Guest post by Bravado Trading
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In 2008, a paper came online titled Bitcoin: A Peer-to-Peer Electronic Cash System. Penned by Satoshi Nakamoto, readers and investigators soon came to the conclusion that Nakamoto did not exist and that whoever the real person or people responsible for introducing Bitcoin wished to remain anonymous.
The very first two lines of the Bitcoin abstract read:
A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending. We propose a solution to the double-spending problem using a peer-to-peer network.
From the outset, Bitcoin was designed to be an autonomous network for digital cash that made third-party financial institutions obsolete. The way Bitcoin accomplished this was through the introduction of an entirely new technology called blockchain. Blockchains are ongoing chains of events organized into blocks. Think of them as sprawling ledgers that continue adding transaction data as it comes in. Deciding exactly which transactions can be added to the blockchain, however, is where the real revolution is happening.
In order to add information to a blockchain, that information must first be validated. But unlike the centralized validation practiced by financial institutions, transaction data on a blockchain is validated by a decentralized network of nodes, or servers, who work to create consensus surrounding a chain of events.
The chain of events with the most consensus surrounding it becomes the longest one and is therefore trustworthy.
Similar to Wei Deiʼs b-money network wherein nodes minted new coins by solving computational problems, Bitcoin also utilizes a form of competition to validate the transactions which form a blockchain. This competition is based on a network of validators, called miners, who compete with each other for the transaction fees locked inside every new block. This process, called mining, is essentially what keeps the network honest.
Transactions happening on the Bitcoin network are rolled into blocks according to their timestamps. When a new block comes along, miners on the network use considerable CPU power to try and guess the target hash (a 64-digit hexadecimal number) for that block. The target hash being guessed at is the key which unlocks that blockʼs transaction fees and rewards them to the miner who guesses first. The winning miner then broadcasts the result to the rest of the network, and if all nodes agree that the new blockʼs transactions are valid (based on the past history of blocks), then it is added to the blockchain and work begins on the next block. This process of finding a number, broadcasting it, and then beginning work on the next block is called proof of work.
All of this work is what goes into preventing double-spending without having to appeal to a centralized financial institution for the truth. Since the longest chain represents the truth of a blockchain network, in order for a double-spend to occur an attacker would need to either redo the work of all of the validated blocks in the chain (an impossible computing task), or take control of 51% of the nodes on the blockchain network and have them all signal a chain containing false transactions.
Through the work of mining, miners ensure that the blockchain network retains the core qualities of being:
- Immutable: Once blocks are finalized and work begins on the next one, finalized blocks are said to be immutable. This means they can not be altered, edited, or copied in any way and become a permanent truth.
- Decentralized: Decentralization refers to the fact that blockchain networks are made up of a vast array of nodes which all maintain identical copies of the blockchain record. If one node were to go down, then any number of the operational nodes could be referenced. This makes blockchain networks highly secure and reliable.
- Consensus-based: Rather than being reliant on a central fixture for decision making, blockchains are based on majority consensus between the nodes of a network.
A New Era of Trust
Satoshi Nakamotoʼs creation of the proof of work method for accepting new blocks onto the blockchain was a watershed moment in the history of trust, and the reason is simple.
Blockchains ensure trust between two parties without the need for a middle-man who decides what is true and what is not.
This new, digital trust that is backed by a globally distributed network enables people the world over to transact with each other directly in a way that is fast, peer-to-peer, extremely low-cost, and highly secure. After a decade of operation, the Bitcoin blockchain has never recorded a double-spend or a dishonest event of any kind.
With every subsequent block added, the already impossible computational power required to attack the network becomes even more so.
Bitcoin is a digital currency backed by a blockchain, otherwise known as a cryptocurrency. When you buy bitcoin, what you are purchasing is a piece of the network which was created in limited supply (referred to in the previous section as scarcity). As of the time of writing, 17 million bitcoins are in circulation, and only 21 million will ever exist in total.
Using bitcoin is essentially just like using any other currency – it is a mode of payment between two parties. The difference, however, between bitcoin and dollars, yen, and euros is that unlike traditional forms of currency bitcoin is a global currency with a fixed supply. When governments are in need of more money they simply print more of it. Bitcoin, on the other hand, is limited to 21 million after which no additional bitcoin will ever be created.
While taking these qualities into consideration, it is important to note that there are 7.4 billion people on earth, with over 3 billion of them having access to the internet, and all of them having at least some necessity of money. As banks and legacy financial institutions fail their clients the world over through economic crises, debt, exorbitant payment processing fees and wait times, and other inconveniences, how long will it be before those people turn to the financial autonomy offered by Bitcoin and other blockchain-based cryptocurrencies?
Judging by the speed with which major financial institutions across the globe are adopting blockchain technology, the answer to that seems to be sooner rather than later.
Stay tuned for our next guest post from Bravado Trading: Order Type Basics.