How Bitcoin Achieves Disintermediation
A part of bitcoin that can be largely mis-understood is the removal of a trusted central authority. The goal of bitcoin was to create “A purely peer to peer version of electronic cash” (Nakamoto 1). By using a decentralized global ledger that removes the need for a trusted third party, but this creates new issues like double spending. This article will talk about the benefits of disintermediation and how bitcoin maintains a secure network that can be trusted Without the need of trust.
When a customer buys something online it is going through a trust-based model because of this “trust” there is a certain percentage of fraud that is an accepted cost. Satoshi Nakamoto purposes in the Bitcoin white pages “What is needed is an electronic payment system based on cryptographic proof instead of trust”. By building a system off cryptographic proof it removes counterparty risks and transaction costs. The modern banking system makes use of local ledgers. This creates a single point of failure that can affect many accounts so Nakamoto proposed a global ledger that anyone can access (Nakamoto, 1) (Goorha 1)
A global ledger that anyone can access would be useless if it is not secure. Bitcoin secures its network through proof. The way the White Pages explain how it achieves this proof starts with the Timestamp server. Today this is known as the blockchain. The reason it was called a timestamp server then is because it works by “taking a hash of a block of items to be timestamped and widely publishing the hash… the timestamp proves that the data must have existed at the time… each timestamp includes the previous timestamp in its hash, forming a chain”.(Nakamoto) The Blockchain by itself is not secure but through a computationally costly consensus algorithm that makes use of a nonce preventing things like double spending.
Double spending occurs when a transaction that is taken place with a digital currency is spent multiple times essentially spending the same money twice. The blockchain does not allow double spending because of its chain of hashes. It goes back in its chain to confirm the person making the payment has enough currency in their addresses to send to the payee. The use of a consensus algorithm allows this and can be easily explained with the Byzantine Generals Problem. (Nakamoto 2) (Goorha 2)
The Byzantine Generals Problem explains the importance of proof of work and incentives. If there are three generals and two of the generals are loyal to their king but one is a traitor the entire system is at risk of failure this is because, if the traitor tells one loyal general that he is attacking and tells the other loyal general he is retreating and deicides to retreat that will leave the one loyal general to be defeated in battle. This example clearly explains why it is important to have a type of proof of work to support the claim of their attack. This can be done by making sending a message a real cost of energy making sending spam costly, and in return disincentivizes traitors. The next step is to create incentives for loyalty by providing a stake in the desired outcome. It makes being loyal far more prosperous and gives less of a reason for someone to want to be a traitor. (Goorha 2–3)
This Proof of Work (PoW) is what makes Bitcoin stand out from the rest of cryptocurrencies. PoW is what confirms the validity of a block in the blockchain. PoW is achieved through solving a cryptographic puzzle. This puzzle is solved through Mining. Mining can be done by Full Nodes. Nodes and Full Nodes are members of the Bitcoin network and is responsible for the security of the network. Full Nodes use hashing power to protect the network. This hashing power is created by searching for a nonce based on a hash function called SHA-256 algorithm this is how mining on the Bitcoin network works and how PoW is achieved. (Nakamoto 3) (Goorha 3)
Why would someone want to mine and use up their resources, because mentioned before in the Byzantine Generals Problem there was use of incentivizing the generals by giving them a steak in the desired outcome. Bitcoin achieves this by rewarding a successful miner a block reward. This reward amount depends on the reward era. This creates loyalty to this money system making it not feasibly possible for attackers to defeat the blockchain. “The system is secure long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes.” (Nakamoto 8) (Goorha 2–3–4)
Disintermediation saves on transaction costs by essentially cutting out the “middleman”. There are many fees that come along with intermediation that are within banking, lawyers, cost of wiring and other fees used to maintain trust with banks and its users. Relying on trust is a costly expense that fails due to human error. We are entering a time of efficiency that goes beyond human capabilities. Bitcoin provides a new answer to money and should be allowed to grow to help understand the capabilities of the tools used by Bitcoin.
Nakamoto, Satoshi. “Bitcoin: A Peer-to-Peer Electronic Cash System.” 2008.
Goorha, Prateek. “Class Notes for ECON 333: Cryptoeconomics.” Bridgew.blackboard.com, 2022, bridgew.blackboard.com.