What is Bitcoin? Examining the historical context
What is Bitcoin, anyway? Magic internet money? A financial revolution? A pyramid scheme? In this series of three articles, Cloudbet explains all the bits behind the coin. In part one we uncover the historical context that led to the rise of Bitcoin.
Quite literally, Bitcoin is a peer-to-peer electronic cash system, as stated by its creator(s), the mysterious individual(s) that go(es) by the alias of Satoshi Nakamoto. Although that description turned out to be somewhat accurate, time has shown that Bitcoin's impact would extend far beyond this pragmatic statement of intent.
Bitcoin has taken wings and, like Frankenstein's creation, a life of its own.
And now, the cat is out of the bag. It's alive.
In context: a brief history of Bitcoin's roots
Before we go into the hows, let's just take a brief look at the how comes.
2008 was an eventful year. Perhaps ominously, The Dark Knight brought growling back into the mainstream. Katy Perry kissed a girl (and liked it). And the world's economy crumbled under the biggest financial crisis in history.
People watched in despair as their lives' savings evaporated by the crookery or sheer incompetence of the world's biggest banks and nations. Institutional trust hit an all-time low, as the whole system proved incapable of (or unwilling to) prevent the meltdown.
Rising inflation meant losses affected not only rich stockholders, but everyone. Fiat currencies throughout the board were diluted to pay for the bill which, adding insult to injury, included a service charge (in the form of big fat bonuses) to the people that enabled the whole thing.
We’ve got trust issues
Well, the biggest casualty of this bloodbath was trust. And, as it happens, trust extends far beyond accepting your creepy co-worker's romantic accolades as true. Trust is the social cement that enables human collaboration.
Trust sprouts naturally inside families and in small communities where everyone knows each other. However, as societies grew larger and business more impersonal, the need for collaboration between strangers became less the exception and more the rule, and the need for a streamlined vessel for trust became increasingly more blatant.
That’s where money comes in.
Show me the mon-ay
The value of money doesn't lie in the paper it's printed on, or in the metal from which it is coined. Nor in how many zeros you have in your bank account, or because any given government says so.
A dollar is a token, an IOU message which translates debt into a universally accepted, measurable and accountable language. It only has value as long as people trust other people will accept it, and only so much value as they collectively believe it will have.
Currencies are incarnations of money evolved inside (and generally controlled by) nation-states. They are agreed-upon - or sometimes enforced - conventions to facilitate the exchange of value between strangers. Currencies have taken countless shapes through times. Before credit cards, banknotes and coins, there was gold, salt, seashells, livestock, cereals, and even giant doughnut-shaped rocks.
All of these were used at some point as stores of value, units of account, and means of exchange, the three fundamental roles of money. And during the time they were in use, each of them satisfied - with varying success - the six requirements for money:
- Durability: good money doesn’t degrade and stores value for longer;
- Portability: money is less useful if it is hard to be moved;
- Divisibility: precision drives more accurate value exchanges;
- Uniformity: multiple instances for the same value creates uncertainty;
- Acceptability: the more people accept it, the more useful it is;
- Limited supply: if money is easy to come by, it will be less valuable (leading to inflation).
Money itself, however, is more than the sum of these traits; money is a symbol. Money is crystallised trust.
It’s the economy, stupid!
Grossly oversimplifying, our financial system can be roughly seen from under this light as a means for storing, communicating and managing trust. The thing is, managing this trust isn't easy. And as our economic activity grew, scaling a system to manage everyone's trust became increasingly harder.
In the 21st century “The Economy” accelerated into a tangle so complex and abstract as to become pretty much detached from most people’s reality. In 2008 this complexity reached its apex with subprime loans, MBS, CDOs, CDSs and a whole alphabet of acronyms for “innovative” financial products that were so complicated no one actually understood them. No, really. Things got so esoteric that Wall Street was hiring physicists to try and make sense of it all. Seriously. Sure someone must have been watching over the economy so nothing bad would come out of this, right?
To deal with snowballing financial complexity, most modern states had evolved a central controlling entity that went on to become the de facto steward of collective (financial) trust: central banks. Manned by highly specialised bureaucrats, these financial institutions’ main job is to oversee a country’s economy and manage its monetary policy to steer it away from recession, inflation and other evils.
On paper, most central banks are designed to operate with a fair amount of independence from the fickle politicking of elected governments (at least in democratic countries). These public servants report (to a certain extent) to elected officials who are (at least in theory) accountable to the public, and these two groups work in tandem to draft and enact financial regulation. What could go wrong?
Hand in hand, they work tirelessly to achieve the common good, always putting public interest in front of their own, in a transparent and easily-accessible system that aims for long-term stability, not short term gains. Except…
To the surprise of absolutely no one, reality has shown this not to be the case. Or at least some of the cases. Enough cases that 2008 happened, and trust was broken big time.
