In many technological fields, the line between an unworkable concept and not only viability but success is often extremely thin, and it took one tiny feature to turn digital currency from an interesting concept into an entire world of decentralised finance accessible from a wallet app.
The foundational principle of decentralised finance is that the ultimate arbiter of any transaction is not a small number of banking institutions but instead a wider set of decentralised nodes that individually verify transactions and create a collective validated consensus for what money went where.
Cryptocurrency as a concept has existed since 1982, with micropayment systems in operation as early as the 1990s, with DigiCash.
The problem with all of these systems is that they relied on the mass adoption of central banking authorities, which ultimately made them practically little more than payment processors, loyalty card points, or caused them to fall foul of banking legislation.
The solution was to set up a medium of exchange without a central banking authority, but whilst concepts such as blind signatures, the blockchain and proof-of-work verification already existed in various contexts, there was one small but fundamental issue standing in the way.
How do you stop people from spending the same coin twice?
The Double-Spend Problem
The concept of double-spending has existed since the dawn of money; counterfeiting units of exchange has always been an issue, and has always led to trust and inflation issues when it has emerged.
With digital money and digital payment processes, the issue is not necessarily always a matter of criminality either; due to the nature of online payments, it is possible for two payments online to be processed at the same time, which can cause problems if there is only enough money in the account for one of the payments to go through.
The answer used by most online banking systems is that the central banking authority makes that decision, generally by allowing both payments to go through and charging the account holder for overspending. Sometimes it can prioritise some types of payments over others.
It is not a perfect solution, but it allows the system to function effectively and works because bank accounts (and to an extent banknotes and coins) are abstract representations of money and not the finances themselves.
With digital currencies without a central authority to make the final decision, the problem of double-spending becomes much harder to fix and far more problematic, as it can lead to mass confusion as to the state of the chain and where someone’s transaction actually went.
DigiCash relied on the banks to fix this, whilst e-gold relied on gold reserves and their own central authority to resolve issues, something that ultimately contributed to the legal troubles the platform found itself in around the time of its shutdown in 2008.
A year later, the enigmatic Satoshi Nakamoto managed to fix this issue through its implementation of a proof-of-work consensus model.
The idea is designed to bring together the decentralised elements of the blockchain and create a collective agreement about transactions and balances.
The idea is that multiple servers store the ledger of public transactions, but given the nature of online transmissions, there is a case that two servers will receive different transaction requests by the same wallet holder at the same time, leading to problems with determining which purchase came first.
This could lead to a fork, which is where the chain effectively splits in two and there are two financial realities at the same time, which is exceptionally bad from a trust point of view.
To get around it, Bitcoin batches transactions into blocks that point to each other, only allowing servers to produce a block after solving a puzzle. This is, in effect, what bitcoin mining is and servers are incentivised to do so by being rewarded with newly generated BTC.
The issue becomes far less likely, although not entirely impossible, as whilst it is possible for two blocks to be mined at the same time, the longest chain will always be considered to be the valid one, largely incentivising miners to stick to one version of reality.
Proof-of-work verification also makes it extremely expensive, if not impossible for the double-spending issue to emerge through a 51 per cent attack, where a single group controls the majority of the mining power.
It did actually happen in 2014, when the mining pool GHash managed to briefly obtain 51 per cent of hashing power in Bitcoin, but voluntarily reduced its power to 39.99 per cent to maintain the integrity of the currency.