Era of Gold Coins

The era of gold coins started around 650 BC. The use of coins resolved some of the basic and fundamental problems with the barter system. For example, gold coins serve as a common unit of value. Now a certain number of goods could be exchanged with a gold coin. Gold is also non-perishable in nature and can be easily transportable. Gold coins also have a couple of flaws, primarily that they are expensive and insecure. Anyone can easily steal gold coins. Moreover, it was not easy to mine gold. All of these issues led to paper-based currency, aka FIAT currency.

FIAT Currency

The paper currency era started around 960 AD. During the initial days of paper currency, people deposited gold coins to third-party financial corporations. Some of these financial parties are now called banks. In lieu of gold coins, these third party gave IOU notes, which were treated as standard currency notes. These IOU notes were also termed the first form of FIAT currency.

People who have these IOU notes can exchange them for goods. There are many advantages to using paper currency. It is lighter than gold and easy to mine. It was initially backed by a tangible commodity like gold, and later by an intangible commodity like banks and governments that issue these notes. All the government institutions that back various currencies have a standard acceptance of exchange rates. FIAT currency has been used across the world in one form or another, as shown in Figure 7-1.

In spite of paper currency being successful and used currently as well, it has its flaws. FAIT currency is unsecured, inflationary, and untraceable. There is no way you can tie paper currency to a person. Anyone can steal your currency and use it again. Government institutions backing currency have no way of knowing who owns the currency. Once the currency is in the market, there is absolutely no way to trace it. This can create a lot of inflation in the market, leading to economic issues like black money hoarding and parallel economies. Some of the countries also use demonetization drives to replace the running currency with new currency notes to stop creating parallel economy.

Using Checks

With the rise of all these issues, government institutions brought another exchange medium in the market, i.e. checks. The first checks were created in 1717 AD. Checks resolve some of the issues with currency and have quite a lot of similarity with existing cryptocurrency. First and foremost, they resolved the security issue. Checks contain the sender’s and receiver’s identities. Checks also used a very elementary form of cryptography (i.e., the signature) to validate the actual sender, as shown in Figure 7-2. Each check can have a different value than any others, which means two checks can have different amounts. Checks were successful in resolving some of the vital issues with previous medium exchanges.

However, checks also have a few issues, especially transaction verification time. Consider a normal case, when a buyer needs a good and he issues a check in lieu of getting those goods. The buyer gets the good but the seller now has to verify the authenticity of the check only when the seller’s bank talks with the buyer bank and gets the clearance of debt. Currently, check clearance takes from 1-4 working days. There are chances that the check is fraudulent and in practical scenarios, the seller now needs to chase the buyer. Checks also have a very basic version of cryptography, via the signature, but that can easily be forged.

Promises of E-Wallet

With so many flaws with FIAT currencies and checks, there was a need to create a new medium of exchange, based on which e-wallet was introduced. E-wallet is almost a perfect medium of exchange. There is no need for paper currencies and you don’t need to carry a wallet with you. It is fast, convenient, and efficient, with transaction verification happening in a couple of seconds. This solves the biggest issues with checks. It can easily be installed and accessed from any device, including mobile devices. By using various mobile biometric and IRIS security measures, the validating transaction can reach the highest level of security compared to using signatures on checks. As there is no paper currency involved, it’s easy for a regulatory authority to track the transaction and track the money usage and its supply. It thereby reduces illegal money uses and black money hoarding.

Blessings in Disguise: Bitcoin

While all these issues were happening, a group of people (or a single individual) under the name of Satoshi Nakamoto published a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System,” shown in Figure 7-3. It challenged the very concept of money and having intermediaries to deal with it. In this paper, Nakamoto proposed a system that is comprised of a chain of blocks, which is later called Blockchain. In this paper, Nakamoto coined the term Bitcoin as a peer-to-peer electronic cash system supported by a distributed decentralized network.

The progress of cryptography and the emergence of some clever solutions like proof of work, mentioned in Nakamoto’s paper, opened the door to create a new kind of digital currency. The release of this paper issued in the era of cryptocurrency. Bitcoin, as shown in Figure 7-4, is the most popular and the oldest of the cryptocurrencies.

Thank you, Satoshi Nakamoto! Bitcoin, among others, is now a real alternative to banking dominance. While writing this book, there were around 1400+ cryptocurrencies in the market, with Bitcoin being the oldest one.

