Don’t Trust Me
(TLDR: this article intends to offer a high level explanation of Bitcoin for people who need to grasp the basics. It’s not going to get very technical and will stick to explanations a non-coder can understand. I’ve linked to resources for those who want to explore more of this in depth.)
That’s a phrase used a lot in blockchain technology. “Blockchain enables trustless transactions.”
It’s a counterintuitive statement. We have to trust that a transaction will work, especially one involving a lot of money, or we’ll never enter into it.
“Trustless,” in a blockchain context means you don’t have to trust the people in the transaction, because you can trust the technology that facilitates it.
Bitcoin’s technology is basically pretty simple. It has three components:
- A ledger that records transactions of people transferring value to one another
- A cryptographic algorithm that progressively encrypts the ledger with unique ID numbers
- A system that rewards users who validate the transactions on the ledger with Bitcoin
The users who validate the ledger are called “Miners,” but they don’t dig up anything. They own computers connected to the internet that run the Bitcoin software. Bitcoin software is free. Anyone can download it and see the ledger of every Bitcoin transaction ever made.¹
The Bitcoin software powers a peer-to-peer network among the connected computers (kind of like Napster or BitTorrent) and constantly tracks the activity of all users sending/receiving Bitcoin. Every ten minutes the software gathers the all the transactions on the ledger and runs them through a cryptographic algorithm.
A cryptographic algorithm is a formula for a really hard calculation that converts all the transactions from that ten minute period into a unique string of numbers and letters.
Ultimately, it looks like this:
There are several steps to this process but essentially, because the calculation uses the list of transactions as its source data, any computer on the network using the same source would produce the same unique string of numbers if they perform the calculation correctly. If the string is different, then it would indicate the source data is incomplete or someone might be trying to manipulate the ledger.
Once a Miner believes they have produced the correct string, they share their result and the other computers on the network check the work by repeating the same version of the calculation to see if it’s correct. Once a majority of the computers on the network produce the same ID, it serves as validation that the list of transactions they have collected are identical. The ID and corresponding section of the ledger is posted to the network, where anyone with the Bitcoin software can see it. This group of transactions is called, a “block.”
Then the process repeats itself — with one additional step: the ID from the previous block is listed as the first entry in the new group of transactions. As before, a string is calculated and shared, the transactions are validated, and a block is created. But this time, because the source data contains the ID of the previous block, the new block is now “chained” to its predecessor.
The first computer that comes up with the string is given an award of Bitcoin.
The rest of the computers can also profit from the process by receiving transaction fees paid by users. These fees are nominal, based on the data size of the transaction and volume of activity on the network.²
This means all Miners have a stake in keeping the network transparent, and an incentive to validate transactions as quickly as possible.
Safety In Numbers
If someone tries to manipulate the ledger and spend Bitcoin twice, or transfer someone else’s Bitcoin to their account, their string won’t match and the attempt to “counterfeit” or “steal” will be rejected by the network.
The longer the network is active, the safer it becomes. A bad actor can’t go back in time and find the record of someone’s massive Bitcoin horde and move it to their account because it would change the source data of that block. That would change the cryptographic ID and therefore the bad actor would have to change the IDs and data of every subsequent block for the manipulation to succeed. They would also have to replace the record of the ledger on every other Miner’s computer on the network. Because these computers aren’t owned by one person, but thousands, the reality of breaking into all of them is basically impossible. Finally, any attempt to do this would be obvious, and the rogue ledger would be deemed invalid and worthless.
The only major risk to the system is if one person buys enough computers loaded with the Bitcoin software to own more than 50% of the processing power on the network. As of today, statisticians estimate there are as many as 100,000 miners controlling 5000 processing nodes, and Bitcoin’s total market capitalization is over 100 billion dollars. A bad actor would have to commit massive amounts of wealth to take over the network. But if they did, and gained the majority of the processing power, they could effectively rewrite transactions without users consent. Then they could counterfeit or steal, but because the identity of every Miner is public, and everyone on the network can audit the path of all transactions, the unethical activity would be seen immediately. Trust in the network would be broken and Bitcoin would fast become worthless.
So the only way to manipulate the Bitcoin network is to destroy it. This provides huge incentive to those who have invested in the network to protect it, and a tall barrier of expense and effort, with almost no reward, for those seeking to damage it.
This means numbers (representing Bitcoin balances) can travel from one user account to another transparently, securely, and reliably.
