Mental Models for Crypto

Where finance and organization in our society is headed, and why you should pay attention

Sit back and watch this mental model walk into the arms of your mind
  1. Old Money — Here we’re setting the scene with a brief discussion of traditional currencies and cash systems
  2. Digital Money — With the invention of the internet came a need and the ability for digital exchange of value
  3. Towards Decentralization (of digital money) — Here we discuss the motivations behind a decentralized money system
  4. Peer-to-peer money (blockchain) — Next, we look at blockchains and the broad ideas behind it
  5. Looking forward — This is the final part where we tie everything together and discuss what it means for financial systems, for civilization builders and more broadly, for human societies…

Old money

Imagine an island state Monetopia that prides itself on having the most secure and functional payment systems in the world.

Need for Global Currencies

Digital Money

So over the next 30 years, the monetary authorities created digital money, gradually removing a large percentage of physical money from the economy to be replaced by its digital counterpart.

  • Printing: The central bank was already responsible for printing physical money historically, so they just became custodians of this digital money system and controlled the printing of digital money
  • Transfer: As opposed to passing around physical banknotes, transferring money is now done with an update to this system of accounts. (If I pay you 10 units of money, the banks in the system update the record such that I now own 10 less and you own 10 more).
  • She signs an electronic document or note and gives it to her bank, to authorize the payment
  • Her bank updates that Alice now owns 10 fewer units, and informs the central bank that it needs to pay Bob at Bob’s bank
  • The central bank updates its systems to reflect that Alice’s bank owns 10 fewer units and Bob’s bank owns 10 more units, and sends a confirmation to Bob’s bank
  • Upon confirmation of this receipt of the money from Alice’s bank, Bob’s bank updates Bob’s balance to reflect 10 more monies

Towards decentralization

One day the government of Monetopia, along with other governments in the world decided to take themselves off the prevailing Precious Resource standard. This scared the inhabitants of Monetopia for various reasons that included the already well known drawbacks of centralized digital money systems:

  • The centralization of the money supply allows governments to create money from scratch, such as sometimes creating almost 3x the total money in circulation to finance relief programs during economic downturns
  • Even if their own government played honest, they frequently conducted trade with other economies of the world and a lot of their citizens owned money in many different local currencies. These other governments may print money arbitrarily, causing a devaluation of their citizens’ ownership of those currencies
  • Other existing problems like centralized stakeholders being able to monitor and censor transactions

Double Spend

For reasons mentioned above, Monetopia’s inhabitants wanted a decentralized (does not require a trusted third party) and censorship-resistant digital cash system that was not controlled by the government or any single institution.

Source: The Money Mongers
  • In the case of physical banknotes — once you transfer cash from your hand to another, it no longer exists in the previous hand so the original owner can only spend once
  • In the centralized digital system there is a central bank that keeps a record of everything that everyone owns
  • So if I wanted to spend the same amount of money twice, they would only allow the first transaction to be successful

Decision by majority

Now, maybe one way to solve this problem would be to have everyone vote on new transactions and use a majority to decide if a record should be added to the account-book.

Peer-to-Peer Money

If not by simple majority, how can you allow computers to achieve consensus (i.e. agree on the correct set of transactions) in this system? You need at least two things:

  • to solve the problem of digital duplication
  • A way for everyone to agree how to add new transactions
Source: Balaji Srinivasan’s video from a16z startup school

Looking Forward

Okay bringing this back to the real world — the new system was developed by Satoshi Nakomoto and is called Bitcoin, and the technology underpinning it is the blockchain. While Bitcoin was a first application that just kept track of balances in the common record (and therefore is just a currency system), other projects, such as Ethereum, came along that allowed programmability on these balances, and opened the door to a plethora of new use cases.

Coordination and Trust

First, let’s take a little step back and evaluate how far we’ve come.

Arweave aims to be a permanent Library of Alexandria [Source]

One Bank for All

Apart from scaling coordination, a lot of financial infrastructure that existed in the physical world is now being built for the decentralized world. If you’ve ever seen the HBO show Deadwood, which depicts the birth of a city during a gold rush in the late 1800s — you realize that a bank is a critical piece of infrastructure in any new economy.

  • full control of their own wallets and instant access to their money for everyone, everywhere, everytime
  • full visibility and execution guarantees on the bank’s code
  • gives every individual the ability to pool their assets and collateral in a common place
  • globally pooled capital for scalable and cheap lending and borrowing
  • globally pooled liquidity for exchanging between different cryptocurrencies

Why I’m Excited

All of the above gives us plenty of reasons to be terribly excited!

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Abhav Kedia

Data Science, FinTech and the future of Technology. MA CompSci & Math, University of Oxford.