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Financial Background: Bitcoin and Blockchain Technology

To have value, it cannot be possible for a currency to be spent more than once. This applies to virtual currencies as well. The “blockchain” technology behind Bitcoin solves this “double-spending” problem. The blockchain is the decentralized, distributed ledger where all Bitcoin transaction are stored. The record on the blockchain is immutable and ensures that Bitcoins cannot be spent more than once, thus solving the double spending problem that often occurred with credit transactions. Below are some examples of the double spending problem and how blockchain technology fixes it:

  • Scenario 1: Jane buys a hat from Joe for $5 cash. Jane pays Bob $5 and Joe gives her the hat. Jane cannot now go to Bill and spend her $5 again because she already gave it to Joe. There are no issues with a “cash for cash” transaction.
  • Scenario 2: Jane buys a hat from Joe for $5 on credit. She promises to pay Joe in one week and records this amount in her books. Joe is satisfied and gives her the hat. Jane then scratches out this transaction in her ledger and buys a pair of shoes from Bill with the same $5. Jane records this transaction, Bill gets paid, and Joe is out of luck. This manipulation possibility led to serious trust issues and led to third-party assistance.
  • Scenario 3: Jane buys a hat from Joe for $5. Jane’s bank records a deduction of $5 for Jane and an addition of $5 for Joe. Joe trusts that the third-party bank will record, transfer, and process the $5, so he gives Jane the hat.
  • Scenario 4: Jane buys a hat from Joe for $5 and pays for it with Bitcoin. The Bitcoin transaction is transferred to the blockchain where a permanent record of the payment is automatically stored. Jane cannot now go to Bill and try to spend the same $5. This result is the same as Scenario 3, except there is no third party or intermediary needed.

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