If Bitcoin changes the way we transact and the way we store wealth – and it has the potential to do this – the repercussions could be enormous. Think what email did to the postal service, or what the internet did to newspapers, publishing, music and television. With the huge costs involved in the printing and distribution of physical newspapers, news publishing was once the exclusive domain of a few large companies. Now any blogger, aspiring journalist or start-up can publish on the web, effectively for free. Huge opportunities have opened up to the masses, and the old dinosaurs have seen their monopolies eroded.
We’re still a long way from that, but Bitcoin could do something similar to banking, finance and, even, the large state model under which we live. Without wishing to get too excited, it could bring about the huge changes to society so many are clamouring for, re-balancing the skewed distribution of wealth and opportunity. The implications are enormous.
That’s why Bitcoin is important.
What is Bitcoin?
When you type a website address into a browser you might have noticed that the letters ‘http’ appear at the front. ‘Http’ stands for Hypertext Transfer Protocol. In typing an address you are actually sending an HTTP command to transmit that website to you. Hypertext Transfer Protocol is the means by which information is shared across the web.
Similarly, when setting up an email account, you might have noticed the letters ‘smtp’ – for example, ‘smtp.gmail.com’. SMTP stands for Simple Mail Transfer Protocol. SMTP is the protocol by which we send emails to each other. What actually happens when you send an email through Gmail to, say, someone with a Yahoo address is that a Google server reaches out to a Yahoo server and transmits a text file; then the Yahoo server says to its user, ‘you’ve got mail’.
So, a protocol is an agreed system by which information is shared across a network.
Bitcoin – with a capital ‘B’ – is another protocol. The function of the protocol is to send and receive payment information.
With Bitcoin, your computer reaches out to another user’s computer, gives it some binary gibberish proving you control X number of coins at this address and want them to increase the balance at that address.
The unit of money on the Bitcoin protocol is the ‘bitcoin’ (with a small ‘b’). As the dollar is the unit of money on the US banking network, so bitcoin is the unit of money on the Bitcoin system.
So, Bitcoin is two things – a protocol and a unit of money.
How do you get bitcoins?
Using dollars or pounds is easy.
You get paid in them. They’re in your bank account (hopefully). And you can pay for things with them via electronic banking, by cheque, credit card, or in cash.
But where on earth do you get bitcoins?
There are three ways.
You can get paid in bitcoins. You can buy bitcoins. And last of all (the very unconventional bit), you can make bitcoins. Yes, you can, literally, create money.
You earn bitcoins by doing or selling something in exchange for bitcoins – just as you would earn normal money. If I do this job for you, you pay me in bitcoins.
You buy bitcoins just as you would buy and sell foreign currency – from the Bitcoin equivalent of a bureau de change, known as a Bitcoin exchange, or directly from an individual. You hand over your dollars, pounds or whatever currency you’re using and you receive bitcoins.
To create bitcoins, you run the Bitcoin software on your computer. It’s called ‘mining’ – more on that later. But I should say that mining has now progressed to the point at which regular home computers are no longer much good.
Of course, you need somewhere to keep your money. You could keep your dollars in a bank account, your back pocket, your wallet or purse, even under your mattress. Bitcoins are kept in a ‘digital wallet’.
There are hundreds of places to get a wallet, just as there are hundreds of places to get an email account. Often people will have more than one. You can keep a wallet on your computer or your phone, you could keep one on a hard drive off-line, or you could keep one with an exchange. Some people with lots of bitcoins keep them in a wallet on a hard drive in a safe.
Each wallet has its own address – a sequence of different numbers and letters. To make a payment, you click on your wallet, type in the number of coins you wish to pay, copy and paste the payee’s wallet address, hit send and the payment is made. To receive a payment in bitcoins, all the person paying needs is your wallet address. When you receive a payment, your computer might give you a little ‘ching’ sound to notify you. It is as simple as sending an email.
With barcodes you can open your wallet on your smartphone, photograph the barcode, hit send and the payment is made. The day is not far off when you will walk into a shop, select an item you wish to buy, photograph the code on the label, payment will be made automatically and off you go.
Once you get the hang of it, it is as simple as using a credit card. And, as long as you have internet access, there are no barriers to entry.
Cash in my wallet, money in the bank
I bet you use different kinds of money all the time, sometimes without even realising it.
In various online accounts, I currently have: some dollars, some pounds and some euros. I have some air miles from two different credit card companies. I have some supermarket rewards points from three different companies. In addition, I have some bitcoins in a wallet on my computer.
These are all tokens with some kind of value, which can be swapped for goods or services. They are all, in other words, different forms of money – nine in total.
Of course, the dollars are more widely accepted than my supermarket rewards points – they are a more effective form of money. But those supermarket reward points are still exchangeable for goods and services of some kind and therefore are also a form of money.
