Double-spending is a problem that arises when transacting digital currency that involves the same tender being spent multiple times. Multiple transactions sharing the same input broadcasted on the network can be problematic and is a flaw unique to digital currenciesDigital MoneyDigital money, or digital currency, is any form of money or payment that exists only in electronic form. It lacks a tangible form, such as a bill, check, or. The primary reason for double-spending is that digital currency can be very easily reproduced.
- Double-spending is a problem that arises when transacting digital currency that involves the same tender is being spent multiple times.
- The primary reason for double-spending is that digital currency can be very easily reproduced.
- There are primarily two ways to combat double-spending – central clearing counterparty and blockchain.
How a Successful Double-Spending Attack is Administered
- Broadcast to the network a transaction where attacked merchant receives payment
- Secretly mine a branch that is built upon the block before the transaction, a transaction that pays the attacker
- Once the transaction to the merchant receives enough confirmations, and the merchant sends the product
- Continue the secret contradictory brand until it is longer than the public transaction, and then make the blocks public. The network will identify the secret branch to be valid because it is longer than the public block, and the payment to the merchant will be replaced by the payment to the attacker.
How to Combat Double-Spending?
Preventing double-spending involves a more strenuous verification process and ensures that the same input cannot be shared over multiple transactions. There are two primary ways to combat double-spending:
1. Centralized Clearing Counterparty
Centralization can potentially mitigate 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. The added entity would perform a function equivalent to central counterparty clearing.
In finance, central counterparties are often financial institutions that take on counterparty credit riskCredit RiskCredit risk is the risk of loss that may occur from the failure of any party to abide by the terms and conditions of any financial contract, principally, between two parties and ensure that a transaction clears. The services are commonly applied to facilitate the trading of financial derivative instruments.
Decentralized digital currencies, such as BitcoinBitcoinBitcoin is the forerunner of the cryptocurrency market. Operating on blockchain technology, Bitcoin is set to disrupt the currency market. Invented in 2008, utilize 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. Therefore, Bitcoin comes with a historical public ledger facilitated through blockchain that provides empirical verification of property rights and transfer.
In order for a market participant to fraudulently double spend, they will need to use a significant amount of computing power to eliminate the previous blocks in the chain, and effectively double-spend the transaction. Additionally, as time passes, confirmations of the block exponentially grow, further protecting the integrity of the transaction.
Challenges Associated with the Use of a Centralized Authority
One of the notable challenges of implementing a centralized authority is the creation and maintenance costs. Assigning a bank as a centralized authority will result in commission cuts on digital currency transactions. It can be expensive, especially in cases were 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 maintaining a considerable number of servers storing identical and up-to-date copies of public transaction ledgers. However, transactions that are broadcasted may reach servers at varying times. 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, in cases where a transaction is duplicated or the same token is used for payment, the duplicated transaction will be rendered invalid, as the servers will only validate the first transaction. However, once the servers become mismatched, the validation of true balances becomes nearly impossible. Such a drawback can be resolved by the use of a consensus algorithm, which syncs the various servers. Examples of such algorithms include the proof-of-stake and the proof-of-work consensus mechanisms.
CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™Program Page – CBCAGet CFI’s CBCA™ certification and become a Commercial Banking & Credit Analyst. Enroll and advance your career with our certification programs and courses. certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:
- CryptocurrencyCryptocurrencyCryptocurrency is a form of digital currency that is based on blockchain networking. Cryptocurrency like Bitcoin and Ethereum are becoming widely accepted.
- Double TaxationDouble TaxationDouble taxation is a situation associated with how corporate and individual income is taxed and is therefore susceptible to being taxed twice.
- BlockchainBlockchainBlockchain networking allows maintenance of a growing list of records. Blockchain authentication is what supports cryptocurrency security.
- Virtual CurrencyVirtual CurrencyVirtual currency is a type of unregulated digital currency. It is not issued or controlled by a central bank. Examples of virtual currencies include Bitcoin