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The Basic Correlation between the Blockchain and Bitcoin


And The Future Protocol Innovations that will Impact both Technologies.






Collin Thompson
Collin Thompson
What’s the difference between Bitcoin and the Blockchain?

What is this Bitcoin?

or;

I know the blockchain is important.

I know it’s affecting my company/industry, but what exactly is it and how does it work?

What can you do with it, and how will I be impacted?

This could possibly be a line you’ve either come across or has crossed your mind at one time or another. If this isn’t the case, then this is probably your first foray into the wonderful world of blockchain technology.

Nevertheless, you can’t afford to be ignorant about Bitcoin, as it’s the most popularized understanding of blockchain technology.

It’s disrupting how the financial services industry and government have always done things. The odds are even higher for an entrepreneur, a developer, or any other professional who needs to embrace new ideas to remain relevant.

In an October 2015 issue, The Economist pointed out that “the technology behind Bitcoin could transform how the economy works.”

In this article, I seek to ground you in the basics of blockchain technology. In a simple and easy way to understand the underlying functions and principles.

You should at the end of the article, know the difference between the currency (Bitcoin) and the underlying technology (the blockchain).

You should also know what the Double Spend theory is and why it is important. Other things I will include is mining, Proof of Work (PoW) and the challenges that Bitcoin has, especially with scalability.

I must mention, though, that when sharing Bitcoin knowledge, one particular challenge always pops up.

You can see it in Bitcoin meetups.

The speaker, for the benefit of the novices, starts by addressing the question of what is Bitcoin, those who have been through the drill before roll their eyes and are almost shouting out aloud, ‘here we go again!’

This article is not for the experts, or so-called gurus. It’s for individuals who want to get their foot wet with a basic understanding of the technology so that they can participate in an intelligent discussion and pursue greater depths of knowledge.

As we have outlined in these other articles:

Why have I heard so much about Bitcoin?

Bitcoin, the decentralized digital crypto currency.

Isn’t that what drug dealers and terrorists use to buy things online without revealing their identity?

Yes, but what exactly does that mean? And why it shouldn’t deter you from exploring the technology?

A Ledger to Track Digital Units of Value

Before the era of money, we simply had communication and trade. If I killed a buffalo, which, of course, would be too big to finish alone, I would share it with members of my hunter-gatherer community, maybe even a rival tribe. This is with the expectation that when they kill a buffalo in the future, they would return the favor.

Such owed favors or debts would accumulate to the point I am unable to keep track. What’s more, I wouldn’t really have a choice of what I get in return. As an answer to these challenges, and others slightly more complicated, we humans learned to use scarce commodities to keep track of our debts.

These rare items, for example, bird feathers or precious metals, served well as promissory notes. Today we call them money, or currency.

Now, if a tribesman needed a piece of my buffalo, they would issue me a promissory note, which meant they would repay me in future. Even more, I don’t have to keep the promissory note until the issuer has something to share with me, I could easily pass it over to clansman in exchange for what I need immediately. There is inherent value, based on trust.

This is important, but now back to bitcoin.

Bitcoin is a digital unit of value on a distributed ledger online, mores specifically on a computer network. The ledger basically states that X owns X amount of value (in Bitcoin units), and Y owns Y.

The ledger is continually changing and dynamic.

This is in response to additions and subtractions to the Bitcoin units assigned to users (through their public key addresses) as they receive and send “value” respectively.

This ledger is what is known as the blockchain.

It’s like the railroad tracks, or infrastructure that keeps things moving on time and in order.

Everyone has access to an up to date version of the Blockchain, as a copy exists on every node on the Bitcoin network.

This simple architecture was created by Satoshi Nakamoto, the (invented) inventor of Bitcoin. He explains in greater detail in the Bitcoin whitepaper; which is a must read if you want to really understand the benefits of the technology.

Why the Double Spend Problem is so Important

Among the earliest attempts at a blockchain or decentralized ledger of value, we had E-Gold and DigiCash. These first private digital currencies were centralized, this was necessary because someone had to guard against the Double Spend problem.

You see, if I have a music file, and I send you a copy, I still have a copy on my drive, and I can still send it to another person.

But that is not how money should work.

If I send you a dollar I shouldn’t have it anymore; otherwise, we have a Double Spend problem.

With the blockchain technology, Satoshi Nakamoto solved this problem through a consensus making algorithm known as Proof of Work.

Consequently, the need for a trusted third party to maintain the ledger and stop double spend was removed.

“The purpose of a consensus algorithm, in general, is to allow for the secure updating of a state (of the blockchain) according to some specific state transition rules, where the right to perform the state transitions is distributed among some economic set,”–Vitalik Buterin, Ethereum Co-founder and Lead developer,[1].

