As it often occurs in the field of science, the idea of digital money took some time to become reality. Prior to the invention of Bitcoin in 2008, many attempts at creating forms of electronic cash had taken place, some of them guided by the imperative of decentralization. This is that story.
1980s – Dutch Gas Thieves and the Talented Mr. Chaum
One of the first attempts at creating a cryptocurrency was made in the Netherlands in the late 1980s. Remote gas stations were suffering from nighttime thefts and the operators were reluctant to put guards at risk there. As gas stations had to be kept open overnight to allow trucks to refuel, someone had the idea of linking money to newly-designed smartcards. Truck drivers were given these cards instead of cash to pay for gas, and the stations were now safer from robbery as they no longer had paper money lying around – and history was made.
At that time, however, theoretical investigations on what it could take to create electronic cash had been going on for some time already. In a series of articles dating back to the first half of the 1980s, American computer scientist and cryptographer David Chaum conceptualized a digital currency which could be transferred both safely and privately between individuals. Several years later, in 1989, Chaum started the company DigiCash to put his concepts into practice and proceeded to build his digital money invention, eCash, that allowed users to store their money in a digital format, cryptographically signed by a bank, and spend it at any shop accepting the currency.
Although DigiCash went bankrupt in 1998, the concepts put forward by the company played an important role in the development of later digital currencies. By the late 1980s, the ideas of anonymous digital cash and pseudonymous reputation systems exposed in David Chaum’s 1985 paper “Security without Identification: Transaction Systems to Make Big Brother Obsolete” had in fact coalesced into something like a movement: the Cypherpunks.
Early 1990s – Cypherpunks and the Double-Spending Problem
As individuals advocating widespread use of strong cryptography and privacy-enhancing technologies as a route to social and political change, the Cypherpunks became a semi-organized group in 1992. They expanded their reach through a mailing list where they discussed questions about privacy, government monitoring and corporate control of information among other things, and gave life to ideas like digital currency and promoting freedom using technology.
In practice, creating a digital currency completely free from the interference of a third party, such as a bank, faced a major challenge: overcoming the double-spending problem. Gold, for example, cannot be reproduced. Someone with 1 ounce of gold cannot generate 2 ounces through pure alchemy, and that is one of the main reasons why gold is viewed as a great store of value. The same goes for paper money. One cannot physically double spend the very same dollar she owns, that is, fraudulently give the same physical dollar to two different people.
For digital money, however, the story is different. A digital asset is no more than a set of codes that, in the absence of a security mechanism, could be quite easily duplicated and sent to several recipients. In other words, if a digital coin can be easily copied and “double spent”, that digital currency cannot function as a store of value. That necessary security mechanism could involve a trusted centralized entity that controls the issuance, distribution, and verification of cryptocurrency units, but for the liberty-focused individuals that were the Cypherpunks, that option was not acceptable. The double-spending problem had to be solved using a decentralized approach.
Late 1990s – Four Pioneers in Pursuit of Decentralization
In the late 1990s, four cypherpunks, Adam Back, Nick Szabo, Wei Dai and Hal Finney came up with pioneering projects attempting to tackle the challenge of the decentralized digital money grail. The notion of scarcity with respect to digital money was famously introduced by Adam Back in 1997 when he implemented the idea of building cost (or digital scarcity) into his project HashCash, an anti-spam mechanism that added a cost to sending emails. The idea was that a sender needed to take a modest amount of time to generate a stamp (a Proof of Work) to be added to the header of the email before sending it, and that these few seconds of work would be too high of a cost for the spammer and the thousands of e-mails he sends.
Soon thereafter, in 1998, Szabo via Bit Gold applied the concept of digital scarcity towards the creation of money. His primary goal was to turn code into something people valued, and in Szabo’s scheme, a participant would dedicate computer power to solving cryptographic equations. These solved equations would be sent to the community, and if accepted, the work would be credited to the person who had done it. While DigiCash solved the double-spending problem by relinquishing some control to banks, Bit Gold proved that it was possible to turn solutions to difficult computations into property in a decentralized fashion. However, privacy was not foremost on Szabo’s mind, and Bit Gold fell short in terms of protection from tampering with the property registry.
The same year, Wei Dai, focused on anonymity and a distributed way of issuing coins and introduced b-money: a proposal for an anonymous, distributed digital cash system. While it was never developed beyond the whitepaper stage, it included a number of concepts that ended up forming the basic principles of modern cryptocurrencies: a distributed ledger (participants keep a separate database of how much money belongs to the users), the digital signing of transactions, the creation of money via Proof of Work (like Bit Gold), and incentives for participants to remain honest by putting their money on the line, which loosely resembles what would today be called a proof-of-stake system. B-money was never implemented due to the fact it was not yet a practical design, and Dai moved on to other things shortly after sharing the proposal.
Finally, in 2004, Hal Finney, attempted to improve upon Bit Gold and created a digital system he called Reusable Proofs of Work (RPoW), by using Hashcash’s Proof of Work system to mint new tokens. Although Finney actually coded up an RPOW prototype, his creation did not totally live up to the ideals set by the Cypherpunks: the double-spending problem was solved by relying on a centralized server. It would then take another five years before a fifth member built upon the various ideas of Back, Szabo, Dai, and Finney, and finally put an end to the Cypherpunks’ quest: creating the first viable, trustless, and fully-decentralized digital money.
2008 – Bitcoin by Satoshi Nakamoto
On October 31, 2008, a whitepaper entitled Bitcoin: A Peer-to-Peer Electronic Cash System was introduced by a pseudonymous actor, or actors, named Satoshi Nakamoto. The network launched on January 3, 2009, upon the mining of the first 50 bitcoins by Nakamoto himself, which came to be known as the “Genesis Block”. Slowly, word of bitcoin spread and won accolades from some of digital currency’s greatest minds: Zsabo, Dai and Finney. For the record, the latter was the receiver of the first bitcoin transaction, when he downloaded the bitcoin software on the day it was released on January 12, and received 10 bitcoins from Nakamoto that same day.
Bitcoin’s success in creating a fully-decentralized digital currency was made possible by a major breakthrough in the way all participants of the network reach consensus without the need for trusted intermediaries: blockchain technology. To reach consensus in a secure way and prevent the double-spending problem, bitcoin uses HashCash’s Proof of Work and relies on a majority of hashrate – the network’s processing power – and incentivizes miners to play by the rules. Simply put, acquiring a majority of the network’s hashrate is expensive, making it very costly for a miner to tamper with the database, while handsome bounties of newly minted bitcoins awarded to the winning miner who correctly solves the Proof of Work puzzle forces the rational and economically-motivated miner to commit to securing the integrity of the blockchain.
Bitcoin’s elegant incentive structure borrowed from HashCash’s Proof of Work gradually turned digital money into an increasingly mainstream phenomenon. In February 2010, the first known commercial transaction using bitcoin occurred when programmer Laszlo Hanyecz bought two pizzas worth $20 for 10,000 bitcoins, thus valuing bitcoin for the first time. Over time, Bitcoin’s creation led to the creation of alternative cryptocurrencies, and exchanges emerged to buy and trade those assets, which all led to the cryptocurrency market we know of today. But that is another story for another time.
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