Bitcoin, cryptocurrencies, blockchain technology. You might have heard about these terms from the geeky kids in school, or in discussions by the water coolers. But what exactly is this new technology that people are talking about? What about it simultaneously excites and scares so many powerful people? Is it really a currency? An investment? Or is it just a fad/bubble that will go the way of the perceived Tulip Mania of the 1600s? This introductory article helps you make sense of this nascent industry, and takes a closer look at the role of trust in our economy – its importance, implications and future.
Every single transaction made by humans, since time immemorial, has required a middleman to oversee the proceedings. Middlemen add a level of trust that enables us to exchange goods in relative safety and without fear of fraud. If not for the middleman, who is to stop me from dishonouring my end of the agreement?
Middlemen come in all shapes and sizes, and offer certain guarantees – Governments/central banks issue currencies that hold value for us, banks guarantee payments on their respective cards, and clearinghouses guarantee delivery of assets.
You may notice a commonality here – trust is always centralized onto a middleman. This can lead to several issues:
- If the middleman proves untrustworthy or corrupt, the entire system collapses in on itself. History is rife with examples of corrupt/greedy middlemen causing entire economies to collapse (such as the Medici banking collapse, or South Sea Bubble).
- Most middlemen require payments for their services, and since they operate in near-monopolies, they can charge relatively high fees.
- Though regulations exist to curtail bad behaviour, it is still very difficult to ensure that the middleman performs his duties fairly.
A breach of this trust can lead to bank runs, and economic downturns.
Financial Crisis Brings New Era
We have always known of the problems associated with trusting an intermediary, but we made do for want of a better alternative. And for most people this was seemingly working fine, until the Financial Crisis of 2008.
After the crisis, a person or group of people using the pseudonym “Satoshi Nakamoto” released a White Paper detailing the functionality and design of a novel peer to peer electronic cash system that he had been working on and laid the groundwork for what would one day grow to become Bitcoin.
One of the greatest features of this new asset was the fact that there was no central authority managing the supply of the currency or the exchange of currencies among individuals. Instead, it combined three things – a unique rewards mechanism, cutting-edge cryptography and a new record-keeping mechanism called blockchain – to make a market where individuals can trade with each other without requiring a trusted 3rd party to act as a middleman.
Very simply put, it works something like this:
- Bitcoin markets consist of miners, exchanges, investors, small and large global businesses, remittance businesses, legal services, banks, governments, and a host of global individual users. These trade bitcoins amongst each other to utilize the faster, cheaper and more secure blockchain technology, for profit, privacy, security, reliability, less prone to criminal activities and potentially for a host of other reasons.
- New transactions are collected into a pool (mempool) of unverified transactions.
- Bitcoin Miners collect as many of these transactions as they can, verify their integrity, and order them into a list, called a block.
- Simultaneously, they race against other miners to solve a processor-intensive mathematical problem
- The first miner who solves the problem gets to add his block onto the current chain of blocks – hence the term blockchain.
- End user transactions are confirmed after one block. And the miner is rewarded a set amount of Bitcoin (miner reward) which becomes spendable after 100 blocks.
- The entire process is encrypted using an algorithm called SHA-256, which makes it near-impossible for an attacker to edit a transaction once it is listed on the blockchain.
- A new block is added once every 10 minutes or so, with the current miner reward being 12.5 Bitcoins.
- The miner reward halves every four years until the supply ends at 21 million.
A system that is nearly impossible to attack by malicious agents, which ensures that transactions once confirmed cannot be edited, where trust is an inherent property rather than an add-on offered by a third party. A means of removing trust.
Why do we need a bank to help exchange funds if we are capable of doing it on our own?
Why do we need a clearinghouse if we can exchange assets directly? Why do we need the central bank issuing our inflationary currencies if we can create our own programmable currency systems? Why do we need middlemen if we don’t need trust? We don’t. And that is precisely the fearsome power of a trustless system.
Crypto-assets help remove reliance on trust by decentralizing the financial system. Blockchain decentralized technology also allows for the better formation of decentralized organizations.
Should you care? More importantly, how would it affect you? Well, here are a few use-cases that may have a significant impact on your life:
- Freedom of speech – and censorship resistance – We live in a time when voicing your opinions can get you jailed in some countries. Imagine a public opinion magazine that cannot be shut down by local governments because there is no central office to shut down. Imagine a VPN service that allows you to surf websites in complete anonymity, completely hosted and run by others like you.
- Security – Bitcoin is a proven technology of over 8 years. It is cryptographically and economically secure. Its security is based on an economic model that overlays the software side of it. It is impossible to hack, crack, or change the fundamental nature of the system unless you do a Hard Fork and users intentionally and willingly use malware that lowers its security. A decentralized system is spread out over many such points of failure. Attacking a few of these points would do nothing to affect the integrity of the system as a whole. We’ve seen several instances of hacker groups running massive attacks on major companies such as Sony and HBO. These attacks are generally possible only because of centralized servers that provide a single point of failure, an attack on which brings the whole organization to its knees.
- Charity – You donate to a charity fund out of the goodness of your heart. How do you know whether the money you donated is put to humanitarian use instead of lining someone’s pockets? Simple – transparent peer to peer money. Having no central organization controlling the funds brings the flow of donations into the public eye – you can see precisely who reaps the benefits of your good deed. This same line of thought can be applied to voting, fair trade, and identity verification, among others.
What can we expect in the future?
Decentralization is an important step forward. In the span of a few years to a decade, it is likely to disrupt several industries from the ground-up.
You will see many organizations attempt to shut this idea down when it is young – nip it in the bud, so to say. Corporate coups funded by big banks, developers gone bad and bribed by paper money. You might privy to conversations that would have been unthinkable a mere decade ago, you will come across naysayers fearful of change.
You will see more investors and hedge funds divert huge monies into cryptocurrencies and related projects. The volatility of today is nothing like it will be in the future.
And please be aware that there will be more conmen and scammers attracted to the burgeoning sector attempting to make a quick buck off ignorant individuals.
You will also find many educational sources, and as with all things, before investing large amounts do your due diligence, question, look at sources, have a glance the Bitcoin White Paper.
You will be privy to the rise of the future of finance, the next generation of organizations. A new way of looking at money, allocating resources, and interacting with others.
I’m excited. You should be too.
Date Published: [sc_post_date]
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