Bitcoin & Blockchains — What’s the problem?

When a person initially comes across bitcoin, the first question that typically comes to mind is “What is it?” While this seems like a good place to start, it doesn’t actually help anyone’s understanding when the response is something like: “a trustless peer-to-peer digital currency network.” We could analyze each word of the answer seeking true understanding — and people have — yet a newcomer will not be any closer to understanding its significance or why it is even needed. In the Western world we have online banking, why is this new thing even needed? Why is bitcoin different? These questions, which ask why bitcoin exists in the first place, are much closer to the main question we should be asking: What problem does bitcoin solve?

The problem

To answer this we need just two concepts that everyone already intrinsically knows, but are central to explaining why bitcoin is important:

  1. A currency that is easily faked is useless.
  2. Computers can copy anything perfectly.

When you combine these two facts it becomes apparent that a currency, which only exists on computer networks that no one controls, will not be useful. After all, how can you have something on your computer that cannot just be copied?

The entertainment industry is locked in a never ending battle with piracy. It is impossible to stop anyone copying and distributing something digital. While in the case of entertainment this is considered an annoyance, it would immediately destroy a digital currency. This is known as the double-spend problem or the byzantine generals problem.

Information & value

Invented in 1041, the moveable type printing press allowed information to be easily copied. It was one of the major contributors that brought about the end of the dark ages, making it one of the most important inventions in the history of human civilization. Allowing people to become more productive through learning from others around the world, the printing press liberated the poor and birthed the middle class. Although at first, due to high cost and illiteracy, only the rich could afford it. However, as with all technology, given time it became accessible to everyone. A large portion of the rich dismissed and resisted the printing press, many believed that it was inferior and demanded that their texts remain handwritten manuscripts. If the printing press was the birth of modern society through the release of information, is there a similar technology for value? We could say that the invention of paper money and comparable financial products had similar effects on society.

Gold existed as a solution to the double spend problem for the past few millenia due to its physical properties, it cannot be forged and it requires an immense effort to produce. Gold also has some inconvenient physical properties such as, difficulty in dividing it, it can be easily stolen requiring immense security, and it is inconvenient to handle in large quantities. To get around the inconvenient properties, but keep the desirable ones, civilisations tend to transition onto a representation of gold. This also allowed for a huge expansion in economic wealth due to having more efficient trade. Examples of other financial products that make the economy much more efficient are: the stock market, insurance, and futures.

However, in a digital world, all of these representations of value suffer from the same fundamental issue; the double spend-problem. Because the fundamental difference between information and value, is that value cannot be in two places at once.

The current solution

Up until today, the double-spend problem was solved by having a trusted third party in the middle of every transaction, as to ensure that no one can copy anything. Examples being financial institutions, payment providers, notaries, etc. However, this ’solution’ as we know it, requires that a single entity has complete power over everyone else within the system. In every financial transaction or product in modern day society, there is a middleman involved, an entity that has the ability to manipulate the system however they see fit. This is the only way that humans have ever been able to get around the double-spend problem without the use of precious metals or stones.

Today, not a single person in the existing system has financial sovereignty due to these trusted institutions, except the institutions themselves. This doesn’t only apply to individuals, this applies to, every entity on the planet from small businesses to international conglomerates to governments. All have given up their sovereignty. So the question arises as to how you choose that entity? How do you ensure that it treats everyone fairly and doesn’t take advantage of its position? Currently we trust central banks to control our money. Throughout history they continue to break our trust.

Blockchain will return financial sovereignty

In the world of cryptocurrencies no one is in the middle of your transaction, you simply communicate to everyone in the system that a transaction has occurred. Thanks to the invention of Bitcoin in 2009 by Satoshi Nakamoto which is a probabilistic solution to the double-spend problem. Satoshi Nakamotos invention makes it possible for an individual or institution to retain its own financial sovereignty. The Bitcoin protocol is just the first variation of this technology, much the same as the first printing press had many iterations on its design. Similarly many other interesting protocols have emerged since but we will get into that in a separate article.

Follow us on medium and twitter so you don’t miss part 2.

Cyber Capital research: Alex Fauvel, Fundamental Analyst, and Amadeo Brands, Fundamental Analyst. Cyber Capital is a crypto-asset investment fund based in The Netherlands. The fund portfolio is actively managed and contains up to a 100 different crypto-assets.