Many of the stones that were quarried in Palau never actually made it all the way to Yap, particularly when travelling by unmanned raft. Many would sink. There is even one story of a crew making it to within a mile of Yap before a storm sunk both the canoes and the rock-laden rafts they were carrying. On one of the rafts was a particularly large stone, which was now lying at the bottom of the sea, miles off the coast. Even this stone, and other sunken stones besides, would be traded, with ownership of the stone recorded orally in the same way as ownership of the stones that were visible in the villages. You know that stone that sunk three years ago and is lying on the ocean floor? That’s Gary’s.
There are all sorts of parallels between this primitive system of Yap and the idea at the core of Bitcoin.
Bitcoins stay on the internet, just as Rai stones stay where they stand. But with each transaction that takes place, ownership of those bitcoins changes. That ownership is recorded on a ledger – a huge database that is shared across the Bitcoin network just as ownership of a Rai stone was shared across the local memory. The database is transparent and there for all to see. Every bitcoin transaction that takes place for even the smallest amount – every detail is recorded on it. The database provides the mathematical evidence – the so-called ‘crypto-proof’ – on which Bitcoin is based.
It is called the ‘block chain’.
The evolution of digital cash – and the monies that failed
In 1955 and 1956, a generation of computer geniuses was born. This gamechanging cohort includes Tim Berners Lee, Bill Gates, Steve Jobs – and a little-known mathematician by the name of David Chaum.
Chaum was one of the pioneers of early cryptography and the grandfather of digital cash. He first proposed the idea of digital cash in 1982,15then developed his thinking in 1985 with the fantastically titled paper, Security Without Identification: Transaction Systems to Make Big Brother Obsolete. By the late 1980s he had teamed up with two Israeli cryptographers – Amos Fiat and Moni Naor – and they wrote the paper Untraceable Electronic Cash.
In 1990, Chaum founded the company Digicash to try to commercialize his ideas. This led to the development of ‘ecash’, which you could use to ‘safely and anonymously pay over the Internet’.16 At this moment in history, credit cards were still considered unsafe and insecure. It was not clear who was going to win the battle to control internet payments.
Company after company became interested in Digicash, but each time, Chaum scuppered the deal. He faxed a copy of one offer he received to all the other interested parties – and, in retaliation, the other parties pulled out. ING and Goldman Sachs were about to list Digicash on the stock market, but on the day of the deal – with eight VIPs from the two banks in the room – Chaum refused to sign. Bill Gates is said to have made an offer of $100 million, wanting to integrate ecash into every copy of Windows 95. But allegedly Chaum wanted two dollars per sold copy of Windows 95. In 1996, Visa wanted to invest $40 million – Chaum asked for 75.
Sometimes he wanted more money. Sometimes, say those who worked with him, he got paranoid. Sometimes he was too controlling. Throughout he believed so arrogantly in the superiority of his product that he thought a better offer was always just around the corner.
Eventually he paid the price for his hubris. He never made the deal – and credit cards won the battle to control electronic payment.
Chaum faded into the background and in 1999 Digicash went bust.
(By the way, if I’m correct in my assessment of who he is, Satoshi even worked for Digicash in the 1990s.)
Perhaps the most famous digital money before Bitcoin was E-gold.
E-gold was the invention of an oncologist and economic history buff, Douglas Jackson, and an attorney named Barry Downey.
The idea was that you could open an account, buy some gold and then use that gold as means of payment to other E-gold account holders.
E-gold was founded in 1996. By 1999 – even though gold itself was right at the bottom of a 20-year bear market – it was already so successful that the Financial Times called it ‘the only electronic currency that has achieved critical mass on the web’.17 Jackson believed his payment system, backed by solid gold, would eventually rival fiat currencies.
At its zenith in 2008, E-gold was processing over $2 billion worth of transactions a year with some four million accounts open. The problem was many of these accounts were operated by money-launderers and drug-dealers. It fell victim to hacking, fraud and identity theft. E-gold was already under FBI investigation in 2005. By 2009, it had been shut down.
Its founders faced all sorts of legal calamities – and are still dealing with the fall-out. I’ve no doubt seeing their fate is part of the reason Bitcoin’s founder so prizes his anonymity.
Other companies with similar models to E-gold sprang up and failed in the Noughties – eBullion, Standard Reserve, INTGold and even a multi-million dollar Ponzi scheme that had no gold at all, OS-Gold. James Turk, founder of the gold storage facility Goldmoney, had also patented an e-gold payments system, but Goldmoney abandoned this in 2012 because of the cost of compliance.
So, Digicash failed because it had an erratic man in charge and it went bust. E-gold failed because the FBI shut it down. For all their genius, the success of both systems was dependent on the companies that ran them – they had a central point of failure.
‘A lot of people automatically dismiss e-currency as a lost cause because of all the companies that failed since the 1990s,’ said Satoshi. ‘I hope it’s obvious it was only the centrally controlled nature of those systems that doomed them. I think this is the first time we’re trying a decentralized, non-trust-based system.’18
Bitcoin is different. There is no single company that issues the coins or maintains the system. It is a distributed network – there is no central point of failure.