This creates what we call a “store of value.” It means we have a digital system that functions as a commodity, like gold. Gold isn’t really intrinsically valuable. It has a few industrial purposes, but nowhere near enough to prop up its price. Gold’s value comes from these unique qualities:
- Gold is scarce, and it can’t be manufactured
- Gold is difficult to obtain, so its rate of inflation is relatively stable and reliable
- There is only so much of it on the planet, at some point it will become a fixed supply
The same is true for Bitcoin. Like gold, it’s not intrinsically valuable, its value comes from the agreement of the community that trades it.
- It’s scarce, there are only so many Bitcoins and they can’t be manufactured outside the rules of the network
- It’s difficult to obtain because it requires ever increasing amounts of computing power to earn a mining reward
- There will only be 21 million Bitcoin ever, because the software is pre-programmed to gradually stop adding them to the network
Capping the number of Bitcoin that can be injected into the network also protects it from the devaluing effects of inflation inflicted by artificial manipulation from corrupt banks or dysfunctional governments.
This is important: Bitcoin’s monetary policy is based in math, not politics. Its mechanisms are completely transparent to provide a stable³ monetary unit immune to the pressures of economic or political stress. Though digital money may seem esoteric for people living in the wealthiest countries in the world, imagine being able to access a currency that couldn’t be corrupted by the influence of government or central banks if you lived with hyperinflation in a place like Venezuela, Zimbabwe, Serbia or Turkey. The list goes on and on.
Bitcoin is also resilient because it isn’t stored in one place, like gold in a vault. Every computer that validates the ledger stores the entire history of transactions, making it vastly redundant. And the people who own the computers that form the network collaborate together, without the control of a corporation, central bank, or government to insure trust.
This is called, Decentralization. And this system of organization is ultimately why Bitcoin, and other new instruments developed from this technology, have the potential to change the world.
Decentralized governance will affect more than just monetary systems. Newer iterations of this technology have built layers of functional programming on top of the ledger that can automate the secure transfer of value in increasingly complex ways, and can be used to unlock any kind of service or good that can be accessed by the internet. These are most often called, “Smart Contracts.”
Imagine being able to buy a house anywhere in the world without needing to validate ownership, title, or escrow funds, making the transfer of land as simple as buying something on Amazon.
Imagine getting paid for adding your unused hard drive space or computing power to a network that provides those services to others, by simply downloading some software.
Imagine a town or small city with a software that would help you subsidize an investment in solar energy by selling your capacity to your neighbors, creating a micro-power grid that could eliminate decaying, public utilities.
Imagine an electronic voting system that was impossible to hack.
The level of entrepreneurship and development in this space over the last five years has been staggering, and what’s even more incredible is that this movement is financing itself. Projects begin by issuing their own asset and, based on the potential value of the technology and experience of the team, individual investors are now being joined by venture capitalists, and even large banking institutions, to own not just Bitcoin, but a variety of different assets that promise to create more efficient businesses, entirely new business models, and potentially new models of government and citizenship.
If that sounds bold, you don’t have to trust me. You just sit back and watch.
Stuart Hynson Culpepper is Director of Production at Havas NY, specializing in innovation and experience design, where he works at the intersection of technology, media, and community.
I am going to follow up with an article on the technologies being built on top of decentralized blockchains. Feel free to leave any requests in the comments for things you‘re curious about and I’ll try and include them.
¹ The belief that Bitcoin transactions are anonymous is not really true. Every transaction has a numeric ID that can be seen in the ledger and it is possible to link that ID to the account owner unless they take steps to change the transaction ID number frequently. So transactions are not anonymous, but pseudonymous.
² Because mining is driven by transactions, the inventor of Bitcoin estimated that if there was enough circulating currency for Miners to pull in 21 million Bitcoins, the volume of transaction fees alone would be sufficient incentive to continue validating the ledger. Current estimates indicate we may reach that point sometime around the year 2140.
³ It’s important to understand that “store of value” and “valuation” are different things. Though Bitcoin’s valuation against other currencies has been highly volatile, this is a normal behavior of any new asset class and doesn’t affect its mechanism as a store of value. Just as the price of gold has fluctuated broadly over the centuries, that price movement hasn’t changed its inherent functional qualities as a store of wealth. Influential economists and financial analysts predict Bitcoin will become less volatile over time.