It’s not as if the idea of digital money is new or novel. The idea of trust-less transaction methods has been around as long as money has been invented. Unfortunately, the largest problem that needed solving was known as “double-spending.” If a digital currency is trusted, there need to be assurances a person can’t spend their money in more than one place at a time. It was this challenge that has prevented digital currency from being adopted – until Bitcoin was invented.
How Do Cryptocurrencies Stay Accurate?
Making sure that all data contained within a given cryptocurrency network is accurate is one of the most important aspects of ensuring the coin’s survival. This accuracy is maintained by using what is known as a consensus mechanism, which is essentially a protocol that works to verify the legitimacy of transactions and other data before they are added to the blockchain. The first consensus mechanism used (by Bitcoin) was Proof of Work. Since then, new cryptocurrencies have used other algorithms – many are Proof of Work, some are Proof of Stake, and some are entirely new, like Proof of Authority.
No matter which consensus mechanism a cryptocurrency network chooses to use, consensus mechanisms verify data by making sure that all nodes (users) on the network are synchronized and agree with the legitimacy of transactions taking place. This is how cryptocurrency networks remain decentralized and free from users that could potentially change data for their own personal gain.
How Bitcoin stays Secure (using Proof of Work)
PoW is used to verify transactions within the protocol. The amount of electricity, time, and hardware invested in building the blockchain makes it incredibly costly to launch attacks on the information stored within it. If someone had enough computing power to disrupt Bitcoin – which no one does – it would be more profitable to simply start mining it instead.
From Monetization of Trust to Trust-less Transactions
The blockchain is a technology that automates trust-less transactions. Let’s break it down even further to help you understand how blockchain works.
Without trust, individuals will not engage in transactions because of the fear of theft or loss. If you wanted to send money to your friend, would you give your money to someone you don’t know and hope he’ll pass the money to your friend?
Credit cards are an example of a digital transaction system that monetizes trust.
- Credit card users believe the credit card companies will not steal their money.
- Businesses trust in the credit card companies ability to transfer funds from the customer to their account.
In exchange for this trust, the business is charged a transaction fee on every item sold. Inversely, the credit card companies charge interest to users who do not pay their bills on time. A 3rd party entity – the credit card company – is the trusted intermediary that facilitates digital transactions.
Blockchain technology enables digital value transactions without requiring a 3rd party for trust. The trust is automated within the technology, taking the place of a credit card company and reducing friction for all users involved. Imagine you could purchase or sell a good or service without being beholden to a credit card company or a bank – that is one big advantage of blockchain technology.