Paper Belt on Fire: The Satoshi Story

Part memoir, part guide for the next generation of innovators

If the Rust Belt has come to define the hollowed-out industries of the Midwest, in the next ten years the Paper Belt will come to define the paper-based industries from Washington, D.C., to Boston. In D.C., they print money, visas, and laws on paper. In Delaware, companies incorporate on paper. In NYC, they print media on paper. And in Boston, Harvard, and MIT print diplomas on paper. I am dedicated to lighting the Paper Belt on fire. (Excerpted from Paper Belt on Fire.)

The invention of Bitcoin is arguably the greatest unsolved mystery of this century. It may well prove to be the most influential invention as well. Its inventor is on the way to becoming the richest human who ever lived. Only time will tell if one day it replaces the dollar as the world’s reserve currency. But whatever its ultimate fate as a currency, it represents a tremendous breakthrough in computer science with profound philosophical implications that will continue to play out in the decades ahead. That story began, fittingly enough, on Halloween in 2008—at 2:10 p.m., New York time to be exact—when a dry, unassuming apparition appeared from out of the Internet mists on an obscure email list composed of cypherpunks and other cryptography enthusiasts. He called himself Satoshi Nakamoto. He used an untraceable email account. 

“I’ve been working on a new electronic cash system that’s fully peer-to-peer, with no trusted third party,” Nakamoto announces without fire or poetry. He then directs everyone to a nine-page research paper hosted on a Website—bitcoin.org—which he’d registered two months earlier, again using an untraceable account.

The key electrifying term in his announcement is “no trusted third party.” It was as if this practical joker was claiming he found a way to generate a working paradox. He was saying, in effect, that he’d invented a form of trustworthy bookkeeping that required no bookkeeper, an unerring ledger that required no certified accountant, or, to bring back the coordinating technology from the last chapter, a tamper-proof public clock with no timekeeper. How would that paradox even be possible? 

The experts on the cryptography mailing list were not impressed with Nakamoto. Versions of electronic cash and e-gold had been invented before, but the problem was that they all relied on someone in the middle of transactions to verify them and to keep track of them. That man in the middle—a “trusted third party”—was, in the end, a vulnerability for security, because a guardian or institution could become corrupted over time or grow lax in its protection of data. The weak man in the middle also represented a target for any use-of-force monopolies (the rather charming term cypherpunks use for governments), should any government decide to shut the system down by decapitating its center. Recall Napster, the pirate file sharing service for music that was shut down in 2001, after pissing off anyone who ever won a Grammy and destroying the entire music industry’s business model. It was easy for the Justice Department and the FBI to thwart Napster because it was a corporation with a CEO and other officers. Because of such vulnerabilities, a mantra had emerged in the 2000s among many cryptography geeks: “trusted third parties are security holes.” So it’s not surprising that the initial response to Satoshi Nakamoto from the email list ranged from ho-hum to skepticism. No one had invented an electronic cash system without trusted third parties before. It didn’t seem possible. The doubts started coming in right away in replies to Nakamoto’s Halloween email. Nakamoto parries them all as they come in, which anyone can read in the email record, but by the lack of enthusiasm, it’s clear he hasn’t won any believers. 

Then on January 3, 2009, two months after his initial email to the group, Nakamoto fired up his new system on his computer and mined the very first Bitcoin. To make a point about corruption in the financial system, he tucked a reference into the data underlying the coin, a headline ripped from the Times of London that day:

The Times 03/Jan/2009 Chancellor on brink of second bailout for banks

Over the next six days, he continued to tinker with the software and created more Bitcoins. By January 10, Nakamoto found his first believer on the cryptography email list. Hal Finney, a member of the cypherpunks since the earliest days, stepped forward. Finney had already tried his own hand at creating an electronic currency a few years before. As soon as Nakamoto made the Bitcoin software available, Finney downloaded it. There followed a flurry of matter-of-fact emails between the two as Finney points out bugs in the software and Nakamoto corrects them. Then, two weeks later, Nakamoto sent Finney Bitcoin in the first-ever transaction verified and secured by a blockchain. Bitcoin was born. 

Institutions are fuzzy concepts. Marriage is an institution. Baseball is too. But so is a gargantuan administrative body like the Federal Reserve. One researcher on the subject lists twenty-one different definitions for institutions drawing examples from economics, sociology, anthropology, and other redoubts of obscure scholarship. Each has a different emphasis, but a general feature of institutions is that they are the durable forms of our common life, to borrow a phrase from the political scientist Yuval Levin. Institutions structure what we do together in the pursuit of social goals. To see the far-reaching implications underlying crypto, it’s important to see that Bitcoin and Ethereum are not just computer networks, and certainly not startups, but whole new institutions meant to surpass the performance of decaying old ones. They are tools for structuring what we do together in the pursuit of common goals. They do this through an intricate set of incentives and rules, which display a workmanship, precision, and interlocking machinery so unbreakable, so startling in ingenuity, that even the greatest of Swiss horologists would be astonished. 

