Bitcoin solves millennia-old accounting problems
Bitcoin and its ups and downs have been in the news a lot lately, but many people are still left confused about exactly what bitcoin is and how it works. In short, bitcoin is an independent currency system that solves three main problems: middleman banks, so-called ‘double-spending,’ and security.
In our traditional banking system, the bank acts as a third party, holding our money in an account until we make a purchase, when the bank forwards our funds to the merchant’s account. Throughout history, this middleman system has created a lot of problems, including breaks in the chain of communication, the banks simply not having enough cash on hand to pay out on accounts in emergencies, and meddling or mistakes in the bank’s centralized ledger that keeps track of accounts.
Bitcoin fundamentally solves these problems by eliminating the middleman and decentralizing the ledger. This means that instead of putting your trust in a central institution, there’s a decentralized network of independent computers around the world that each must confirm and enter every transaction. That means you have full control over your own account – called a “wallet” – with the added security of multiple copies of the ledger so any attempted tampering or mistake is instantly noticed and rectified.
Bitcoin isn’t the first attempt to make a bankless, decentralized online currency. All previous projects, however, had the same problem – the possibility of double-spending. Double-spending means using the same amount of money multiple times in different transactions by sending an amount into a merchant’s account, but not deleting them from your own. In traditional, centralized systems, the bank ensures that money is no longer available once it has been spent. Decentralized systems never had a central authority to make sure this occured until the brilliant system of bitcoin was created.
Bitcoin solves this problem through the “distributed ledger” system mentioned earlier. The entire decentralized network – or at least a significant majority – must computationally record that bitcoin has moved OUT of the payer’s wallet and IN to the receiver’s. Once this occurs, the transaction is finalized and the payer can’t use any tricks to get that money back and spend it again. It’s simply impossible to trick the entire network into thinking the transaction never occured. If there’s a legitimate reason for refunding a purchase, the merchant can simply broadcast a new transaction that sends the bitcoin back.
The impossibility of tampering with transactions is part of what makes bitcoin so secure. The decentralized network has thousands of individual computers that operate on the bitcoin protocol. With each transaction, a record is made individually on each copy of the ledger, and once a certain number of transactions take place, they are cryptographically sealed together into a unit called a block, which is recorded in a system called a blockchain. Each block on the chain is protected by an incredibly complex cryptography problem called the ‘hash function,’ which is too difficult for anyone to solve without the cooperation of most of the network.
This ensures that no one can go in and alter past entries into the ledger. Any disputing parties can simply look at the objective record on the blockchain and know for certain which transactions occurred at what time. The finality of transactions also makes additional layers of security possible. For example, merchants don’t need to collect billing information from customers, so customers can keep their address and other personal details – even their name – private.
The First of Many
Today, there are many cryptocurrencies available that all use variations of this blockchain technology, but bitcoin was the first pioneer into this new way of using money and making irreversible transactions. With so many useful applications, it’s no wonder that this technology has rapidly increased in value. It’s the money of the future.