The Blockchain through Bitcoin
The world is increasingly moving towards a digital economy with globalisation, digitalisation of societies and the development of e-commerce, which creates an ideal environment for disruptive technologies such as Blockchain.
A Blockchain can be thought of as a distributed database or ledger shared by a network. This technology makes it possible to store and exchange data on the Internet without the need for trusted third parties to make them trustworthy and secure.
This technology is well known for its role in cryptocurrencies but it goes much further. Blockchains are also the engine of decentralised applications, also called the Web3 era with its many use cases such as decentralised finance (DeFi), non-fungible tokens (NFT) and many other applications.
This article aims to give a practical explanation of this technology using Bitcoin as a concrete example. Bitcoin is the project that first made the Blockchain so popular and served as the starting point for the development of decentralised protocols.
A blockchain differs from a traditional database in the way data is collected and structured. It collects information such as transactions, and bundles it into blocks. Each block will be validated by the network and once a block is validated and linked to the chain, another one can be filled in. This mechanism forms a chain of blocks in chronological order, called a Blockchain.
Once blocks have been added to the chain, it is extremely difficult to go back and change their content unless the majority of the network has reached a consensus to do so, making the timeline irreversible.
The decentralised nature of the Blockchain means that all transactions can be viewed by anyone to allow them to verify the veracity of the data. The Blockchain technology relies on consensus mechanisms to run and be trusted by users. Once all the transactions are publicly known, the majority has to agree which transaction is the legitimate one.
Blockchain ability to maintain a decentralised and secure record of data makes it crucial for cryptocurrencies and its major illustration: the Bitcoin’s case.
Bitcoin is an electronic peer-to-peer payment system that allows any willing parties to transact directly with each other, without the need of any intermediary.
In common electronic payment solutions, a financial institution, such as a bank, verifies transactions and guarantees that the person making a payment has the funds to do so. The payee has confidence in the bank and therefore does not have to worry about the buyer’s ability to get the money. In this case, the bank is the trusted third party.
Bitcoin uses Blockchain technology in a decentralised way to eliminate the need for a trusted third party so that the control of the system is not in the hands of a centralised entity but is distributed through the network itself.
Each Bitcoin can be thought of as a ledger containing a list of transactions and digital signatures of each of the previous owner so that a payee will always be able to verify the chain of ownership of a coin. These digital signatures do not trace back to the person’s real identity so that users can remain anonymous while preserving transparency.
Although the payee can verify the chain of ownership he will not be able to check if the coin has not already been spent. This is the double spending issue and it occurs when someone alters a Blockchain network and creates a new transaction with a coin that has already been spent. Bitcoin solves it by broadcasting all the transactions to the network nodes, allowing them to verify that transactions are valid and not already spent.
The Bitcoin consensus implies that the earliest transaction is considered as the legitimate one so if a double transaction is made with the same coin, only the most recent will be taken into account so that participants agree on a single history. This is the proof that at the time of each transaction, the majority of nodes agreed it was the first received.
Bitcoin is maintained by its network according to clear and transparent rules. This network is made of nodes that are basically computers managed by people called the “miners”. These computers verify and store each block in the Blockchain.
As long as the majority of nodes work for the system rather than against it, Bitcoin will be trustworthy. A way in which Bitcoin could be threatened would be if more than 50% of the computing power of the network were combined in a coordinated way to tamper with the trusted Blockchain. However, this threat is extremely unlikely on big Blockchains like Bitcoin because the financial costs would far outweigh the benefits. The system is built in a way that is much more profitable to work for the system than to attack it.
Bitcoin uses a cryptographic proof to secure its Blockchain. This means that the information contained in a transaction will be transformed by a cryptographic function into a hash (just like dough is transformed by an oven into bread). And just like the bread cannot go back into dough, a cryptographic function cannot be reverse computed. It is very easy to create a hash, but impossible to start from a hash to get to the information that had generated it. It is a one-way function and any change in the basic information will strongly affect the hash that comes out of the cryptographic function. In this way, even the smallest change can be easily identified.
But Bitcoin has a condition, the hash has to begin with a certain number of zeros to be accepted by the network and getting these zeros is a very difficult exercise that takes up a lot of computing power and electricity. This work is called the Proof-of-Work. Its purpose is to make it more difficult to tamper with transactions since any change in a block will strongly modify its hash and the hacker will have to redo the Proof-of-Work of the block in question and of all those that follow. Each new block making the previous ones more secure. But, even by doing this, succeeding with such a hack would require that the hacker controls more than the majority of the network’s computing power to catch up and surpass the work of the honest nodes.
To motivate the nodes to maintain the Blockchain, incentives have been implemented. New coins are created and awarded to the first node that succeeds to find the right hash. The reward for the first hash to get the network started in 2009 was 50 BTC (Bitcoin). Every 210.000 blocks, that reward gets cut in half making Bitcoin a limited resource in the same way we look at gold. There will only ever be 21 million Bitcoin and once they are all distributed, miners will be rewarded through transaction fees.
Blockchain is a disruptive technology as it represents an alternative to centralised models that rely on trusted third parties. Blockchains can be applied to any transaction or data exchange system that requires traceability and visibility.
Bitcoin was the first successful Blockchain to be implemented and the proof that decentralised systems can be maintained in a trustworthy and secure way. Since then, the Blockchain technology has a lot evolved with the emergence of many other Blockchain applications developing the Web3 era. New consensus mechanisms have appeared, such as the Proof-of-Stake which is much less energy intensive than the Proof-of-Work.
The exponential growth of the technology will come from the convergence of the digital and physical worlds as the more they converge, the more Blockchain applications will develop, forming an ecosystem in which companies, customers and suppliers are able to collaborate in a secure, transparent and traceable way.