You can’t always trust people to pay you — but what if you could trust the money itself?
Money: what is it?
We all use it. We all want it. We all think about how to make more. Money can be tangible, in the form of a bank note. Or it can be intangible, in the form of a snippet of code, rushing through the interwebs as it’s transacted from place to place.
Money can be the pathway to our greatest desires.
But why do people want money? What value is there in a specially coloured piece of paper, much less an abstract number? People don’t value those things on their own.
At its root, money has value because we say it does. They value them because everyone values them, so they know they can exchange it for the things they really want. If nobody accepted money, then nobody else would accept money either — but they do.
That hasn’t always been the case, however.
Originally, the U.S. economy and currency were based on the gold standard. Every dollar printed had solid gold confirming its value. If you went to the central bank and said, “Here’s your money, give me my gold”, you would actually get it!
Of course, gold is also valuable only because people so. Otherwise, it’s just a rare soft shiny metal that can’t be used for very much. But the point is, it’s still something.
After 1971, money became backed by nothing.
Fiat money, which is what the USA switched to using, doesn’t have any physical commodities backing up its value. It derives from other peoples’ perception of worth. It’s valuable only because people decide it’s valuable, and everybody in the world somehow agrees on exactly how valuable it is.
In a booming economy like 1970s America, this kind of move made sense. The government could now print more notes. They could make as much money as they wanted, without having to hunt around for gold to back it. What’s more, they could be fairly certain that the value would hold steady, as it was based on the health of the economy, which is to say, how much value people were giving it.
That “health” would be maintained by everyone — even non-Americans — since a dip in their economy would hurt the established international economy. If the value of their money went down, everyone else’s money would go down as well.
Fiat money was just the first step.
Credit cards are commonplace in almost everyone’s wallets these days. Stores everywhere accept them.Customers find them convenient, since they don’t have to carry around cash and fiddle with change.
The first ever credit card was pioneered in the 1960s by the Diner’s Club. It was advertised as the ‘ticket to a new modern lifestyle’. Cash didn’t seem modern enough to fit into a rapidly-changing newly-digital world. What’s more, credit cards allowed one to spend unlimited amounts of money: buy what you want now, pay for it later.
Credit cards caught on fast, with more companies offering cards and increasing numbers of people buying them. By the 1970s, almost half of all Americans had a credit card.
Today, we often don’t use physical cards at all, opting instead to make our payments online or wirelessly through net-banking and wallets like Paytm. There’s not really any need for cash.
Until, there is.
Most transactions that happen today are closely recorded. Chances are, your credit card company and bank can say exactly how much you spent on any given thing, and when.
For some people, that’s not a very high price to pay, for the ease they’re getting in exchange. But for others, personal data is too high a cost.
For as long as people have known digital money, they have dreamt of a digital cash. That is, a form of currency that worked like cash — untraceable, anonymous, and instant — but still completely digital. They wanted a currency that wouldn’t be dependent on one powerful Central Bank, a bank-account that couldn’t be frozen on the whim of an official.
This basically boils down to a form of online transaction where there wouldn’t be a third party looking over your shoulder and taking notes the entire time.
A group of Byzantine generals encircle a city. Now, they have a choice to make: attack or retreat?
The thing is, any decision they take has to be unanimous, since they need the full firepower of their collective armies to take the city. Even if one general decides to retreat while the others attack, they could all die.
The other thing is, none of them trust each other.
So, they have to route all their battle plans through a third party that verifies their decisions and holds them to it.
The only problem is, the basis of digital cash requires that you throw that third party out.
The internet was built on trust.
And I’m not being metaphorical here. The technology that we call the internet today was developed with the basic idea that the person using it would be a verified party — like a government employee or a teacher. It was designed to help multiple computers operate on a single network, thereby making administration easier.
But today, everyone uses the internet. And not everyone can be trusted by everyone else, just as the Byzantine generals can’t trust one another.
This leaves us with a bit of a contradiction: we don’t want the third party taking notes on our exchanges, but we can’t really have the exchanges without the third party taking notes.
