Bitcoin – Part 1 can be found here

Yesterday we said it’s the technology behind Bitcoin that you should be excited about, rather than with Bitcoin itself. So today, lets go deep on the tech side of things. Quick caveat though. We are not tech-heads. In fact, we are far from it. Knowing that we should turn it off and on again is about the extent of our computer wizardry.

The Technology Behind Bitcoin
There are three key ingredients to Bitcoin’s structure. There’s the Blockchain, the Distributed Ledger and the Cryptography. We’ll discuss each one, but if you really want to get into the detail,  we’d highly, highly recommend watching this video.

The BlockChain: In super simple terms, The Blockchain is a way of saying “the complete history of every transaction which has ever occurred in the order that it occurred”. For example, say there were just two people in the world who owned bitcoin, Matt and Damon. Matt pays Damon 50 bitcoins and then later Damon pays Matt 25 Bitcoins. The Blockchain would look like this:

Matt has 50 bitcoins
Damon has 0 bitcoins
Matt pays 50 bitcoins to Damon
Damon pays 25 bitcoins to Matt

Now because you know both Matt and Damons starting balances and because the blockchain has every transaction which ever occurred, you can very easily work out their current balance. In the case above, Matt starts with 50, pays 50 and then receives 25. Meaning his current balance is 25.

It’s called blockchain because rather than adding transactions one by one, they get added in blocks, like links on a chain. Or blocks on a chain even. Hence the “blockchain”. And that’s really it.

What gives Blockchain its power though, is when it’s combined with a distributed ledgerand cryptography.

Distributed ledger: So, a Blockchain is just a ledger showing all historical transactions in the system. Importantly there isn’t just one copy of this ledger. There are thousands of them. And they are kept on of different people’s computers (called “Miners”) all over the world.

When a new block of transactions occurs, all these miners/computers update each of their ledgers simultaneously. Importantly anyone with a powerful enough computer can keep and maintain the ledger. Therefore, in geek-speak, the Blockchain is kept on a distributed ledger, distributed across many different computers.

The libertarians of the world love this by the way, as it means control of the ledger/blockchain is decentralized. It’s distributed “among the people” rather than owned by a single corporation of the government. 

Cryptography: You know how your dollar-dollar-bills-yo have watermarks on them? This is to make it really hard for people to create counterfeit copies of them. To verify the notes are legitimate, people will put them into the light and check the watermark is as they expect. In a really rudimentary way, they are “decoding” the watermark with their eyes to verify it’s valid. Watermarks are really difficult to make (meaning they are hard to forge), but their validity is really easy to verify.

Cryptography is the computer-world version of the watermark. And when a new block of transactions gets added to the blockchain, a computerised watermark using cryptography is added to that block as well. This watermark uses a lot of mathematics and is extremely computer power intensive to generate. This is intentional, to make it extremely difficult to create and hence forge a block of transactions, just like with the watermark example above.

Once one of the computers within the distributed ledger generates the watermark all other computers are able to verify whether it’s correct or not really simply by doing the computer equivalent of putting a note up against the light. Therefore, the cryptography used means the watermark is extremely difficult to generate, but super simple to verify.

Once verified, the new block of transactions gets added to the front of the blockchain on every single computer making up the distributed ledger.

So blockchain is just the term for the history of all transactions. These transactions are kept and maintained by heaps of computers all over the world (the distributed ledger). When new transactions occur, rather than being added one-by-one, they get added to the system in blocks. And each new block is assigned a unique watermark which is impossible to forge.

My eyes have glazed over and I’m literally sleep reading. Can you just summarise it and maybe stick with real finance stuff?

Ummmm…. Ok. No need to get rude.

Blockchain technology enables a historical, unalterable record, which is kept on 1,000’s of people’s computers, of every single transaction which ever occurred in the system. It provides a full audit trail, of everything, ever. And it can never, ever be changed. Therefore the system has complete trust and forgery is near impossible.

We’ll leave you with two quotes from yesterday:

“It is really important you realise that Bitcoin is a completely made up currency that only exists on computers and the internet. And technically, it’s not even a currency at all. It’s an invention. It’s a piece of technology. And it’s the technology part which is super interesting. The bitcoin itself, not so much.”

“Remember, currency has no inherent value. It gets its value because its backed by the full faith of the government, and they way the government proves that to you, is by accepting it in return for the payment of taxes due.”

Anyway, quite a bit more than 5 minutes. And we’re sorry.

Categories: Bitcoin, Investing

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