A History Of Money as Cryptocurrencies
Tags: crypto
May 12, 2021

Cryptocurrencies are really vast and complicated. On first glance, it can be hard to see why some of them exist at all. People generally know about Bitcoin and sometimes Ethereum but rarely DeFi. The minute you start to dig any deeper, all these other cryptocurrencies come out of the woodwork. What are all these for? Why do they all exist?

Here, the history of cryptos will be told with a focus on that "why" question. Inspired by Perry Merhling's Wonderful History of Money and Banking, I want to go back and use the history of these different cryptocurrencies to highlight what problems each new one solved or attempted to solve.

A lot of crypto "research" falls under "in my opinion doing a deep technical dive on coin $XYZ, I think this looks more secure and thus better." Frankly, this bugs the hell out of me. This post aims to be that "deep technical dive," at least in layman's terms so you can get a sense of why each cryptocurrency is perhaps important. Obligatory Notice: none of this is financial advice and all of it is my findings on crypto. Some may disagree with its explanations. You're free to email me. I am long many cryptocurrencies and my specific portfolio always changes. I have never sold. ## Bitcoin: the Big Kahuna Bitcoin came about, circa 2010, to solve the need of a trustless, permissionless, and decentralized currency. Nobody is there to stop you from sending money to the wrong address, nobody can take that money away from you. You see, any sovereign power has control over the currency you hold. The tax authorities can seize your bank accounts, the banks can stop any dollar transactions done in your name (via KYC laws), and the federal reserve can print money for any reason thus dilluting the value of the currency you hold. In the past, there was this concept of gold being nation-less. If you wanted to conduct business, you traded gold. This was the only acceptable thing. Sure, you might owe your friend a few dollars here and there but at the end of the day you wanted to hold gold. This almost always meant physical gold in a vault that you could touch in your own bare hands. Nations backed their currencies with gold. In the United States, your$20 could be redeemed for an ounce of gold prior to 1933.

Gold being the standard -- literally the phrase "gold standard" -- means that no nation can devalue your currency. Because gold has a realtively finite supply, it can't be inflated. Some have argued that gold's inherent deflationary aspect caused the Great Depression.

It could be argued that using gold is arbitrary. Many civilizations used all sorts of precious metals or commodities for money. There is some truth to this. But gold is also lindy. The fact that it's been around as a means of value for thousands of years across many societies means it has stood the test of time. Gold is also a noble metal and will not degrade like diamonds nor replicated to inflate supply. At the time of it's "discovery," it was found in its inert and pure form so that even pre-Columbian Americans, who otherwise couldn't extract minerals, were able to use it. Gold is found just about everywhere in the world. [1]

Of course gold has a lot of drawbacks. Good luck storing your 401k in it -- you'll need to own a vault with security guards. This usually involves paying somebody to do that. It also means that sending lots of money with gold is a pain. Nowadays, countries trust that their mutual deposits will be held securely. The British Empire used to keep other sovereign nations' wealth in its own vaults. The US does so today with Fort Knox.

It's into this world that Bitcoin was born. Bitcoin has the decentralized aspect of gold. Nobody can tell you what to do with it making it unlike any other central bank currency, which are half-jokingly derrided as "fiat" in the crypto world. But unlike gold, Bitcoin is incredibly portable so you can transmit it far easier. Like Gold, Bitcoin is valuable because its mutually agreed upon by everybody to be valuable. It has no real inherent purpose beyond as a means of value. [2]

Bitcoin does this by solving a really difficult math problem called the Byzantine generals problem. The idea is that several generals are trying to attack a fort. To win, they all need to attack at the same time. If anybody defects or the timing is off, then the attack is a failure. People can defect because they're able to attack independently. Timing is difficult because each message sent has a delay. How do you solve this?

Bitcoin solved it. You can read the solution in this very Academic whitepaper. [3]

How did it solve this? Why is it important?

Suppose we're a bank. We have to keep deposits and withdraws. We do so with an accounting ledger. People come and deposit money and withdraw it. If anybody wants to know how much they have at the moment, we add up all their deposits, add up all their withdrawls, and subtract the latter from the former. Now we can know how much they have.

Now let's abstract this a bit. Instead of depositing and withdrawing dollars, we'll deposit and withdraw some made-up value. Let's call it Bitcoin. To know anbody's current balance on this ledger, we simply add up all the deposits and subtract the withdraws.

But what if this value is just made up? What if I go and change the values to make myself richer? In the past and in most cases today, we have some source we trust to hold the true value. This trusted source is incredibly important; if we don't trust it, then whatever is written in the ledger means nothing.

So first we need to spread out who holds the source of truth. That will mean we don't have to trust any one person. But now we have a new problem: how do we coordinate all these different sources of truth to come to a consensus? How do we prove that they agree with one another and nobody is making things up? That's where the byzantine general problem becomes important. The value has to be not only distributed but agreed upon by everybody and it has to be done so knowing it will take time for the information to be received by some servers. This is what Bitcoin solved.

Bitcoin does throw in some other important technologies too. For instance, the use of "mining blocks" to determine how much total bitcoin there is. But this core idea of consensus amongst many servers who don't know nor trust each other is very powerful.

To flesh this out for future sections: Bitcoin puts all transactions onto a "block" of 1 megabyte (the size is important). This block then gets agreed upon by a bunch of servers in the network through a consensus protocol (think fancy math). Once agreed upon, it becomes part of an immutable record called the blockchain that is currently ~300gb in size. Anybody can look at all transactions. To prevent people from sending money they don't own, they have to use a private key. To receive money, they show their public key. All public keys can be generated from their respective private keys. A pair of keys is called a wallet, though some consider a collection of keys to be a wallet.

