2 Nov, 22
Bitcoin History: What Led to the First Cryptocurrency
When Satoshi Nakamoto published his/her/their whitepaper on Bitcoin, they created a new way of thinking about money and value. Despite the ever-growing cryptocurrency environment, Bitcoin’s history is the most colourful and meaningful. It includes game theory, economics, computer science, cryptography, politics, philosophy, monetary history, human rights, privacy, investor psychology and more. Therefore, this article is only a brief history of Bitcoin. There are many unknown facts about Bitcoin and its dynamic origin, so as time passes, it is likely additional information will be discovered that is not included in this article.
Satoshi Nakamoto and Bitcoin’s Whitepaper
Learn more about the whitepaper by reading our Bitcoin Whitepaper Summary.
Setting a standard around the establishment of cryptocurrencies, Bitcoin began with Nakamoto’s famed whitepaper. After publishing the paper on the Bitcoin website, the whitepaper was then announced publicly on cryptography-related mailing lists by a mysterious individual or group under the pseudonym Satoshi Nakamoto. The email explained the properties of the Bitcoin network, introducing it as a fully peer-to-peer electronic cash system without the presence of a trusted third party.
To date, many have claimed to be Nakamoto. However, none of these assertions has been proven. Nonetheless, little is known about the mind behind Bitcoin. Some suspect that Nakamoto could have been a team of many people. Others lend credence to the belief that Bitcoin’s creator was Japanese-born in 1975 based on his P2P Foundation profile. Additional theories emerge that one of Nick Szabo, Craig Wright or Paul Le Roux is the real-world identity of Nakamoto. However, many claim to disprove this based on the timestamps of Nakamoto’s Bitcoin forum posts and his native-level use of English.
Satoshi Nakamoto was influenced by the gold standard when creating Bitcoin, often referred to as digital gold. The gold standard was a system of fixed exchange rates that was created in the late 1800s and abandoned in 1971. Countries used the gold standard to peg the value of their currency to gold. Accordingly, these nations could exchange their currencies for gold or other currencies that were denominated by a value in gold. As more countries subscribed to the gold standard, it became a domestic method for regulating the quantity and growth of the money supply. Due to the inability of governments to print money, this standard facilitated long-term price stability. Therefore, the average inflation rate between 1880 and 1914 was 0.1%.
Nakamoto took two main aspects of the gold standard into consideration when creating Bitcoin. Firstly, both Bitcoin and gold are stateless, ergo providing a currency owned by no country, instead to be utilised internationally. Secondly, Bitcoin, like gold, is limited in supply. Gold is scarce and bitcoin’s supply is capped at 21 million. No central bank or authority has the ability to create additional Bitcoin or gold. Additionally, the restricted supply of Bitcoin provided positive price pressure on the token as demand increased at a higher rate to the rise in supply from mining – maintaining its cap of 21 million.
The 2008 Recession’s Influence on Satoshi Nakamoto
Bitcoin and its peer-to-peer payment system were created during the devastating financial crisis known as the 2008 Global Financial Crisis, or GFC. This recession was caused by a lack of transparency between banks and their customers whereby unscrupulous banking transferred the risk to investors and borrowers. The Gramm-Leach-Bliley Act, which enabled banks to invest their customers’ deposits using derivatives, was the first domino that led to the GFC. These derivatives were created using subprime residential mortgages enabling individuals with low credit ratings to borrow to purchase a house. Accordingly, with an increased ability to penetrate the real estate market, demand for homes soared. In an attempt to raise the funds to purchase additional derivatives, banks eased their lending criteria to generate more mortgages. Subsequently, banks offered interest-only loans that were affordable for these subprime borrowers. However, in 2004, when the Federal Reserve raised interest rates by 0.25%, borrowers could no longer afford their mortgages. Upon the supply of houses growing beyond the demand for homes, borrowers began defaulting on their loans. With this, the banks’ derivatives and other investments tied to the subprime residential mortgages lost all of their value. The financial and social implications of this event were catastrophic. Indeed, the US unemployment rate reached as high as 9.6%, retirement funds fell by more than 20% and America’s GDP loss was $12.8 trillion USD throughout the subsequent years.
