Bitcoin may be many different things to many different people, but at its core Bitcoin is a breakthrough in computer science. In fact, it may be the biggest breakthrough in computer science in our lifetimes. To better understand it, it’s helpful to get a brief history of financial innovation.
A brief history….
tarting back in the late 80’s to early 90’s, banks increasingly began to see the Internet as a way to streamline their business. They looked at the Internet as a way to offer customers better financial products and increased financial access to a wider range of people. Stanford Federal Credit Union was among the first financial institutions to offer online Internet banking to its customers. This transition was an important one for currencies evolution as it shifted where financial data was updated and stored.
Before the Internet, all banking financial information was stored on a physical ledger or spreadsheet. Each transaction involved the physical transfer of paper. Sometimes that paper was a physical fiat currency, like the US dollar and sometimes it was just an “I owe you” or some other debt instrument issued by the bank like a line of credit. Physical books had to be checked and re-balanced periodically and coordination between different branches was of the utmost importance. Maintaining a correct and up-to-date financial ledger was a very time-intensive process for financial institutions. When the Internet came along, they saw an opportunity to streamline this process and instead of having to record financial information by hand, they could instead store it on online, bank-owned databases. Hence the first digital currencies began to appear.
Now the main responsibility of a bank was to protect its customer’s deposits. At first, that started with physical backing of gold reserves or fiat currencies in their secured bank vaults. For a client to access their money, they would go to a physical branch location or ATM and withdraw their money. Over time these bank vaults, rather than having to physically move gold or currency between different branches, which is both costly and risky, began to move “I owe you’s” or other financial debt instruments from bank to bank. This would save the banks valuable time and resources by not having to physically move any valuable assets but instead moving paper agreements to who owns the assets.
Once the Internet entered the picture, assets increasingly began to go digital. Instead of having to enter financial information into a physical ledger, they could now enter that information into an Internet database owned by the bank, or usually an intranet. Now that financial information was stored online, it was of the utmost importance that only the “right” people could change it, or those authorized by the bank. That financial information could be viewed by whatever party they chose to give access to, but it was of the utmost importance that only certain people could maintain the ledger. Banks responsibilities were to protect customers’ funds, and as such they would allow only the most trustworthy of people to control and update the financial ledger. Banks created an artificial sense of digital scarcity for the Internet era. We had to have faith that these companies and institutions that kept track of our money would act responsibly on our behalf. We had to have faith that those numbers on the screen represented a real-life value backed by physical assets. Our trust of these institutions allowed them to create an artificial sense of digital scarcity. That was before Bitcoin entered the picture.