Bitcoin was introduced to the world in 2008 when the first bitcoin whitepaper was released by the pseudonymous Satoshi Nakamoto. He built on the work of earlier cryptography enthusiasts and thinkers such as Hal Finney, Wei Dai, and Nick Szabo, all of whom have been thought, at some point, to possibly be Satoshi. Some have speculated that Satoshi was a pen name for a group of people. His identity was never disclosed, and he stepped away from the project by 2011.
Szabo, a Hungarian-American computer scientist, explored ideas of digital currency in the decade preceding the first bitcoin whitepaper. He published an essay in 2002 titled, Shelling Out – The Origins of Money, which profiled the rise of currency and exchange through human history. Szabo begins by recounting 17th Century European colonists’ discovery that the North American indigenous peoples they encountered had been using forms of money for thousands of years. Called wampum, this currency was made from the shells of particular types of clams (the origin of the term “shelling out”).
Despite their reservations about wampum being “real” money, the colonists eventually came around and used it like official currency until British authorities decided to use coins, as mass-manufacturing techniques led to wampum becoming less scarce.
“Money evolves naturally,” writes Szabo, pointing out that shells and “collectibles” have been used as currency for as many as 75,000 years. Trade has been necessary for groups of humans to exchange resources to avoid starvation, and trade was often in commodities that had value. He recognizes, however, that inter-band trade was inhibited by the difficulty of making transactions, as many used systems based on delayed reciprocity (essentially an honour system). Szabo further argues that wealth transfer is much less wasteful when the currency is in collectibles like shells and jewelry, rather than consumables like food or tools.
Eventually, societies realized that coins were a very efficient collectible to use for transactions. The famous Greek king Alexander The Great was an early example of this, melting down “low-velocity” collectibles seized in conquests into “high-velocity” coins. As coins became more common, governments began to monopolize coin issuance. Szabo attributes this to three factors:
- The mobility of coins resulted in more efficient markets
- A more trackable, efficient currency maximized taxation revenues
- Only governments could enforce laws to prevent counterfeiting
These form a self-reinforcing cycle: efficient markets led to prospering economies, which could be efficiently taxed by the government, providing the revenues necessary for government activity, including enforcing laws around coinage. Szabo also proposed three necessary qualities for a collectible to be considered a commodity:
- Security from accidental loss and theft
- Difficult to forge value
- Ability to be approximated by simple observations or measurement
Fiat found an even more convenient medium on the internet. Thanks to mobile banking and digital platforms like PayPal, people could manage money from a device that fits in their pocket with a reasonable level of security (for modest sums).
This was accomplished by a system of account balances and transfers among them by PayPal, the banks, and credit card companies, and worked because people decided, over time, to trust all the players in the system to fairly settle all their transfers – and because people trusted the currency represented by those account balances. But both of these trusts are, from time to time, violated.
Szabo points out that fiat currencies are “very poor stores of value”, citing the problem of inflation, which has “destroyed many a “nest egg”. Collectibles have experienced a resurgence in the past century, a phenomenon that he suggests results from the tendency of even the most stable fiat currencies to suffer inflation over time. Numerous countries have suffered extreme hyperinflation, and there are some suffering this fate today.
The evolution of money is leading humanity closer to a better store of value and a better medium for conducting transactions. Many now believe that the next evolution of our financial system centers around cryptocurrency, the market cap for which exceeds $250 billion. The “Big Four” consulting firms (Deloitte, EY, KPMG, and PwC) have all recently had to shift their strategies to adapt to cryptocurrency and many hedge funds are investing in cryptocurrency. The listing of Bitcoin on major futures exchanges has propelled it into a global commodity like gold and silver, being traded alongside stocks like Apple and Amazon. Cryptocurrencies like Bitcoin, and BTG eliminate issues of uncertain inflation and satisfy the requirements for a currency articulated by Szabo.
Bitcoin and similar cryptocurrencies are secured by hash functions and blockchain technology, which supports a distributed ledger. Essentially, the distributed ledger allows all its users to continuously verify each other’s transactions and balances, removing the need for a central bank that must be trusted. These transactions are then permanently stored in the decentralized ledger. Hash functions are used to certify validity, like a signature.
