The world of cryptocurrency is weird and complicated.
In this four-part series, Information Age looks at the history of crypto, how you can get your hands on some, what you can do with it, and the Australian innovators looking to capitalise on this emerging technology.
Well, it looks like an historic cryptocurrency bull run is over.
Prices across the board took a dive last month, bringing an end to another flurry of activity for the largely speculative market.
Futures markets are also signaling the onset of a cryptocurrency winter as traders exercise caution around what continues to be a volatile ecosystem.
Good riddance, you might be thinking, it’s just a form of unregulated gambling.
Or maybe you got swept up in the latest hype cycle and took your first steps into crypto through Dogecoin only to sell-up in disgust when the Elon Musk-fueled mirage started fading.
Either way, the end of another surge in mainstream attention is as good a time as any to look closer at the history of cryptocurrency and its largest asset: bitcoin.
Who is Satoshi Nakamoto?
Satoshi Nakamoto invented bitcoin and nobody knows who he/she/they really are.
Investigative journalists have spent months trying to track Nakamoto down including Forbes writer Andy Greenberg who thought he cracked the case in 2014 when a source found a possible lead in cypherpunk Hal Finney.
Seven years on and Nakamoto’s identity remains a mystery, but his legacy lives on in an asset that is worth around $1 trillion, and which spawned an entire ecosystem valued more than $1.5 quadrillion.
The history of bitcoin has long roots in alternative digital currencies like David Chaum’s Digicash, but it’s simpler to start with Nakamoto’s 2008 whitepaper titled ‘Bitcoin: A Peer-to-Peer Electronic Cash System’.
In it, Nakamoto outlines what he sees as a major flaw in the existing digital financial system: trust.
Transactions were always going to be mediated through a third-party financial institution due to issues around fraud and disputes which in-turn slowed down e-commerce and, crucially, entrenched capital power in the hands of large banks and a cabal of global finance giants.
The system was going to stay broken without a way for ordinary people and small businesses to exchange value in a way similar to real-world cash transactions.
“What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party,” Nakamoto said.
“Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers.”
A trustless system of value exchange that allowed for escrow between parties would make bitcoin the go-to currency for black market trading of drugs and other illicit material on dark web sites like the Silk Road – but it also carried connotations of individual empowerment.
Bitcoin was born out of the ‘Cypherpunk’ techno-political movement whose proponents championed privacy and had an anti-authoritarian bent that verged on anarchism.
And Nakamoto published his whitepaper six weeks after Lehman Brothers filed for bankruptcy and the world was coming to terms with the Global Financial Crisis (GFC) and the epic collapse of a self-serving financial system driven by greed.
“It’s hard to believe someone with such breadth of knowledge as Satoshi would be working in isolation from what he was witnessing in global financial markets,” wrote Chris Burniske and Jack Tatar in their book Cryptoassets.
“Satoshi was not creating Bitcoin to slip seamlessly into the existing governmental and financial system, but instead to be an alternative system free of top-down control, governed by the decentralised masses.”
Indeed, the mysterious creator encoded a message on the first bitcoin transaction to act as an indelible reminder of the GFC and the principles upon which cryptocurrency was created: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”.
When the price of bitcoin crashed last month, no central authority came to its rescue; no one changed the rate of supply or adjusted the protocol – the network just kept running.
You may have noticed a difference between the lower-case bitcoin and upper-case Bitcoin. Typically, the former refers to the cryptocurrency and the latter to the Bitcoin software which is the first working example of blockchain technology.
In the years since Bitcoin’s invention, different cryptocurrencies have evolved to include different ways of forming blocks and distributing coins while testing new use-cases for the technology.
What follows is a somewhat simplistic, and maths-less, description of the Bitcoin network and its features.
A blockchain is a collection of different records bunched together (blocks) that are cryptographically linked (chained).
In order to maintain its integrity, each block must be immutable so none of the information on the blockchain can be retroactively altered changed.
In the case of bitcoin, and many other cryptocurrencies, blockchains represent transactions on the network.
For example, say Alice sends Bob one bitcoin (BTC) from her wallet to his. The transaction occurs through a bitcoin node which bundles it together with other transactions on the network to form a block.
The job of a node is to test transactions and make sure that no one is double-spending coins. It keeps the information accurate by communicating with other nodes on the network.
At any given time, there are thousands of nodes running the Bitcoin peer-to-peer protocol and verifying the blockchain – and because the code is open source, anybody can set up a Bitcoin node at home so long as they have the hardware, a decent internet connection, and the know-how.
For the block of bitcoin transactions to be confirmed by the network of Bitcoin nodes, it must be added to the blockchain, or ‘mined’.
A miner adds a new block to the chain by creating a cryptographic hash out of the new transaction data.
The hash is a fixed-size string created by combining the new transaction data, the last block’s hash, and another number called a ‘nonce’ through the SHA-256 algorithm which basically scrambles the data in a very specific and difficult-to-untangle manner.
If this new hash matches certain criteria, or ‘difficulty’, then the miner sends it to the network for confirmation, is rewarded with bitcoin, and the new hash becomes the starting point for adding the next bundle of transactions to the blockchain.
If the hash doesn’t meet the difficulty, the miner tries again.
It’s mostly about luck so modern mining equipment is specially designed to go through a massive number of attempts in the shortest time – often measured in terahashes (one million, million hashes) per second – to increase their odds of finding the right hash and taking home the bitcoin prize.
Like network nodes, anybody can be a miner. There are even services like NiceHash that let people pool their idle computing power in order to run hashing algorithms and share in some of the rewards.
Between the nodes and miners, the Bitcoin network is designed to be a secure, decentralised way of exchanging bitcoin.
Unlike fiat currency, bitcoin is finite and deflationary. Only 21 million bitcoins will ever be mined but that’s not due to happen until around 2140 due to the structure of Bitcoin.
Satoshi Nakamoto introduced different ways to keep the mining rate consistent while controlling the overall supply in such a way that adds scarcity to the cryptocurrency.
Firstly, each block should take around 10 minutes to mine. To achieve this, the network regularly checks the hash rate on the network and adjusts the criteria – ‘difficulty’ – miners use to check if their hash is successful.
When the network notices the total hash rate – the number of attempts to find the new block’s hash – has changed, it will increase or decrease the mining difficulty to keep the rate of mining consistent.
The rate of mining rewards also changes. After every 210,000 new blocks are mined – which happens roughly every four years – the reward for miners who find the right hash is halved.
The last time this happened was May 2020 and it saw the reward for bitcoin miners drop from 12.5 to 6.25 bitcoins per block.
Because all this is programmed into Bitcoin, when the price of bitcoin tanks it’s up to broader market forces to decide their actions: miners might redirect their resources, investors cut losses, and exchanges prepare for sudden changes in liquidity.
The Bitcoin network doesn’t have in-built stimulus packages or quantitative easing measures to pump extra coins into the market in times of economic stress; it’s not affected by the emotions of an uncertain electorate or the disproportionately loud voices of corporate lobby groups.
Since the first block was mined in 2009, Bitcoin has spawned an entire ecosystem of cryptocurrencies, many of which seek to improve on the ideas of the progenitor while finding novel ways to expand the underlying technology into all facets of our increasingly digital world.
In part II of the series, we will look at some of the alternative cryptocurrencies, how to buy them, and pitfalls to be aware of.