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Cryptocurrencies Cut Out the Government Middleman

By Bret Baker | October 30, 2017

46 years ago, President Nixon took the United States off what remained of the gold standard, a system where the value of the dollar was directly linked to gold. This tying of paper currency to a physical commodity gave individuals assurances that their life savings had some value beyond the paper their cash was printed on. Once off the gold standard, US currency became “fiat money,” meaning its value was determined by the government that printed it.

While there are benefits to both systems, trusting a government more than 20 trillion dollars in debt to have a sober valuation of its currency can be a bit of stretch for some people. After the financial crisis, trust in financial institutions dipped, and people looked for alternatives to the existing system. That’s when the idea for bitcoin emerged. Now over 8 years later, it has proven a viable commodity for people to put their trust in – precisely because it doesn’t require the top-down central authority required in other systems.

One of the most significant developments in the history of the financial industry was the advent of double-entry bookkeeping, where both parties in a transaction would keep track of their exchanges. This introduced transparency into the financial system for the first time, preventing to a marginal extent fraudulent financing because there was a record of past transactions to verify accounts. Building off this concept, Benjamin Dean, the Ford/Media Democracy Fund Technology Exchange Fellow at the Center for Democracy & Technology, describes bitcoin as a system of “trustless double entry bookkeeping at scale without a bookkeeper.” 

Bitcoin allows this bookkeeping to occur at scale because it uses blockchain technology. Blockchain is like a public ledger that allows parties exchanging bitcoins to cross-reference transactions themselves, which is why bitcoin doesn’t require a central authority to verify that transactions are valid. Because the entire system is digital, there are no actual coins per se, but rather just a ledger of transactions. Crypto-ledger may be a more appropriate term than cryptocurrency for this technology for this reason. The ledger keeps a constant record of past transactions, updating about every 10 minutes with a list of new transactions. Transactions are initially validated between parties by digital signatures, similar to encrypted emails. Once all the transactions are determined by a majority of the network to be unique and valid, these new transactions are then cryptographically sealed into a block of data, which is then added on to the existing list of transactions, creating a continuous account of bitcoin transactions available to anyone.

If there’s a public ledger available to verify transactions, the integrity of the ledger would be the next question skeptics of the system might have, as each new block presents the opportunity for manipulation. The way the system checks against this is by creating incentives for a multitude of individuals to check the ledger and make sure the blocks in the chain are valid and currency is not being double-spent. The system rewards this crowd of block-checkers, which use computing power to decode the output of cryptographic hash functions to create the next block in the chain, by paying them in transaction fees and newly-created bitcoins. Each block’s hash is unique and requires the previous block’s hash to work, thereby preventing fraudulent chains from emerging. Over time, the computing power needed to verify the growing chain increases, and the system produces less new bitcoins for miners, while transaction costs rise. This is what helps the bitcoins retain their value and makes bitcoins attractive compared to US currency, since dollar bills can easily be printed by the US government, thus lowering their value in the eyes of consumers.

A majority of the network must agree to the valid chain, so as individual computers validate the growing chain of transactions, there exists the possibility for collusion amongst 51% of the network’s computing power to change the ledger. This is incredibly difficult to do, as the past hashes must all be solved to replace the original blockchain with an alternative chain. Since decoding even a single hash is like finding a particular grain of sand on a beach, this is unlikely to ever occur, making it ideal for security purposes going forward. That being said, because there is no central authority to oversee transactions, disputes between parties can’t be resolved, and those scammed have no means for recourse.

As blockchain technology in general and bitcoin move forward, it seems increasingly likely that governments will try to intervene to get a share of this emerging market. Bitcoin operates like nothing else in the financial industry, which has made it tough for regulators to oversee it, but with countries, like China, looking to get in on the crypto-ledger action, the future of blockchain is very much up-in-the-air.

Because bitcoins are such a new innovation, it is difficult to foretell the extent of their possibilities. With plenty of recent adoptions of blockchain technology, there is plenty of room for growth and understanding among users and would-be regulators. Before stifling this emerging technology and the possibility for substantial economic growth, wannabe controllers would be best to wait. After all, the lack of a central gatekeeper is what has made bitcoin and blockchain successful in the first place.