How Cryptocurrencies Work

David Andolfatto: So now we come to cryptocurrencies. We come full circle. This cryptocurrency is a revolution in the truest sense of the word, in the sense we've come around in full circle. It's a blockchain. But as I've tried to convince you, this blockchain idea has very ancient roots. And so we've come full circle.

But what's the difference here is that we've had these technological advancements in data storage. Computer servers now could be used to replace our human brains. We've got electronic messaging that permits us to communicate across the globe. We're no longer restricted to communicating in a small room vocally the way I'm doing to you right now.

There have been a-- cryptography has evolved to the point that we can secure electronic messages and secure digital databases. And also importantly, there's been developments in game theory, I would argue, that permit us to come up with consensus algorithms that permit us to achieve consensus on a much broader scale.

If you combine all of these things, what you essentially do is replace the primitive blockchain with a network of interconnected computers that are going to do the processing in a communal manner. There's no single delegated intermediary. This could just happen on just on all our individual computers at the same time.

And so now, if Adam wants to buy breakfast using Bitcoin, say, the user experience is very much the same as just using online banking. The front end is very similar. The difference here is in the back end about how the payments are processed and managed. Now, instead of sending a message to your bank, you send a message that is transmitted to the entire community. In the case of Bitcoin, it would be the community of miners-- volunteer accountants if you want to put it that way.

And so this message is transmitted throughout the community, they verify that Adam indeed does have his Bitcoin, that the address indeed belongs-- I guess we don't necessarily know who is the owner of the address. But all the information has to square up.

So Adam has the Bitcoin to send. There's the recipient address. The miners in Bitcoin come to a consensus in some manner that can get involved. The technical details are kind of involved, but you don't have to worry about the technical details. The point is that somehow consensus is achieved.

And this is the way Bitcoin transactions would work. A huge innovation in the sense that for the first time, we can have a digital money system that does not rely on some trusted third party like a bank or some other similar intermediary. This can be done completely in the absence of the conventional institutions that we presently use to manage and process payments. So in that sense, it's really quite an ingenious invention. And it's still very much in its infancy. And it's only about 10 years old right now.