Nakamoto witnessed what happened with centralised authorities during this time period and wanted to create a system where trust was not required. By giving all users access to information about how and what transactions were processed by their network, the Bitcoin network intentionally avoided establishing a hierarchy. Satoshi Nakamoto realised that if there was a public record of all transactions made across every computer in their network, then there would be no need for intermediaries or gatekeepers. Spotlighting their stance against banks and the existing financial system, Nakamoto encoded a unique string into Bitcoin’s Genesis block. The string read “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”. Immutably installing this headline into the core of Bitcoin depicts Nakamoto’s motivation to erect an alternative model to the fractional banking system that puts the general public at risk.
Even before Satoshi Nakamoto came the CypherPunk Movement which represented a radical shift in thinking that began in the 1980s. It was inspired by a plethora of ideas including the GNU Manifesto (1985), the Techno-Revolution (1986), and the Crypto Anarchist Manifesto (1988). These tenets sparked Eric Hughes’ A Cypherpunk’s Manifesto (1993), marking the official inauguration of the Cypherpunk movement. The movement’s goal was to use cryptography as a means of privacy and freedom from censorship, which it saw as a necessary tool for resisting government intervention in private lives.
At its core, the crypto movement sought to address three main issues: the lack of privacy online; censorship and regulation on the internet; and control over data stored on computers. To achieve this goal, these cypherpunks developed cryptographic software tools like PGP (Pretty Good Privacy) encryption software for email communications. Cypherpunks were also responsible for the creation of anonymous remailers that would mask their identities when posting messages online so that only those intended recipients could read them. Nakamoto was part of the Cypherpunks Movement. After publishing the source code of Bitcoin onto Sourceforge, Nakamoto encouraged other Cypherpunks to join in the discussion around Bitcoin.
One Cypherpunk that reviewed the Bitcoin code was Nick Szabo. Acting as a quiet, yet dominant individual in the blockchain space, Nick Szabo was a computer scientist and cryptographer who was working on electronic cash systems independent of Bitcoin before its creation. The cryptographer is actually credited with coining the term “smart contracts”. In his 1996 paper, Smart Contracts: Building Blocks for Digital Markets, Szabo lays out the functionality of these self-executing, digital contracts.
Furthermore, Szabo actually visualised the idea of a cryptocurrency before Bitcoin; this culminated in his brainchild, Bit Gold – introduced as a paper in 1998. Like Bitcoin, Bit Gold was based on a decentralised ledger system, now known as a blockchain, which facilitated peer-to-peer transactions without reliance on third parties. These similarities have led many, such as Elon Musk, to associate Nick Szabo with Satoshi Nakamoto – however, Szabo has denied this on numerous occasions.
One of the most important contributors to Bitcoin’s development was Len Sassaman. Widely considered to be “Cypherpunk #3”, his knowledge of cryptography and involvement with the Internet Engineering Task Force led him to create the TCP/IP protocol which underlies and protects users of the internet.
Sassaman additionally participated in the completion of Mixmaster, open-sourcing the anonymous remailer in 1996. This revolutionary technology was the first of its kind, allowing users to send emails that could not be traced back to them. Indeed, this concept was the major predecessor of Tor onion routing software which facilitated private browsing and free exploration of the internet. Sassaman also wrote an early version of PGP, the encryption program that was eventually adopted by Satoshi in creating Bitcoin’s wallet addresses.
Sadly, on the 3rd of July, 2011, Sassaman ended his own life, prompting a flood of praise from the community as they remembered the cryptographer for his work. Sassaman received a permanent memorial on the blockchain that every node on the Bitcoin network carries. This obituary was hacked into the transaction data, and this deed fitting for the cryptographer in the eyes of the community.
