How They Work and Why They’ll
Change the World
The technology behind Bitcoin could touch every transaction you ever make
Bitcoin was hatched as an act of defiance.
Unleashed in the wake of the Great Recession, the cryptocurrency was touted by its early champions as an antidote to the inequities and corruption of the traditional financial system. They cherished the belief that as this parallel currency took off, it would compete with and ultimately dismantle the institutions that had brought about the crisis. Bitcoin’s unofficial catchphrase, “In cryptography we trust,” left no doubt about who was to blame: It was the middlemen, the bankers, the “trusted” third parties who actually couldn’t be trusted. These humans simply got in the way of other humans, skimming profits and complicating transactions.
Bitcoin sought to replace the services provided by these intermediaries with cryptography and code. When you use a check to pay your mortgage, a series of agreements occur in the background between your financial institution and others, enabling money to go from your account to someone else’s. Your bank can vouch that your money is good because it keeps records indicating where every penny in your account came from, and when.
Bitcoin and other cryptocurrencies replace those background agreements and transactions with software—specifically, a distributed and secure database called a blockchain. The process with which the ownership of a Bitcoin token will pass from one person to another—wherever they are, no matter what government they live under—is entrusted to a bunch of computers.
Now, eight years after the first blockchain was built, people are trying to apply it to procedures and processes beyond merely the moving of money with varying degrees of success. In effect, they’re asking, What other agreements can a blockchain automate? What other middlemen can blockchain technology retire?
Can a blockchain find people offering rides, link them up with people who are trying to go somewhere, and give the two parties a transparent platform for payment? Can a blockchain act as a repository and a replay platform for TV shows, movies, and other digital media while keeping track of royalties and paying content creators? Can a blockchain check the status of airline flights and pay travelers a previously agreed upon amount if their planes don’t take off on time? If so, then blockchain technology could get rid of Uber, Netflix, and every flight-insurance provider on the market.
If the blockchain were a religion, Satoshi would be God. This anonymous hacker is responsible for writing the Bitcoin white paper, releasing the first Bitcoin code, and inspiring legions of blockchain developers. Many have sought to reveal his/her/their identity, but to this day that information remains secret.
Those three proposed applications aren’t hypothetical—they’re just a few of the things now being built on Ethereum, a blockchain platform that remotely executes software on a distributed computer system called the Ethereum Virtual Machine. In the blockchain universe, Ethereum, which has its own cryptocurrency, called ethers, is by far the project that is most open to experimentation. But zoom out and a diverse collection of potentially disruptive innovators floods into view. New groups are pitching blockchain schemes almost daily. And the tech world’s titans don’t plan to miss out: Microsoft is offering its customers tools to experiment with blockchain applications on its Azure cloud. IBM, Intel, and others are collaborating on an open-source blockchain initiative called Hyperledger, which aims to provide the bones for business-oriented blockchains. Meanwhile, many of the largest banks—the very institutions that blockchain pioneers were trying to neutralize—have cobbled together their own version of the technology in an attempt to stay ahead of the curve. And even Bitcoin, which runs on the first and most successful blockchain, is being retrofitted for applications its designers never dreamed of.
Pretty much without exception, these new blockchain projects remain unencumbered by actual mass adoption. No single blockchain concept or strategy has yet revolutionized any industry. Bitcoin itself is used by no more than 375,000 people in the entire world on any given day, according to Blockchain.info. But the investor dollars are pouring in, and proposals are floating and colliding like tectonic plates on a hot undercurrent of hype and intrigue.
When the mantle cools, which blockchain platforms will persist, and which will slowly sink back beneath the surface? To make any kind of prediction, you’ve got to understand what a blockchain really is and what it does. The place to start, logically enough, is with Bitcoin.
How Do Blockchains Work? The Bitcoin Example
In 2009, an anonymous hacker
(or group of hackers) going by the name of Satoshi Nakamoto unveiled the first entirely digital currency. The technology worked on the principle that, at its foundation, money is just an accounting tool—a method for abstracting value, assigning ownership, and providing a means for transacting. Cash is the historic means of accomplishing these chores. Simply possessing the physical tokens—bills, coins—equals ownership, and it’s up to the individuals to negotiate transactions among themselves in person. As long as cash is sufficiently difficult to replicate, there is no need for a complete accounting of who owns what portions of the money supply, or for the details of who the various holders were of a single $50 bill going back to when it was printed.
However, if you could piece together a running tabulation of who held every bill, then suddenly the physical representations would become unnecessary. Banks and payment processors have already partially sublimated our physical currency into digital records by tracking and processing transactions within their closed systems. Bitcoin completed the transformation by creating a single, universally accessible digital ledger, called a blockchain. It’s called a chain because changes can be made only by adding new information to the end. Each new addition, or block, contains a set of new transactions—a couple of thousand in late August—that reference previous transactions in the chain. So if Helmut pays Hendrieke a bitcoin, that transaction appears at the end of the chain, and it points to the transaction in which Helmut was previously paid that coin by Helche, which in turn points to the time before that when Helche was paid the coin by Halfrid, and so on.
Bitcoin’s blockchain, unlike the ledgers maintained by traditional financial institutions, is replicated on networked computers around the globe and is accessible to anyone with a computer and an Internet connection. A class of participants on this network, called miners, is responsible for detecting transaction requests from users, aggregating them, validating them, and adding them to the blockchain as new blocks. Shortly after the Distributed Autonomous Organization debuted on the Ethereum blockchain, someone siphoned US $60 million in ethers from this autonomous version of a venture-capital fund. In a bold move, the Ethereum developers rewrote the blockchain code to return the money.
Validation entails both verifying that Helmut actually owns the bitcoins in his transaction and that he has not yet spent them elsewhere. Ownership on the Bitcoin blockchain is determined by a pair of cryptographic keys. The first, called the public key, resides in the blockchain for anyone to see. The second is called the private key, and its owner keeps it safe from view. The two keys have a special mathematical relationship that makes them useful for signing digital messages. Here’s how that happens: Helmut takes a message, combines it with his private key, does some calculations, and ends up with a long number. Anyone who has the original message and knows the corresponding public key can then do some calculations of their own to prove that the long number was in fact created with the private key.
In Bitcoin, transactions are signed with private keys that correspond to the public key most recently associated with coins being spent. And when the transaction gets processed, those coins get assigned a new public key. But the main role of miners is to ensure the irreversibility of new transactions, making them final and tamperproof. The method they use for doing so is thought to be the most significant contribution that Satoshi Nakamoto—whoever he or she is—made to the field of computer science.
Ensuring irreversibility becomes necessary only when you invite anyone and everyone to take part in the curation of a ledger. If the Bitcoin blockchain were being run by a single bank with a set of known validators operating under a single jurisdiction, then enforcing the finality of transactions would be as simple as writing it into company policy and punishing anyone who didn’t follow the rules. But in Bitcoin, there is no central authority to enforce the rules. Miners are operating anonymously all over the world—in China, Eastern Europe, Iceland, Venezuela—driven by a diversity of cultures and bound by different legal systems and regulatory obligations. Therefore, there is no way of holding them accountable. The Bitcoin code alone must suffice. To ensure proper behavior, Bitcoin uses a scheme called proof of work.
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