Let’s return to the advent of the mechanical bell tower clock in the medieval European era. Like the Federal Reserve, this was a public institution serving the common good. Practically all relationships benefit from coordination in time. There are two essential aspects of the bell tower clock that make it a good public institution: it is reliable and trustworthy. Reliability means that the clock is accurate. As far as the technology is concerned, it does what it’s supposed to do. The intent of the engineering matches the sweep of its hands. (More formally, we can define reliability as the closeness that repeated actions have to desired results over time. Hitting a bull’s eye over and over is the sign of a reliable archer.) That effectiveness leads to a wider social function, which is to tell the time for a medieval town. It provides a measure for when and for how long shared events should occur. At first blush, this may appear to be of little consequence, but, as we have seen, the tower clock makes all the difference when it comes to settling disputes between laborers and owners about how long anyone has worked in a day. It also allows anyone within earshot to coordinate activities in ways that just weren’t possible when no one knew what time it was. Suddenly time could become a measure of the sacrifice made in any undertaking. The idea of wage-rate labor became intelligible and workable for the first time. A trustworthy answer to the question, “how much time did you devote to this?,” became a rough indirect measure for how much anyone should be paid for completing a task. 

As useful as that may be, however, citizens can rely on that first property, and the social benefits it brings, only if the second property can be relied upon as well: the bell tower must be secure from human manipulation. It must be trustworthy. If neither laborers, nor shop owners can trust the time, they simply would cease to use it to forge agreements. Systems of coordination would fall apart. For this reason, the clock’s inner workings must be tamper-proof. Some security to prevent this can be structural. The fact that the clock is the tallest building in town makes it difficult to access. Its height also makes it highly visible and therefore easier for anyone in town to detect abnormal change. Monitoring costs are low. A second tower clock in town may reinforce the trustworthiness of the public time, since whenever there is a lack of synchronization, all will know something is off in the tolling of the bells. Tamper-proofing also relies on trust in humans, sadly but not surprisingly a weaker solution than engineering. Here we run into the cypherpunk complaint: trusted third parties are security holes. But the only people who might be able to shave or add minutes to an hour are a small number of insiders, the guards, the clock-maker, or any other authorized person with a key to the bell tower. Collusion is difficult. 

These two properties of the mechanical medieval clock tower—reliable performance and resistance to tampering—led to a massive change in medieval social interactions. Nick Szabo, an eclectic polymath and cryptographer, wrote an essay in 2005 on the invention of mechanical clocks and how their advent helped end feudalism. Szabo credits more precise and trustworthy time-keeping technologies as a decisive factor in the decline of serfdom and the rise of wage-rate free labor in Europe. So far as I can tell, Szabo coined the phrase “trusted third parties are security holes” in a 2001 essay on computer security. There is also something else of interest about Szabo. He is on every expert’s shortlist as the man behind Satoshi Nakamoto. 

There is a famous problem in computer science that goes back to the 1970s. It is often illustrated with a story about a group of generals who must attack a Byzantine city. The problem is that these generals need to send messages to each other and agree on a time to attack. The circumstances of the battle are such that the generals can only achieve victory if their armies all attack the city at the same time. If any single one of the generals retreats while the others attack, then all are defeated. So it’s of the utmost importance that each general receives a reliable message with the correct time of the attack. But there is trouble. The conditions around the city make communication unreliable. Night has fallen. Spies are everywhere. Sent messages can be lost, or enemies can intercept the messages and tamper with them, providing an incorrect time of attack. Perhaps even one of the generals himself is inclined to treason and is tempted to send false information. So, a computer scientist asks, how do you invent a reliable and trustworthy system of communication that ensures the generals attack at the same time? In other words, is it possible to build a tamper-proof bell tower clock with no clock tower? Ever since the problem was first proposed forty years before, the computer science community thought it was unsolvable.

Whoever Nakamoto is, on November 13, 2008, he announced to the email list of cypherpunks that his blockchain framework solves the Byzantine Generals problem. The ingenious technique behind his solution has come to be known as Nakamoto Consensus. It’s what prevents the counterfeiting of Bitcoin or the double spending of the same Bitcoin. It’s the bookkeeping without the bookkeeper. It also allows the generals to attack the city at the same time. 

