We explain how Bitcoin works, the blockchain technology that underpins the digital currency, and its future business applications.
Today most of us use online banking to sort out our finances, but that’s still based on traditional currencies. However, there's an all-digital currency, and it's called Bitcoin. Unlike other currencies, Bitcoin only exists on the internet and not in physical form.
Bitcoin works a little differently, so instead of a central authority, it uses an encrypted peer-to-peer network to store your balance, confirm and verify any transactions or purchases. This is called the blockchain, and it can also be thought of as a huge list of every Bitcoin transaction that has ever taken place. It’s stored on every computer (or "node") in the bitcoin network, and lists the sender, receiver, value and approximate time of every Bitcoin transfer, all verified and anonymised.
So, how does Bitcoin work, what is the blockchain exactly, and does it have a place in business? Here's all you need to know.
How Bitcoin works
The best way to understand how the blockchain works is to follow how it’s added to step by step, starting with transactions. When a user wants to send bitcoins to someone else, they broadcast the details of the transaction – their public key, the recipient’s public key, and the bitcoin amount transferred – to a network of interlinked nodes.
This transfer information is independently verified by other computers in the network, analogous to having witnesses present when signing a contract. These other nodes use a "digital signature" to authenticate a transaction.
This long, complex string of letters and numbers is generated from a combination of a user’s private and public keys, along with the transaction message itself. The alphanumeric pattern is unique to every transfer and can't be used twice, to further guard against fraud.
Once it’s been confirmed that the transaction message is genuine, the transaction data itself must be added to the blockchain to be considered "confirmed". Nodes periodically collect "unconfirmed transactions" – those that have been verified genuine but not yet added to the blockchain – into sets, and broadcast them to the network as a new potential block.
These blocks are comprised of a group of transactions that have all been judged to take place at roughly the same time. Each new block that joins the chain must reference the preceding block, and in this manner, the blockchain establishes a traceable chronology that runs all the way back to the first bitcoin transfer.
The strength of the blockchain relies on group verification. Every node in the network has a copy of the blockchain, and if a node submits data that doesn’t match the rest of the network’s blockchain data, that information will be rejected.
Therefore, it’s important that all network nodes operate from identical blockchain information. In order to prevent clashes deriving from two different blocks being proposed by separate nodes at the same time, before a submitted block is accepted into the chain, nodes must first solve an incredibly complex cryptographic puzzle.
Involving highly complex mathematics and algorithms, the puzzle essentially boils down to each node guessing random numbers. The best comparison would be trying to guess the code to a combination lock, or the weight of a cake at a church fair.
Statistically speaking, a lone computer would take years to arrive at the right solution. Multiple computers on the network guessing simultaneously, however, average a solution time of about ten minutes. The first node to solve the puzzle gets their block suggestion added to the chain.
Nodes that perform this function are known as miners, and each node that successfully solves a block puzzle is rewarded with bitcoins, as an incentive to keep the blockchain going, and keep the system operational.
However, there is a finite number of bitcoins in existence, and every four years, the amount of coins generated per solved block is halved, in order to stave off the currency’s deflation. Some experts have stated that in spite of this, Bitcoin is unsustainable in the long term due to the gradual and irrecoverable loss of private keys.
One of the key benefits of Bitcoin over traditional monetary systems is its anonymity. What designates Bitcoin as a "crypto-currency" is that Bitcoin, and the transfers thereof, can't be traced back to individual users.
How the system achieves this is linked to the methods in which transactions are managed. Although the network has a public and open record of every transaction, the blockchain keeps no details of users’ individual balances.
Instead, the blockchain uses a reference system to ensure that users have enough funds to cover any bitcoin transfers. When sending money to another user, this transaction (known as an output) must be validated by referencing the information stored in the blockchain of one or more payments you received in the past (also called inputs).
To prevent users referencing the same input in more than one transaction – double-spending – each input can only be referenced once before it is considered "spent" by the system. For every transfer, the network checks these references against their copy of the existing blockchain data.
