Blockchain and the Birth of Bitcoin

The Rise and Fall of the Golden Standard

In 1944, the world, torn apart by devastating wars and exhausted by economic shocks, started to rebuild itself financially. Representatives from 44 countries gathered in July that year in New Hampshire to devise policies to ensure ongoing prosperity.

Beyond the creation of the IMF and World Bank, the golden standard was reintroduced, after being abandoned on several occasions in the early 20th century. It is a financial system where the value of a currency is directly linked gold. The scarcity of the commodity's supply was** aimed to minimise instability, limit inflation and restore faith in financial institutions.**

The situation changed drastically in 1971. By that time, due to the intensified international trade, the value of foreign US dollar holdings by far exceeded the value of the US gold reserves. This raised doubts about the golden standard. The struggling US economy also urgently needed a boost. This led president Nixon to abandon the standard.

Currently, the golden standard is not used by any country.

This gave rise to fiat currencies. They are means of exchange whose value is not backed by physical assets. In this world, governments are in full control of the money supply.

Fiat currencies undoubtedly contributed to the unprecedented rate of economic growth in the second half of the 20th century. But the unlimited supply of money also made the new financial systems more susceptible to 'bubbles'.
One such bubble would soon challenge the entire foundation of the conventional monetary system.

Satoshi Nakamoto and Bitcoin

Forward to October 2008. A white paper titled 'Bitcoin: A Peer-to-Peer Electronic Cash System' was published and authored by Satoshi Nakamoto. The name is a pseudonym and the true identity of the author, in spite of numerous rumours, remains unknown. The paper proposes an electronic payment system, which does not rely on a trusted third party, for example a bank, to verify transactions.

Instead of trust, Nakamoto argues, the new system is based on cryptographic proof from the decentralised peer-to-peer (P2P) network. This allows one party to send payments directly to another party without the need for financial intermediaries. The paper points out the high transaction costs and limits on the minimal transaction size associated with the trust-based systems - problems that are addressed by Nakamoto's solution.

This was the intellectual birth of Bitcoin that, it's often argued, was effectively a response to the weaknesses and inadequacies of the modern financial system, which were exposed in the global crisis of 2007–2008.

It would take Satoshi Nakamoto another 15 months to launch the network and with it release the very first unit of the new cryptocurrency, bitcoin.

As opposed to the currently prevalent trust-based systems where the supply of money is effectively endless, Bitcoin introduces an element of scarcity. The algorithm makes adjustments to the rate of production (or 'mining') of new bitcoins in such way that the overall number of coins can't exceed 21 million. And 17 million of those had been mined as of April 26th 2018, implying that the rate of mining will rapidly slow down. This in some way resembles the golden standard where the supply of the commodity is inherently limited.

In a nutshell, Bitcoin is a P2P payment network that allows participants to exchange funds directly, whilst ensuring high levels of security. But in order to truly grasp how Bitcoin functions one needs to have an understanding of the underlying technology, blockchain, on which the payment network is based.

Blockchain and How It Works

Blockchain is often dubbed 'Internet 3.0', not just because in some way it performs a similar function but also due to the comparable significance of the two breakthrough inventions. Saying that blockchain is revolutionary would hardly be an exaggeration.

Blockchain is a new way to record data. Broadly speaking it is a highly secure database powered and run by the participants in the network. In the case of cryptocurrencies, blockchain is a ledger of financial transactions. But the application of the technology is much broader than this.

Blockchain allows to build networks on top of the Internet. So technically, with the right tools, one can create any application; trading platforms, voting systems and even games are currently being developed using the new technology. Ethereum is a blockchain network aimed at enabling the wider application of blockchain beyond just currencies.

To illustrate blockchain's benefits and key operational principles, the new technology can be looked at from three different perspectives: Immutability , Decentralisation and Security .

Immutability

Immutability, or a characteristic of something that can't be changed over time, is a crucial element of blockchain. P2P networks, on principles of which the new technology is based, existed since the start of the century. But it's the addition of the immutability aspect that revolutionised the technology.

Credit here should be given to Satoshi Nakamoto, who in his white paper proposed a solution to the double-spending problem.

A characteristic feature of digital assets is that they can be reproduced and copied; digital piracy is a good example. And it's an issue when it comes to money, among other things. Once a purchase is made, it must be ensured that the buyer transfers the specified amount to the seller without being able to spend this money again. Currently, financial intermediaries, such as banks, validate and record transactions.

