Crypto vs. Bank

Cryptocurrencies and banks operate account transactions using the same four principles: (1) identity management, (2) service, (3) record management, and (4) trust.

Banks ensure identity management by requiring a customer to provide personal information that ties her bank account to her identity. Banks complete their services (or transactions) by transferring money from one account to another and manually verifying those transactions. Banks ensure record management by electronically or manually entering all validated transactions into a ledger. Finally, banks ensure trust by establishing standard employee operating procedures and complying with government regulations.

Cryptocurrencies satisfy these same principles but tackle them differently.

Identity Management

Cryptocurrencies manage identities through the use of public and private keys. A public key may be thought of as a mailbox address, while a private key is a key that opens that mailbox. When receiving cryptocurrency, a customer provides his public key, or, more specifically, the bitcoin address that relates to his public key. To redeem cryptocurrency, he uses his private key.

One differentiating factor between bank identity management and cryptocurrency identity management is that a bank account is directly tied to a person’s identity, but a cryptocurrency account is pseudonymous. Pseudonymity can be thought of as a mask protecting your true identity. The mask is still connected to you, but unless someone can associate that mask with your true identity, you’ll remain pseudonymous.

Service

When you receive an emailed picture, did you receive the original image or just a copy of that image? The major hurdle cryptocurrencies must overcome while servicing transactions is the Double-Spend problem, they need to ensure that the digital asset itself is being sent, rather than just a copy of the digital asset.

Cryptocurrencies solve this problem using the unspent transaction output model (UTXO). The UTXO model differs from traditional accounting because instead of debiting and crediting a single account, the UTXO model creates a “UTXO” for each transaction a person makes. A UTXO may be thought of as a piggy bank. Each time you want to pay someone, you smash that piggy bank, send the necessary amount, and receive a new piggy bank filled with any change that may have come from that transaction. In this way your transaction record is tied to the cryptocurrency itself.

Record Management

While traditional banks serve as a centralized recordkeeping service for all of their customers, cryptocurrencies use a decentralized system.

Instead of one organization keeping the records of thousands of people, cryptocurrencies allow each user to keep their version of the record. By distributing this same record to every other cryptocurrency user, however, individuals cannot alter their transaction records without obvious deviation from the rest of the users.

Trust

Bitcoin is decentralized. There is no one person or organization in whom users place their trust. Instead, each user must come to a consensus with every other user about the validity of transactions.

In order for a transaction to be validated, the majority of blockchain users must vote to allow that transaction. For example, suppose that both Jonah and Daniel simultaneously request 10 bitcoins from Nick. If either Jonah or Daniel looked in Nick’s wallet and saw 10 bitcoins, they would both think that Nick has enough to satisfy that transaction and they would vote to validate the transaction. This potential overdraw is averted, however, because in order to validate the transaction between Jonah and Nick, Daniel would also have to vote on it. Daniel would realize that Nick is trying to pay both him and Jonah with the same 10 bitcoins. Daniel would vote against this transaction. Similarly, Jonah would figure this out and vote against the transaction. This two-to-one vote would lead to the transaction not being validated.

In a cryptocurrency world where 500 different pseudonymous bitcoin accounts can be created and all tied to one real person, how is one vote assigned to one real person? Bitcoin uses the “one CPU, one-vote” method. This means that the number of votes you can cast to validate a transaction is simply dependent on your computing power, not the number of bitcoin accounts you have. It is also important to recognize that these votes are implicitly cast as a part of the bitcoin protocol; there is no need to log on and explicitly cast votes.

Conclusion

1. Bitcoin handles its identity management with public and private keys
2. Bitcoin services its transactions using the UTXO model.
3. Bitcoin handles its record management with a decentralized copy of the ledger for all users to check and enforce.
4. Bitcoin instills trust (or consensus) with its “one CPU, one vote” system.