This is another aspect of the authentication system blockchain uses, in concert with the digital signature mentioned earlier. The signature ensures that the transfer is authorised by the account holder, while the input references make sure that they have sufficient bitcoins to send.
Another factor in Bitcoin’s anonymity, and the thing that makes it so attractive to criminal enterprises on the dark web, is that it’s possible to maintain complete separation between bitcoin transfers and your real identity.
Privacy-conscious users can use anonymising services such as TOR for extra identity protection, but this isn’t really necessary. The public keys that bitcoin holders use to receive payments are randomly generated sequences that can be generated at will by your wallet software, with almost limitless combinations.
How blockchain works
Blockchain has been making waves beyond Bitcoin for a while now. Described by many as a distributed database, blockchain gives professionals the ability to store vital information and assets in a list of ordered records that updates in real-time.
Blockchain was conceptualised in 2008 by Satoshi Nakamoto, the pseudonym used by the mysterious founder of Bitcoin, whose real identity remains unknown to this day and may in fact be more than one person. It was designed and implemented to fix the so-called "double-spending" problem, whereby people are able to spend digital tokens more than once. The technology also avoids the need for a financial authority or central server, essentially removing bureaucracy.
While it's fair to say that Blockchain wouldn't be the same without Bitcoin, it's beginning to attract interest in other areas. The Bitcoin design has, in many ways, acted as inspiration; blockchain systems are usually secure-by-design and fault tolerant, making it possible to create a decentralised way to store important information and events. Blockchains are being used in scenarios such as medical records keeping, identity management, transaction processing and provenance.
The rise of blocks
In most cases, blockchain systems are organised in the form of 'blocks'. Each block carries a unique timestamp and can be linked back to an older block. That's handy for industries where it's crucial to track information by time and event. Another great thing about blockchains is that they're often resistant to editing.
Once critical information has been recorded in a block, it can't be changed retroactively. Although some may find that frustrating, it bodes for a more verifiable and permanent transaction process between two parties. Creators of blockchains can also design them so that transactions are triggered automatically, which makes for greater efficiency and accuracy.
More affordable and efficient
As a decentralised type of public ledger, blockchains are commonly operated through thousands of global computers. Thanks to this, users are able to organise and audit information quickly and efficiently. In most scenarios, people running and using blockchain systems take collaborative approaches and may have common aims.
If you work in the financial services sector, for example, your main intention is to ensure that you have a safe, secure way to store and process customer transactions. A physical file room may have dominated in the past, but with technology like blockchain, you can process timely data more accurately.
Blockchain could also bode for more affordable financial processes and diminish the chance of fraudulent activity at the same time. Such systems are mainly in the experimental phase right now, but they're always advancing and we'll no doubt see more use cases come to light in the foreseeable future.
Does blockchain have a place in business?
The beauty of the blockchain system is that it can be used as a model for other peer-to-peer authentication networks. This technique can be applied to access codes to secure clouds, encrypted file transfers and communication logs.
While the blockchain is almost always associated with bitcoins right now, it looks set to be an important part of the technological network throughout this century.
Because Blockchain is secure-by-design and decentralised in nature, it's become an effective way of storing important, timely data such as names, medical records, financial transactions and identities.
While Blockchain technology is still in early stages and constantly evolving, there are many people who believe it has the potential to revolutionise business processes.
Broad business applications
The common stereotype surrounding blockchain is that its only use is in Bitcoin, but that's certainly not the case. More businesses are exploring how the technology can help them streamline operations and internal processes, particularly when it comes to organising critical information.
Ruchika Mishra, security manager at WhiteHat Security, says blockchain is changing the cards for storing, distributing and transacting data. In particular, she expects it to transform the financial industry over the next few years, ensuring institutions conduct transactions efficiently.
"Despite blockchain technology underpinning cryptocurrencies like Bitcoin, the concept of a de-centralised and cryptographically secured ledger has multiple business applications. Any 'asset' that can be stored, distributed or transacted – property titles, music, insurance and even personal data – could make use of blockchain technology," she says.