First, cryptocurrency makes money more secure than ever. Similar to a signature on a cheque, each transaction requires a unique cryptographic signature based on mathematical calculations, which is easily verified but virtually impossible to fake. Blocks of transactions on the blockchain are also signed, preventing unauthorized transactions or changes to the ledger. This secures the transaction history and therefore secure’s everyone’s balance. The decentralized system allows anyone to participate in securing the system through a process known as mining. Individuals and groups dedicate computing power to do the cryptographic security work to sign blocks full of verified transaction. The miners are given a small reward of new currency in each block as an incentive to do this work. This small reward, which decreases over time, is also the only source of new money supply in the system, creating a predetermined and decreasing rate of inflation. Miners also receive any additional fees that users of the cryptocurrency choose to give them in their transactions; as the rate of “new coin” rewards goes down over time, these fees will continue to incentivize miners to do the work.
Unlike a traditional cheque, it is virtually impossible to forge a Bitcoin transaction with publicly available information. Well-established cryptography that has been researched as far back as 1985 ensures that while anyone can confirm that a signed transaction hash is authentic, nobody can create a valid transaction without a secret private key held only by the account owner. Also unlike a traditional cheque, a Bitcoin transaction can’t “bounce” for lack of funds, because the miners confirm the source account balances before accepting a transaction to go into a block of the ledger – and the prior account balances can never be altered because the blocks have been signed by the miners (any attempted change to a block would make the signature invalid.)
The amount of cryptocurrency can be easily easily determined (it’s a number in a ledger) and easily subdivided (each Bitcoin can be divided into one hundred million pieces called “Satoshis,” after Bitcoin’s creator.) As mentioned above, cryptocurrency is only created by the mining process and there’s a fixed future supply, making it necessarily scarce (the decreasing rewards rate guarantees that Bitcoin and Bitcoin Gold will each have a maximum supply limit of 21 million coins).
Just like fiat or reserved-backed currency, the relative value of a cryptocurrency is determined on the free market where the currency is traded. As a new asset class still undergoing price discovery, the value of Bitcoin and other cryptocurrencies has been very volatile, but has clearly been rising over time. Bitcoin rose from pennies per coin to dollars to hundreds to thousands of dollars per coin!
Bitcoin Gold, a cryptocurrency very similar to Bitcoin, has a core mission of decentralization. Using a proof-of-work algorithm that prevents powerful mining farms from dominating the process, Bitcoin Gold keeps the market from falling under the control of an elite few. By relying on an independent blockchain rather than central banks, a cryptocurrency can ensure that inflation or other supply manipulation is controlled or prevented, rather than being subject to arbitrary changes by governments. For example, while Bitcoin and Bitcoin Gold currently have 3.8% annual inflation due to money supply growth, those rates are steadily decreasing and the system ensures that growth rate of the money supply can only decrease – there can be no inflation surprise in future years. (For reference, Litecoin and Ethereum currently have inflation rates of about 9.1% and 7.3% while Zcash has an annual inflation rate of over 50%).
Recently, the Bitcoin Gold Organization released BTGPay, a program which assists businesses in doing things like paying wages and creating purchase orders via cryptocurrency. This offers tremendous cost savings to businesses (especially international businesses) by allowing them to avoid high transaction costs and reducing processing time. Take, for example, a retail business that needs to make an emergency $10,000 purchase order from a supplier in South Korea. Using Bitcoin Gold, the funds can be transferred in an instant with transaction costs of less than a penny, saving the business up to $700 in transaction costs and days of time, as compared to using wire transfer.
Another important problem addressed by cryptocurrency is the immense number of “unbanked” people in the world – perhaps 2 billion people without a bank account. Yet, a 2016 McKinsey report estimated, 90% of people in developing nations will have access to a mobile phone by 2020. This offers tremendous opportunity to the unbanked to start using cryptocurrency to make transactions over networks despite not being affiliated with a traditional bank.
Kora Networks and others are developing cryptocurrency-based platforms to give greater financial opportunity to the world’s unbanked. They aim to provide universal access to low cost international financial services using blockchain technology. According to the McKinsey report, the increasing digitization of finance could boost developing nations’ economic output by 6% in the next decade.