Trustless Transactions: Banking on the Blockchain
Noel Thomas | Staff Writer
As long as two people agree on the value of something, they can engage in transactions without involving anyone else. If you and I agree that the price of an apple is two oranges, we could keep on exchanging apples for oranges for as long as we like; but the problem with the barter economy is that the table that is supposed to maintain the exchange ratio grows exponentially as more and more fruits enter a market. Keeping track of the exchange ratios for different kinds of commodities is a resource-intensive task, so much so that accountants of the middle ages were paid to keep track of these changes. In today’s world, you and I would expect things to change, but other than a change in the kind of tools involved, the rudimentary blocks of our accounting systems have stayed largely pedestrian, even though the silicon chips we use today are a billion times more powerful than any computational technology of the past. Most ledgers that big banks and big governments maintain are identical to large spreadsheets and, like any other human activity, the tables do not always tally.
The law of supply and demand is the principal axiom of capitalism; it is a universally valid, intuitive statement, and most of the time it is violated by the preexistent power structures of a system. Anyone with access to a large amount of capital is easily able to influence decision making – in socialist states, the elite can influence policies by lobbying, and in authoritarian ones, the voices of the minority are muted by censorship. In both cases, the obstruction in the path of a decision is the mediator. This is why cooking a meal yourself is less expensive than hiring a cook, or teaching yourself to code is easier than attending a university. Anarchists who see the world’s complex interplay of decision making might identify the centralization of power as a dangerous precedent for a cold, bleak future. For instance, the rate of inflation refers to how much new currency is printed each year; given this reckless violation of demand, the rising prices of any good is an innate problem of centralized economies, because technically, a central bank is assigning value to blank paper at its whim, essentially like that adamant professor of yours who insists on not giving you the full worth of an assignment that you completed.
Satoshi Nakomoto’s whitepaper talks about solving this age-old problem of the middleman in a financial transaction, using a digital ledger that is referred to as the bitcoin network today. What is surprising about this technology is that all of the components used were already being utilised in the digital world – trapdoor functions using cryptography, signature verification in encryption, distributed databases in chat applications, and free market economies in idealized conversation. The bitcoin platform keeps track of who owes how many bitcoins to whom in an ingenious fashion – new transactions are added to an append-only list, whose copies are maintained and synchronized continuously in a p2p network. Valid previous transactions are hashed into this list, where each new transaction has its parent in a previous transaction. Since there is no single point of failure (unlike traditional payment systems, where Government Inc. or Paypal Inc. house all their data on centralized servers), blockchain systems are impossible to attack (all the hacking incidents on the bitcoin network were failures on the part of nodes, never on the integrity of the network) and are tamper-proof. Breaking the bitcoin system means you would have to either have 51% computing power on the network (unrealistic, because bitcoin miners have access to a thousand times more resources than even the most sophisticated supercomputers) or you would have to break they asymmetric cryptography employed in it (if one could accomplish this, he would much rather overturn a country) so, as far as we are concerned, bitcoins are mostly hack-proof.
Bitcoin is money, like euros or rupees, but unlike any fiat currency in use today, the difference is that it has no democratic backing through governments or large banks. Instead, it is maintained wholly online, where records are constantly scrutinized through a blockchain. The blockchain breaks each transaction to its component peers and directs them across valid digital bitcoin addresses. The SHA-256 algorithm is intentionally hard to solve, unless brute-forced, which means a powerful computer that can run through as many hashes as it can is maintaining the ledger, and it periodically adds the payment to its own payment address. It is this reward that miners around the world race their application specific integrated circuits for.
Different from the network itself is the currency that it uses, although, unlike the images of a coin that you see online, a coin is nothing more than a private key paired to a public key, where a balance in bitcoins was owned against payment through a previous owner of bitcoins. Bitcoin gains its tremendous utility through the upset of traditional financial systems, and more people are starting to see it as an alternative to gold as an investment. Part of what makes this a hot idea is the deflationary nature of the currency – only 21 million bitcoins would ever exist, but each bitcoin is pisible into a million parts as well. This property of bitcoin makes it fundamentally different from a digital asset because the cryptographic hash of a certain dataset is a mathematical one-way function, these are also scarce by nature. Digitally scarce sounds like an oxymoron, but simply put, this is what bitcoin represents – a detailed way of making sure natural limits exist in a world we all thought was infinite.
This radical idea has quirky implications – we have a viable medium of exchange that has most of the desirable properties of physical money, and several more significant ones. A bitcoin is more pisible, more permanent than printed paper, more portable, more fungible. As falsification is impossible, rules made on a bitcoin network could be mathematically primed to meet their conditions, without fear of obfuscation by third parties or intermediaries. Such is the story of Ethereum, a digital currency like bitcoin that treats transactions as financial contracts that can execute when an if-loop is constructed or some other constraints are met. Augur aims to be a prediction market where you can bet on the outcome of an event, implying a better forecasting model where anyone anywhere can gamble in the unknowns without intrusion. Ripple aims to speed up transfers for large amounts of money to a span of seconds where wire transfers take weeks. Maybe the next big thing in the blockchain space is not even here yet, because the market resembles the initial phases of the internet, hence there is wild speculation and lots of misinformation.
So, this is what a lot of reckless investors have been asking – how valuable is this bitcoin thing anyway? In 2009, they were mostly worthless, but as of now, a single bitcoin is worth almost 12000 USD. There are many economists who believe that the current price is highly inflated but to those who look into the technology as a substitute for the petrodollar, or as a legitimate store of value, believe that cryptocurrency technology is highly undervalued, which makes this a great investment opportunity. After all, the price of an item is what we agree upon as the collective value of its worth; if that is the case, then even at its current price of 20000 USD, a single bitcoin is undervalued. Much of the woes of the world past the agricultural age have been a result of democracy’s favourite experiment – putting power in the hands of misinformed bureaucrats. If the world Satoshi Nakomoto dreamed of comes to be, then the world stands to gain much in its becoming of a meritocratic algorithm. How about a world governed by the nature of infallible algorithms, instead of deep divisions in anthropocentric opinion?