You can’t have a digital cash until you solve the Byzantine Generals Problem.
Lucky for us, someone did.
No one actually knows who Satoshi Nakamoto is. A man, a woman, or a group of people? We may never know.
What we do know is, Nakamoto successfully created a radically new currency. This currency was digital, free to use, and as untraceable as cash. And the currency was called Bitcoin.
The whole framework of the Bitcoin is based on a fundamental concept called “block chain”. A blockchain is a transaction ledger, somewhat similar to the ones that banks maintain. This ledger is constantly updating with every transaction made by everyone. It keeps track of which accounts have how much money, and whom they paid, and when.
Except, the ledger is located not in one place. Copies are located on many computers all over the world. In fact, it could be any computer anywhere in the world — including yours.
There’s no one person who maintains the ledger. Accounts use a mathematical trick — asymmetric key encryption — so anyone can verify a password without knowing what the password is. This trick comes from cryptography, the art of making and breaking secret messages. That’s what gives bitcoin and its relatives the generic term: “cryptocurrencies”.
In Bitcoin, anyone can look through the ledger records, and make sure nobody’s doing anything fishy. If someone tries to spend money they don’t have, every single bitcoin app in the world will reject it. The transaction won’t be valid. It won’t exist.
The burden of updating the blockchain is quite a high one. But that too is not on one central party. Anybody can volunteer to do the work, which involves double-checking the latest transactions and solving a complicated math problem. And why would someone volunteer to do all the hard work? Well, those volunteers are called “miners”, and they get compensated. They get a bit of money for their work. In bitcoins, of course.
All this makes for a trust-less system, where nobody is taken at their word, nobody is in control, nothing is regulated, and yet, everyone knows that everyone else is following the rules.
Suppose I promise you money, in exchange for some work. You do the work, but I say “Ha ha, I’m not going to pay you after all”.
With everyone keeping an eye on the blockchain, Bitcoin prevents cheating. But it only does so to the same extent that cash does. It can’t prevent someone from promising to pay later and then going back on their word.
That’s where Ethereum comes in.
Ethereum is a new cryptocurrency, which goes beyond simple money. It lets you create “Smart Contracts”, bits of code that automatically get run when they receive the trigger. For example, let’s say I’m sending you a parcel worth ₿200. None of us trust each other. We run into a problem.
If you pay me as soon as the parcel is sent, I can contact the delivery-company to cancel the shipping, cheating you of your money. On the other hand, if you wait till the parcel reaches you, I can never be sure if you’ll actually pay me or not.
So, we write up a Smart Contract which says something like this:
If parcel [parcel number] is delivered by Saturday, pay ₿200 to [my account]. Otherwise, return the ₿200 to [your account]
As you can see, the Smart Contract has its own account-money all to itself. You deposit your ₿200 into its account before starting, and it gives it back at the end of the week if your parcel’s not delivered — which you’ve coded to figure out by looking up the delivery-company’s website.
On the technical side, there’s no one person who runs the code. Anybody can do it and check that it’s valid, the same way as they check an ordinary transaction.
Smart Contracts are just like a trusted third-party. Except that you can really trust this one, because it’s in software code.
Bitcoin and Ethereum aren’t the only currencies of their kind out there. Far from it.
Cryptocurrencies have now become a “thing”, and everybody’s rushing to make their own, each with their own addons and features. Some are truly decentralised, as Bitcoin was designed to be, while others have “back-doors” in their code which let them be controlled by certain governments or organisations. So, beware of which ones you decide to use!
If there are so many cryptocurrencies, how do you choose between them? Which ones will manage to survive? It’ll all depend on which ones get popular. Like ordinary money, cryptocurrencies are still worthless unless you have someone to trade it with.
Cryptocurrencies don’t change the way money works. Not the basics, anyway. What they do is to take the whole system away from big governments and corporations, instead allowing anyone and everyone to verify the transactions for themselves. They’re like a bank that’s owned by nobody at all.
Or, to look at it another way, they’re one that’s collectively owned by everyone in the whole world.
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