He has defined the economic set as users with the right to collectively perform transitions according to the algorithm. And the important property of their consensus being that it is securely decentralized.

But how is this achieved?

Within every ten minutes, each node (miner) in the Bitcoin network puts together a block of transactions that have been proposed and hashes it for a predetermined data value. This is what Bitcoin mining is about. We mine for blockchain state consensus and for reward.

The network will accept the block from the first miner to find the expected data value as the next valid batch transactions on the blockchain. In return, the winning miner gets a reward of newly released units of Bitcoin.

Once the record is made:

it is permanent.

It can’t be changed.

This is the property of immutability that the blockchain carries.

However, Bitcoin mining consumes a lot of energy. It also requires specialized hardware (ASIC mining rigs), whose price is ever rising and must be replaced after every short stint to match up with the growing mining difficulty.

In response to high energy consumption and special hardware that Proof of Work requires, other consensus making mechanism have been developed. Proof of Stake is one them.

With the latter, nodes in a network, also known as validators, stake their coins, which are used to pick the node that validates the next block. This doesn’t require a lot of electricity but nonetheless it actually secures the network.

Several altcoins (alternative cryptocurrencies) that have come after Bitcoin use this
mechanism. They include NXT and Peercoin. Ethereum is contemplating a switch to proof of Stake in the future.

We can do more with the Blockchain Technology

Now, the kind of value that the blockchain can track is not limited to monetary. If you can think of any asset that could benefit from a decentralized transfer of title and ownership, you have a use case for a blockchain.

Already there are startups developing solutions on the blockchain such as management of property titles, security of proof of existence and copyright of creative works.

The Ethereum blockchain [2], whose code Vitalik Buterin wrote and published in 2013, has been hailed as most accommodating to a wide range of decentralized applications.

In particular, ethereum, it makes it easy to develop smart contracts, “legal” agreements written in code that self execute based on transactions done over the blockchain network.

The Future and Scalability

Although Bitcoin is the pioneer of decentralized applications and blockchain technology, it is not been without shortcomings.

The most discussed is the scaling problem.

Currently, the Bitcoin network can support a paltry seven transactions per second. Compared to what Visa transaction network does: 45,000 transactions.

The cause of the problem is the limited block size.

The batch of transactions confirmed after every ten minutes. Satoshi Nakamoto capped this at 1MB. The community has been debating on how to increase it to 2MB or more.

As the size of the block limits that ability to create and perform complex transaction that our businesses and society requires.

The downside to bigger blocks, however, is that they will need larger memory space on miners as well result in increased data usage. Demand for more of these resources might lead to centralization of mining.

This is because only a few well-funded players can afford to participate.

Which seemingly defeats the purpose of a decentralized network to exchange value, where it can be co-opted. This is increasingly becoming a major obstacle for the growth of bitcoin, and what many are making the distinction between bitcoin and a blockchain.

Lightning Network Protocol Innovation

This reality has led the bitcoin community to consider other solutions. One that is at an advanced stage of development seeks to have the majority of transactions happen off the blockchain. With that, only their nets would be confirmed on the blockchain.

This is what is known as a lightning network [3].

It uses smart contracts to make it possible for two or more individuals to transact amongst themselves without broadcasting to the Bitcoin network.

They will only need to bring the net of their numerous transactions onto the blockchain once in awhile.

“We hope to help solve bitcoin scalability and instant transactions, enabling bitcoin to encompass all transactions — even many thousands of micropayments per person,” Joseph Poon, one of the two developers behind the idea, has been quoted saying.

Blockchain.info Blockstream, and Lightning Network, are a some of the companies that are already working to bring the lightning network to reality.

“Thunder has the potential to facilitate secure, trustless, and instant payments,” Blockchain.info states [4], “It has the ability to unleash the power of micro-transactions, to allow the bitcoin network to handle heavy loads, and to increase user privacy.”

Indeed, there are many blockchain innovation and application being developed. And when they come into the market, human society will be very different from what we have at the moment.

(1) https://blog.ethereum.org/2014/11/25/proof-stake-learned-love-weak-subjectivity/
(2) https://www.ethereum.org/foundation
(3) https://lightning.network/
(4) https://blog.blockchain.com/2016/05/16/announcing-the-thunder-network-alpha-release/

Collin Thompson
Collin Thompson is the Co-founder, and Managing Director of Intrepid Ventures, a blockchain startup studio that invests, builds, and accelerates Blockchain startups solving the world’s most difficult problems. Collin focuses on early stage investments, innovation and business design for corporations, governments and startups working with Ethereum, Distributed ledger, Blockchain, and Emerging Technology.

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Monday, November 7th 2016
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