Throughout history, human errors have been the cause of spectacular failures but also meaningful progress that would end up propelling us forward as a species. Take cars, for example; while their invention in the 19th century provided a life-changing solution for mass transportation, it would take until the mid 20th century for the modern seatbelt to be implemented and reduce the increasing amount of fatal accidents cars had caused. The rest, as they say, is history.
We might just find ourselves at another history–defining moment, but this time it’s not in the transportation industry. This revolution in the making is taking place in the world of finance. By now, you might have heard of a new type of currency known as “cryptocurrency.” While it may seem like a simple trend for investors when you study the forces that shaped the inception of cryptocurrencies, you’ll quickly realize that it has the potential to change the financial sector — and, as a result of that, entire economies — as we know it.
That’s because cryptocurrency provides a peer–to–peer payment solution that completely cuts out the middlemen, such as banks or governments. In other words, rather than being managed by a centralized institution, it operates as a decentralized body in which the account holders are fully in control of their funds and transactions without ever having to go through a third party.
To really understand the significance of this new, decentralized currency and its impact on a global scale, we need to take a closer look at a handful of key moments throughout history while asking ourselves, “Why was cryptocurrency invented?”
Cryptocurrency History Part 1 — The Problem
A broad definition on Wikipedia offers that, “Currency […] refers to money in any form when in actual use or circulation as a medium of exchange, especially circulating banknotes and coins.” The key words here are “medium of exchange,” because from the very beginning, the main purpose of introducing currency in any shape or form was to facilitate an exchange of value, e.g. money for food.
Currencies Throughout History
Forming the basis of trade for over 1,500 years dating all the way back to Ancient Egypt, different metals were used as a symbol to represent value stored in the form of commodities.
However, this form of currency was hard to store, account for, and protect, so silver and gold coins (and sometimes bronze) were introduced around the 7th century BC as a more accurate and universally measurable store of value that would allow trading more swiftly.
Then, the first form of paper money was invented in China during the Tang dynasty (618 –907). Paper money came with many promises: it erased the need for risky transports of gold and silver, it allowed currency to be divided into credit and specie backed forms, and it enabled the sale of shares in companies that consisted of joint-stock.
Most importantly, however, the combination of gold, silver, and paper money facilitated the first at–interest loans: the lender could give out a loan in form of paper money based on the fact that the underlying specie (gold or silver) never left their possession until someone else redeemed the note. This arrangement went on to form the core engine behind the modern banking system.
The Centralization Of Banks In The 17th Century
While the gold–and–silver–backed lending of paper money was a breakthrough for economies all around the globe, it also came with a built-in risk; namely that the whole chain of value would collapse when bank robbers would steal the gold or silver reserves that guaranteed the value of paper money in the first place.
In an effort to prevent these types of robberies, Central Banks would be introduced to act as lenders “of last resort,” thus, enabling a network of local banks to guarantee each other’s deposits knowing that the Central Bank would back them. Centralizing the gold and silver reserve by holding them at a Central Bank, however, created another problem. Now, if the Central Bank was robbed, the entire network of local banks would be in trouble forcing governments to step in and bail them out.
Society Pays The Price For Centralized Banks
Even though gold reserves no longer played a role as part of the local and global banking system starting with President Nixon’s decision in 1971 to unilaterally cancel the direct international convertibility of the U.S. dollar to gold, the inherent problem of Central Banks persisted. There were, and still are, two ways in which societies pay a toll for centralized banks to exist:
- Money Supply Increase Offsets General Price Decreases
As one Reddit contributor put it best, “Society gets better at producing stuff cheaper all the time. So, […] you would expect prices to drop every year. That they don’t is the effect of money creation.” In other words, Central Banks backed by governments have the power to consistently increase the national money supply to slowly cause inflation and keep prices of goods steady rather than allowing them to drop.
- Taxpayers Pay For Bailouts
One phrase that gained popularity in the aftermath of the 2008 financial crisis confirmed the existence of “banks that are too big to fail.” It means that there are a handful of big banking institutions, including JP Morgan Chase and Bank Of America, which are so interconnected with national and international economies that their failure would lead to a catastrophic event of global proportions. So rather than letting them collapse during a crisis, the government steps in and bails them out to prevent an economic breakdown. The money to bail them out, of course, comes from taxpayers.
The 1980’s And 90’s
As personal computers and the Internet took hold of Western culture, so did the philosophy of individualism. People now had access to enough technology and wealth to support a quest for defining their own, unique identities separate from their status as a cog in the wheel of society. This cultural shift especially had an impact on the financial market as more and more people started investing in Wall Street to finance their passions and desires.
It also spawned first attempts at designing currencies powered by technology and even early versions of cryptocurrency. One of those was “Digital Cash” (or “Digicash”), which was conceived by an American cryptographer called David Chaum. Due to a few missteps and turning down a $180 million deal with Microsoft, however, Digital Cash ended in bankruptcy in 1998.
Chaum’s initiative was only one among hundreds of start-up companies that were trying to disrupt the financial market with digital money. The only one that showed signs of lasting success was PayPal, which launched in December 1998.
PayPal, however, was still integrated into the traditional banking system, so it didn’t solve any of the problems centralized banks were causing. In addition to that, any attempt at establishing alternative currencies that existed outside of the regulated financial market would be squashed by the federal government in the wake of the 9/11 terrorist attacks. It was simply considered too risky.
