SATOSHI'S REVOLUTION: How The Creator Of Bitcoin May Have Stumbled Onto Something Much, Much Bigger

We gave our Person of the Year award for 2013 to Satoshi Nakamoto, the pseudonymous creator of Bitcoin.

We know some of you laughed.

If you did, you may want to read on. It's becoming increasingly clear that Satoshi's creation has the potential to change how much of commerce itself works, and for reasons not even many Bitcoin fans realize.

By many accounts, Satoshi came up with a real-world solution to an actual, longstanding computer science paradox, known as the double-spend problem, or the Byzantine General's problem (the professor who named it thus explains why he did so here). The dilemma is how to send and receive money online without the need for a trusted third party, like PayPal, ensuring that the same digital credit standing in for the amount being exchanged isn't being spent twice.

In the real world, this problem gets avoided with cash, which is quite difficult to counterfeit. In practice, digital counterfeiting is much easier.

Satoshi's solution was what has become known as the blockchain: a ledger of all transactions owned and monitored by everyone but ultimately controlled by none. It's like a giant interactive spreadsheet everyone has access to and updates to confirm each digital credit is unique.

It is this technology that programmers are now working to deploy for uses that go far beyond Bitcoin. Ironically, Satoshi does not appear to have been looking to solve this problem when he created Bitcoin. But his design for the blockchain, which he spelled out in his 2008 Bitcoin spec paper, has profound implications.

"For the first time, two people can exchange a piece of digital property, without any prior relationship, and in a secure way, over the Internet," Jeff Garzik, one of Bitcoin's core developers now employed by payment processor BitPay, told BI. "As a computer scientist, and in computer science in general, when you talked about building distributed systems, there tended to be a purely theoretical view about how computers would talk to each other, how to keep them coordinated. Satoshi and the blockchain really solved that problem in an elegant and unexpected way.

I don't think the computer science community has really caught up yet.

"I don't think the computer science community has really caught up yet."

The breakthrough means that theoretically any act of commerce on the web can be decentralized and stripped of a controlling authority.

Perhaps the most straightforward example of a post-Bitcoin service currently using Satoshi's blockchain is called Proof Of Existence. Created by Manuel Araoz, a 23-year-old developer in Argentina, the site allows you to upload a file to certify that you had custody of it at a given time. Neither its contents, nor your own personal information are ever revealed - rather, all the data in the document gets digested into an encrypted number. Proof Of Existence is actually built on top of the Bitcoin blockchain, (there's a 0.005 BTC fee), so the thousands of computers on that network have now collectively verified your file.

A slightly more politicized application of the blockchain is Namecoin. Currently, international non-profit ICANN governs nearly all top-level web address domains, like .com. But three years ago, engineers developed something called Namecoin that serves as a new domain name system for registering web addresses that end in .bit. In this case, instead of ICANN controlling the domain name system, you and all the other people in the Namecoin system control the domain names. Again, blockchain technology makes it so that something which previously required a centralized authority can now be managed via community.

At this point, payment processors like Western Union probably have the most to fear from blockchain competition, according to Gil Luria, a managing director at Wedbush Securities covering financial technology. You may have heard this before, but Luria explained why the blockchain is the true threat: Most processors currently use hub-and-spoke models, he said, which are able to charge fees for crossing jurisdictions, and for smaller transaction amounts. Decentralizing and distributing the network gets rid of all that.

"It's a much more competitive business model," Luria told us by phone recently. "Instead of paying 5 to 10% in fees to Western Union, you're going to be 2 to 3%, possibly even less.

A startup called Ripple represents the most active threat to the mega processors. We profiled Ripple, and the group that created it, last month. Computers all familiar with each other on Ripple's network mutually agree on changes to its blockchain (Ripple calls it a ledger). This allows transactions to be processed instantly, and without a third party. It's actually even faster than the Bitcoin network, because everyone using the Ripple ledger gets their own copy of the whole ledger, in contrast with the nodes on the Bitcoin network all sharing a single one.

The blockchain is even stalking credit card companies: In an interview in Goldman Sachs' note on Bitcoin last March, Fred Ehrsam, the CEO of mega Bitcoin payment processor Coinbase, observed that a Bitcoin-like payment network would solve the problem of having your credit card info stored with a big box retailer like Target. Even sending money through Venmo, the app that lets you text your friends for picking up dinner that one time, still takes five days to clear.

