How safe is crypto?

Source: Clipart Library

The crypto universe began in 2008 when someone writing under the pen-name Satoshi Nakomoto – the ironic Japanese translation of “Central Intelligence” – published a white paper entitled: “Bitcoin: A Peer-to-Peer Electronic Cash System.” The author sent it to an obscure mailing list of cryptographers. It describes a way for individuals to hold, send, and receive items of value digitally, without a central intermediary keeping records.

Bitcoin was designed to solve a problem of modern life. Increasingly, our lives have migrated online. But money remains stuck in an analog age. Either we use physical cash, or we exchange ledger entries recorded in a central database. Cash is limited by its physical character, and central databases can be hacked or suffer from other problems. The problem with digital currencies has always been that digital assets can be infinitely reproduced. If I write you a digital check, there’s no way to tell, without asking my bank, whether I have enough money. Bitcoin needed to solve this verification problem.

It did this in two ways. The first was using a unique form of password protection, called “cryptgraphic hash functions” (CHF). CHFs are one-way functions, and they’re how Bitcoin owners prove that they have the right to transfer their assets. I’ve listened to mathematicians and cryptographers grow lyrical when they describe the bitcoin algorithm. They get that dreamy, far-off look in their eyes, the way that only residents of “Mathworld” can.

Steiner Inellipse. Source: Mathworld.

Nakomoto combined the CHF algorithm with a distributed ledger – a record of all the hash functions in the bitcoin universe, kept on the hard drives of all the computers participating in the bitcoin network. It’s as if a bunch of different computers had a record of who owned which serial number on every US Dollar bill. Because computing is now globally interconnected, these computers constantly check and correct each other in their distributed network.

This distributed network makes sure that bitcoins don’t get copied or counterfeited. Because every computer has a record of every transaction, if Mickey gives Minnie a bitcoin, he can’t just turn around and give Daisy the same bitcoin. The computers run in Orlando, Paris, and Anaheim would all cry foul – and they all talk to one another.

The notion of a distributed ledger seems novel, it isn’t really. It only seems new because it’s being applied to a computer network and can be used for monetary transactions. But distributed ledgers have actually been around for millennia.

One example is ancient manuscripts. Early copies of the Bible were carried from community to community and hand-copied. Those documents were checked and re-checked for problems. If only a single error was found, often the entire manuscript would be discarded. Sometimes manuscripts from other communities were compared. Again, the standards of comparison were rigorous. Sentences, words, and even letters were counted, mid-points were calculated, and so on. My point here isn’t to outline ancient standards of manuscript transmission. Rather, we should understand that there was a wide network of recognized experts dedicated to verifying the accuracy of these texts, and they had generally agreed-upon rules and canons to guide their decisions.

Ancient biblical text from the early 4th century. Source: Wikipedia. Public Domain.

Another distributed network is found today, in the accounting world. When firms prepare their annual financial statements, these must be audited by a Certified Public Accountant. CPA firms check statements against internal records and external balances. These need to tie out and match, typically down to very small amounts. There’s no central accounting authority to keep a record and make sure they conduct their work according to generally accepted principles. But firms do check each other periodically. Staff can be shifted from one client to another, and sometimes people change firms. There’s an open, informal network of accountants who are constantly checking each other’s work. This distributed network of expertise is one of the reasons we can trust a firm’s audited financial statements.

Distributed ledgers exist to correct errors and determine authenticity. They’re highly robust. Two decades ago, the Enron scandal shook the accounting world to its roots. It was unclear how far Enron’s corruption went, and how many firms were implicated. In the end, only a handful of public firms were found to be “cooking the books,” and the Sarbanes-Oxley reforms did much to restore confidence in the profession. Similarly, ancient manuscripts have survived fires, plagues, wars, and internal schisms. The distributed nature of these ledgers is why they survive.

Medieval illustration of the Second Crusade. Source: Wikipedia.

Bitcoin’s distributed ledger is what allows it to work, and the open character enables crypto-assets to serve as a 24/7 payment system that settles electronically with no central authority. Digital money can be used for payments, lending, and investments. While Satoshi Nakamoto’s code may be new, it relies on a mechanism that has been part of society for almost as long as civilization itself – serving in many different arenas: religion, finance, sports, law, science, news, etc. This diversity – not just a beautiful algorithm – is a source of strength.