How Bitcoin works
If I send you an email, I can, if I want, then copy and paste that email and send it to someone else. I could do the same with a picture, a document, a film – any form of digital code. What’s to stop me doing the same with digital cash – cutting and pasting the code and spending the same piece of cash over and over again? This is the problem of double spending.
This is not, of course, a problem with physical cash. I cannot give the same dollar bill to two people at once. But it has been one of the fundamental problems of digital cash. If people can spend the same money twice, they’ll find ways to spend it hundreds of times over, rendering the money useless.
Banks prevent this happening. Take old-fashioned cheques. If I wrote two cheques for $10 each and I only had $10 in my account, the bank would decide which one to honour and which one to bounce. With internet banking, they have other preventative systems in place.
PayPal, as blogger Gwern notes, processes transactions in real time, ‘so you cannot log into your PayPal account in two different browsers and send your entire balance to two different people’.19
Both Digicash and E-gold also relied on a central body to log all transactions and police the network.
But all these systems, whether they use fiat money, gold or ecash, rely on a so-called ‘trusted third party’. That was unacceptable to Satoshi.
‘The usual solution is for a trusted company with a central database to check for double-spending’, he says, ‘but that just gets back to the trust model. In its central position, the company can override the users, and the fees needed to support the company make micropayments impractical…’20
But, in a distributed system without centralization, there is a different set of problems. Who runs it? Who has power of veto? With two conflicting transactions, who decides which is the real one? Who prevents double spending? Put another way, how do you guarantee trust?
This was something that had confounded computer scientists for years, so much so that the idea of digital cash had all but been abandoned. It was known as the Byzantine Generals problem.21 And Satoshi solved it.
The solution lay in the block
chain.
In ordinary life, neither you nor I can create money. We can earn it. We can be given it. But we can’t create it out of nothing.
Bitcoin is different. If you want to, it is possible to make them yourself.
Obviously this is quite a startling idea. So let’s go through it slowly.
You make bitcoins, or, to use the correct term, you ‘mine’ them by downloading the Bitcoin software and running it on your computer.
That’s right. Anyone with a computer can, in theory, ‘mine’ bitcoins – just as, once upon a time, one could mine gold and silver, or collect shells or salt.
Early in Bitcoin’s evolution, when few coins existed, an ordinary home computer was more than enough to mine coins. But, as bitcoins have grown in value, competition to mine them has grown – and, as a result, so has the amount of computer processing power required for mining. Now you need many powerful computers working in tandem consuming large amounts of electricity. Look up professional mining operations on YouTube and you’ll see huge banks of computers all whirring endlessly away.
When you run the software – when you mine – what actually happens is that you maintain the block chain. You are adding and verifying the records of every recent transaction on the public ledger – compiling it all into a block. A block is, in effect, a file with a record of recent transactions, like a page in a book of accounts. Each new block is then added to the chain – thus you have the block chain. Once a block is added, it is never changed.
Imagine a record of every dollar transaction, however large or small, that has ever taken place and of every new dollar that has been created. It would be amazing and enormous. That is what the block chain is for Bitcoin – an astonishingly comprehensive and completely public record. It will continue to grow – but it needs a great deal of maintenance.
In exchange for mining a block, you are rewarded with bitcoins. So, the dynamic is that people are incentivized to maintain the block chain. It is in people’s interests to mine coins – you’re, effectively, printing your own money. Bitcoin makes use of this self-interest.
As well as a record of recent transactions and a reference to the block that came immediately before, each new block also contains the answer to a complex mathematical puzzle. There are now computers all over the world all competing to solve the puzzle – and thus mine the block – in order to receive the bitcoin reward.
The computer that solves the puzzle first mines the block.
Then the race to mine the next block begins.
A block is mined every ten minutes. The network automatically adjusts the difficulty of the mathematical problem in order to maintain this average of six blocks per hour. If blocks are solved quickly, the puzzles become more complicated – and vice versa.
The idea also is that money should have a cost of production to it. Money should not be free (as it is at the moment for those lucky bodies, governments and banks, that have the ability to create it). Just as gold and silver cost money to mine – and there’s no guarantee that in spending money on mining you’ll actually find and produce metal – so do bitcoins. Bitcoin is a deliberate digital replication of the mining process. Early bitcoins were easy to mine – so is surface gold. As the mine goes deeper underground, it gets more expensive and labour intensive.
So, the cost of bitcoin production is block chain maintenance.
At present, you receive 25 bitcoins (current value about $12,500) for successfully mining a block. The number of coins will fall as more blocks get mined. There are currently about 12 million bitcoins in existence. The eventual maximum will be 21 million – there is a finite supply.
When that maximum is reached, you will no longer be rewarded with new bitcoins when you mine – but mining will still be profitable. Instead, the reward for maintaining the block chain will come from small commissions paid by users every time they send coins.
