The significance of bitcoin and blockchain
In this article I will attempt to synthesize and break down many podcasts and videos worth of knowledge into the simplest possible concepts. I hope this is a good intro for people just dipping their toes and is designed to be understood by nontechnical folk as well as software people. I’m going to be grossly simplifying concepts here, so please cut me a little artistic license. If I got something extremely wrong, please leave a comment!
Bitcoin and blockchain in general are extremely revolutionary concepts, but it takes a bit of time to grok them and their significance. Before we begin, I’m going to define two terms:
- Blockchain — a database, spread across the globe, of which there are thousands of copies. Significantly, it has the properties of being immutable (impossible to change) and highly replicated (we can lose many or even most copies without losing any data).
- Bitcoin — the first major application built on blockchain technology, which provides a gold-like digital currency.
What is Bitcoin?
Bitcoin is basically a digital currency — a way for us to store value and send it to other people.
Why is Bitcoin valuable?
Most if not all forms of currency derive value primarily from their usage. Same as gold or fiat currency (paper money based on our faith in government). The value is established through supply (digging up gold, or printing paper money which is “carefully” controlled by governments) and demand (usage for transactions).
If it’s digital, can’t it be forged?
Ok, here’s where we go through the looking glass.
Gold is difficult to forge because there are relatively simple tests to detect its chemical structure and there is no known way to produce gold other than to dig it up. USD is difficult to forge because it’s printed on fancy fiber with special inks and holograms. Nonetheless, forged USD and fake gold circulates all the time. Bitcoin is just some bits on a computer. How come it is impossible to forge it?
Bitcoin is created through a Proof of Work algorithm. Imagine that this is a very difficult problem for a computer to solve but once you have a solution, it’s very easy to check. Consider prime number factorization. If I gave you the number 282943 and asked you to find which two prime numbers were multiplied to get it, you’d be working for a really long time. But if I told you those numbers are 541 and 523, it’s easy to multiply them to see that the answer is correct. Turns out there are problems like this one which are also hard (take an unreasonable amount of time) for computers, but that are very fast to verify.
Bitcoin works on the same principle. Your computer solves a very hard problem, which is called Mining. The process of Mining acts to validate the transactions of others and whoever solves the problem first gets awarded some bitcoin defined by the bitcoin algorithm itself (importantly not a central authority). Everyone else can quickly look at your answer and validate it and know that it took a specific amount of work to get there. Work in this case is basically electricity spent solving this problem.
The beauty of this system is that “creating bitcoin” is actually related to mining a valid block on the blockchain. In order for your block to be considered valid, everyone else has to agree that its valid. Therefore the only way you can counterfeit a bitcoin is by having control of a huge portion of the world’s electricity resources in order to control the decision of what is valid.
Ok, so let’s say I have some bitcoin. How can we ensure it only gets spent once?
Gold or paper money physically changes hands, so it’s easy to say we understand why you can’t spend gold twice. You give it to someone and now it’s in their pocket.
What about traditional digital banking? When you wire $5 from account A to B, you contact your bank and it makes two ledger entries, one that shows $5 leaving A and another that shows $5 entering B. How does a traditional bank ensure that you can’t double spend? Basically it has a fancy database with strong transactional properties that ensure that both sides of the equation get written at the same time.
With bitcoin, there is no central authority. This is extremely important. There is no clearing house for bitcoin like there is in your bank or even in Paypal. That means there is no one institution that can go down, be hacked, be coerced into changing its bits. Instead, bitcoin is a network.
When you create a transaction like sending $5 from A to B, what you’re really doing is announcing to the network that this is happening. The network consists of thousands of computers spread across the world. Each computer on this network picks up your transaction and puts it into their database. Instead of one central database like at your bank, we have many thousands of copies of this distributed database ledger.
If there is a dispute about the transaction actually having occurred, we can ask the thousands of nodes whether they saw it. This database that everyone has on their computer containing all the transactions is called the Blockchain.
If there are thousands of copies of this blockchain database, how can we ever prevent double-spends? Can’t everyone modify their database to look like whatever they please?
Remember how we said there is no central authority and everyone has a copy of the database. This creates a very fun distributed systems problem — namely, how do we actually know which copy of the data is correct? Here we go further down the rabbit hole…
When we are mining (solving the Proof of Work algorithm), we are actually trying to write transactions into this Blockchain Database that everyone has a copy of. All machines on the bitcoin network around the world are taking transactions that have been announced to the network, putting them into a “block” which is just a piece of data, and then solving this difficult Proof of Work problem against this block. If they succeed in solving the problem, they have created the next Real Block. This One True Block is the only real block that will be allowed to be written to the blockchain.
Once someone has solved their problem by expending enough electricity (and therefore money), they announce to the network that they have the next block, and because it’s easy to validate, everyone can confirm that this block is legit even though it took an inordinate effort to produce it. This block is then attached to the previous block in the blockchain.
Everyone starts mining against this latest block again, to write more transactions into the database. When you create a block you get a Block Reward (some bitcoin) and you also earn some Transaction Fees (based on what went into the block).
In this way we are essentially ensuring that only one person can write to this database that there are thousands of copies of. So now we have reproduced what our central bank did with a single database but we’ve spread the data across the globe.
Over time, Bitcoin is designed to release a hardwired 21 million total bitcoins on an exponentially slowing curve meaning the block rewards will get less and less as we are “creating” less bitcoin with every new block, while the fees will go up because bitcoin will be presumably in higher use. All of the available bitcoin will be released by approximately the year 2140. Every 2016 blocks (approx two weeks), the difficulty of mining bitcoin adjusts so that if hashpower joins or leaves the network, bitcoin is still produced at an average of one block every 10 minutes, which is what controls the release rate of bitcoin over time. No central authority can change this release rate, unlike with centrally controlled fiat currencies.