Again, without fire, poetry, or swagger, Nakamoto tells the email list how ten generals will coordinate using his system. “They use a proof-of-work chain to solve the problem,” he begins. He goes on to explain the technical details behind what a proof-of-work chain is. Essentially each computer in a network has to race to solve a difficult math problem, the problem being different for each computer but similar in nature. It takes time, energy, and computational processing to solve the problem. Millions of attempted answers must be processed to find one that works. Today, this number is in the trillions. As a result, to participate at all, every computer must make a sacrifice in order to contribute information. (A second consequence: cheaters, fraudsters, and spies are deterred from bad behavior. Collusion is costly. They would have to expend vast amounts of time, electricity, and computational power to try to spoof the others with false information.) 

In any event, the first computer to solve the math problem in the race, which takes about ten minutes on average, broadcasts its answer to the group of other computers. One of the peculiar characteristics of Nakamoto’s math problems is that they are difficult to solve but easy to verify. The other computers quickly verify if the first computer’s solution is correct. If so, the winning computer is awarded a jackpot: newly minted Bitcoin and transaction fees, both as an incentive for maintaining and securing the system. Then, at that very moment, the other computers take the information the first computer broadcast out and they build upon it. The first one of them to solve the next math problem gets to be the one who builds the next information block and then adds that block to the first. A chain begins to form. Every computer has a copy of it. Over time, these blocks of information on the chain keep an immutable historical record: time-stamped receipts of every past transaction, current account balances, and verification of all current transactions. No single computer can cheat or change the record because its fraudulent blocks would be rejected by the other computers in the network. But more to the point, the incentives to maintain the truth and integrity of the ledger only get stronger in time. If the system were to fail even once—one counterfeit block, one rewrite of the past—then the entire value of the system would collapse, and all previous sacrifices would have been made in vain. That’s not so bad if Bitcoins are worth pennies. But it’s a catastrophe to be avoided with great vigilance when they are nearly $30,000 apiece with millions of Bitcoins in circulation. As of May 2022, that loss would be $600 billion. What a thief counterfeits would be worthless, too, since his fraud is only valuable if the whole system is working. Self-interest, channeled into this system of interlocking checks and balances, stands as a sentinel overall.

The earlier the block in that chain, the more credible its information is. It has been verified and built upon by all participants. A consensus has been reached—by whom? No, by what—a distributed system of computers acting in the interest of their owners. That consensus keeps the ledger reliable and tamper-proof, like a good mechanical bell tower clock. Every Bitcoin in every account on that ledger represents everything at stake should its integrity be broken. They also signal the value all of the computers have sacrificed to make the system work.

I believe it is no coincidence that the title of Nick Szabo’s essay on the invention of the medieval clock tower is “A Measure of Sacrifice.” The invention of Bitcoin is the invention of a new way to measure and preserve sacrifice in time. In the words of one investor, In Math We Trust. 

After walking the cryptography group through a concise version of this, Nakamoto delivers the coup de grâce. He tells the email list that after using his software for about two hours there would be a chain composed of at least one block from each of the ten Byzantine Generals. One by one, each general can then verify each of the other blocks created in the proof-of-work chain. Each can also measure the sacrifice needed to create those blocks, thereby establishing common knowledge. The time of the attack is embedded in the first block, which has been verified and secured by the Nakamoto Consensus. “The proof-of-work chain is how all the synchronization, distributed database and global view problems you’ve asked about are solved,” he concludes, without so much as an added peep to his interlocutor that he has just earned the equivalent of a Nobel Prize in computer science in incidental remarks and passing observations. 

From its beginning to today, Bitcoin has been condemned by many serious theorists as unworkable. By all the rules and precedents of Princeton and Harvard economists, Bitcoin should not exist. Yet, here it stands, stronger than ever. Some wiseacre at the Nakamoto Institute website has collected many of the skeptics’ comments over the years and has listed the quotes next to the price of Bitcoin at the time it was said, and then next to that, how much a dollar invested every day in Bitcoin since that time would be worth today. That number is staggering, in the millions for some and hundreds of thousands for others more recent. Some of the great ones: 

Paul Krugman, Nobel Prize-winning economist, September 7, 2011: “So to the extent that the [Bitcoin] experiment tells us anything about monetary regimes, it reinforces the case against anything like a new gold standard — because it shows just how vulnerable such a standard would be to money-hoarding, deflation, and depression.” 

Krugman’s daily one-dollar buy would be worth just over $6 million in December of 2021. More:

Justin Wolfers, University of Michigan economist, April 11, 2013: “Money is: (1) a unit of account, (2) a store of value, (3) a medium of exchange. Right now Bitcoin is none of those things (in any serious sense).” 

Ian Bremmer, political scientist, foreign policy expert, and author, May 14, 2013: “I would be very surprised if Bitcoin is still around in 10 years.” 

Brad Delong, University of California, Berkeley economist, December 28, 2013: “unless BitCoin can somehow successfully differentiate itself from the latecomers who are about to emerge, the money supply of BitCoin-like things is infinite because the cost of production of them is infinitesimal.” 

