Blockchain Basics Pt.1: How Bitcoin Disrupted Technology
What Is Blockchain?
It seems as though everywhere you look these days blockchain is popping up somewhere. It’s been touted by experts as everything from a more efficient method of digital transactions, to a technology that will have ‘a bigger impact on our daily lives than the internet.’
We currently live in one of the most exciting times in human history. The advances in technology that continue to happen at a steadily increasing pace are up until recently, something that we would only ever have expected to see in a science fiction novel or Star Trek episode.
Everything from virtual reality to robotics. Augmented reality, 3D printing, and artificial intelligence, just to name a few. With all this futuristic ‘coolness’ going on, what makes blockchain so special and why has it become such a buzzword lately?
The purpose of this article is not a deep dive into the technical world of distributed ledger technology. It’s an overview of the basics. What blockchain is, where it came from, what it does, and most importantly, why it matters.
The Bitcoin Blockchain
The history of Bitcoin and Blockchain are inseparable.
Bitcoin, and its blockchain, were developed a decade ago by Satoshi Nakamoto.This name was picked as a pseudonym for an individual, or more likely group of individuals. For whatever reason he/she/they have chosen to remain anonymous.
There has been much speculation over the past few years about Satoshi’s true identity. It’s an intriguing story that’s worthy of its own post. In the interest of staying focused on the topic of ‘what’ as opposed to ‘who,’ we’ll save that story for a future article.
The following two paragraphs are the introduction of what is now commonly referred to as the ‘Satoshi White paper.’ Release date October 31, 2008.
The actual title of the 9 page document is ‘Bitcoin: A Peer-to-Peer Electronic Cash System.’ Don’t worry if it seems more than a little confusing at first glance. It would be weird if it didn’t!
The following is the introduction by Satoshi Nakamoto him/her/them? Selves…
The Satoshi Whitepaper
‘Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments. While the system works well enough for most transactions, it still suffers from the inherent weaknesses of the trust based model. Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes. The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions, and there is a broader cost in the loss of ability to make non-reversible payments for nonreversible services. With the possibility of reversal, the need for trust spreads. Merchants must be wary of their customers, hassling them for more information than they would otherwise need. A certain percentage of fraud is accepted as unavoidable. These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.
What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party. Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers. In this paper, we propose a solution to the double-spending problem using a peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions. The system is secure as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes.’
-Satoshi Nakamoto. October 31, 2008.
How It Works
Blockchain is the vehicle or platform that makes it possible to directly transfer value in digital form. It’s done via a peer-to-peer network without the need for third party verification.
Think of it as sending a text message from one phone to another. Bitcoin would be the message, and blockchain would be the telecom network through which the message is transferred.
Here’s another way of picturing it, which also happens to be the easiest way for me. Think of blockchain as the internet, and bitcoin as email. You type an email, hit send, and it goes from one address to another.
That in a nutshell, is how bitcoin transfers work. What makes blockchain so special is it’s unique and ingenious method for the tracking and accounting of value. All without the need for trusted third party involvement.
Most of us use the internet on a daily basis. Generally it’s not the internet itself we’re interested in, so much as what it facilitates. Whether you’re using it to access Google, Ebay, Amazon, Social Media, etc, the internet is just the underlying framework that that allows these different sites to communicate.
There’s no question the internet has changed the way we communicate. It’s also improved the way we do business, purchase products, watch movies, transfer money, etc. It also comes with its own set of problems.
Satoshi’s focus was specifically on solving the challenges related to digital commerce. The focus of this post is to first provide a clear understanding of what those challenges are. Then secondly, look at blockchains role in solving them.
My goal is to communicate what can be a very complex and technical subject, in a very non-complex and non-technical fashion.
Wish me luck…
What Is Friction?
Points of friction are any place where third party interaction is required for a monetary transaction to happen. For example…
Let’s say I want to send money from where I live in Canada, to my Grandfather who lives in the Philippines. Before blockchain existed, I had three main options.
1. Bank wire transfer. This involves physically going to the bank. Then paying the fees associated with an international currency transfer, then sending the money. In addition to the fees, the bank also takes their cut on the exchange rate between currencies.
2. PayPal. The usual fee is a fixed rate of $4.99 + about 3.5% on the exchange rate, IF you’re funding your PayPal account via your bank account. If you opt for using a credit card instead, it’s another 2.9% plus any fees for using your credit card.
Either of these options require both the sender and receiver to have a bank account. Fun fact. Nearly 2 Billion adults (mostly in third world countries) do not have access to a bank account. This is referred to as ‘unbanked.’
3. Western Union, and to a smaller extent MoneyGram. The process is both arduous and the most expensive of all, with fees often costing upwards of 30% of the funds sent in some of the poorest parts of the world.
Never mind the person on the other end having to travel, often on foot, to the closest location just to receive the funds. Many of these people don’t have proper ID which obviously serves to only complicate the issue.
A friction point is any or all of these places along the way that are used to justify the fees. Buildings, employees, operational overhead, marketing, and of course profit as that’s the whole purpose of a business.
One more example a little closer to home. Four days ago I transferred $588.29 CAD, from one Canadian bank to another. It took 2 days and I received $576.72. The branches are literally less than 40 miles apart.
Fees are based on a percentage, and often exchange rates are involved. Transferring large sums can add up pretty quick.
As of the time of this writing, it costs on average $0.15 cents to send bitcoin from my smartphone to any other phone or computer anywhere in the world. Whether I’m sending $20 worth of bitcoin, or $20,000, and it usually arrives in about 20–30 minutes. Often much sooner.
There are now other cryptocurrencies where transactions are instantaneous, and fees are $0. No middle men, no waiting, no fees…no friction.
I originally had posted this as one article. After giving it some thought, I realized that a post with a word count in excess of 3,200 words on this topic is a lot to digest at once.
Take the time to let some of what we’ve covered sink in. In blockchain basics part 2 we will cover exactly how blockchain solves the issues just discussed in part 1.
We’ll start with security. How the blockchain works to guarantee the funds being transferred are secure, and how it ensures the integrity of the system without third party oversight via distributed ledger technology.
We’ll talk about the biggest security vulnerabilities in the current fintech (financial technology) sector and how decentralization helps to solve these issues.
We will also cover the process or ‘mechanics’ of exactly how transactions happen on the blockchain, along with the vital role bitcoin ‘mining’ plays in the process.