During the last six months, many previous Bitcoin skeptics have come out in favor of crypto currency, but have tempered their excitement for “blockchain technology” by dismissing the underlying money associated with it: bitcoin.
As a Bitcoin enthusiast, the author takes special care to encourage anybody who finds a use case for Bitcoin (capitalized “B” refers to the protocol, whereas a small “b” denotes the currency). And because Bitcoin is many things, and can be many things in the future, it makes sense to invite everybody into the proverbial tent. After all, they might find something else that they like too.
In this article, we’ll explore a little bit about the fact that Bitcoin is two things – a protocol and a currency – but will also make the argument that they are inseparable. The two complement one another, and alone, each would wither.
Let’s begin with what Bitcoin is as a whole, and then move into why the currency component is more than a footnote.
At it’s core, Bitcoin is a ledger. Ledgers are easy. People have used ledgers for all of recorded history, and likely beforehand. After all, informally trading favors with friends can be seen as one of the first implementations of a ledger. I owe you, you owe me. You don’t have to write it down, but you can.
More complex relationships require a formal ledger. When groups of people trade on behalf of one another, perhaps in the form of a farm (or company), they need reliable data to track what is going in and what is going out. How much corn is in the shed? Who has the shovel? To whom did we lend our ox cart?
Keeping a ledger is easy, but keeping it honest is hard. Ledgers are subject to honest mistakes, but also to fraud (Enron, Bernie Madoff, etc). The important question is not what is on the ledger, but rather, who is in charge of it, and can we trust its contents?
The solution to this problem has been a process of institutionalizing bookkeeping practices, and for the most part, it works pretty well. Large corporations such as banks, insurance companies, and credit card companies don’t necessarily thrive because they can manage their books better than others, but rather because they have built up trust among their customers for many years. The trust that they engender is that the ledger you rely upon will be the same across the board. And this trust is something that humankind has had to place in the hands of small groups of people, until now.
Bitcoin provides the first example in history of a ledger that you know is accurate, but which you don’t have to trust any individual or group of individuals to maintain. It’s a kind of ledger in the sky that records transactions as if by magic. This is the essence of Bitcoin, from which all of its promise is derived.
So what about the currency? What about “bitcoin” with a small “b?” Well, it’s the money component. Perhaps money has a bad reputation, or maybe it is misunderstood. For whatever reason, it elicits very strong reactions. For example, witness our lexicon, ‘dirty money’ and ‘filthy rich’, these exemplify a conflicted opinion regarding the accumulation of wealth and by whom (if it’s you, it’s probably a good thing, not so for others). But whether you feel that bitcoin constitutes a viable currency long-term, one thing is for certain: bitcoin is the only way to achieve a globally trusted ledger.
The level of trust in the blockchain is directly proportional to how difficult it would be to corrupt it, or to control it unilaterally. And this level is easily observed by the amount of energy which is being expended to secure it. This energy comes from people – anybody – who devote processing power to searching for bitcoin the currency. Known as “mining,” under the hood it represents a self-interested activity that processes transactions and assures their fidelity as a byproduct. That’s right. The incentive to earn bitcoin comes first, and the network comes second.
When bitcoin was simply funny money that people traded for pizza (look up the 10,000 bitcoin pizza story for reference), the blockchain was weak. It limped along hopefully, pleading that nobody would fire up 10 laptops and mess with its sacred transactions. As time passed, the network strengthened. More and more people began to “mine” after they heard about a new, secure and limited currency that couldn’t be counterfeited, which could be transferred to anybody across the globe, instantly, and for no fees. This currency was just a ledger. But then again, money might just be a ledger too. It always had been, to some degree. Even the most traditional individual still holds the majority of their cash in bank accounts, which are just 1s and 0s on a database. Not only is this money not tied to something tangible, such as gold, it doesn’t even exist as physical cash in a vault because banks are permitted to lend much more than the reserves they hold.
In short, without the incentive to mine bitcoin, there is no security, and without security, there is no blockchain. The two are inextricable. The blockchain can be separated from bitcoin, but then what would it be? It would revert back to a simple ledger, something that anybody can keep with a cheap computer and a version of excel. The piece that new advocates are missing is that a ledger secured by a third party is par for the course – but a global, audited, real-time, ledger that you can trust must be secured by its own currency.
Could we replace bitcoin the currency, renowned for its volatility, with an existing one? At first, this may seem like a good idea. But where would this currency come from? Who would pay for it? The wonder of Bitcoin is that the issuance of its underlying currency is tied to its security, with no bounds. If bitcoin is cheap, the network is weak. If bitcoin is dear, the network is strong. The currency has to originate from within the system to support the system. Any external party who pays for the security, or who tries to implement a set of guidelines for how the currency is valued (perhaps with some algorithm that pegs it to a particular CPI or fiat currency such as dollars, euros, or yen) will reintroduce the trust of a third party, the avoidance of which was the whole point to begin with.
The Bitcoin blockchain is beautiful, and its new advocates are close to understanding it fully. MasterCard, Goldman Sachs, and the US Government already have their own blockchains. They can build on theirs, but you can’t, and that makes all the difference.