The basics of Bitcoin: Value in the blockchain

The blockchain is the underpinning of the Bitcoin network, and helps make it a secure digital currency. It has many potential applications beyond Bitcoin, and we’re just at the beginning stages for such advancements.

Bitcoin is money, but it is also a shift in technology that is disrupting financial and technology sectors. In order to help secure bitcoin as digital money, Satoshi Nakamoto created the principle of the blockchain.

If you haven’t already, check out part one of this basics of Bitcoin series.

The Bitcoin blockchain is protected by cryptography, time, and distribution.

Cryptography is a means of distributing information in a secret manner, even though the channel may be public. I like to think of play calling in sports as simplistic cryptography. A baseball coach can send signals to a hitter by touching his elbow, cheek, etc, but nothing means anything until he touches his ear. The players know the trigger signal, so everything else is noise. The real call is hidden in plain sight.

In digital cryptography, the two parties have keys that can unlock the message that is transferred. Anyone else looking on only knows the jumble that is created by the cryptography process.

Time is an important element for a blockchain. Each transaction is put in a line with previous transactions. The entire chain of transactions must exist in order for the blockchain to be true. The veracity of the blockchain is ensured due to the cryptography. A break in the truthfulness of the chain would invalidate every transaction thereafter.

I find Anders Brownworth’s video and public demo of the blockchain in action very helpful.

You can see how the the chain is created and ensured to be unaltered through this demo. The third leg of that security is distribution.

Distribution of the blockchain happens over thousands of computers all over the world. Each of these computers has a copy of the ledger and receive updates of new blocks and the transactions within. If a computer detects something wrong, the signal works its way through the distributed ledger, and “consensus” fails, therefore rejecting the transaction. The computer power required to falsify a transaction is incredibly improbable.

The resulting effect of the blockchain is to create a blockchain that serves as what’s referred to as a “shared single source of truth.” We know that the ledger is secure; it is immutable, unable to be changed, thanks to the security principles that design it and the trustless system that implements it.

You can see pretty quickly why this is valuable. And the blockchain doesn’t just have to manage monetary transactions. An entire ecosystem of platforms and applications have been created utilizing similar technology.

Decentralization of the blockchain

A primary benefit of the blockchain is its decentralized nature. You don’t have to rely on a central entity (like a corporation) because the system is supported by nodes all over that help secure and maintain the system.

Each entity in the transaction operates in a self-interested manner. This is a benefit to the entire system, because everyone is incentivized purely by acting in their own interests.

Central entities offer points of weakness. And even with cryptocurrencies today, they can (and do) still exist.

Adding other information on the blockchain

You can manage more than financial transaction data on a blockchain. The underlying principles can used for many types of transactions and contracts.

Smart contracts, supported by several crypto projects, enable people to code custom contracts that are automatically followed along specific logic paths.

Opening up blockchain technology to all sorts of different industries and applications has caused the entire ecosystem to explode with interest. There are currencies and coins used to power a myriad of networks utilizing a blockchain and similar — but usually not identical — design mechanisms as the Bitcoin one.

Centralization and other weak points

One of the most common centralized weak points with bitcoin and other currencies is the exchange.

In order to buy and sell bitcoin or other currencies, you do not need an exchange. You can just send it using open source wallet systems. But the ability to send and receive money doesn’t create a market for trading it.

People are buying and trading bitcoin all the time. Often, they are doing so with a native currency like the US dollar. But there is also a vast market for trading between cryptocurrencies. Traditional stock exchanges help maintain a pricing mechanism to help traders find one another and trade. With crypto, they’ve done the same thing. However, it creates a weak point in an otherwise decentralized system.

In a centralized exchange, I (the person wanting to trade) have to trust the exchange to handle my identity and my money. I have to trust them, and that’s not ideal. That’s why there’s been a rise in decentralized exchanges. We’re seeing more and more projects rise within this realm, as well as technology to aid in the effort — like atomic swaps, which allow transactions between currencies at a much faster pace.

There are other potential weak points in a blockchain, and not all of them are centralized. A committed mining party, for instance (typically one who helps secure the network), could spam the blockchain network with a lot of pointless transactions, stretching the networks limits for handling transactions, slowing it down, and causing issues that otherwise wouldn’t exist.

This type of malicious behavior has been an active part of the Bitcoin blockchain for a few years now. Many of the engineering efforts going into Bitcoin blockchain development are meant to prevent such malicious behavior from being possible.

Do you need a blockchain?

Of course, like any new and popular technology, you can end up with a lot of people and organizations flocking to it for a cash grab.

Blockchain technology has taken off, in part due to its disruptive nature, but also due to speculative pricing of bitcoin and other currencies. There is frequent criticism of some blockchain projects because people claim that they don’t need a blockchain at all — or that they at least don’t need a public, distributed one.

There are several good articles that help walk through when you do and do not necessarily need a blockchain. Often a regular database is just fine, and given the current scalability of most blockchains, more efficient mechanism for a project.

We don’t know every application yet

We don’t know a lot yet. Blockchain technology is only a few years old, and there is a lot to figure out. We are currently in a stage of intense exploration and development, and many ideas will fail. Others will go on to change many aspects of our lives.

Most of the financial and technology sectors are exploring blockchain technology intensely. Some are investing very heavily already. A lot of people like to compare where we are right now to the earlier days of the web. It’s too early to tell if blockchain technology will be as impactful in an every day manner as the web has been, but it will certainly change many, many things.

I am especially excited for how blockchain technology can disrupt traditional financial and record keeping sectors; but its impact will be widespread. Many uses of blockchain technology will be completely invisible to the average person, but it’ll still be making whatever they’re doing more secure and overall better than without it.

I think we’ll look back on how many things were done before blockchain technology came along and the old ways in many industries will seem completely preposterous. That makes me excited that I’m paying attention, and I hope it does for you too.