Centralized Systems

Centralized systems, as shown in Figure 7-5, are the systems that have single point of authority (POA). All the control is concentrated in this authority, which ensures all processes and decisions are carried out at this location. Centralized systems have a couple of advantages. As there is just one point of authority, the decision can be faster and easier to implement. Each point in the authority is responsible for one task. This prevents any single task from being done by multiple points, ensuring no duplicity and faster change management. Some of the examples of the centralized system include banks, Department of Motor Vehicles, credit agencies, title companies, and server CPUs, to name a few.

The centralized system introduces a lot of advantages and hence it’s been popular even now. However, centralized systems also have a lot of flaws. A single POA brings the notion of having a single point of failure. This means if this point goes down for any reason, the entire system will collapse. We witnessed such failure during the financial crisis of 2008. Another flaw with these systems is that centralized system lacks transparency and is prone to fraud and distrust. Centralized systems works like a black box and people using centralized systems might get influenced with fraud and loss of trust. A centralized system has a lot advantages and are more suited for systems that can accept a single point of trust, require fast growth, and of course, don’t require growing systems at scale.

Decentralized Systems

Decentralized systems have multiple points of authority, as shown in Figure 7-6, which ensured that there is no single point of failure and that authority tasks are more diversified. Unlike centralized systems, decentralized systems also ensure a flat hierarchy. You can think of decentralized systems as containing lots of nodes, with few nodes having additional tasks to authority and instead broadcasting that authority to several other nodes.

Decentralized systems are advantageous when you want to make a decision closer to the consumer rather than doing this at one central location. Some of the classic examples of decentralized systems include a Cloud database and state authorities, to name a few. One of the disadvantages of the decentralized system is that, since there is multiple points of authority, chances of a duplicate task is higher, which can affect economies of scale. A decentralized system is more secure than a centralized one, but is still not 100% secure.

Distributed Systems

Distributed systems are the third type of system in which everyone is an authority. Each node has equal power. This is the most secure among the three systems. This doesn’t mean the system can’t be hacked or faked, but to do it, you must have more than 50 percent control over the points of authority. The time needed to fake and hack would nullify any benefits and hence distributed systems are considered most secure systems. See Figure 7-7.

The distributed system ensures a flat hierarchy, which ensures everyone is equal. There are a lot of advantages to having distributed systems. Since all the nodes are equal, it removes the need for an intermediary. Changes are replicated across all nodes and verified by at least 50 percent of the nodes, making it very transparent. Distributed systems make perfect options for a system requiring third-party trust, intermediary, or even trusting another node. While using the distributed system, you don’t need to trust anyone but the system itself. Some of the examples of distributed systems include cryptocurrency and of course, Blockchain.

With decentralization and disintermediation at the core of the Bitcoin system and Blockchain, there is no requirement for people to trust each other, just the system. Distributed systems , however, take some time to set up and require a good initial amount of investment. Among all the three systems, distributed systems are the most stable. Another benefit of using distributed systems is that they are infinitely scalable and hence any process involving scalability issues at large scale can safely vouch for using distributed systems.

Smart Contracts

Smart Contracts are self-executing contracts. They are also known as digital contracts. Smart Contracts are not a new concept. In fact, two decades back, Nick Szabo, a computer scientist, proposed and emphasized the need for the Smart Contract while designing and implementing the decentralized based system.

The Smart Contract can be treated as a computer program that helps in executing contracts digitally. Unlike any other contract, Smart Contracts don’t just define instructions and consequences around an agreement, but also enforce them. With the use of Smart Contracts, computers can take an action if some requirements get fulfilled. In raw terms, Smart Contracts are a suite of various if-else statements. Take a betting scenario case. If Real Madrid wins the La Liga, Nishith gets the money; otherwise, he pays.

In most cases, you might not trust the other party during the betting. In these scenarios, self-executing contracts bring a lot of trust on the table. Smart Contracts also bring options to revise, execute, or even propose contracts, thereby ensuring the highest level of traceability and trust. Take a use case of insurance claims. Currently, all insurance companies use the manual process of paperwork, complex execution, administration costs, etc. It would indeed be beneficial to execute these claims using Smart Contracts to ensure a hassle-free claiming process, less administration cost, and the highest level of transparency. Take another case of payment where you pay to the contractors only when they fulfills your requirement. Smart Contracts and Blockchain can be used to remove a lot of inefficiencies that exist in the contracts management process.

Types of Blockchain