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Bitcoin-A Brief History

"Breeding homing pigeons that could cover a given space with ever increasing rapidity did not give us the laws of telegraphy, nor did breeding faster horses bring us the steam locomotive."

Edward J. v. K. Menge (1930)

The year 2009 unfurled as a time of significant change and notable events across the globe. It bore witness to the cessation of Sri Lanka's protracted civil war, and simultaneously, the World Health Organization alerted the world to the swine flu, declaring it a global pandemic. Zimbabwe's political leaders made a valiant attempt to stem the tide of hyperinflation by introducing a revamped Zimbabwean dollar. The realm of sports saw Tiger Woods bidding adieu to his illustrious golfing career, while Cristiano Ronaldo basked in the glory of being crowned the world footballer of the year. A remarkable achievement in the annals of space exploration was etched with National Aeronautics and Space Administration (NASA) propelling the Kepler space telescope into the sun's orbit. Concurrently, Slovakia embraced the euro, thus aligning itself more closely with its European neighbors. The People's Republic of China underscored its commitment to modernization by making Hanyu Pinyin the official Latinized transliteration of Chinese. In the meanwhile, as the Great Financial Crisis cast a long shadow across the world, several stock markets hit their nadir, marking a pivotal period in global economic history.

The intertwining of these historic happenings formed a background against which the anonymous developer launched the Bitcoin network on January 3, 2009. Indeed, the nascent Bitcoin network was given life amid the turbulence of the most severe financial market crisis witnessed in the last century. The bold maneuvers made by central banks during this crisis-characterized by substantial interventions in the capital market-were not merely stopgap solutions, but marked a significant shift in the financial landscape that continues to be felt to this day.

These radical interventions have created a ripple effect on the free price discovery mechanisms, skewing incentive structures and pushing market participants to grow accustomed to frequent interest rate cuts and a steady upsurge in bond purchase programs and loan securitizations. The prevalence of low and even negative interest rates has consequently put traditional capital market valuation methods to the test, rendering them less relevant, and in some instances, downright misleading.

In the wake of these unconventional market conditions, enormous risk positions materialized, justified solely on the premise of low interest rates, lending an illusion of economic viability. However, with the recent uptrend in interest rates, the veil has been lifted, and the detrimental impact of these precarious positions is gradually coming to light. Such an intricate and tumultuous backdrop underscores the relevance and potential resilience of Bitcoin and other crypto assets in our evolving financial landscape.

Moreover, with each valve of the financial market being successively shut, the global currency market, boasting a daily trading volume exceeding $6.5 trillion, has emerged as the final regulator of pressure. Although central banks hold considerable sway over price movements, their capacity to influence the most pivotal element-the public's trust in a currency-remains decidedly limited.

Since the dawn of the financial crisis, the persistent market interventions by central banks, coupled with the astronomical sums of money in play, have dealt a severe blow to people's faith in the enduring stability of numerous currencies. This gradual erosion of confidence has effectively shaken the bedrock of the global financial system, thereby highlighting an urgent need for alternative solutions.

With the birth of the Bitcoin network, a novel asset class was ushered in, paving the way for the development of a potential alternative. Nevertheless, it is essential to recognize that this reality of a burgeoning first crypto asset did not occur in isolation, but rather, was preceded by the tireless efforts of numerous pioneers who blazed the trail.

2.1 From the Fuel Card to the Trustless Payment System

The introduction of a functioning, decentralized payment system faced not only technical obstacles, but also the challenge of convincing people of the benefits of digital payments. Skepticism toward cashless payments was high in the beginning, and it took some innovative approaches to change people's minds. In the 1980s, a lot of cash was stolen from gas stations in the Netherlands, so the owners put in place a way to pay without cash. The owners wanted to lower their personal and financial risk, so they started accepting credit cards, which customers liked. At the time, this was a big deal because it was not something people usually did.

The advent of Flooz, the first-ever virtual currency, in 1998 marked a significant milestone. Its operational mechanism bore an uncanny resemblance to the familiar bonus point systems we know today. Users were rewarded with Flooz for their online purchases, and these could then be redeemed on affiliated websites. Each Flooz held a value equivalent to a single U.S. dollar. Nevertheless, akin to many analogous ventures, Flooz could not amass the critical user base necessary for long-term viability, and thus, fell, casualty to the collapse of the initial internet boom around the turn of the millennium.

In contrast, there were ambitious projects that took a big shot, as early as the 1980s. One of them was David Chaum's concept of a blind signature system,1 which he patented in 1988. Chaum, a well-known computer scientist, had already set a milestone in the history of encrypted digital communication with his paper "Untraceable Electronic Mail, Return Addresses, and Digital Pseudonyms." Although the patents did not explicitly refer to digital currencies, the methods developed by Chaum were elementary building blocks of crypto assets.

In 1989, Chaum completed the development of a protocol for a digital currency, which he named eCash. The use of this currency was implemented by Chaum's company DigiCash. This concept incorporated many of his discoveries, such as the "blind signature," a technique for authenticating the sender of a message without disclosing the content, which is a crucial component of well-known crypto protocols.2 However, DigiCash and its digital currency did not achieve enduring success. The emergence of e-commerce was just beginning, and despite the exceptional technical execution, the user base could not be sufficiently expanded. In terms of technology, eCash bore similarities to PayPal. However, the reliance on banks authorized to utilize eCash proved to be particularly troublesome. The established connection to the existing financial system circumvented legal complications like money laundering prevention. But this feature did not make eCash more appealing to users as the linkage to existing systems meant it could not be regarded an autonomous monetary system.

In 1998, DigiCash declared bankruptcy. Nonetheless, David Chaum's efforts were not fruitless. His developed concepts and practical testing laid the groundwork for future advancements. Above all, the requirement for a central authority and dependence on the existing banking system were obstacles that needed to be surmounted in the future. The centralized nature of the eCash system and ongoing regulatory challenges made it evident to all digital currency advocates that a sturdy and independent monetary system must be structured in a decentralized fashion.

Roughly a decade after DigiCash's inception, Wei Dai, a Chinese hardware developer, devised the digital currency B-money.3 In his paper, Dai outlined a protocol that presaged numerous facets of Bitcoin. For example, he articulated the possibility of using the computational exertion required to resolve a mathematical issue as a proof-of-work mechanism, while appropriately rewarding the participating machine for the computational task undertaken. Dai also mentioned the use of a shared accounting system (distributed ledger), with entries collectively verified and approved. Although his protocol never advanced beyond the conceptual stage, it significantly impacted later developments. In tribute to Wei Dai, the smallest unit of Ether, the wei, was named after him.4

Another significant forerunner in the realm of digital currencies is Nicholas Szabo, who hails from Hungary. In 1998, this computer scientist devised the bit gold protocol, an immediate antecedent to Bitcoin that already showcased fundamental components of its successor.5 The essence of the bit gold protocol lies in the proof-of-work concept, which Szabo adapted from Adam Back's work. A year earlier, Back had developed a corresponding algorithm designed to circumvent spam messages and protect networks from distributed denial-of-service (DDoS) attacks.6 This concept limits the unrestricted communication of network participants by mandating that previously completed work is a prerequisite for the acceptance of a transmitted message. Consequently, DDoS attackers or spam message senders would face computational expenses for each request or message dispatched, rendering such attacks costly and unappealing.

The proof-of-work concept is as straightforward as it is inventive. Network participants contribute computing power to resolve...