Blockchain 101

From Digital Currency to Cryptocurrency

All the digital currencies that existed prior to Bitcoin had one feature in common, a central server or authority. While these systems worked, the centralization of these services was considered a serious drawback by many in the digital currency community. This centralization ran counter to the peer-to-peer dream of many digital pioneers, like the renown “cypherpunks,” and introduced security and privacy risks. However, this centralization existed for one very good reason, the “Double Spend Problem”.

The term “Double Spend Problem” refers to the fact that digital goods are very easy to copy. Someone in possession of a digital token, even one that is managed with cryptography, can still copy that token rapidly and repeatedly. It doesn’t take long to realize that a currency that can be easily duplicated won’t hold its value for long.

Making a copy of a digital token and attempting to spend it more than once is called double spending. It was this possibility that forced early digital currency systems to implement central servers that functioned like mint or clearinghouse.

In this centralized system, if Alice wants to send one coin to Bob she is unable to do so directly. Her transaction needs to be sent to the central server which can effectively deduct one coin from her account and credit one coin to Bob.

While many in the digital currency cypherpunk world lamented this issue and worked to solve it, Satoshi was successful in doing so.

The concept behind Satoshi’s solution is simple, instead of one server or entity keep a track of who has what coin at what time, the entire network does this work. Satoshi’s Bitcoin software creates a ledger of transactions which is copied and shared amongst all the nodes on the network.

However, this system begs the question of how to coordinate data amongst people who don’t know or trust each other?” This is a well-known issue in distributed computer networks that is called “The Byzantine Generals Problem”.

The Bitcoin network solves this problem and reaches an agreement, or “consensus”, on data in a process that is called mining. Specifically, Bitcoin’s method for achieving agreement on network data is called the “Nakamoto Consensus” and uses a method called Proof-of-Work which will be explored in a later lesson.

While all of the notable digital currencies prior to bitcoin made use of cryptography in some form or another, it is the Bitcoin network’s extensive use of the technology that earned cryptocurrency its name.