Cryptocurrency Basics

Brief History of Cryptography 2.2

Editor’s Note
The following transcript was taken from one of Kelly’s live classes for tax professionals.


Let’s talk briefly about the history of cryptography. The word of cryptography comes from the Greek words kryptos, meaning hidden, and graphein meaning writing. Ancient cryptography was the study of hidden writing.

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Ancient cryptography started becoming popular about the seventh century BC. It goes all the way back to Egyptian times, but ancient Greeks are the ones who first started using it. They used what was known as a cipher cylinder called a Scytale. It was used primarily by the military.

Several hundred years later, in 58 BC, ancient Rome invented their own cipher, called the Caesar (substitution) Cipher. It was again used by the military to encrypt and decrypt military messages. Why did Rome create one that’s different from the one that Greeks had invented? Turns out that the original Scytale cipher was hacked. It was figured out, so it wasn’t useful anymore. However, the Caesar Cipher was slightly more complex making it more useful.

Cryptography has been around a long time and it keeps getting better and better. That’s why Blockchain exists today. They finally solved one of the biggest problems that exists with digital currency; the double spend problem (aka Byzantine Generals Problem*).

Together cryptography, mathematics, and computer software combined in a unique fashion to create the Bitcoin blockchain with Proof of Work consensus (more on that later in the training). This invention finally fixed the double spend problem.

* The Byzantine Generals Problem is a term etched from the computer science description of a situation where involved parties must agree on a single strategy in order to avoid complete failure, but where some of the involved parties are corrupt and disseminating false information or are otherwise unreliable.

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Modern cryptography, unlike ancient cryptography, is of course digital. It applies mathematics and computer science to encrypt and decrypt data for secure transmission over a network. In ancient times data was transmitted person to person using those ancient versions of a cipher.


Here’s a bit of modern cryptography history.

Modern cryptography really started to take off in the 1940s when Claude Shannon revolutionized cryptography by proving that unbreakable digital cryptography was possible. He was an engineer at Bell Labs, and of course his breakthroughs were used primarily by the US military. It took 30 years before they declassified much of his creations.

In the ‘80s David Chaum got a hold of the information that was declassified, and he used it to invent the very first secure cryptographic digital cash. He called it did Digicash. He created the first electronic cash that used mathematics to create trust. Trust is now being created with computer code instead of having to trust an individual sitting at a computer at a bank. This is creating a whole new era of finance and his Digicash system worked flawlessly.

So why aren’t we using it? Do you think he was a little ahead of his time? He was, and he was targeting his invention at banks. He actually got a couple of European banks to come on board, but he had difficulty selling the idea to very many US banks. The more he talked to corporate bankers about his invention the more he got paranoid about making it available to the banking industry.

So, much to the dismay of his employees, he ended up sabotaging his own company, thereby avoiding the release of Digicash software to the business world. His employees ended up kicking him out of the company as they tried to save their sinking ship. The company collapsed several years later which is not necessarily a bad thing, because can you imagine what might have happened if all the banks around the world at that time got a hold of this technology? They’re now trying to play catch-up.


Cryptocurrency is creating a new era of finance. Remember there were decades of broken trust in the financial system during the ‘70s and ‘80s and ‘90s. And there is also a huge concern by many people about a financial crisis that maybe hasn’t happened yet.

In the 1990s there were three men that decided they wanted to do something about this financial problem. They created a group of fanatical computer programmers who were equipped with the latest cryptographic research, looking for ways to create electronic money that could not be controlled by banks or the government. Of course, they were quite familiar with David Chaum’s invention, but they wanted to do it slightly differently because his invention was designed to be implemented by centralized entities like banks. They wanted to figure out if they could create something that would work not just for banks or government, but one that would work for everybody. They called themselves the Cipherpunks.


In 1992 Eric Hughes, Tim May and John Gilmore founded The Cipherpunks at a coffee shop in San Francisco. Two years later they had over 700 members. This is an idea that finally was in the right time. Their goal was to build trust back into the financial system using computer code, along with mathematics and cryptography.

Fun fact: several attempts were made to create electronic money that failed. I already mentioned Digicash, which officially failed and went bankrupt in 1994. In 1997 there was one called Hashcash and in ‘98 there was B-Money. In 2005 there was BitGold. I don’t know details of why each of these failed, but feel free to look them up.


