Bitcoin hit news headlines this week as the price of one unit of the cryptocurrency passed $11,500 for the first time. This introduction explains the most important thing about crypto currencies. After you‘ve read it, you‘ll know more about it than most other humans. Today cryptocurrencies have become a global phenomenon known to most people. While still somehow geeky and not understood by even more people, banks, governments and companies. In 2016, you‘ll have a hard time finding a major bank, a big accounting firm, a prominent software company or a government that did not research cryptocurrencies, publish a paper about it or start a so-called blockchain-project. Although it’s often referred to as new, Bitcoin has existed since 2009 and the technology it is built on has roots going back even further. In fact if you had invested just $1,000 in Bitcoin the year it was first publicly available, you would now be richer to the tune of £36.7 million. Those who don’t learn from history are doomed to repeat its mistakes – so here is a brief history of Bitcoin and cryptocurrency.

1998 – 2009 the pre-Bitcoin years: Although Bitcoin was the first established cryptocurrency, there had been previous attempts at creating online currencies with ledgers secured by encryption. Two examples of these were B-Money and Bit Gold, which were formulated but never fully developed.

2008 – the Mmysterious Mr Nakamoto: A paper called Bitcoin – A Peer to Peer Electronic Cash System was posted to a mailing list discussion on cryptography. It was posted by someone calling themselves Satoshi Nakamoto, whose real identity remains a mystery to this day.

2009 – Bitcoin begins: The Bitcoin software is made available to the public for the first time and mining – the process through which new Bitcoins are created and transactions are recorded and verified on the blockchain – begins.

But beyond the noise and the press releases the overwhelming majority of people – even bankers, consultants, scientists, and developers – have a very limited knowledge about cryptocurrencies. They often fail to even understand the basic concepts. So let‘s walk through the whole story. What are cryptocurrencies? Where did cryptocurrency originate? Why should you learn about cryptocurrency? And what do you need to know about cryptocurrency?

Few people know, but cryptocurrencies emerged as a side product of another invention. Satoshi Nakamoto, the unknown inventor of Bitcoin, the first and still most important cryptocurrency, never intended to invent a currency .In his announcement of Bitcoin in late 2008, Satoshi said he developed “A Peer-to-Peer Electronic Cash System.“ His goal was to invent something; many people failed to create before digital cash. The single most important part of Satoshi‘s invention was that he found a way to build a decentralized digital cash system. In the nineties, there have been many attempts to create digital money, but they all failed. After seeing all the centralized attempts fail, Satoshi tried to build a digital cash system without a central entity. Like a Peer-to-Peer network for file sharing.

To realize digital cash you need a payment network with accounts, balances, and transaction. That‘s easy to understand. One major problem every payment network has to solve is to prevent the so-called double spending: to prevent that one entity spends the same amount twice. Usually, this is done by a central server who keeps record about the balances.

In a decentralized network, you don‘t have this server. So you need every single entity of the network to do this job. Every peer in the network needs to have a list with all transactions to check if future transactions are valid or an attempt to double spend. But how can these entities keep a consensus about these records? If the peers of the network disagree about only one single, minor balance, everything is broken. They need an absolute consensus. Usually, you take, again, a central authority to declare the correct state of balances. But how can you achieve consensus without a central authority? Nobody did know until Satoshi emerged out of nowhere. In fact, nobody believed it was even possible. Satoshi proved it was. His major innovation was to achieve consensus without a central authority. Cryptocurrencies are a part of this solution – the part that made the solution thrilling, fascinating and helped it to roll over the world.

If you take away all the noise around cryptocurrencies and reduce it to a simple definition, you find it to be just limited entries in a database no one can change without fulfilling specific conditions. This may seem ordinary, but, believe it or not: this is exactly how you can define a currency. Take the money on your bank account: What is it more than entries in a database that can only be changed under specific conditions? You can even take physical coins and notes: What are they else than limited entries in a public physical database that can only be changed if you match the condition than you physically own the coins and notes? Money is all about a verified entry in some kind of database of accounts, balances, and transactions.

Let‘s discuss the mechanism ruling the databases of cryptocurrencies. A cryptocurrency like Bitcoin consists of a network of peers. Every peer has a record of the complete history of all transactions and thus of the balance of every account. A transaction is a file that says, “Bob gives X Bitcoin to Alice“ and is signed by Bob‘s private key. It‘s basic public key cryptography, nothing special at all. After signed, a transaction is broadcasted in the network, sent from one peer to every other peer. This is basic p2p-technology. Nothing special at all, again.

The transaction is known almost immediately by the whole network. But only after a specific amount of time it gets confirmed. Confirmation is a critical concept in cryptocurrencies. You could say that cryptocurrencies are all about confirmation. As long as a transaction is unconfirmed, it is pending and can be forged. When a transaction is confirmed, it is set in stone. It is no longer forgeable, it can‘t be reversed, it is part of an immutable record of historical transactions: of the so-called blockchain. Only miners can confirm transactions. This is their job in a cryptocurrency-network. They take transactions, stamp them as legit and spread them in the network. After a transaction is confirmed by a miner, every node has to add it to its database. It has become part of the blockchain. For this job, the miners get rewarded with a token of the cryptocurrency, for example with Bitcoins. Since the miner‘s activity is the single most important part of cryptocurrency-system we should stay for a moment and take a deeper look on it.

(To be continued)

 

The writer is a Master Trainer/Advisor at the Pakistan Industrial Technical Assistance Centre Lahore, under the Federal Ministry of Industries and Production, Islamabad.