Effectively, all these computers around the world are voluntarily competing to maintain the block chain and keep it secure. The system is self-reinforcing. The network of miners effectively becomes the public record keeper and regulator – like a decentralized central bank.
The mining process also serves another function – the dissemination of new coins. Different computers win each race to mine a block, so different computers add to the block chain and different people get the new bitcoins. The effect is one of distribution and decentralization.
One computer might conk out, a mining company might go bust, but another will still mine the next block – and the block chain, which is distributed across the network, is maintained. Without the block chain, Bitcoin is useless. Satoshi described ‘a currency based on crypto-proof rather than trust’,22 the block chain provides that proof.
Protected by computation and a distributed network, rather than by the manufacturer, the decentralized block chain has enabled Bitcoin to succeed where others failed. The same fate that struck those other forms of digital cash does not await Bitcoin because it has no central point of failure. A government can make using Bitcoin illegal, the world can lose all interest and move on to something else, but the system cannot be shut down. How do you shut down something that is distributed? Nobody has yet found a way.
Here for the first time was a way to safely send a piece of digital property to someone else without the need for third party contracts and guarantees. Thanks to the block chain, everybody now knows the transfer has taken place, and nobody can challenge its legitimacy. Blogger Gwern writes: ‘The underappreciated genius of Bitcoin is that it says that the valid transaction is simply “the one which had the most computing power invested in producing it”…Within hours, one transaction will be universal, and the other forgotten’.23
First we had money backed by things, and then we had money backed by political command; now we have money backed by mathematical proof.
What’s more, the core technology has so far proved unhackable.
The most reliable and secure digital technology ever invented
Dan Kaminsky is an internet security researcher, famous among hackers ‘for discovering, in 2008, a fundamental flaw in the Internet which would have allowed a skilled coder to take over any website or even to shut down the Internet’.24
‘When I first looked at the (Bitcoin) code’, he says, ‘I was sure I was going to be able to break it. The way the whole thing was formatted was insane. Only the most paranoid, painstaking coder in the world could avoid making mistakes.’
He devised 15 bugs he thought he could use to hack it. Every time he would get a response along the lines of ‘Attack Removed’.
‘I came up with beautiful bugs’, he said. ‘But every time I went after the code there was a line that addressed the problem. I’ve never seen anything like it…Either there’s a team of people who worked on this or this guy is a genius.’25
Kaminsky continued, ‘Here was a system (that)…Created an enormous global cloud of always-on, listening machine; Spoke its own fiddly little custom network protocol; (is) Written in C++, which for all of its strengths is not usually the safest thing in the world to be reading random internet garbage with; (and) Directly implemented the delivery of a Pot Of Gold At The End Of The Rainbow for any hacker who could break it. By all extant metrics in security system review, this system should have failed instantaneously, at every possible layer…But the core technology actually works…my fifteen point list of obvious likely bugs was systematically destroyed by a codebase that quite frankly knew better.’26
What was exceptional was the robustness of Bitcoin. The pitfalls and security problems that even experienced programmers usually end up accidentally creating in their code were almost completely absent. The implication was that Satoshi, coding skills aside, had a great deal of theoretical and practical know-how. He was savvy. Alessandro Polverini, an Italian coder, tells me in an email, ‘My guess is that Satoshi is not a professional developer but a very highly skilled hacker, probably working in the security field.’
In fact
, the protocol is so bulletproof that it has led some experts to believe a government agency created it.
You’ve heard about bankruptcies, hackings, thefts and fraud, for example. This is because companies using the protocol – certain exchanges, for example (so-called third parties) – have not acted like proper financial institutions. Certain operating systems using the protocol are insecure, rendering bitcoins vulnerable to theft. There are also issues with programmers who have failed to understand the block chain. But while the edges of Bitcoin are vulnerable, the core protocol is sound.
The simple fact that it works is what has enabled Bitcoin to take off in the way that it has. It’s also what enabled Satoshi to be so modest in his promotion of it. Blogger Mike Hearn writes: ‘It cannot be understated: the Bitcoin protocol is a monumental technological achievement. Regardless of whether the system will prove to be a real-world alternative to fiat currency, the technical achievement is undeniable. It solves several previously unsolved cryptographic problems surrounding “distributed trust” (for example, the Byzantine Generals’ Problem) and synthesizes technologies such as public-key cryptography, proof-of-work systems (using SHA-256), peer-to-peer and others.’
Nick Szabo, a computer scientist believed by many to be Satoshi, and inventor of a precursor to Bitcoin called bit gold, wrote in an email to me, ‘The core protocol of Bitcoin is sound, and has an unprecedented reliability and security. In other words the core technology is more reliable and secure than any other digital technology that has ever been fielded.’ That is some achievement.
Some hackers see Bitcoin’s creation as a seminal point in the history of information technology. Rather as we have bc and ad, they have proposed that before 3 January 2009 (the date of the Genesis Block) be named Before Satoshi (bs) and after Bitcoin Era (be).
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