Blockchain Basics Pt.2: Bitcoin POW Technology
Recap Of Blockchain Basics Part 1
This is part 2 of blockchain basics. Below is a quick recap of what we covered in part 1. If you missed it or would like a full refresher here’s the link Blockchain Basics: How Bitcoin Disrupted Technology. What we’ve covered so far…
- How blockchain came to be, and the role bitcoin played in helping it achieve credibility and acceptance.
- Bitcoins anonymous founder(s) Satoshi Nakamoto, and the vision they had for a ‘trustless’ method of commerce through the use of digital currency.
- How the blockchain acts as a the platform which facilitates the transfer of bitcoin and other cryptocurrencies, similar to how the internet connects users with websites and each other.
- What ‘points of friction’ are, how they impact the cost and difficulty of global currency transfers, and what crypto does to solve this issue.
We will now take a look at the subject of security…
The Issue Of Security
The second issue Satoshi needed to solve was that of security. How to guarantee funds being transferred are secure, and ensure the integrity of the system without third party oversight.
Satoshi accomplished this by using a combination of cryptography, decentralization, and distributed ledger technology. Let’s take a closer look at the internet example from blockchain basics part 1.
In addition to Google and facebook, most of us have had experience with online banking. Email money transfers, PayPal, online retailers, etc. It really doesn’t matter whether you send an email or transfer money, the process is basically the same. Information is being sent from one server to another.
The internet is a framework that connects billions of users with millions of websites. Each website stores its information on servers. The more information a company collects, the more servers are needed to store it.
For a company like Google, this means a lot of servers. While exact numbers aren’t made available to the public, the Gartner Research Company published a report in July 2016. It estimated at that time, Google had over 2.5 million servers. They are housed in 15 known locations worldwide.
Facebook servers probably number in the hundreds of thousands, Amazon, PayPal, banks…you get the picture. The problem with servers is they are highly vulnerable to attack. More commonly known as ‘hacked.’
Banks and corporations try to solve this by encrypting the information. Encryption is designed to ensure that only you and your bank can access your ‘secured’ information…in theory.
The fact is, it doesn’t take a very sophisticated hacker to access either facebook or your bank account. If it’s on a server, it can be breached. Once breached, the hacker now has access to all the information it contains.
A few examples
In April 2018 facebook admitted that, ‘the public data of its massive 2.2 billion user account database had been compromised.’
Or when Equifax disclosed that hackers stole the personal information of 147.7 million Americans from its servers. Just this year alone, banks in Canada and Russia have been hacked.
Last year over 400,000 customers of Italy’s largest bank had their personal info stolen. More recently British Airways announced that personal financial information of 380,000 customers has been stolen from its servers.
A centralized location gives hackers a target. No matter how ‘great’ a company or banks security may be, it will always be at risk.The blockchain basics of decentralization work to eliminate this issue.
Blockchain technology is still in its infancy. There are still points of contact that hackers can exploit. Crypto exchanges still operate mostly on centralized servers. That being said, decentralized exchanges do exist and are growing.
Another area of vulnerability is ‘hot wallets.’ This refers to storing your crypto online…like a bank account for crypto.
Cold storage wallets are similar to a flash drive. They are a physical unit for storing your crypto offline making it inaccessible to hackers.
Regardless, blockchain even at this young stage, is a far more secure way of storing information. Almost every major company and bank have already started implementing the basics of blockchain technology. Microsoft, Google, Amazon, Facebook, Goldman Sachs, HSBC, Deutsche Bank. The list goes on and on.
How Does Blockchain Actually Work?
Blockchain is essentially the process of taking the information currently stored on a centralized server, and decentralizing it. This is accomplished by spreading that information in small cryptographically secured chunks, across a network of computers also known as ‘nodes.’
As the amount of computers, or nodes, on the network grows, the more decentralized the network becomes.
The process of accounting for the many bitcoin transactions happening simultaneously is referred to as open source distributed ledger technology. Which in english, means it’s an open ledger allowing for full transparency of all transactions without revealing any info about the parties involved.
Anyone can go online and see every bitcoin transaction that has ever happened starting with the very first on January 12th, 2009.
In the case of the bitcoin blockchain, the incentive for using a computer as a node on the network is achieved through a process called ‘mining.’
Another word for miner could be ‘bookkeeper’ as the purpose of mining basically means that in return for lending your computing power to the network, a miner is compensated in the form of the transfer fees mentioned earlier, as well as in small amounts of bitcoin itself. This process allows for an accurate accounting of every bitcoin transaction.
Other cryptocurrencies use different types of blockchains, but for the purpose of this blockchain basics intro we will just be covering the POW, or ‘Proof Of Work’ blockchain used by bitcoin.
