It is the age old story of the struggle to adapt to environmental pressures, to stay fit, to keep up with an ever broadening, ever shifting social, political, economic, and technological landscape.
And then the internet happened. And it was great — for most of us. It ushered in an era of unprecedented access to information, to goods, to each other, on a scale and with a speed that only decades ago would have been unfathomable.
The digitalization of our world is probably the biggest technological leap since the industrial revolution. The invention, and more importantly, the mass global adoption of the internet is a major inflection point in the history of humanity — a point from which there is no returning to the old way of life. Times such as these bring major disruption. They demand a restructuring of relationships and order. They fundamentally change how we relate to each other, ourselves, and the physical world. Sometimes this restructuring is immediate and obvious, as with email, which virtually negated the barriers of distance, time, and cost for the transmission of information and communication between people. But sometimes the restructuring unfolds in more subtle ways, like the gradual erosion of stone by water. At first the water merely works on the surface, wearing down hard edges, but before long it finds a way inside, it tunnels deeper and deeper, into every crevice. And where you once had solid impenetrable rock, space is created, and pathways emerge. The internet is like that. It is in the act of penetrating every facet of our lives. It is working all the time, exploring, probing, finding the cracks in the system and working its way through.
It would be easy to get into the weeds discussing all the implications of the internet on our modern world, but for the sake of expediency, and to avoid boring you (we hope), we’ll try to get to the damn point:
The internet came and it blew the doors off everything! All sectors were affected. In the finance world one manifestation was a boom of new wildly complex financial instruments — the proliferation of which, combined with deregulation and seemingly amoral business practices led to the 2008 financial crisis and the ensuing recession. Millions of average people lost their homes, savings, and jobs. Meanwhile the banks and institutions responsible were bailed out with billions in taxpayer dollars, but rather than face repercussions for their culpability, the corporate executives responsible for the mess took home millions in bonuses.
In the wake of the crisis, the misfortune of the masses seemed only to grow. Those who hoped for sweeping reforms, for their supposed representatives in government to advance toothed legislation that could rectify what had been done and protect them from future abuse, were driven to further despair. There would be no vindication of the rights of those who had been swindled. When the dust settled nothing significant was done to curb the power or avarice of the institutions involved. The broken system that had allowed, perhaps even encouraged, such despicable actions remained more or less unchanged in any fundamental way.
But then something unexpected happened. In October 2008 an unknown programmer, using the alias Satoshi Nakamoto, published an 8 page “white paper” detailing a new kind of peer-to-peer payment network that could, it claimed, resolve the underlying problems and shortcomings plaguing the modern financial system. Nakamoto’s new network, the proposed solution to the financial woes of the world, was dubbed “BITCOIN.”
Any discussion of cryptocurrency necessarily begins with bitcoin. It’s the godfather of cryptos, or better yet, the primal mother, the very first of its kind that would give birth to a whole new category of currency. To understand Bitcoin’s defining role, it’s essential to grasp what it is, how it works, and how it’s distinguishable from the other forms of currencies that came before.
Right off the bat, it gets a little confusing because when we talk about bitcoin, we may be talking about two relatively distinct things — Bitcoin the system, and bitcoin the token. Let’s begin with the system.
Bitcoin (the system) is an immutable, borderless, decentralized peer-to-peer payment network. At best this description is a mouthful, at worst it’s a snowball of unfamiliar concepts and adjectives that requires serious unpacking. So let’s break it down.
First and foremost Bitcoin (the system) is an online payment network, a kind of digital ledger for peer-to-peer accounting. It’s purpose, it’s primary reason for being, is to facilitate direct transactions between two parties so that no third party is needed. It’s essential claim was YOU CAN’T TRUST MIDDLE MEN — you can’t trust banks, you can’t trust governments, you can’t trust visa or mastercard or anyone to be a chaperone over financial transactions. Why? Because it gives them an unhealthy amount of power, and it gives you none. It means they can change the policies and rules as they see fit. It means they can loan out your money, use it to make risky investments, or make decisions that will benefit them and hurt you. It also concentrates sensitive information into vulnerable, exploitable positions. It pools data and info into big vaults that are impossible to protect and inevitably get raided. In a nutshell bitcoin was proclaiming, while the world was demonstrating, that systems reliant on central authority or third parties to authenticate and verify transactions would be, by design, inherently un-secure and susceptible to manipulation and abuse.
So what do you do if you can’t trust anyone? Bitcoin’s answer — you build a trustless environment. You build a system that does not rely on the honesty of men or institutions, but instead is based in mathematics and computation. You create a system
- that executes precisely as it is written.
- whose rules and conditions are unalterable.
- where no single actor has the authority to reverse, erase, or manipulate inputs.
- in which all participants must be in agreement, must reach consensus, in order to verify and validate transactions.
This is what is meant when we refer to Bitcoin as being immutable and decentralized. There’s no governing body, no central bank or VIPs who hold the keys to the server, control the information, or have the final say. All nodes, all participants, are equal. All transactions, no matter the size, no matter the location, are subject to the same rules. There is no hierarchy. There’s no political or economic avenues to apply pressure or exert unjust influence. The importance of this quality cannot be overstated. Decentralization is the defining characteristic of bitcoin and an essential marker of a true cryptocurrency.
The precise details and technical methods by which Bitcoin operates, and achieves its aims (eg. blockchain, hashing, proof of work) is worth exploring in greater detail. As such it’s the subject of another post, the underlying technology of bitcoin. For our purposes here, however, broader strokes will suffice to get us acquainted and prime us for further inquiry — it’s enough for us to grasp the major concepts behind bitcoin than to necessarily know the technical ins and outs of the tactics or methodology.
In the next post we’ll continue our investigation into crypto as we shift focus from Bitcoin the system, to bitcoin the token, taking a closer look at how cryptocurrencies are fundamentally similar yet significantly distinct from their their traditional currency counterparts.
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