What’s more, I have none of these monies on my person. They are all stored and transacted on some computer somewhere – they are all forms of digital money.
If I want to exchange the supermarket rewards points or the air miles for some kind of good or service, I must do it through the issuer.
I can send you the dollars, pounds or euros, but I have to do it through a bank.
If I had those dollars, pounds or euros in cash on my person and you were standing next to me, I could hand you that money directly. But most of the people or companies with whom we transact today are not in our immediate vicinity, so we have to send the money via a bank or even a courier.
Making payments this way can be costly, particularly payments abroad or for small amounts. Western Union, for example, can charge as much as 10% of the total money transferred.
There is also the issue of privacy – the bank and people who work for it can see how much money you have, what you buy with it, who you buy from – and what your entire spending habits are.
There is also the issue of risk. The courier could be robbed, the bank could go bust (in theory at least) and so on. It is also worth remembering that money deposited in the bank becomes the property of the bank; it is no longer yours – a fact the majority of people are not aware of.
Also, not everyone in the world has a bank account. While over 90% of adults in first world countries do, in poor countries that number falls to about 40%.8 Sixty per cent of people in poor countries, in other words, have no access to basic financial services and thus are excluded from the financial system.
But here’s the key: with internet access, I can send a bitcoin directly to you with no intermediary, just as I could hand you a note if you were standing next to me. A bitcoin transaction is direct, frictionless and private.
In other words, unlike the dollars, the air miles and all those other forms of money, the bitcoin is digital cash.
Digital cash.
The possibilities are endless.
One of the biggest mysteries of our time: where money comes from
Most people have no idea where money comes from.
Even th
ose who think they do know are usually wrong.
Once upon a time, of course, we used metal as money – gold, silver, nickel and copper. We’ve also used items as varied as shells, cocoa beans, whales’ teeth, even salt (from where we derive the word ‘salary’). These ‘commodity currencies’ all occurred naturally and had a cost of production to them. You had to mine the metal, grow the beans, collect the shells and so on.
Gradually, pieces of paper representing gold or silver stored in a vault were preferred to the actual metal, though you could swap that piece of paper for actual gold if you wanted. This was ‘representative currency’. During the time of the gold standard, laws would, eventually, limit the privilege of issuing representative notes to the central bank. However, money was still based on gold and silver and so it still had a cost of production.
In 1914, France, Germany and the UK came off the gold standard. In other words, it was ruled that those pieces of paper money issued by the central bank could no longer be swapped for gold. Now it was the law, rather than gold and silver, which gave money its value. You had to accept this paper in payment of debt. And, because it was now just paper, money had a minimal cost of production.
In 1971, the US followed this same path to fiat money – ‘fiat’ meaning by government command. Effectively, governments had granted themselves the right to create money for nothing, a right they did not previously enjoy. The age of the large state in which we now live would quickly follow.
Over the last 30 years, however, those government pieces of paper have been used less and less. With electronic banking, which began in the early 1980s, money has become digital or electronic. With this change, the power and influence of banks has grown.
In the US, there are currently about 1.3 trillion dollars in existence in the form of bills and coins.9 Some are held in banks, some by companies, and some by individuals. Those 1.3 trillion dollars of printed notes equate to just 8% of all US dollars.10 But many of those printed notes have been lost or destroyed and between half and two-thirds are estimated to be abroad,11 so it is now thought that just 3% of the US dollars in existence are in physical form in the US.
In the UK, there is a similar story: 3–4% of money in banks and building societies exists in physical form.12
Governments have coined or printed the 3–4% of money that is physical cash. But the remaining 96–7% of money is almost all created by banks. Contrary to what most people believe, it is not the government and the central bank that make most of our money. It’s banks.
Many people shake their head incredulously at this. How on earth can it be?
Well, banks (not central banks, but so-called ‘private banks’; the likes of HSBC or Wells Fargo) create money when they make loans. Consider the sale of my house. The purchasers took on a mortgage to buy it, as is normal. In issuing the mortgage (for which they took the deeds of the house as collateral), the lending bank created money, which was then paid to me. The funds didn’t come from investors or from the deposits of others. The money did not previously exist.
Thus modern electronic money – dollars, pounds and euros – is created through lending. Of course, governments create money through such processes as quantitative easing, but, even so, most money is lent into existence. This power to ‘create’ money through lending is what has made the worlds of banking and finance so large, powerful and rich.
Modern money could thus be defined as ‘electronic debt-based fiat currency’.
Research by UK think tank Positive Money shows that since 1989, money creation has been growing by 11.5% per annum. Compounded over time, the entire money stock doubles every six years and three months. This used to be what we called inflation, but modern measures of inflation now ignore money supply and instead focus on the prices of certain goods.
