As a professor with many Facebook friends who are students, I’m seeing a lot of posts lately about the surging value of their investments in digital currency. My students are geeking out over bitcoin and dogecoin and a few lesser known virtual loot systems and rejoicing over how much their meager investments have made in a very short time. I’ve yet to get into the game, my scarcity of time and lack of a computer with a good graphics processing unit being my primary obstacles. Still, digital currency fundamentally appeals to me politically, and the computer science and mathematics fascinate me, as well. The technology of it is perhaps not as fascinating for most people as this account of efforts to track down the founder of the bitcoin movement, which reads more like an international spy novel than a quest to gain an interview with a computer genius. However, digital currency is refreshing because it is an economic accomplishment that depends not on financial insights and market gaming but on a kind of mathematical and programming wizardry that is as rewarding a revenge of the nerds you’ll ever find. In that sense, it is a currency whose purity rivals the gold standard.
The political aspect of digital currency that appeals to me is that there is no central bank through which all money passes. The system is owned and cared for by the community that uses it. There is no central body that records transactions or that tinkers with interest rates. It is a decentralized system that offers great transparency to its participants. Furthermore, there’s no fat cat getting fatter off my money, nobody paying for a summer home in Banff by hedging bets on my investments. I like that … a lot.
So, if there is no central agency overseeing the integrity of the system, why doesn’t it devolve into anarchy? That’s where the computational cool stuff comes in. Every transaction that takes place is reviewed publicly by the community through a shared verification process. This process is called mining. There is a public record of all transactions that have taken place to this point that evolves in real time as money is transferred. An attempted transaction doesn’t become an official one (in other words, doesn’t become part of the public record) until the community has collectively reviewed it and verified its legitimacy. This verification process is extremely demanding computationally. It involves predicting a value that was combined with the public record and the new transaction to produce a particular target value called a hash. Identifying the original value to which a given hash corresponds is not something a single computer or entity could do. However, with all coin users contributing computing power to the transaction verification process simultaneously, this outrageously complicated task can actually be accomplished in a matter of seconds. Once the verification takes place, the newly validated transaction is added to the public record, and those who engaged in the transaction in the first place are notified that their financial give-and-take is now official.
As a reward, the “miner” who cracked the final piece of the puzzle and completed the verification process is then awarded a new batch of coins to add to his treasure. In the case of bitcoin, the number of new coins a miner receives as a bounty will be cut in half every four years until the number of coins in circulation reaches a stable settling point. This simulates the behavior of a finite resource used as the financial basis for an environment that is free from external political and economic influence. In other words, geeks have done what bankers undid. Top that!
How are digital payments actually made? Say I wish to buy a burger from Bobby Jake’s Burger Stand. I use an app or send an email to communicate payment. I unlock my coins using information that only I know. This is my private key. As long as I and I alone possess the private key, nobody else can use my coins. I then encrypt them using Bobby Jake’s undoubtedly grease-covered but still-legitimate public key, which everyone can know. What’s the point of a key if everybody has it or can know about it? Thanks to the mathematical magic of public key encryption, if I encrypt the coins with Bobby Jake’s public key, only the holder of the corresponding private key can decrypt that message. In other words, unless Bobby Jake has been playing fast-and-loose with his private key, only he, as the sole holder of that private key, can claim the coins I’m trying to pay him, because only he can decrypt my attempt to pay him. Again, that dance Bobby Jake and I just tried to do won’t stick until the coin community verifies it through the mining process. Once that’s done, however, Bobby Jake is richer, and I’m both poorer and fatter.
Speaking of poor, I just spent time writing this explanation of how bit coins work instead of setting up a system that would help me get into the game myself. I’m not quite sure whether that would qualify as selflessness or foolishness. Regardless, I hope you feel richer in knowing how digital coins work. Maybe we’ll meet each other on the mining trail someday.