The motivation behind blockchain

The online literature on blockchain is torn between too simplistic rundowns for non-techies and advanced hieroglyphic riddles targeted at those who want to learn blockchain in depth. When I started learning blockchain, unfortunately, hardly did I come across any material that gave me a comprehensive technical understanding of blockchain for beginners. This series of articles is an attempt to fill that vacuum.

Before we learn blockchain, we must understand the motivation behind blockchain. Blockchain was introduced as a technology by the cryptocurrency named Bitcoin in 2008. Originally meant to facilitate digital financial transactions, the influence of the motivation to solve problems associated with financial transactions can be clearly seen in blockchain technology. So, to understand the motivation behind blockchain, we need to understand the history of financial transactions.

History of financial transactions

In the very beginning, humans tried to fulfill their own needs all by themselves. Gradually, they realized that each one could specialize in fulfilling one particular need and they could exchange their produces to fulfill most of their individual needs. For example, a farmer could exchange the food he produced to get the pottery he needed from a potter. So, a farmer and a potter got both food and pots. This is the barter system.

However, this system was not really effective. There were two reasons for this. First, determining the values of products was difficult. Exactly how much of rice is worth a pot? And how do you measure the value of each product in the market against the other? Finding answers to such questions wasn’t easy. Second, this system needed what is termed as a double coincidence. That is two persons needed to have reciprocal needs for this system to work. In other words, a farmer will have to find a potter who needs food, and a potter will have to find a farmer who needs pots.

Invention of money

Such practical constraints lead to the invention of money. Initially, people used products or materials that no one would refuse as money. Usually, it was salt or some precious metal. This was a more convenient option. This also solved the double coincidence problem because money became an intermediary product that people can use for economic transactions. A farmer could exchange food for salt and exchange the salt to get pots later. Money also helped determine the value of products by becoming the yardstick to measure values. One kilogram of rice could be worth exactly one kilogram of salt and one pot could be worth half a kilogram of salt. Thus, money became the de facto mode of economic transactions.

Later, societies started using paper currencies to represent the commodities that they used as money. For example, the USA for some time offered gold certificates as paper currencies. The money’s value was backed by gold, and you could always trade the money for actual gold. In the US, an ounce of gold could be purchased for $20.67, and this value remained constant. This was a more convenient way since you didn’t need to carry the commodities around to perform economic transactions and it helped avoid the depreciation of the value of these commodities through wear and tear.

Fiat currency

But soon governments realized such a monetary system gave them little control over the economy. So, they moved towards fiat currency which allowed them to have greater control of the economy. Here, the fiat currency has no intrinsic value, and the value is guaranteed by the state. Therefore, to trust the value of fiat currency, one has to trust the state. One should trust the state to not alter the value of money and to recognize the notes issued for a long time.

Can you trust money?

But you should already know that the state is the last thing anyone can trust. Let it be the BJP-lead Indian government that demonetized 500- and 1000-rupees notes leading to an economic slowdown, or the cabal led by Bernie Sanders and Alexandria Ocasio Cortez that wants to print more money to pay for their enormous social welfare programs (Sri Lanka went ahead and actually did this crashing their economy), politicians have time and again shown how dangerous it is to let the state regulate money.

Trust is needed when the money is digitalized too. During a digital transaction, no tangible physical commodity is involved. A centralized ledger exists with a trustable party, usually a bank, that would record every transaction. This way money can be debited and credited to different accounts and payment systems can know if an account has sufficient money to perform a transaction.

When I pay an online retailer to purchase something, money from my account is deducted and added to the retailer’s account in the ledger. So, people should be ready to trust the centralized digital transaction system to use digital money. One needs to trust that the centralized authority doesn’t arbitrarily deduct money from their account, doesn’t close down their account and proper security measures are installed to safeguard against security attacks.

Can you trust a centralized digital currency?

Thus, much like fiat currency, centralized digital money also requires trust. But can you trust a centralized digital transaction system? The fact that PayPal has become notorious for closing down accounts and freezing money is all that you need to know to answer this question.

Besides, the Canadian government freezing the bank accounts of those who were protesting against the government demonstrates the perils of a draconian state meeting a centralized digital transaction system. Taking away cash or commodity from people is not as easy as freezing bank accounts or closing them down altogether. So, digital currencies pose a greater risk than physical ones.

Can we create a trustless monetary system?

So, how do we solve the issue of trust in financial transactions?

In the meatspace, tying the money to a valuable commodity like gold can vehemently reduce the need for trust. However, in the digital world, the need for a centralized system is unavoidable. Where do we store users’ login credentials and how do we safely authenticate users without a centralized system? How can we maintain a record of all the transactions without a centralized ledger? Consequently, we can understand the inevitability of centralization in digital transactions.

However, in a world where businesses are being increasingly carried out online, we need a digital solution to solve the trust issue and can’t depend on the gold standard. So, can we decentralize digital transactions by nullifying the need for centralization?

In addition, since personal digital devices are fast becoming a common sight, a decentralized digital transactions system, if it can be materialized, can completely replace the existing monetary system.

This is exactly what the creators of blockchain tried to accomplish. They tried to create a trustless, decentralized monetary system that cannot be controlled by any one party.

Now that we understand the motivation behind blockchain, let’s look at how blockchain decentralizes financial transactions in the upcoming articles.