How are Cryptocurrencies Decentralized?
It’s been said that “innovation is what happens when ideas have sex”. When Satoshi Nakamoto created Bitcoin, they combined three synergistic technologies into a single invention that made economic decentralization possible.
As mentioned previously, governments and banks have historically controlled the creation and distribution of money. This is because it’s almost impossible to create a currency without a trusted, centralized authority. For example, when a stranger sends you money online, you must rely on your bank to ensure that 1) they have the money they say they have, 2) the money isn’t counterfeit and 3) they actually send it.
Bitcoin removed this long-standing limitation by replacing the traditional functions of banks with technology, transferring control of the money supply back to the people.
In particular, it used a combination of three interactive tools:
Blockchains: Immutable databases that record who owns what and that the currency in question is not counterfeit
Digital Keys: Verify that users own their funds
Consensus Mining: Ensures that transactions are legitimate and transfers the funds
So if Alice wanted to send Bob two Bitcoin, the process would look something like this:
The Bitcoin blockchain stores Alice and Bob’s original account balances (i.e. Alice has 2BTC and Bob has none)
Alice desires to send 2 BTC to Bob
She creates a transaction and signs it with her digital key, verifying that it is indeed her requesting the transfer
This transaction is broadcast to a network of miners
Miners receive the transaction and verify that i) it is actually Alice requesting the transaction (via her private key signature) and ii) that she has the required funds
Miners would then update the Bitcoin blockchain with the new balances – (i.e. Alice now has 0 Bitcoins and Bob now has 2 Bitcoins)
Let’s explore each of these concepts in more detail.
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