Exploring Cryptocurrency Trading: Mechanisms and Operations

Double-spending is regarded as a problem unique to digital currencies in which one user can spend the same digital asset more than once. It is a potential flaw unique to digital currencies.

Fact to be noted that even before Bitcoin, there were several attempts made to create a perfect sustainable digital monetary system. But all those attempts failed because of an obvious problem known as “Double Spending'

By the time Satoshi Nakamoto introduced Bitcoin through white paper in 2009, it was not just the first of its kind as a digital currency but also succeeded in countering double spending. So far, no bitcoin was “double-spent' because no new coins were added to Bitcoin’s supply. Instead, the same coins from the same wallet were registered in two different blocks during a typical split in Bitcoin’s blockchain.

Bitcoin blockchain has been designed with the protocol that counters double-spend attacks, it was inspired by the traditional cash system. It uses proof-of-work protocol, a consensus mechanism where transactions are batched into blocks and chained together using a linked list of hash pointers (blockchain). A block can be produced from any server by solving the computationally difficult puzzle (specifically finding a partial hash collision) called mining. The block commits to the entire history of bitcoin transactions as well as the new set of incoming transactions.

Most decentralized systems solve this with a consensus algorithm, a way to bring the servers back in sync. Two notable types of consensus mechanisms are proof-of-work and proof-of-stake. Bitcoin has been countering the double-spending problem successfully, but not all cryptocurrencies use the same consensus algorithm.

However the double-spending problem persists, if two blocks (with conflicting transactions) are mined at the same time. When servers inevitably disagree on the order of the two blocks, they each keep both blocks temporarily. As new blocks arrive, they must commit to one history or the other, and eventually a single chain will continue on, while the other(s) will not.

How to Counter Double-Spending?

Preventing double-spending involves a strong verification process and ensures that the same input cannot be shared over multiple transactions. Primarily ways to combat double-spending:

1. Centralized Clearing Counterparty

Centralization of digital currency can potentially limit the inherent risk of double-spending in transacting digital currency. It is done by implementing a central and trusted third party to verify the transactions.

2. Blockchain

Decentralized digital currencies, such as Bitcoin, can utilize the consensus mechanisms that verify transactions with certainty. The consensus mechanisms are alternatively known as proof-to-work. Practically, the mechanism ensures that each participant node verifies the transaction. This is the very strong reason that Bitcoin is able to counter double spending as it comes with a historical public ledger facilitated through blockchain that provides empirical verification of property rights and transfer.

Challenges Associated with the Use of a Centralized Authority

One of the notable challenges in implementing a centralized authority is the creation and maintenance costs. Assigning a centralized authority or a central bank will result in commission cuts on digital currency transactions. It can be expensive, especially in cases where more than two agents and/or banks are involved in the transfer, processing, and authenticating of funds being transferred.

Making Use of a Decentralized Approach

Double spending in decentralized systems is more challenging to resolve, as it requires the maintenance of a considerable number of servers storing identical and up-to-date copies of public transaction ledgers. A key component of a decentralized system approach is that validity is given to the initial transaction that is picked up or received by each of the servers.

Hence,even if a transaction is duplicated or the same token is used for payment, the duplicated transaction will be treated as invalid, as the servers will only validate the first transaction.