Why do we even need crypto?
- The problem crypto solves
- Double Spend & cost of mediation
- Trust in governments
Learn Crypto’s aim is to provide easily understood explanations of what cryptocurrency is and how it works. This gives a good practical foundation for beginners. To really understand crypto, however, you need to ask the why questions, the most fundamental being, why do we even need cryptocurrency?
Anyone looking to launch a new business or product should always start with a fundamental question - what problem does it solve? If it doesn’t a problem, why would anyone want to use it?
When Satoshi Nakamoto create Bitcoin - the very first cryptocurrency - in 2008, he/she/they clearly had a very specific problem in mind, because right at the beginning of its blueprint - called the Bitcoin whitepaper - the problem/solution is outlined:
We propose a solution to the double-spending problem using a peer-to-peer network.
What is the Double Spend Problem?
Okay, so you’re now going to rightly ask ‘what is the double-spend problem?’ It simply refers to the fact that our current banking and payment systems work on a trust model. Yes there is plenty of technology involved in processing payments but that cannot guarantee that a payment will not be reversed.
Almost everyone reading this will have experienced that in one way or another. Maybe it was processed twice, maybe it was fraudulent. There are a number of reasons why the existing way we spend money cannot provide what is called ‘irreversible finality’.
In order to sort out these issues, the centralised organisations offering financial services - like banks or payment processors - have to invest in huge support teams whose job is to provide mediation when this ‘double spend’ problem emerges.
This weakness drives up the cost of transactions, because this mediation cost has to be passed on to the customer, and is the reason why sending very small transactions is largely impossible. It simply wouldn’t be cost-effective to offer micro-transactions given the costs of reversing fake, incorrect or fraudulent transactions
Their inability to offer trustless transactions means that financial service providers need to know who their customers are, which is why anytime you open a bank account, credit card or even want to trade crypto with an exchange, you have to pass KYC - know your customer - checks. Which means handing over a lot of personal information.
That institution isn’t willing to serve you unless they have a whole load of information about who you are up-front, and that is because they want to mitigate double spends, which cost them money to sort out.
Bitcoin didn’t start running until January 2009, a few months after the whitepaper was released, and since then, there has never been a single instance of a Bitcoin transaction that needed to be reversed. That 100% efficiency has been achieved by a trustless system - no KYC needed, no email address - that is totally decentralised - it has no staff, no mediators, no customer service agents.
That is some achievement, but Satoshi’s system isn’t perfect. That finality comes at a price. The individual takes responsibility for controlling their Bitcoin, and where humans are involved there will always be points of weakness, which is why scams are rife within the space. Bitcoin works perfectly, but people are fallible.
Fiat Money & trust in governments
The fallibility of people is at the heart of another problem that Bitcoin solves, that isn’t outlined in the whitepaper, but appears elsewhere in the messages left behind by Satoshi.
In the Genesis Block, the very first block of data in the Bitcoin blockchain - the historical record of transactions - there is a hidden message. A link to the following newspaper headline from the Financial Times:
"The Times 03/Jan/2009 Chancellor on brink of second bailout for banks."
It could be that this was added for fun, but given how meticulous Satoshi was in creating Bitcoin it is hard to ignore the relevance. The world was reeling from one of the biggest ever financial shocks, the effects of which we are still feeling today, and by including this headline as an immutable record in his new financial system, he/she/they was making a statement about the roots of that 2008 crisis - which comes back to human fallibility and centralisation.
Many books have been written about what caused the 2008 financial crisis and it even inspired a blockbuster movie. Read our review of ‘The Big Short’ and other crypto-related movies, or buy a good analysis from Amazon, but the TL;DR is this. If financial power is concentrated in a few hands there is always a risk that they will abuse it for their own personal or political benefit.
The problems in 2008 stemmed from the US housing market, but the same issue of centralised control lies at the heart of money creation itself, which is controlled by the government.
Since 1971 money has been backed by nothing but trust in governments to be prudent with how much money they create and where they use it. This is what the term Fiat Money means. The same trust model that creates the double spend problem, has resulted in the US National Debt of over 23 trillion dollars, more than the entire value of the US economy.
In the many messages Satoshi left on the forum set-up for early Bitcoin advocates to discuss its potential - Bitcointalk - you can see his distrust of fiat money.
“The root problem with conventional currency is all the trust that's required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.”
So the problem Satoshi was trying to solve with Bitcoin, and the answer to the question ‘why do we need cryptocurrency?’ is simple - creating financial systems that don’t rely on trust.