2008 — A Year Of Crash And Change
Considered by many economists as the worst financial crisis since the Great Depression in the 1930s, the 2008 global financial crisis was the beginning of a long period of economic downturn known as “Great Recession.”
The two main factors that produced this disastrous event were: 1) a large number of people defaulting on their subprime home mortgage payments, which were given to them at unreasonably low-interest rates by the banks, and 2) predatory lending in the private sector as well as excessive sales of securities with loose underwriting criteria.
This resulted in one of the biggest U.S. investment banks (Lehman Brothers) collapsing as well as the urgent need for massive bail-outs of major financial institutions. All of this was a direct result of a failing centralized banking system that puts the decision–making powers in the hands of just a few influential people.
It is no coincidence that coat–tailing the failure of this increasingly outdated banking system was the arrival of a new era benefiting cryptocurrencies. The world was ready for a decentralized solution that would take out the middleman — e.g. banks — and let all the parties involved in a financial transaction deal directly with each other.
“I think it was a principled issue, a vision, [asking] wouldn’t the world be more efficient if individuals could deal directly in financial terms as much as they do in other markets?” Blythe Masters, the CEO of Digital Assets Holdings, summarized the notion following the financial crisis in a 2016 interview with the Wall Street Journal.
Cryptocurrency History Part 2 — The Solution
2008: The Beginnings Of Bitcoin
In October 2008, a person or group called Satoshi Nakamoto — which to this days remains unidentified — published a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” outlining the vision and solutions cryptocurrency would provide as an antidote to centralized banking. The following are the main points illustrated by Nakamoto in the paper:
- “What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”
- “The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work.”
- “Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers.”
In short, Nakamoto proposed a platform that would no longer require banking institutions and do away with the illusionary trust-concept that has been the foundation of banking systems for over a century.
2009: Blockchain Technology Provides The Solution
Following the publishing of the paper, Nakamoto released the first bitcoin on January 3rd, 2009, thereby introducing the very first decentralized form of digital cash that had no central governing body. The key to making bitcoin work was a technology called “blockchain.”
The easiest way to describe how blockchain technology works is to imagine a long string of blocks. Every time a new transaction occurs, a new block is built and attached to the already existing string of blocks, essentially forming a “blockchain.”
What’s revolutionary about this system is that instead of a central institution, a network of thousands of computers and developers (aka “miners”) around the world share the task of building new blocks (aka “mining”); so every single block undergoes a vast amount of scrutiny until it comes into existence.
Additionally, the fact that all of these transaction blocks are strung together in a chain means that no transaction can ever get lost or be retrospectively manipulated, thus, creating an incredibly secure and indestructible public record holding each and every participating party accountable for their actions. In hindsight of the early days in currencies and banking, this impenetrable public record is a very simple and powerful way to prevent robbery and other foul play.
Finally, Nakamoto also thought about the issue of inflation and money creation — which, as discussed above, central banks use as a tool to manipulate general prices of goods — and capped the available amount of bitcoins at 21 million. Once 21 million bitcoins have been issued (or “mined”), no additional money will be created. Instead, with more demand and increasing coin circulation, the numbers will most likely end up being calculated as fractions rather than wholes.
If the creation of bitcoin powered by blockchain technology wasn’t enough to drive home the point that it was a direct answer to the financial crisis and failure of traditional banks, Nakamoto went as far as provocatively labeling the very first block in the bitcoin blockchain with the text: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”
2017 – Today: Explosive Growth And Acceptance
Following a decade of other, new cryptocurrencies entering the market — including major players like Ethereum, Litecoin, and Dash — 2017 proved to be a breakout year for cryptocurrencies in general, as they finally started entering the mainstream receiving more coverage in the media and being accepted by major companies like Microsoft and Expedia.
That’s most likely due to the explosive growth with bitcoin, for example, being worth $1,017 in January and closing out 2017 at $14,600 in per coin value. “The total value (or market cap) of all of the cryptocurrencies in circulation passed $100bn in June 2017 and peaked at $850bn in January 2018,” Oliver Dale of Parameter reports.
While some experts thought 2017 looked like a “bubble,” others commented that it was only the beginning of the rise of cryptocurrencies. The latter might not be far from the truth considering that, for the first time in history, the U.S. Congress dedicated an entire section of the 2018 joint report on the state of the U.S. economy to cryptocurrency.
In fact, in a bipartisan effort, Congress launched the Congressional Blockchain Caucus in 2016 to explore how decentralized blockchain technology could actually help improve the centralized government in areas like healthcare, issuing of IDs, and digital voting.
Could A Merger Of Centralized And Decentralized Systems Be The Future?
“A growing number of national banks, including the Federal Reserve, are interested in using blockchain technology to power a centralized national currency,” Dyani Sabin alleged in a recent article on Futurism.com.
Says Dyani, “A dollar would still be a dollar, but transactions would use blockchain to make them more secure.” He added that another way blockchain technology could support the existing, centralized banking system would be if consumers moved their “bank account from something like CitiBank and transform it into an account in the Federal Reserve itself. If all of a nation’s money were centralized, it would make the Federal Reserve more efficient at its job of stabilizing and regulating the economy.”
Whether the government and centralized financial institutions will play nice with blockchain technology and cryptocurrencies remains to be seen; but if the developments over the last decade are any indicator, it looks like the human error that caused the 2008 global financial crisis might have simultaneously marked the beginning of a new, decentralized era that looks to improve how financial transactions are executed and secured for both governing bodies and consumers.
It is entirely possible that we might have learned from our mistakes yet again.