Cryptographic Influences on Bitcoin
Cryptography is the science of encryption and decryption which is used to secure the Bitcoin blockchain. Since 1900 BC in Ancient Egypt, cryptography has been used to protect and transfer secret information. A method of cryptography, now known as the Caesar Cipher, was adopted by Julius Caesar in 100 BC to send messages in private.
Bitcoin utilises public and private keys based on an elliptic curve (secp256k1) to execute transactions with digital signatures without one’s information used to send BTC being made available to the network. SHA-256 is a cryptographic hash function utilised by the Bitcoin blockchain which allows us to securely and deterministically modify data into a new form to the extent that it cannot be reproduced back to its original form. Accordingly, SHA-256 is used to verify arbitrary large data whilst simultaneously storing it effectively and privately. This type of hash function is used to implement Bitcoin’s proof of work execution model.
However, cryptography is only one piece of the puzzle. Bitcoin uses cryptographic techniques to overcome the notorious Byzantine General’s problem. This issue emphasises the difficulty in ensuring that decentralised parties reach a consensus without relying on a centralised, trusted entity. An analogy can be used to comprehend this problem. Imagine that several generals have surrounded the city of Byzantium and are ready to attack. With the combined forces of the generals’ armies, they can overcome the city. However, if they attack at different times, Byzantium will effectively defend itself. In this example, the generals have no definitive way to communicate with each other due to the possibility of interception of their messages. The fundamental problem becomes clear. How can the generals unanimously agree on a time to attack the city?
Although Bitcoin’s cryptographic solution to the Byzantine General’s fault is proof of work, the origin of the remedy comes from game theory.
Game theory is the study and mathematical modelling of strategic decisions made by humans. Fundamentally interconnected with behavioural economics, game theory maps out how rational and irrational agents logically interact with games. Notably, games refer to all situations involving a group of players with various choices in which the outcome for one player is dependent on the decision made by other players.
Bitcoin’s continued existence without protocol-level exploits and attacks is due to Satoshi’s fundamental understanding and subsequent use of game theory. On the Bitcoin network, miners have a lot of power to influence transactions that go through and the authenticity of those transactions. To mitigate the likelihood of miners cheating the system for their personal gain, Bitcoin uses game theory to protect the network. The idea of a chain of blocks acts as a disincentive for miners to create blocks of transactions that include doctored transactions. This is primarily because other miners will not add blocks on a block of incorrect transactions. In this sense, the original miner will receive no benefit in BTC, however, will have lost value in using the computing power necessary to build the block. Hence, the Bitcoin network comes with an in-built “punishment model”, discouraging miners from leveraging their power of the blockchain to act nefariously.
Bitcoin’s proof of work mechanism resolves this issue by establishing an irrefutable, immutable, transparent history – the chain of existing blocks. The rules of the Bitcoin network and the large costs on block producers to make blocks that are replete with correct transactions incentivise the publishing of honest information. Moreover, the chain of blocks acts as a history to which all miners on the network give credence. When a new block is added to the chain, it is broadcast to all miners, preventing differences in miners’ personal history.
Ultimately, the Bitcoin Network and its native coin have a colourful history that covers a multitude of areas. Despite Bitcoin seemingly being created to be a trustless digital currency, free from centralised influence and double spending, the underlying philosophical, political and ideological implications are still being unveiled. The genius of Satoshi Nakamoto was creating a mechanism that incentivises rational actors to positively participate in the network, subsequently giving it value. Understanding what Bitcoin really is spotlights its uniqueness and accentuates why its underlying fundamentals give the network the potential to spark a new paradigm of money and technology.
Zerocap provides digital asset investment and digital asset custodial services to forward-thinking investors and institutions globally. For frictionless access to digital assets with industry-leading security, contact our team at [email protected] or visit our website www.zerocap.com
This material is intended for illustrative purposes and general information only. It does not constitute financial advice nor does it take into account your investment objectives, financial situation or particular needs. You should consider the information in light of your objectives, financial situation and needs before making any decision about whether to acquire or dispose of any digital asset. Investments in digital assets can be risky and you may lose your investment. Past performance is no indication of future performance.
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