Of course, it's possible the existing financial behemoths could adopt their own blockchain technologies. In the same Goldman note, Goldman information technology services analyst Roman Leal writes that, "just as a flurry of new entrants - such as Square, Groupon, and PayPal - encouraged payment networks and payment processors to develop a mobile payments strategy, we expect traditional payment players to develop digital currency strategies."

Two groups, BitShares and Ethereum, are hoping to blockchain-ify...everything. BitShares founder and CEO Daniel Larimer has his eye on stock exchanges, voting, music distribution, and on. He calls such futuristic entities distributed autonomous corporations. To use the music example, Larimer envisions artists having the ability to issue shares in their own songs, incentivizing fans to spread the tune far and wide to increase returns. "We give power to shareholders without centralizing in any way, because we've eliminated the barriers to entry for starting a company," Larimer told us at the "Inside Bitcoins" conference recently.

Incidentally, he said having a conference called "Inside Bitcoins" was akin to having a conference called "Inside AltaVista."

There are of course loads of technological and regulatory hurdles that must still be overcome for all of this to materialize. And there are plenty of things that could be reset on a blockchain. But investors don't seem too concerned: Marc Andreessen (who also invests in Business Insider) and Fred Wilson are betting big in this space.

Our 2014 fund will be built during the blockchain cycle. - Fred Wilson

In a recent blog post, Wilson equated the breakthrough Blockchain represents to the web browser and social media. He specifically refers to this moment as the "blockchain cycle."

Our 2004 fund was built during social. Our 2008 fund was built during social and the emergence of mobile. Our 2012 fund was built during the mobile downturn. And our 2014 fund will be built during the blockchain cycle. I am looking forward to it.

"I think we see every week now somewhere between one and three entrepreneurs come in with blockchain ideas," Andreessen Horowitz's Chris Dixon told BI. "There's definitely some momentum behind it."

We'll leave you with an extremely futuristic example of how the blockchain could be deployed. In a talk given last fall at the Turing festival, Mike Hearn, a former Google employee who quit his job to work full-time on Bitcoin, laid out this scenario: A 20-something Scottish girl named Jen wants to meet up with her friends downtown. She doesn't own a car - no one does in the future - so she dials up a cab through a network Hearn calls TradeNet.

Jen's request acts as a request-for-bid on TradeNet, and all the robot cabs available start automatically posting offers, like on an exchange. Jen's node then ranks the bids and presents them to Jen based on criteria including price but also things like whether she's used that cab before, and what other people have said about it. All of this is done on a distributed, blockchain system, so no centralized taxi company needs to manage the orders.

The blockchain, by the way, will have improved that recommendation process, Hearn says. Currently many recommendation systems at places like Yelp or Seamless say they use your social network to help you choose services. In practice, they end up producing what amount to spam reviews, since it's unlikely a friend you trust will have reviewed the same service you're looking into. Hearn says cryptography - without which Bitcoin couldn't exist - has helped reduce spam by providing more authoritative, useful authentication.

In this future scenario, the roads on which Jen is driving will have also become autonomous actors, doing trades with the car on TradeNet. They can submit bids to the car about how much they're going to charge to use them. If she's in a hurry, Jen can choose a road that's a bit more expensive but which will allow her to get into the city faster.

Awesome, right?

"This is possible because of Bitcoin," Hearn says. "Bitcoin has no intermediaries, therefore there's really nothing to stop a computer from just connecting to the internet and taking part all by itself. All you need to do to instantiate a Bitcoin wallet is generate a large random number."

Hearn gives other examples of where the TradeNet could be deployed, like buying fruit and vegetables, or units of computation time if you're buying clouds services. Any transactions that are fast, lightweight and commoditized - which the current system, Hearn says is bad at - could be done so much better on the Blockchain.

The entirety of Hearn's talk is pretty amazing, and we recommend you watch it.

With a handful of exceptions like Proof Of Existence, it's still too early to see fully functional applications of blockchain technology. Ripple, for instance, is still courting financial institutions that would benefit from using its payment rail. Bitcoin's main developers are still figuring out ways to tweak its protocol without bringing down the entire network. And of course there remain a host of outstanding regulatory issues that will need to get sorted out before massive expansion of these proposed services can occur.

The blockchain helps end the debate about what Bitcoin is. Previously there's been discussion about whether Bitcoin is a currency, or commodity, or technological protocol. There are good arguments for each categorization, but each is unsatisfying in some way.

Now we know why this debate is so unsatisfying. Bitcoin represents a novel form of organization - a blockchain-based enitity - that's not quite like anything seen before it.