Under The Hood Of The Internet

Why Bitcoin Was Invented

will young
Jul 21, 2017 · 8 min read

Bitcoin was invented to solve a large and difficult problem. This problem affects millions of people, but it isn’t a very obvious problem. It exists because of a quirk in the internet that affects all economic activity that occurs on top of it. Half of the confusion surrounding Bitcoin is the fact that few people are even aware of this problem. How can we understand the solution to a problem if we aren’t sure what the problem is in the first place?

Old Old Wooden Ships

A quick history lesson is in order. In the old days information was transported in the same way that goods were transported. It had to be physically moved from one place to another. Letters were put on ships and carried across oceans. If the ship sank the information went down with the ship.

Before the invention of modern communication technologies information was physically transmitted from the source to the destination.

As we began to understand electromagnetism we found new methods for moving around information. New technologies like the telegraph, telephone, and the radio made it possible to move information across vast distances at astonishingly fast speeds.

These improvements were made by subtly altering the way information was sent. Instead of sending the original source from place to place we began sending copies of the source from place to place. It was no longer necessary to send a physical letter across the ocean. Instead, one simply had to send a radio signal. Someone at the other end of the signal could listen to that radio signal and recreate the information.

The invention of radio made it possible for information to quickly travel across vast distances. This method creates multiple copies of the original information.

One improvement is that this method makes it very easy to retransmit information if there is ever an error in the transmission. The chances of losing the original information are virtually eliminated. Wooden ship transmission errors were not as easy to overcome.

The Worlds Largest Copying Machine

The Transfer Control and the Internet protocols (TCP/IP) that underpin the internet function just like the telegraph and the radio in the sense that all of these technologies work by sending copies of information. Everything that touches the internet is copied.

If this doesn’t seem like a big deal then you probably don’t make money from a little thing called copyright law. Needless to say, the music and film industries were none to pleased with this “feature” of the internet.

Eventually these industries found ways to marry their content with the internet and derive value from some if it’s other features (like distribution). Many other industries had to adapt to the internet as well. It wasn’t always easy or obvious, but it seemed that there would be away to adapt almost anything to the internet. There was only one thing that couldn’t be easily adapted to it.

Cash Rules Everything Around Me

The Wu Tang Clan likely realized the problem immediately. It turns out that putting cash into a big copying machine doesn’t work out very well. Try it at home if you feel like having a nice chat with the police. Copying cash (a.k.a. counterfeiting) is illegal because the system functions so long as cash is hard to acquire. Cash is supposed to be scarce, hard to get, and therefore valuable. If anyone were allowed to arbitrarily make their own cash then these conditions would no longer exist and the system would collapse.

The question was,

How do we use something that cannot be copied (cash) on a system that only works by copying things (the internet)?

In computer science this issue became known as the double spend problem and it turned out to be quite difficult to solve.

The Double Puppy Problem(/Solution)

To see why, let’s briefly consider what happens when other things are sent over the internet. When you send a picture to someone else who has a copy of that picture?

The answer of course, is that both people do. Two copies of the picture now exist and you own one of the copies. This means that you can send that copy to a third person or a fourth person. Likewise your friend can send copies to their friends. You can send the picture to as many people as you want.

When friends share pictures many copies of those pictures are created. Neither friend can know for sure how many copies of the picture exist. Anthony Weiner learned this lesson the hard way.

Now replace “picture” with “cash” and the problem becomes apparent.

In order to prevent the double spend we would need a way of sending pictures without copying them. The recipient needs to know that they have received the picture and that the person who sent them the picture no longer has it. They need 100% confidence that only one copy exists.

In the physical world we can’t give the same dollar to two different people, but on the internet we can easily give the same dollar to two, three, or even a hundred different people. We can spend that cash more than once or “double spend” it. This is a big problem.

Without a solution to the double spend problem it is impossible to do a cash transaction on the internet. The only problem was that millions of people wanted to do exactly this! A solution needed to be found.

Egad Holmes!

The solution that was found was a creative one. We determined that the double spend problem was impossible to solve and so we just gave up! This is the solution we use today.

This meant it was still impossible to do cash transactions on the internet. It didn’t mean we couldn’t do financial transactions on the internet. It only meant that these transactions had to be something else. It meant that all transactions on the internet essentially had to become credit transactions. This largely ignored fact directly affects the way all e-commerce functions.