If I’m a malicious bitcoin node, can’t I just modify the code to screw up the blockchain and create lots of money for myself?
Here’s where it gets really interesting. We said Proof of Works takes a whole lot of energy right? All that electricity everyone around the world is spending to mine bitcoin is the only way to create valid blocks. The energy being put into mining is actually Bitcoin’s security mechanism!
If you want to take control over what the network thinks is a valid block, you need to own just over 50% of the network. This is often called a “51% attack”. Ok, let’s say you’re a government that wants to buy up a whole bunch of hardware, spend billions and disrupt the blockchain. That’s in the realm of possible, although would be extremely expensive. A year ago, an economist article noted that bitcoin miners produced 13,000 times more power than the worlds 500 most powerful supercomputers — so you’d need a lot of money to disrupt this network.
However, it’s not quite as simple as that. If you control the network, you can control the blocks that will be written in the future. However, if you wanted to modify some block in the past, you would have to expend pretty much as much energy as was put into that part of that chain just to do that (technically quite a bit more, since if you have 51% of the hashing power of the original network you’ll have to work about twice as hard). Long story short, all the power the miners are expending to validate transactions is also acting as a security barrier that makes it extremely difficult to attack the network and damn near impossible to rewrite history.
Ok enough with the geekery, why is this really amazing and important?
Central banks are susceptible to failure
Employee fraud, government takeover, or financial crisis — there are many ways that banks fail. This may not seem as big a deal to us in the US, many third world countries have very broken central government and banking functions. In some african countries it may take weeks to send money to another country and it may not even arrive. Every government eventually goes bust. Until this day, the only way to store value in an asset that was not government dependent was more or less gold. Gold however is hard to move around and transact with. Bitcoin can cross across the globe in a matter of seconds or minutes and holds the same properties as gold. Even if you live in a 1st world country like the US, you just have to think back to 2008, a time when all the markets crashed and the government started printing money. Bitcoin cannot be made to “print money” any faster or slower than the algorithm is designed to do, and thus is not susceptible to fluctuations of supply like fiat currencies are. All you need to use bitcoin is a computer or cell phone. If you live in a country with a completely broken banking industry, no way to track credit or ownership, the bitcoin blockchain allows you to start transacting even if you have no local banking infrastructure.
The bitcoin blockchain is the first globally distributed immutable record of human progress that is likely to last for centuries or millennia
As long as there are computers around to run it, we will have a permanent, untouchable record of everything that has happened since the blockchain came into being. This is the first permanent record of human history that has the potential to survive for thousands of years. The stone tablets of our ancestors from thousands of years ago are eroded and damaged. The blockchain cannot be eroded or damaged, and thus as long as we don’t wipe out computing in general, it may well exist for thousands of years. Not only is it useful for financial transactions, but we can record other types of data into it (ownership, provenance, history, etc). More blockchains with fancier capabilities are coming into existence, and bitcoin itself is evolving to meet some of these needs. There are also broader concepts of decentralized storage coming into play (such as IPFS) which will ensure the longevity and historical snapshots of data on the internet in general.
There are entire industries that exist only because we are horrible at record keeping.
In real estate transactions, you pay thousands of dollars to a title company to act essentially as insurance against the house not actually belonging to the person who is trying to sell it to you. How crazy is that? What if when the house was built, we put a record into the blockchain showing the initial purchase, and then every purchase after that was also recorded. The indisputable, fully public nature of the blockchain means no more title industry. While this may be hard to imagine in 1st world countries, in places where title insurance industries have not yet formed, this is very important.
Blockchains are evolving to become generalized computing platforms
Ethereum is one example of the blockchain database with a Turing complete language (read — you can do pretty much anything you can do on a regular computer) on top. While we are in extremely early days of this, we are now able to construct many financial and legal concepts completely in code. Imagine starting a company with collaborators from across the globe, holding a crowd sale to fund the company, raising money that is held in special escrow which requires multiple people to sign off to release funds, eventually transferring those funds to another entity which enables shareholders to vote on proposals to control the direction of the company, and handling payments from customers and disbursements to shareholders all without a single piece of computing infrastructure, and all managed completely by a (relatively small) piece of code. Better yet, imagine building a government built through direct and delegated democracy, all done through secure voting mechanisms that cannot be tampered with. This is all happening today on Ethereum. This is just the beginning of the future; we haven’t even imagined all that is possible once you can write distributed banking applications in 100 lines of code.
Let’s put this all into perspective
In 1993 when we first saw the web, we had a bunch of blue links on a white page with some information. Today we have self driving cars self updating from the cloud. The web is about 25 years old. The bitcoin blockchain is only about 8 years old and Ethereum is barely 3.
Try to imagine going back to 1993 and imagining what the internet looks like today, and now try to fathom what is possible with Bitcoin and Ethereum already, and what it might look like in 25 years. It’s hard to even scratch the surface of where this technology may take us, but it is certainly going to be a major disrupting force.
Yes this is extremely early days — most users today are software developers or people with deep understanding of financial markets, economics, and the legal system. Before we can spread all this to normal users, we need to abstract away all the geekery that is deeply prevalent in this industry. Regular people should not have to think about public/private keys, the pros and cons of hot and cold storage of tokens, and the like.
There is a lot of work to be done there, but I believe we will look back on the invention of Bitcoin as one of the major inventions of this century.
