This is one article in a collection of 52 articles published weekly throughout 2023 on the basics of Bitcoin. The series is intended for people unfamiliar with Bitcoin or people wishing to enhance their understanding of the fundamentals that underpin the technology. Please contact us, if you have any questions or comments.
The idea of a digital form of cash was not what made Bitcoin such a novel idea. For example, Digicash, which was one of the first major digital currency projects, was started in 1989 by David Chaum. Digicash innovated a method for digital transactions to occur anonymously through the use of public and private key cryptography. The purpose of Digicash was to allow users to conduct online transactions with complete privacy. Digicash, which was used exclusively by the banking system and existed before the prevalence of online purchases that are ubiquitous today, eventually filed for chapter 11 bankruptcy in 2002.
Adam Back, a British cryptographer, came up with the idea of Hashcash in 1997. Hashcash created the concept of proof-of-work which allowed individuals to generate new Hashcash by solving complicated mathematical formulas. The formulas utilized to generate the new Hashcash were so complicated that computers were left to guess at the inputs that would generate the correct answers to allow the computers to mint the new Hashcash. However, Hashcash eventually failed because, among other reasons, once the Hashcash was generated it could only be used once so new units needed to be created any time a user wanted to spend the Hashcash. Additionally, an individual with enough computing power could inflate the supply of Hashcash which reduced the value of each unit of Hashcash.
In 1998 Nick Szabo improved upon Back’s Hashcash when he theorized about a project he called Bit Gold. Bit Gold was one of the earliest attempts to create a digital currency without a trusted third party. Similar to Hashcash, Bit Gold used the proof-of-work concept, along with time-stamps and a title registry that would store the transaction history through the use of nodes (individual computers participating in the network) that made up the decentralized, distributed system in lieu of a trusted third party (e.g. a bank). Unlike Hashcash, Bit Gold could be reused which made it a more useful system. While the project was never formally launched, it was known and discussed among cryptographers.
These projects along with many others provided useful guidance in the creation of the Bitcoin protocol. The Bitcoin protocol was the first to successfully incorporate the various ideas from the previous failures that tried to bring the idea of a decentralized electronic system of cash to fruition. The Bitcoin protocol incorporates the ideas of pioneers in technology and cryptography to create the synergy for Bitcoin.
Furthermore, few people know that there is a long history of private money in the United States that far pre-dates these projects. In fact, going back to the 19th century privately issued bank notes were an important part of the US economy. Therefore, the idea of private money is not a novel feature of Bitcoin. With the advances in technology, Alan Greenspan, former Chairman of the Federal Reserve, believed some sort of digital cash was inevitable. In a 1996 speech at the U.S. Treasury Conference of Electronic Money & Banking: The Role of Government Greenspan stated:
…We could envisage proposal in the near future for issuers of electronic payment obligations, such as stored-value cards or ‘digital cash,’ to set up specialized issuing corporations with strong balance sheets and public credit ratings. Such structures have been common in other areas, for example, in the derivatives and commercial paper markets.
In conclusion, electronic money is likely to spread only gradually and play a much smaller role in our economy than private currency did historically. Nonetheless, the earlier period afford certain insights on the way markets behaved when government rules were much less pervasive. These insights, I submit, should be considered carefully as we endeavor to understand and engage the new private currency markets of the twenty-first century.
One of the things the last several years has taught us is that there are no irrefutable experts when it comes to abstract, non-static, evolving fields like medicine, economics, and currency. However, Greenspan’s 1996 speech provides a good history lesson of how private currency once operated in the United States and the pivotal role it played in pre-civil war banking. Today, many people ignorantly dismiss the idea of separating the currency from the governmental authority. This is short sided. Greenspan’s insight and thoughts about the future of money are not the only misunderstood items. Many people who easily dismiss Bitcoin are unaware of the numerous failures discussed at the beginning of this publication that created innovations that were eventually incorporated into the Bitcoin protocol.
