What were the types of digital money (also known as virtual currencies) that preceded bitcoin, and ultimately led to the creation of a new kind of digital cash? Why did these systems ultimately fail, and what were the lessons that led to the success of cryptocurrencies?
To tell this story, we’ll take a walk down memory lane and visit five of the most important projects that preceded bitcoin (and all cryptocurrencies that followed): namely, Ecash, E-gold, hashcash, b-money, and BitGold.
Electronic money, digital, or virtual currencies?
First, there’s a lot of confusion around names: electronic money, digital and virtual currencies, cryptocurrencies - these terms are sometimes used interchangeably.
So before we start we need to distinguish between digital fiat money, which is issued by central banks and governments, and independent, digitally-native currencies, epitomised by bitcoin.
The concept of digital money goes way back. Banks started using computers to store digital ledgers of financial transactions already in the 1970s, and with the end of the gold standard (1971), this digital representation increasingly became the norm. The birth and growth of the internet exponentially increased the use of electronic money, turning paper into bits - but with no fundamental change in the issuance and control by the authorities.
Although there’s no ultimate agreement, the term “digital currency” usually refers to electronic representation of sovereign (fiat) currencies - but it’s also widely used as an umbrella term for all kinds of electronic money.
In contrast, according to the European Central Bank, virtual currency is defined as "a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community". You know, the exciting kind. Since we’re not the European Central Bank, there’s nothing to stop us from referring to bitcoin’s ancestors by any of the aforementioned terms.
And that’s where our story starts.
A brief history of cryptocurrencies
These developments were at the core of the Cypherpunk movement in the early 1990s. By 1994, the list grew to 700 members, culminating at over 2,000 members around the end of the millennium, including some of the most brilliant minds in cryptography, computer science, and a myriad other areas - as well as one Satoshi Nakamoto.
Ecash and DigiCash: pioneering digital money
Computer scientist David Chaum first introduced the idea of using cryptography to enable a form of anonymous digital cash in 1983. He conceived Ecash, the world’s first attempt at an independent, cryptography-based digital currency with focus on privacy.
In a research paper titled “Untraceable Electronic Mail, Return Addresses, and Digital Pseudonyms”, Chaum mentioned the importance of privacy and developed the concept around public keys cryptography — which led him to invent the blind signature technology.
Later in 1989, David Chaum created DigiCash Inc. - an electronic money corporation that aimed to commercialise the ideas found in his research and put Ecash to work. Pioneering privacy, transactions were anonymous. The Mark Twain bank in Saint Louis was the first institution to implement Ecash for digital payment.
After a one-year trial, adoption failed and the company declared bankruptcy in 1999. Perhaps crucially, e-commerce was still not fully integrated into the web at the time. Chaum later claimed that “as the web grew, the average level of sophistication of users dropped. It was hard to explain the importance of privacy to them”.
The concepts pioneered by Chaum evolved and grew, together with increasing pressure for privacy and cryptography. The blind signature concept was a key strategic development for the birth of bitcoin.
E-gold: digital gold with instant transactions
E-gold was a virtual currency created and released by oncologist Douglas Jackson and attorney Barry Downey in 1996. The E-gold system was a digital gold-based currency that enabled peer-to-peer transactions. It was once described by the Financial Times as “the only electronic currency that has achieved critical mass on the web”.
A pioneering form of a successful micropayment system, e-gold allowed instant transfers of digital gold tokens through micro transactions. It was used by individuals and merchants for online services such as trading, auctions, and casinos, as well as non-profit organisations.
Despite its popularity, e-gold suffered a government intervention that led to its complete shutdown. Under the Code of Federal Regulations in the U.S., e-gold was banned from the definition of "currency" and was accused of operating without the required money transmitter license.
Ultimately, e-gold got shut down because the US government wasn't happy with a company running a currency that competed with the US Dollar. A case was brought against e-gold in 2008 and Dr. Jackson pleaded guilty to "operation of an unlicensed money transmitting business" and "conspiracy to engage in money laundering".
The immediate settlement enabled by e-gold drove the emergence of systems based on peer-to-peer transfers and digital rights — ideas which will be taken in the development of smart contracts.
Egold had its security flaws, which helped future projects from the start. But most importantly, it highlighted the greatest weakness of early attempts at digital cash: being centralised and dependant on a single point of failure, the whole system could be arbitrarily shut down almost overnight.