In Nakamoto's solution, each piece of data (e.g. transaction) is represented by a block. With each subsequent transaction, a new block is time-stamped and added after the previous one, creating a chain. That is where the name comes from. What this means is that a block of data can't be changed without changing every block that came after.

This makes blockchain transactions effectively permanent and irreversible.

Decentralisation

Decentralisation was one of the cornerstones of Satoshi Nakamoto's philosophy when devising Bitcoin. Instead of relying on a central authority to store data and verify operations (e.g. servers), blockchain harvests the power of the community to do this.

Participants in the network are known as 'nodes' and store entire blockchain networks on their machines. The P2P principle is probably best known for its application in torrenting sites, like Napster, where pirated content is stored on users' devices.

In the absence of central authority, each transaction still needs to be verified and recorded. In the new world, these functions belong entirely to the participants of the network known as 'full nodes' or 'miners'.

Mining is a process of solving difficult mathematical puzzles, which these days requires large computational power, in order to verify transactions between independent parties. They are people who practically add new blocks to the chain.

The decentralised nature is one of the most prominent features of the blockchain technology and the one that opens virtually limitless opportunities, in finance and elsewhere.

Security

Entire blockchain networks are stored on multiple devices of the participants. This has significant security implications. Normally, the data would be stored on a central server, which can, if compromised, disable the entire network. Storing information on multiple devices substantially enhances the security of blockchain networks, making them much less susceptible to hacking.

In addition, the removal central authority, helps preserve the integrity of data. No single party has the ability to unilaterally change or manipulate information. All blocks are visible to all the participants and to change one piece of data would mean changing all subsequent ones too.

The most widely discussed aspect of the blockchain security is, of course, cryptography. It is a process of encoding information into unintelligible form for subsequent decoding, primarily for protection, and that's where cryptocurrency takes its name from.

Cryptography is what Satoshi Nakamoto based his alternative to the traditional trust-based systems on. Miners solve complex mathematical puzzles to record transactions. And for that they use cryptography. Anyone with suitable hardware can participate in mining but the more complex the network grows, the higher the CPU requirements become.

What especially notable from the security standpoint is that in order to tamper with a piece of data, one also needs to change all subsequent ones, making it harder to hack the network with every added transaction. What this effectively means is that as long as most participants (or rather most CPU) in the network are not trying to attack it, the blockchain will remain secure.

In other words, the bigger the blockchain, the more secure it is.

The New Frontiers

Some might be sceptical about comparing the significance of blockchain to the Internet, an innovation that most certainly revolutionised the world. Internet 3.0, however, is a well-deserved nickname. In fact, Tim Draper, the famous American venture capitalist, goes as far as to say that Bitcoin is 'bigger than the internet, the Iron Age, the Renaissance and Industrial Revolution.'

The financial application of the new technology, cryptocurrency, has definitely brought the spotlight onto blockchain. It challenged the old ways of thinking and denounced the glaring inadequacies of the conventional financial systems, such as asymmetric power, high costs and exposure to external interference.

This sentiment resonated very strongly with audiences around the globe. And combined with good chances of high profit, this led to an unprecedented spike of interest and activity in the crypto space, with more and more coins entering the market.

Despite currency being the first mainstream implementation of blockchain, it doesn't represent the full potential of the technology. Blockchain is a network, on top of which a range of different applications can be built.

Cryptography-based voting systems are among initiatives that are currently being developed. In the last few years, public confidence in the election process has been shaken Europe and North America due to numerous allegations of hacking and foreign digital interference. President Trump also added fuel to the fire with his concerns of illegal voting.

These are the problems to which blockchain may offer creative solutions. The immutability aspect and high network security may act as guarantors of the integrity of the voting process. The technology, being decentralised and digital, may expand the reach of the electoral systems and engage previously excluded social groups.
Time will show. And yet it's apparent even now that blockchain is on the path to change the world.

In the constantly and rapidly changing world of blockchain, it can be a struggle to stay ahead of the game. Follow Bitcoin Compass on Telegram (t.me/bitcoincompassofficial) for cryptocurrency trading and investing signals, Bitcoin updates, blockchain content, and more.