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How Cryptocurrencies Work
November 05, 2018

Transcript
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.

The idea of a communal ledger for transactions is ancient. Cryptocurrencies like bitcoin have modernized the
concept.
In this video, recorded at a recent Dialogue with the Fed event, St. Louis Fed Vice President and Economist
David Andolfatto discusses how bitcoin has merged modern technologies with old ideas about commerce to
facilitate digital payments.
Additional Resources
• Dialogue with the Fed: Blockchain, Cryptocurrencies and Central Banks
• On the Economy: Is Bitcoin a Good Money?
• Open Vault: Three Ways Bitcoin Is Like Regular Currency