Hashcash: anti-spam proof-of-work system
Despite its name, Hashcash has little to do with cash - or in that sense, with human currencies or money in general; nor was it created to have. Hashcash was created in 1997 by Adam Back, a British cypherpunk and one of the most prominent figures in crypto today, as a proof-of-work system used for spam control for emails.
In a somewhat gross analogy, you can think of Hashcash as a system that charges computer-currency (namely computing power and time) as part of the logic for executing a certain operation. Just like a toll, but for computers.
We know, we know - including it alongside actual digital currencies is a bit of a stretch. But hey, there’s “cash” in the name, and it did play a pivotal role in the development of cryptocurrencies. Without Hashcash’s proof-of-work there would be no bitcoin as we know it today.
B-money: anonymous, distributed electronic cash system
B-money, proposed by computer scientist Wei Dai in 1998, built on top of Hashcash and earlier digital currencies. It was an attempt at enabling “an anonymous, distributed electronic cash system”.
The core concept, which is mirrored by some of the biggest cryptocurrencies today, combines the idea of a collective ledger with game theory elements, whereby participants should be rewarded for their services to the network. It was described as a “money which is impossible to regulate.” Unfortunately, it was also impossible to build, and it never left the paper.
That said, b-cash was one of the biggest inspirations for bitcoin. Indeed, Satoshi Nakamoto, who took some ideas from the cypherpunk mailing list, referenced the project in the original bitcoin whitepaper.
With that many similarities between Bitcoin and b-money, some people speculated that Dai could be Satoshi Nakamoto, a claim which he vehemently denies.
Bit gold: decentralised network project
Bit gold was a proposed system described in 2005 by computer scientist, cypherpunk, professor, and cryptographer Nick Szabo that integrates the fundamentals of a financial system based on blockchain technology. Satoshi Nakamoto implemented many ideas from the bit gold project in the bitcoin protocol.
Visionary, Szabo believed in the creation of a transparent financial system with no intermediaries, and mentioned his reasons to believe in the project: “A long time ago I hit upon the idea of bit gold. The problem, in a nutshell, is that our money currently depends on trust in a third party for its value”.
Bit Gold was the first to entertain the idea of using a decentralised network and to propose the complete removal of a trusted third-party to verify transactions, the last missing piece for the bitcoin puzzle to fall into place.
Cryptocurrencies and beyond
Bitcoin was the first project to fully implement a secure, decentralised economic protocol with a digital currency and peer-to-peer transactions. By cleverly combining the best features of its predecessors and learning from their failures, bitcoin enabled a completely new way of organising trust.
Satoshi’s creation paved the way for other cryptocurrencies to evolve. The first ones were merely bitcoin forks like Litecoin and Monero, but others improved upon the system and took it to a whole other level (like Ethereum).
Although there is much debate around the future of bitcoin and cryptocurrencies, a lot of really smart people are certain that they are here to stay. And after one decade of development and the rise of a whole new market (worth hundreds of billions of dollars), reality seems to confirm this.
Furthermore, bitcoin is no longer alone. High-profile coins and projects as Litecoin, Stellar or Ripple offer different paths for the future of finance. Privacy-oriented projects like Monero, ZCash, Beam and Grin aim to return privacy to humans in the age of surveillance. And finally, general-purpose systems like Ethereum, EOS and Cardano aim to become a decentralised, censorship-resistant world computer, enabling smart contracts that extend the same level of trust to countless other use cases.
The future of cryptocurrencies is far from clear, and many obstacles remain - such as scalability, energy consumption, adoption, and perhaps more crucially, regulation. Today bitcoin is already considered a first-generation cryptocurrency (in contrast with second- and even third-generation), and TechRadar highlighted 6 other cryptocurrencies which could become the new bitcoin.
So will bitcoin win in the end? Or will another currency become the next bitcoin? Does this question even make sense at all? As we enter a brand new age unlike anything we’ve encountered before, perhaps there’s no single winner, but a host of currencies coexisting in harmony, exchanged from peer to peer, each carrying their own benefits and limitations.
Living this close to the bleeding edge, we seem to be constantly a few lines of code away from a new paradigm. How about you - what do you think a crypto future will look like?