Cryptocurrency Trading: The Good, The Bad And The Ugly (And The Big Problem Digital Currencies Solve)
By Fabio Canesin, co-founder of Nash
Everyone talks about “sending” files over the internet. We send messages, photos and documents daily. But when we send electronically, it’s not like we’re sending them through the mail. Send data over the Internet and you are really making copies of that data.
When you share a photo in WhatsApp or WeChat, you create a copy of the file that exists on your phone. This copy travels to their servers and on to its destination. But the original file is still with you when the copy arrives. You have not transferred ownership of the file.
Imagine if money worked this way!
If sending digital money were like sending a picture, you would never transfer ownership. Instead, you would multiply your assets and be able to spend the “same coin” twice.
This is known as the “double-spending” problem. It is a fundamental challenge that must be solved by any system wishing to represent money digitally. How can we guarantee that the “original” asset has been deleted and that the “copy” represents a transfer of ownership? How can we make a digital equivalent of sending a physical package through the mail?
For decades, the only practical solution to the double-spending problem was a trusted third party. To send money to another person, you would have to trust a third party — be it a company, consortium or individual person — to mediate your transaction and protect it from exploitation or censorship. Both sender and receiver would have to trust the third party with their assets, and the third party would guarantee to transfer ownership on their behalf.
Everyone uses trusted third parties like this in the form of banks and brokers.
The first practical solution to the double-spending problem that did not involve a third party was proposed in 2008 by the pseudonymous Satoshi Nakamoto. In a now-famous paper, Nakamoto presented the protocol for a digital currency called Bitcoin, which was subsequently implemented and launched in 2009.
Bitcoin uses a decentralized network of computers to achieve consensus on a transaction, rather than relying on a single party. Each computer in the network stores copies of all transactions, which are collected in a “blockchain”. To add transactions to this chain, computers must solve cryptographic puzzles. When a computer solves a puzzle, it can record a bundle of transactions to the chain within a single “block”.
Solving these puzzles secures the chain. The network counts the longest version of the blockchain as official. If someone wishes to spend the same coin twice, they have to re-compute the puzzle for the block that recorded the first time it was spent. However — and this is the crucial part — they also have to re-compute the puzzles for every subsequent block in the chain. If they fail, their “fraudulent” version of the blockchain will be shorter than the “official” version, which will have continued to grow in the meantime. To achieve this, an attacker would need to control more computing power than everyone else in the Bitcoin network. This is impractical, so long as the network remains sufficiently decentralized.
Bitcoin protocol solves the double-spending problem by using a decentralized network, not a trusted third party. This is what makes Bitcoin valuable today: it solved a decades-old problem that was fundamental to transferring assets in the digital era. Now, for the first time, we have a digital form of money that does not involve handing control over to a single party. This is a must in the age of the globalized Internet.
The creation of Bitcoin was followed by that of several other networks employing similar principles. Collectively, these became known as cryptocurrencies.
Today, these networks are used to represent much more than just money. They can record ownership transactions for any kind of digital asset. Not long after Bitcoin appeared, the same techniques introduced “smart contracts”, small computer programs that run on a decentralized network. Smart contracts simulate legal agreements over future transactions, which will execute if certain conditions are met.
The group of technologies that allow these different networks to function has become known as “blockchain” — a reference to the original Bitcoin implementation. Blockchains are networks that can represent ownership and interactions with digital assets in decentralized form, without trusting third parties.
So, on the most fundamental level, blockchain is the technological solution to the problem of trust.