Proof Of Work
Anyone who owns bitcoin has two cryptographic addresses, one public and one private. Not unlike an email transfer where your email address serves as your public address, and your password would be similar to your private address.
Bitcoin is sent via the blockchain from one encrypted public address to another public encrypted address. The only way to access the value within that address (value in this case being bitcoin) is by ‘unlocking’ it with its own unique cryptographic private address…the second of the two addresses each bitcoin owner possesses. A typical bitcoin address looks something like this…
It’s not necessary to know the identity of either the sender or receiver to process a transaction, all you need is a public address to send it to.
The basic bitcoin blockchain was designed by Satoshi to process transactions in 10 minute ‘blocks’ as this was the optimal time calculated to ensure an accurate distributed ledger.
Put another way, when a bitcoin transaction is ‘broadcast’ or sent through the blockchain network, the miners or ‘nodes’ mentioned earlier, will add it to an upcoming block. Each block therefore contains many transactions along with many transfer fees.
Encoded within each block is a mathematical puzzle that miners compete to solve. I use the term ‘miner’ loosely as it’s really the software on a computer that does this all automatically.
The purpose of the puzzle is to ensure that each block takes on average 10 minutes to solve, thereby ensuring the integrity of the transaction ledger.
The puzzle is dynamic in that the difficulty in solving it changes based on how long blocks are taking to solve. If it starts happening too quickly, the difficulty increases, and visa versa if it starts taking too long.
There is more than one correct answer to each 10 min puzzle, which means that multiple miners or nodes will end up solving it. Once solved, the transactions within that block are quickly calculated, and by having multiple miners coming up with the same number, ‘consensus’ is reached that the ledger is accurate.
The reward of fees and bitcoin is split between the miners who successfully reached consensus. This process is repeated over and over in 10 min blocks.
Blockchain basics still a little confusing? Join the club! Here’s another way of thinking about the process…
A ‘Real World’ Example
Imagine 100 people, each being given a single sealed envelope. Enclosed within these envelopes is the exact same set of transactions that need to be calculated in order to ‘balance the books’.
The catch is, each of the 100 sealed envelopes comes with a Rubik’s Cube that must be solved before you’re allowed to open the envelope and calculate the numbers within.
Once the majority (in this example would be 51%) of these people have solved the Rubik’s Cube AND arrived at the same number from the calculations in the envelope, consensus has been reached.
The reward is split between the 51 people, and they are all given a new envelope and Rubik’s Cube that has been adjusted to be a little harder, or a little easier, based on how long the last one took to solve…rinse and repeat.
Personally, I can think of far more exciting ways to spend a Sunday afternoon…
Once 4 blocks in a row have been confirmed in this fashion, they are now officially a new link in the chain, and added to the end of the existing blockchain.
This is an accurate, but very simplified (yes I did just say simplified) explanation of a very complex subject.
As I stated earlier, the purpose here is to give an overview, and hopefully better understanding from a ‘big picture’ perspective. For those interested, will be covering this subject in far greater detail in future articles.
The good news is that none of this technical stuff is necessary to enjoy the benefits of bitcoin or any other cryptocurrency.
In fact it’s not just currency that currently benefits from the use of blockchain technology, this is just the tip of the iceberg…but let’s save that for another article.
For me at least, when I first started to learn about blockchain basics it took some time before I truly started to grasp the concept. I would read an article, let it percolate for awhile, come up with a specific question, do some research on that, let it sink in, and come up with another specific question.
The point is, whether this your first or 10th introduction to the concept of blockchain, it takes some time to sink in. Especially if, like me, you are not naturally a technical minded person.
That being said, if you stick with it and let things sink in little by little, you WILL eventually have that ‘lightbulb’ moment where it all just clicks.
A last word of warning
Once you’ve had that lightbulb moment, once you truly understand the power and potential of blockchain basics not just as a means of simplifying and securing the transfer of digital currency, but the endless endless possibilities decentralization creates, you’re screwed.
Going back to what I said at the very beginning, when the internet first came along, can you imagine the difficulty in trying to explain something like Google or Facebook to someone 30 years ago? It would have been virtually impossible as we had no point of reference.
There’s no question that as blockchain tech continues to develop, there will be things like Instagram and Amazon that we haven’t even thought of yet. The difference however, is this time around we at least have some sort of reference point, as obscure as it may be, and once you’ve got your head wrapped around that…there’s no going back.
In the words of Ralph Waldo Emerson…
’The mind, once stretched by a new idea, never returns to its original dimensions.’
I hope you got a good stretch in today.
As usual, if you have any questions or comments please feel free to contact us here or on our twitter account.