Cryptocurrency has been making headlines recently, but what is so special about it? The key lies in the crypto part. Crypto is short for cryptography, the type of computational function used to process transactions. Why should anyone care about using cryptography to run a currency, why not just keep your dollars in a bank and send and receive money using Paypal?
The problem is simple; we rely entirely on central governments and international bodies to manage our economy and the money we work hard to earn. The US government states that the USD has value, and so we trust that it does. When we give the bank our money for safekeeping, we trust that it will be waiting for us when we want it. But in 2007, excessive risk taking by some of the largest financial institutions in the world lead to an economic downturn and global recession lasting over 18 months. The average US household lost nearly $5,800 in income, and $2,050 of their taxes spent bailing out the collapsing banks. Stock and housing prices declined, losing the average household a shocking $100,000 in asset value. Clearly we have great reason to look for other ways to store our money.
The issue with creating a digital currency absent of any central authority has been how we give the currency value. If it is just a line of code, what stops someone from copying the line of code and creating infinite amounts, or spending the same amount of money twice before anyone notices since it has no physical form. Normally the job of preventing fraud and assigning value to a currency is done by each country’s government. We have seen how badly this can turn out. Satoshi Nakamoto (creator of Bitcoin) gave us the solution. A list of all transactions is constantly extended every time any person sends any amount of the currency. The list is publicly available, and stored on many computers (nodes) across the world. If a transaction appears on the list which does not seem right, e.g. someone trying to ‘double spend’ their money, some nodes will have a different list to others, and the fraudster is detected. But how do the nodes know which list is correct, and which contains the fraud?
This is where crypto(graphy) comes in! To extend the list, a complex cryptographic puzzle must be solved. In reward for solving the puzzle (and extending the list), the ‘miner’ receives an amount of said currency. The job of mining is left up to anyone anywhere on the planet to compete for. Those with the largest computing power will earn the most rewards. This incentive means the total computational power of all the people in the world competing to extend the list is huge. The nodes automatically take the longest version of the list to be correct. So if our fraudster wants to credit himself some currency out of nowhere, they must solve the cryptographic puzzle, and then continue to solve every puzzle after that to keep their list longer than everyone else’s. The computational power needed to do this is impossibly large, and so we have a digital currency which cannot be double-spent or duplicated, and requires no central authority to monitor.
If enough people are attracted by the decentralised nature of this currency, and agree it has value, then the rest is history. This is the story of Bitcoin, and the revolutionary blockchain invented by Satoshi Nakamoto.