"The technology shows great promise for improving the financial industry's efficiency. For example, the three-day wait on 'pending' transactions could be eliminated if a distributed ledger were implemented. This is because a public registry, such as blockchain, would remove the need for a central authority to verify the identities of all parties in the transaction. Settlement could then be instantaneous, since the transaction and settlement would happen simultaneously once the ledger is updated," she adds.
Mishra can also see blockchain having a positive impact on identity management, providing companies with a way to control who has access to valuable information and ensuring it's protected from cyber criminals. This is something that's crucial for firms, especially as the number of cyber attacks carried out each year is constantly increasing.
"An alternative business application is to use blockchain technology for identity management. As we go through our lives, each snippet of our digital identity is being collected to form a publicly-obtainable digital profile of us. Blockchain technology could help us take control back over our virtual data: who has access to it and how much they can obtain. This could be a great leap forward for privacy protection," she says.
Blockchain is an emerging technology and one that's advancing rapidly, with people quickly realising the potential it offers. Sam Davies, lead technologist at the UK’s tech industry growth organisation Digital Catapult, says blockchain will grow immensely over the next decade. In the 2020s, it'll be an industry generating billions, many predict.
"The impact Blockchain will have on business over the next 10 years will be transformational. This distributed ledger technology will completely reimagine the way data and transactions are recorded and processed," he says.
"Well-known for its applications in fintech, this disruptive technology is growing at an unprecedented rate with potential reaching far beyond finance. Gartner predicts that by 2022 a blockchain-based business will be worth US$10 billion, and the technology itself will established as the next revolution in transaction recording."
Davies believes that as blockchain technology and solutions improve, it will become an integral part of the business world and Internet of Things (IoT) industry. "As the underlying blockchain infrastructure matures, businesses are presented with a great opportunity to implement increasingly automated and intelligent smart contracts," he says.
"This, for example, offers the potential to redefine what the IoT can deliver. By taking away the need for a centralised broker, the distributed, decentralised nature of IoT devices can be reflected in any underlying access, management or marketplace systems," he adds.
Streamlining government and banking
Jason Ward, senior director of enterprise Dell EMC in the UK and Ireland, says blockchain can streamline clearing processes and internal operations for banks. There's also huge potential for governments right around the world, such as civil servants using blockchain to combat fraud, error and the cost of paper-based systems.
"Blockchain offers the promise of addressing some of the key challenges faced by the financial sector and offers a way of improving central clearing, back office operations and cross-border payments. If banks started sharing data using a tailor-made version of Blockchain, they could essentially remove the need for a lot of manual processing, and speed up transactions," Ward explains.
Governments are also starting to explore the possibilities of blockchain, with Ward pointing to a recently-published report from the British Office for Science, which recommended the UK government begins work to exploit distributed ledger technology in the public sector.
"The report highlighted how distributed ledger technology could provide governments with new tools to reduce fraud, error and the cost of paper intensive processes," explains Ward. "Of course, there is a need for more education if we are to ensure policy makers understand how it works and its potential applications, independently from 'Bitcoin'.
"Blockchain has the potential to help drive unprecedented opportunities for innovation, as well as new and better ways to interact with citizens and businesses, and more efficient regulatory initiatives."
James Lowry, head of state at Street Global Exchange in the European region, is also a believer in blockchain technology. He says it'll transform the global financial system, but there are still some challenges the biggest of which is cyber security.
"Blockchain is one of the more compelling vehicles in terms of technological disruption – and opportunity – because it could create a single source of truth for transactions and other types of shared data. We believe that this could have far-reaching consequences for the global financial system," Lowry says.
"There are some challenges," he adds. "One is that blockchain must show that it has the wherewithal to withstand a major cyberattack. Its cryptography does provide a strong element of security but it is unlikely to be infallible against all cyber threats. Secondly, numerous firms are creating their own private blockchains, which is somewhat contrary to the idea of a public, shared blockchain."
But, in the end, the technology will evolve and even more benefits will be realised.
"While the industry is still far from realising the full impact of blockchain and other emerging technologies within financial services, if we can make blockchain the internet of financial services, we all benefit – particularly if it allows for real-time settlement across different geographies and currencies," concludes Lowry.