Double-Spending

A problem caused by transacting digital currency that involves the same tender being spent multiple times

What is Double-Spending?

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 currencies. The primary reason for double-spending is that digital currency can be very easily reproduced.

 

Double-Spending

 

Summary

  • 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

  1. Broadcast to the network a transaction where attacked merchant receives payment
  2. Secretly mine a branch that is built upon the block before the transaction, a transaction that pays the attacker
  3. Once the transaction to the merchant receives enough confirmations, and the merchant sends the product
  4. 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 risk between two parties and ensure that a transaction clears. The services are commonly applied to facilitate the trading of financial derivative instruments.

 

2. Blockchain

Decentralized digital currencies, such as Bitcoin, 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.

 

Related Readings

CFI is the official provider of the Certified Banking & Credit Analyst (CBCA)™ 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:

  • Cryptocurrency
  • Double Taxation
  • Blockchain
  • Virtual Currency

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