## Bitcoin's Technological Drawbacks

Bitcoin is not a perfect technology though.

Satoshi Nakamoto disappeared and with it any sort of unified leadership. Bitcoin is developed by a committee that moves awfully slow. This is probably a net benefit -- you don't want your money to change on you constantly -- but it has proven a nuisance at times.

Bitcoin has a 1mb block size. This limits how much information can be included in the ledger when everybody is coming to a consensus. To include your transaction in a block, you need to bid on it. This amounts to paying a transaction fee. If a lot of transactions want to happen, the network is said to be congested and the price to get a transaction through becomes very expensive. As the general price of Bitcoin rises relative to the US Dollar, the transaction becomes more expensive in dollar amounts.

A high price to transact defeats the purpose of Bitcoin in the minds of some. Bitcoin is supposed to replace gold, but are we to go back to when gold was the only thing we traded? Or are we to recreate the digital equivalent of gold vaults where you rarely transact with Bitcoin itself but instead use digital deposit receipts as proxies?

Bitcoin is also not turing complete. To vastly simplify, turing complete languages can do any computation another turing complete language can do. Python and C++ are turing complete so whatever one can do the other can also do (though not necesarily as well). Should Bitcoin just be a trustless way to store value or should it be expanded to allow for other trustless computation?

## Forks: a short primer

This needs to be gone over for those not in the open source world.

Linux is the prime example of open source. This means anybody can pull down the entire source code of linux, make some modification for whatever reason they want, and then use it. It's completely transparent. When you do this, you're forking the source code.

Android is a famous fork of Linux. Google took the source code of linux and modified it for mobile phones.

Forks benefit Linux. Google wanted to modify the source code for things they deemed important such as bettter video technology and better battery life. These changes were then put back into the linux kernel.

Cryptocurrencies are, like Linux, open source. It means anybody can change the source code and raise their hand saying "you should check out my changes, they'd improve this."

Unlike Linux, cryptocurrencies are inherently distributed. That means a group of people have to agree upon whether changes should be included. This is why there's an Ethereum council, a Bitcoin council, Ethereum Improvement Plans (EIPs), and so on. [4]

Forks also mean you can create a new currency from an old one. If you don't like the direction of Bitcoin, then you can take the source code and fork it. Permanently. All transactions up until this fork will hold. This is called "hard forking" and, in the world of financial assets, is unique to cryptocurrencies. This will become important later.

## Increasing the block size of Bitcoin

To solve Bitcoin's congested network, we could increase the block size to allow for more transactions in each block.

## Oracle Tokens to guarantee consensus for contracts

Oracle tokens are another category of cryptocurrency. They are used to solve the "oracle problem" I mentioned earlier in DeFi.

Perhaps most notable of these is Chainlink. The idea is that programs can be written to run across a number of nodes that then come to a consensus on what the "true" value should be.

If we go back to the weather example, you could have multiple nodes using multiple APIs and then averaging or computing some combination of them to be the true value of weather. You could include checks if APIs go down. If you include enough API checks, then your contract should be stable with no ability for a specific bad actor to mess with your smart contract. Chainlink tokens is the currency used to execute these "truth" checks.

There are many other examples of oracle tokens and the space is incredibly new but is very exciting.

## DAO: New Frontiers?

If one is decentralizing everything in blockchain, can we decentralize decision making?

That is the idea behind DAOs or Decentralize Autonomous Organizations.

DAOs work like a government, enabling a group of people to vote on decisions of that organization. This is incredibly important for legal purposes. Remember that Ripple has gotten in trouble because its very centralized. [7]

Many cryptocurrencies, including Ethereum itself, are DAOs. Some issue separate tokens for voting vs value. MakerDAO is one such example. $DAI is issued to be stable with 1:1 with the US dollar while$MKR is issued to vote on governance proposals. DeFi exchanges also use governance tokens for decisions, including PancakeSwap to make votes on whether rewards should be changed. This is, of course, all facilitated with smart contracts.

It's notable that wyoming recently legalized them. Ownerless legal entities? What does that mean for the world?

## Conclusion

Cryptocurrencies have a profound list of use cases that, at some level, change how you think about the world. Whether its the permissionless store of value that is Bitcoin, the overcollateralized loans of DeFi, or the decentralized governance voting of DAOs, it's crazy to think how these things can work.

This piece should give you a primer on how the ecosystem has evolved and what problems these different tokens solve. It's not about memes but problem solving. But unless you're deep in the space, it can be hard to see how any of these coins provide value.

Comments? Questions? Correction? Feel free to email me.

## Footnotes

[1] Though current deposits require pretty substantial mining efforts these days. Gold literally requires cyanide to be leached out of the ground. There's a lot to be said about the environmental effects of this.

[2] Gold is not really used beyond a store of value. This is why Warrent Buffet has argued against it. It's use cases in micro-electronics and other areas is incredibly small.

[3] Bitcoin started the tradition of publishing whitepapers though most are not nearly as rigorous as this. It's also why many, including myself, think Hal Finney was Satoshi Nakamoto.

[4] Naval Ravikant has commented that cryptocurrencies turn democracies into markets -- people with more money have their vote "count more" than those with less. The same unit economics work out here with how much of a token one owns and contributes to the network.

[5] Node operators, notably, do not collect Ethereum fees. This is surprising to me as it would decentivize running a node, at least in theory. Other crypto likely makes up for this but I'm not aware of it.

[6] Murray Rothbard has written extensively about this and the Scottish Free banking era (~1650-1800). The wikipedia article is particularly good.

[7] The chase for Satoshi Nakamoto is part of this. If he's identified, than he could, in theory, be charged as "creating a new security." By staying anonymous, Bitcoin is "ownerless" and thus not a security under US law.

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