Picture the kind of hyper-simplified scenario economists love. Ten people buy and sell various kinds of widgets to/from each other using hard currency. Ringo sells Edith one of his widgets for a coin, Prakash buys two of Sameera’s widgets for three coins, and so on. When everybody’s done trading for the day, there’s no question of where they stand financially: they can just count their coins.
Things are a bit more complicated if the market operates on credit. Edith owes Ringo a coin, Prakash owes Sameera three, but no physical currency changes hands. In this scenario, any self-interested, sufficiently motivated party would note their transactions in order to keep track of what they owe and what others owe them. But unless every party is perfectly conscientious and implausibly scrupulous, never forgetting to carry a 1 or giving into the temptation to fudge, disagreements will arise.
To ensure that everything is fair, the group needs a central ledger. That way when there is a discrepancy, a final arbiter is there to resolve it. But who controls the ledger? Does the group hold an election? An arm-wrestling contest? How often does the position rotate? Should two people share the responsibility? Perhaps two ledgers should be kept simultaneously, or maybe that causes more problems than it solves. Most importantly, how does the group keep whoever it chooses from asserting the Divine Right of Ledger-Keepers and extracting rents from the masses?
Ideally, everyone would keep the ledger. In other words, each would have equal input and oversight when it comes to the central ledger, rather than each keeping their own. That is a daunting technical challenge, but fortunately, it is one that distributed ledgers, also known as blockchains, have largely overcome.
Trustlessness and Proof of Work
Distributed ledgers have (nearly) solved a problem that has long vexed cryptographers: trust. In any of the scenarios above, people have to rely on each other’s decency. Personal, family and community ties can massage the temptation to cheat the disempowered and inattentive, but those mitigating forces break down on a larger scale.
