What Bitcoin Achieved
September 21, 2018
Bitcoin cannot be looked at from the perspective of what it does. The 3 biggest use cases that Bitcoin has are as a store of value, digital transfer of value, and as a speculative investment. However, gold is already used as a store of value, we already have Paypal for digital transfer of value, and the stock market already provides plenty of investment opportunities.
So what is Bitcoin? How is it different? To answer this question, we cannot look at what Bitcoin is from the perspective of what Bitcoin does. We must look at Bitcoin from the perspective of what Bitcoin changes.
Bitcoin is the first decentralized unit of value to provide scarcity in the digital world. That was a mouthful; let’s break this down.
First let’s look at the word “decentralized”. Merriam-Webster defines “decentralization” as “the dispersion or distribution of functions and powers”. In a centralized system, there is just one authority. This authority holds all the power and more importantly, all the risk. For example, a bank controls everyone’s money and they take on the risk of holding all that money. In Bitcoin, decentralization provides dispersing the power AND the risk. The power and the risk is distributed between all the users of the network. This prevents any no one authority from having power over your money and makes the collective system much more secure because there isn’t a single point of failure.
Torrents are a good example of a decentralized system. Everyone keeps a copy of the file for themselves and lessens the risk of shutdown by the government. No one single computer has absolute control of the file (and therefore does not have the power to impose a fee for downloading the file).
Next, let’s look at “digital scarcity”. When we break things down, all digital things are just 0s and 1s. All 0s and 1s are reproducible by anyone. Say I offer you the number “100” by text for your 100 dollar bill. Will you accept this offer? Maybe so if you aren’t sober at the time. If you are sober, you’ll reject this deal because the number “100” doesn’t have any value in itself. Anyone can replicate the text “100” on any computer with 1100100 (binary for 100).
To solve this problem of digital numbers not being scarce, we keep track of how much of that number everyone has — their slice of the digital pie, if you will. Say a bank offers to update your bank account by 100 dollars if you give them a 100 dollar bill. This offer is a lot more fair since the bank is keeping a track of how much money you have. No one except the bank can update the list, making digital scarcity possible.
Both decentralization and digital scarcity were already solved way before Bitcoin. However, having BOTH decentralization and digital scarcity isn’t so simple. The problem with decentralizing money is that we spend and receive it constantly, meaning a ledger of accounts must constantly (or at least, semi-constantly) be updated. In the traditional system, when I want to spend a 100 dollars (via card or bank transfer), what I am essentially doing is asking my bank if I have enough money and then transferring the amount requested to a different specified account. What the bank does is it subtracts 100 dollars from my balance (the number that is associated with my store of value) and then adds 100 dollars to the specified account. Because we are constantly sending and receiving money, my account balance is always changing. Because my balance is constantly changing, decentralization is difficult to achieve; if there is no person or computer to adjust the various balances, who will do the adjusting?
Perhaps a decentralized network of computers?
Let’s say we have a decentralized network of computers in US, Korea, and Canada keeping track of how much money everyone has at any given time. Let’s say that I am in the United States and I send 50 dollars over to Bob in Korea. All the computers in all the countries take note of this and update the balances as needed.
Now let’s say that just before I sent the money to Bob, a nationwide power outage happened in Canada, and all the computers in Canada go offline. All the computers in the US and Korea take note of my transaction, of course, but all the computers in Canada cannot. After my transaction has happened, Canadians finally get their grid back up, but we have a problem: the network is now asynchronized. What do the Canadian computers do now? Just accept that my transaction has happened? How do the Canadian computers know that the computers in the US and Korea haven’t cheated? If they don’t accept the transaction, then does my transaction get reversed? This is just one transaction — what if this happens with some of the computers in the US and Korea as well while millions of transactions occur? What is the correct balance for everyone?
Satoshi Nakamoto created a protocol called the Blockchain that keeps the network in sync. The Blockchain gives the power of ordering transactions to a special group of computers called miners and the order they choose is the correct order. This new invention has allowed Bitcoin to be the first decentralized medium of exchange in a digital world. And that is pretty incredible.
Originally published at billfodl.com.