Eric Hughes wrote the Cipherpunks manifesto, which was a highly read document by anybody interested in cryptography and blockchain. There’s one quote out of there that is world-famous:

“Privacy is necessary for an open society in the electronic age. Privacy is not secrecy. A private matter is something one doesn’t want the whole world to know, but a secret matter is something one doesn’t want anybody to know. Privacy therefore is the power to selectively reveal oneself to the world.”

I would read that again until you fully understand it, as this is the power of blockchain, not just the cryptocurrencies born out of it.


You may have figured out that Santoshi Nakamoto was a member of the Cipherpunks. Santoshi Nakamoto is not a real name, it’s a pseudonym. It’s a persona, a nickname for somebody, or group of somebodies. We don’t know if Santoshi Nakamoto is a person, a man or woman, or a group of people. On November 1, 2008 Santoshi Nakamoto posted his white paper on the Cipherpunk mailing list about an electronic cash system that he called bitcoin. It was a peer to peer online payment system that did not require a trusted central authority like a bank. Between November 1st, 2008 to January 3rd, 2009, he and some other guys on the mailing list, some of the first members, one was Gavin Andreson I think, were constantly talking back and forth, trying to figure how to get the system to work for sure. In January 3, 2009 the bitcoin block chain was officially birthed with the first block of transactions. At that time bitcoin had no value whatsoever.


Why is cryptography so important that they were working so hard at the Cipherpunks to create something? The problem is that we cannot build trust into the existing global network of computers because according to the senior cryptographer at Microsoft, “the Internet was never designed for security. This is a known fact. Sending data, crypto, emails, whatever, via the Internet, is like sending postcards through the mail.” If you want to send some private information, do you use a postcard? No.

Audience member notes a movie that’s educating us about how much information the powers that be, whoever that is, is collecting on us. The movie is Hacked. It sounds like it’s worth watching. They’ve got up to half a million pieces of data on everybody in the room. I assume that my social security number is already in some database with a bad guy. I’m just grateful that there isn’t enough money in my Fiat account for them to care.

Another question: an audience member is still a little bit confused by the difference between digital currency and virtual currency. He said he understands how digital currency was born out of paper dollars and coins. He is not sure how bitcoin comes into existence and has any value. Answer: How is digital currency that is legal tender created right now? He says you deposit a check into a bank account and you now have money to spend, pay your bills, do whatever. Where did the money that you deposited in your account come from? The bottom line is that the only reason digital currency, that is a legal tender exists, is because it was created through fractional reserve banking or it was created through quantitative easing.

It’s like somebody went to a computer and said I’m going to inject a $1 billion into the economy right now. Done! What’s fractional reserve banking? you put your hundred dollar bill into the bank and they go lend 90% of it to somebody else. When you go take your money out to pay your bills, what are you taking out exactly? They’re just numbers on a screen that are being made by an institution that the government has said can do that. There’s a relationship between our US government and the Federal Reserve Bank. They also do it through bonds. You can learn more about bonds from the Federal Reserve. I understand how it works but not well enough to stand here and say it back to you, so there’s fantastic videos on YouTube, free of charge. If you want to understand how the Federal Reserve works, just go watch a five-10 minute video.

This money that we spend is worthless. What backs it? Full faith and trust in the US government and I might also add, in the Federal Reserve. There is nothing physical backing it. There is a system in place that we’re used to, that we trust. When I work really hard, I get a paycheck. Right now it’s in US dollars. I put that check in the bank, I know there’s some numbers on the screen there, up to the amount that I put in. It that says I can go spend that now. But truthfully, that’s worth no more than a piece of paper. It’s not worth anything, it’s just digital ether that we decided has value. What really gives it value? Where does fiat money get its value? I don’t believe it really gets its value from trust and faith in the government or the Federal Reserve. Its value comes from how hard you and I work. That energy that we put into the system is what gives value to those units on a computer screen. That will help you understand bitcoin. We haven’t gotten into the technology about how was bitcoin actually born. I’m about to go there and I think this will help you understand how bitcoin has value.