The morals of such a system – where certain privileged groups get to create money – are dubious. The system has, as I argue in depth in Life After the State, created all sorts of inequalities across society, chief among them the wealth gap. But, because money supply growth is no longer considered important, many of the causes of inequality go undetected, while the proposed cures are misdiagnosed.
The shortcomings of our money systems are something that Satoshi was attempting to address when he designed Bitcoin:
The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. Their massive overhead costs make micropayments impossible. 13
Discounting trust, Satoshi set out to design a system of money based on ‘proof instead.’14
Cryptographic proof.
The science at which Gandalf the Grey was a master
You send a letter to a friend. The contents of that letter are between you and your friend – you don’t want the postman or anyone else reading your letter – so you seal it in an envelope.
A man is in a restaurant with his wife. A waiter is standing at their table. The wife wants to tell her husband something, but without the waiter knowing. She nudges him under the table or gives him a secret look.
Pursued by the nine black riders of Mordor, Gandalf needs to get a message to Frodo and Strider. The future of Middle Earth is at stake. He leaves some runes on a pile of stones on Mount Weathertop.
We are discussing the practice of secure communication between parties within the presence, but without the understanding, of third parties. When such communication takes place electronically, and confidentiality is desired – perhaps it is a communication between you and your bank, and you don’t want internet service providers, crooks or the NSA to know what’s being said – some sort of encryption software is used. As you can imagine, the role of encryption in the computer age is enormous.
The science of encoding and decoding data to maintain privacy is the science of cryptography. And remember, when Satoshi Nakamoto first announced Bitcoin, he did it on a mailing list only read by people with an interest in cryptography.
The primitive tropical island that would become a blueprint for Bitcoin
The tiny tropical island of Yap lies in the eastern Pacific Ocean, about a thousand miles to the east of the Philippines. It is about 38 square miles.
Many hundreds of years ago, voyagers, led by a man named Anagumang, travelled some 300 miles from Yap to its closest neighbour, the island of Panau. There they found a kind of limestone rock, rather like marble – calcite rock to be precise – which they had never seen before. It was white, translucent and it sparkled in the sun. They were transfixed by what they saw. Using stone tools and shells, they quarried some of the rock and brought it home.
Back on Yap, the shiny rock was a big hit. People wore it as jewellery and expeditions soon set out to retrieve more of it. Its beauty, its scarcity and the great risks involved in bringing it home (300 miles by canoe) made it extremely precious to the Yapese – just as gold and silver were to people elsewhere in the world.
Deals were struck with the Palau-ans. For the privilege of quarrying their rock, the Yapese paid them beads, coconut meat (copra), even sea cucumbers. They also did jobs for them.
As the rest of the world moved from using gold and silver as jewellery to using it as money, so the Yapese – who had no precious metal – started using this stone as money. It was cut into disc shapes – like coins, in many ways, although considerably bigger. Most were about a foot to two feet in diameter, although they could get as large as five feet across. Holes were cut through the middle of the discs, giving them the look of large doughnuts, so they could be carried on a bamboo pole. They are now known as Rai stones.
They were transported back to Yap on rafts, towed by canoes with sails. During the summer months
when the winds and currents were favourable, unmanned rafts were pushed out to sea carrying their valuable stone cargo. Of course, many of them would not make it back to Yap.
The more gold there is in a coin the more valuable it is. The more of this rock there was in a Rai stone the more it was worth. When European travellers arrived in the 19th century with larger ships and iron tools, the stones got even bigger. The largest that made it across the water is found on a small island to the north of Yap, called Rumung. It is almost ten feet across and a foot in width. Weighing several tonnes, it would take over 100 men to lift (it takes about 40 men to lift one tonne).
The Rai stones were the biggest, heaviest, least portable currency in all human history.
The largest stone has been found where it was abandoned back on Palau. It weighs some seven-and-a-half tonnes and is almost 12 feet across. It is also broken. And therein lies one of the problems with this stone cash. Not only were many of the rocks too big to be constantly moved about as you might move around gold, silver or any other form of money, they could also break easily. So the larger stones were simply left in prominent positions in villages and outside people’s homes as displays of wealth.
Rather than move the stone each time a transaction took place, the stone was left where it was and ownership of the stone was transferred. The ownership was recorded orally and retained in locals’ memory.
Picture an enormous Rai stone sitting prominently in a village. Everyone in the village knows the stone and who it belongs to. Of course this stone wouldn’t be used for everyday transactions, but perhaps the owner gives it to someone else as part of a dowry, or a political deal. Perhaps it is inherited. The stone doesn’t move. But the villagers will all now know the stone belongs to someone else.
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