Bitcoin 101: What even is it?

When it comes down to it, all monetary systems are based on trust. We trust that the five-dollar note in our pocket will be accepted at face value when we hand it over the counter at our local café, and the barista trusts that the note is authentic when they hand over our coffee.

In different societies and at different times in history, that trust has been founded in different ways: in the authority of a large banking institution, for one, or the strong arm of a central government. But what if these sorts of intermediaries—these arbiters of trust—became unnecessary, or even obsolete? That has been the dream behind the development of cryptocurrency  –  digital money that guarantees its own trustworthiness through cryptographic security.

image of individual gold bitcoin

In 2009, a mysterious person (or persons) named Satoshi Nakamoto introduced a new digital currency called bitcoin, which quickly became the most famous of its kind. As with physical notes, digital currency can be exchanged for goods and services, and passed from owner to owner. But since it exists chiefly as information online, it is possible, in theory, to make fraudulent exchanges – to use the same money twice, perhaps, before anyone noticed you didn’t have it. This is known as the ‘double spend’ problem, and previous theorists of digital currency had struggled over it.

This problem is essentially one of record keeping, and Nakamoto came up with an elegant solution. Bitcoin uses an innovation that is known as a ‘distributed ledger’ – a public record of every transaction ever, which is collectively written and authenticated by the many different computers networked into the bitcoin system.

Each new ‘block’ of transactions added to the ledger is collaboratively approved and validated using complex cryptographic procedures, and each new block contains an encapsulated record of all blocks prior to it, creating a chain of evidence back to the very first payment. This innovation is therefore known as the blockchain. The ledger is impossible to fake or fiddle with, and easy to check.

Bitcoin transactions are basically anonymous (payments are sent to a numerical address, rather than a named person), and this privacy has made it the currency of choice in the illegal markets of the ‘dark web’. But it has also received growing mainstream acceptance: Melbourne received its first bitcoin ATM in 2014. Its value has also seen some ups and downs  –  in 2010, one man paid 10,000 coins for 2 pizzas, which in 2013 equalled around US$7 million; in 2016, that dropped to a slightly less astronomical US$4.4 million.

Although it doesn’t look like bitcoin will replace the dollar anytime soon, the key innovation that underlies this currency—the blockchain—may be about to reshape our world in myriad ways: not simply financial transactions, but business, and government, and more.

Since the blockchain is simply a means of record keeping, just about any system in which information is exchanged and stored can possibly benefit from the application of this kind of distributed—or ‘decentralised’— ledger. Blockchain technology could be used as a foundation to build more secure and efficient ways to register ownership—such as land title, or copyright—or to digitally record votes in a democratic election, or to collect taxes, or even to automatically enforce contracts.

pink piggy bank

At the extreme end, enthusiasts of the technology foresee a future in which many of the intermediaries we take for granted in today’s society—not only bankers, but accountants, lawyers, and supply chain managers—cease to be necessary, and even the biggest central intermediary of all, government, is radically affected.

But critics are more cautious. Already, researchers are predicting ways in which the blockchain’s formidable cryptographic security could be undermined – scenarios which may be more possible than fans would like. And, at present, the bitcoin blockchain requires an enormous amount of computing power to build and maintain, making it very energy inefficient (a problem which may not apply to other applications of the technology).

But it’s also worth asking whether decentralisation is the right move to make.

Libertarian technologists dream of a world free from the control of strong institutions, but the distributed, peer-to-peer networks they design may have their own potential for abuse of power. When it comes down to choosing how our records are kept—between the labyrinthine rules and regulations of, say, a central bank, or the cryptographic operations of a blockchain ledger whose workings are no less mysterious to the layperson—the question is: which to trust?

If you’re interested in learning more about the implications and uses of Bitcoin and the Blockchain check out the Six Ways to Change the World event at MKW17 and explore what this technology means for the future of economics and politics.

Written by James Douglas.

Brought to you by