Buying a T-shirt

Let’s say that Alice wants to buy a shirt from Bob. In a real world transaction with hard money, Alice would hand Bob physical cash and Bob would give Alice a shirt. Only two people are involved in the transaction.

On the internet this transaction occurs differently. Alice and Bob are not in the same room so Alice can no longer give Bob the physical cash. Instead, Alice must somehow transfer the money to Bob electronically. However, there is no way for Bob to verify if Alice is sending him legitimate cash or cash that has already been double spent. This means that the best Alice can offer Bob is a promise.

“Hey Bob here is some money which I promise is totally not fake, can you send the shirt to my house please.”

The transaction can only take place if Bob trusts Alice completely, but in most real world examples Bob and Alice will not know each other and so it is unlikely that they will trust each other.

What does Bob do? Bob can’t complete the transaction without finding someone else that he does trust. So, Bob finds a third party that he can trust and hires them to be the middleman or escrow agent in his transaction.

There are now three people involved in the transaction, Bob, Alice, and the trusted third party. Bob asks Alice to pay the third party and after the third party verifies the money Bob releases the merchandise. The online version of the shirt purchase will then look something like this (simplified example),

Alice“Hey Bob I would like to buy your shirt and I promise I have the money.”

Bob“Ok Alice, I use XYZ third party to process my payments, please write them a check for the amount.”

Alice — (writes a check to XYZ third party)

Bob “Hey XYZ third party did you receive the money from Alice.”

XYZ Third Party “Yes we have her money and we can confirm that it is authentic.”

Bob“Ok Alice I will put your shirt in the mail.”

The details are hidden behind user interfaces and so Alice and Bob feel like the transaction they are conducting is identical to their face-to-face cash transaction. However, at no point in this transaction is any money actually being transferred over the internet. Bob asks Alice to write a check to a third party. The third party confirms that Alice has deposited funds with them. The third party moves those funds into the account Bob has with the third party. Finally, Bob ships the t-shirt to Alice. Communication is occurring over the internet, but the transfer of money is not.

This affects transactions in two important ways.

1. Third Parties do not perform their services for free.

2. Alice must first give her money to the third party before she can conduct a transaction. Said differently, Alice must give up custodial control of any money that she wishes to use online.

It feels like money is being transferred online, but it is not. Instead communication is occurring online and money is being transferred offline on the third parties’ private system. The transaction can only be completed if the money is already in that private system.

This setup has several drawbacks for the average person.

1. Third Parties charge fees for their service and so transactions are more expensive than their cash equivalents.

2. Third Parties have control of the underlying assets. They can freeze your account or institute various fees that you are effectively forced to pay (i.e. “convenience fees” charged because a particular transaction is convenient).

3. Processing times are longer than necessary. Money is not being sent over the internet and so transactions do not benefit from internet data speeds. Transaction speed is throttled by the processing speed of the third parties’ internal systems.

Without a solution to the double spend problem, three parties must be involved in every financial transaction that occurs on the internet. All three of these parties must give their blessing in order for a transaction to go through. If one party vetoes the transaction then no transaction can take place.

The Rub

This leads to a surprising conclusion.

Third party businesses have the power to stop all financial transactions over the internet from occurring.

There are a myriad of social, political, and economic reasons that might stop them from doing this, but there are no technical reasons. This is because no transaction is actually occurring on the internet. All transactions occur on closed private systems owned by third parties. The internet is only used to process requests.

Pandoras Box

Bitcoin is the world’s first viable solution to these problems. It is a solution to a problem that many believed was impossible to solve. Because of this a pandoras box of opportunities has been opened.

1. It is now possible for transactions to occur at internet data speeds because transactions can actually be conducted over the internet (like email).

2. It is now possible to conduct transactions for virtually no fees (roughly the same cost as sending an email).

3. People do not have to give up custodial control of their assets to conduct a transaction online.

4. Third parties cannot stop a transaction from happening. If two people agree on a transaction then it occurs.

5. Because third party private systems are not required, anyone in the world can build their own systems and grant access to anyone else.

6. Third parties cannot prevent anyone from accessing the system. Approval is not required.

7. Because the cost of transacting is dramatically reduced, transactions involving very small amounts of money (micro transactions) are possible.

The Internet has revolutionized the world. However, money couldn’t be used on the internet and so innovation in money did not experience this same explosion. The true and exciting innovation of Bitcoin is that this condition no longer exists. As Andreas Antonopoulos is fond of saying, Bitcoin is the Internet of money and the implications of this have the potential to be revolutionary.

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