And as anyone who ever got caught lying knows, trust is one hard vase to mend.
Let’s do a quick recap:
- Worst recession in history
- Governments bail out those responsible with public money
- Bonus bonanza to everyone involved
- Nothing changes
If there is one takeaway from all this is, even if safeguards are in place to mitigate it, people always find a way to abuse trust. That’s bad enough when a single person is affected by the abuse, let alone the world’s whole freaking economy.
It was clear that we could benefit from taking these points of failure (also known as humans) out of the system as much as possible, and that a system that does not require - or at least that requires less - trust was desirable. But how? Sure such trustless system was impossible. If people can’t be trusted, what can?
In code we trust
As chance may have it, since the early 1990s a jolly group of privacy-obsessed geeks had been tirelessly working on possible solutions to this very problem. Born circa 1992 as a mailing list, this group called itself the “Cypherpunks” in playful reference (or perhaps reverence) to the science fiction subgenre.
At their inception, the group’s focus was in discussing high-level concepts like cryptography, privacy, and individual freedom. These shared ideals were translated into bytes at a 1993 manifesto by hacker Eric Hughes. This document, presumably dismissed by contemporary intelligentsia as a libertarian’s wet dream, was quite the premonition of what was to come:
[P]rivacy in an open society requires anonymous transaction systems. Until now, cash has been the primary such system. An anonymous transaction system is not a secret transaction system. An anonymous system empowers individuals to reveal their identity when desired and only when desired; this is the essence of privacy.
-- The Cypherpunk Manifesto - Eric Hughes (1993)
Before you condescendingly shrug it off as "just some stupid nerd-crusade” and crack a joke about their parents’ basement, we encourage you to take a look at some of the names that came out of the cypherpunks' ranks:
Participants were scattered all over the political spectrum and held a vast range of beliefs, but one thing they all seemed to share was a profound contempt for centralised powers and the current politico-financial establishment. They opposed what they perceived as the ever-growing empowerment of the state, and the steady decline of individual freedoms.
Over almost two decades, albeit sometimes inconspicuously, they had been one of the strongest pro-privacy and pro-freedom champions of a fledgling internet. Through their activism (and actions), they helped shape the cat-ridden, social media-ruled den of Rick Astley-dancing trolls that we now call the web. And yes, it could be much, much worse.
Some cypherpunks, including Adam Back, Wei Dai, Hal Finney, Nick Szabo and the elusive individual(s) that went by the alias of “Satoshi Nakamoto”, went even further. As it was, they took upon themselves to try and find a solution to what they perceived as being the most fundamental flaw of the whole system: the state’s control of currency. You know, because the state was doing such a great job?
For these visionary geeks, the way to do that was obvious: to remove the weak link (people) from the controls, instead handing the running of the operation to the relentless, incorruptible logic of code.
Ever since the David Chaum’s ecash, several attempts had been made at an electronic cash system (such as Adam Back's hashcash, Wei’s b-cash and Szabo’s Bit Gold), but up to then, they all fell short for one reason or another. However, one iteration at a time, they were slowly building up towards that vision of an anonymous, secure, near-instant digital currency.
In 2008, most technological components were already there; it only took someone with that spark of genius to put them all together. So, after several iterations and improving on the works of many brilliant predecessors, at that fateful October 31st, Satoshi finally cracked the puzzle.
However, it’s not enough for a piece of technology to be revolutionary. Even if a given tech is safer, better and faster than everything we have in place, to really make an impact and change the world, there is one key ingredient that needs to be present: public interest.
That seems quite easy in theory. Why wouldn’t the public be interested? However, as many an entrepreneur have found out, it doesn’t work that way. Any changes to the established order is met with strong resistance by the powers that be. This was true of arabic numbers, light bulbs and electric cars, let alone when you are going against the whole financial establishment, who we can only imagine as boasting a “if it ain’t broke, don’t fix” tramp stamp at a sunny Cayman Islands private beach.
Until then, everything seemed to be working just fine, so why should anyone care?
Perhaps tellingly, at the same time the 2008 financial crisis hit is peak, and it became blatantly clear that something was indeed broken. And suddenly Bitcoin wasn’t just a libertarian-geekish dream anymore.
Satoshi Nakamoto, whoever she/he/it/they is/are, has brought about something that many really smart people believe is going to change the world. Bitcoin holds promises beyond the obvious financial applications it already has. As a new network paradigm and innovative trust-management system, it has the potential to revolutionise myriad human endeavours.
How come? In the second part of this article, we explore what exactly does Bitcoin do, how does it do it, and why should you even care about it. After that look under the hood, in the third and final part we explore where does Bitcoin stand right now, take a look at the whole ecosystem and try to understand what lies in the future.