Jamie Dimon, CEO and President JPMorgan & Chase, January 23, 2014: “It’s a terrible store of value. It could be replicated over and over.”

What is this devilish Bitcoin good for? What are these eggheads missing? Throughout history, many different kinds of things have served as money—gold and silver—to name some obvious ones, but also even weird things like seashells, beads, cattle, and, in prisoner of war camps, cigarettes. Money, like the public bell tower clock, is a social technology and is best understood by examining the problems it’s intended to solve. Professor Wolfers’ comment above is correct in outlining the three things money has to do to be useful. First, it’s got to be a medium of exchange, meaning people acquire it not to consume it, but to use it to buy something else (which is why cigarettes might work alright as money in a prison but nowhere else). That function has a network effect to it, where the more people accept something as money, the more useful the good becomes to its holder. One other single person doesn’t just want it; everyone in the network wants it. Next, to serve as money, a good’s got to be a unit of account, meaning its value is stable enough for people to form judgments and make long-term plans with it. Think about the Metric and Imperial systems for units of weights and measures. People shopping at Home Depot can estimate what they need to build a house based on that system. Money is no different. As a measure of the value of our time, people make career decisions based on a feel for compensation. They have a sense of how much rent and groceries should cost and how that relates to their income. The difference between inches and miles, on the one hand, and dollars and cents on the other, is that inches and miles don’t change lengths over time. But the value of money shifts. It can expand or shrink. For it to work as a unit of account, though, it must be relatively stable across time. Lastly, and perhaps most importantly of all, money must be a store of value. People have to have confidence that their money will hold its value well into the future. Grain, cigarettes, and cattle may serve as a form of money in the short run, but they rot, fall apart, or grow old and die. Good money must have integrity through time, which is why gold has been prized so highly since the dawn of civilization. It’s tough to destroy, it never rusts, it never corrodes, it never disintegrates. Gold is also extremely scarce, not just here on earth, but throughout the galaxy. Its creation required the rare collision of two neutron stars to generate the unimaginable power necessary to fuse its subatomic particles into place. (Whereas copper and silver required the explosion of supernovae, a more common occurrence, which is why there is more of both to mine.) 

And here we come to the nut of it. For a good to maintain its value through time, the supply of it cannot increase too rapidly during the time someone owns it. The value of a single cigarette in a prisoner of war camp decreases dramatically as soon as the prisoners are freed. The value of a dollar decreases the more dollars are printed. The relative difficulty of producing new units of a good that serves as money determines the hardness of that money. Easy money, like dollars, is easy to make more of. New hard money requires tremendous effort and cost. 

Gold is great hard money because it’s so scarce. If the price of gold kicks up, the miners start digging deeper for more. But it’s not easy work. Even at record high prices, the amount of new gold has always accounted for only a tiny fraction of the total stock of gold. That means it’s hard to devalue. Over the last seventy years, for instance, despite prices spiking, the growth rate of newly mined gold has never gone higher than 2 percent. That explains why gold has always retained its allure as a store of value. There are natural, physical limits that prevent dramatic increases in its supply. But, even so, it is not without its problems. As rare as it is, the supply of undiscovered gold is theoretically unlimited. Governments can easily prohibit people from buying gold. It is difficult to hide should governments want to seize it as well. To take one underappreciated historical example, President Roosevelt signed Executive Order 6102 in 1933, which banned anyone from owning gold in the United States, a law that lasted until 1975. Americans were forced to sell their gold to the government at a rate of $20.26 an ounce. Then Roosevelt turned around and sold that gold on the international market at $35 per ounce. (Now there’s a new deal!) In light of these vulnerabilities, as impressive as gold is as a primordial element for the store of value, it has its limitations. 

Bitcoin, however, is the hardest money ever invented. It is the ultimate store of value. Because of Nakamoto’s math problems, which increase in difficulty over time, the rate of new Bitcoin creation decreases no matter how high the price of Bitcoin rises. Nakamoto has also placed a hard cap on the total stock. There will only ever be 21 million total Bitcoins. 18.7 million are in circulation now and it’s getting harder and harder to make them. It is the first money in human history that there will never be more of. 

The Bitcoin network has been in operation for eleven years now without so much as a single hiccup. It is more reliable than any central bank. More trustworthy, too. Unlike gold, it can’t be seized, it doesn’t need a vault, a life’s savings could fit on a memory stick, and its integrity gets stronger every ten minutes. And it never ever fails. A use-of-force monopoly would have to destroy every computer in the network, which now spans the globe and whose nodes number in the millions. Bitcoin is the height of monetary design and technology. No wonder academics hate it so much. 

Stay tuned for another installment. You can buy Paper Belt on Fire here.