I sat through a presentation by one of the industry’s leading experts on blockchain, and was shocked that he constantly confused the audience by talking about blockchain and bitcoin as if they were the same thing. It would be like explaining the concept of a wheel by talking about Uber. Yes, cars use wheels, but the commercial model of Uber has nothing to do with wheels. Nor does the mining of bitcoins have anything to do with blockchain.
In one statement he said “We need to be careful that we don’t consume all of our datacenter capacity mining new blocks in the blockchain…” – oh dear, and so begins the confusion. You mine for bitcoins, not blocks. The crazy thing is, the expert knew this, but often when you become an expert at a very complex topic it’s hard to explain it without getting your messages mixed up a little bit.
So lets be clear, bitcoin is an example of what blockchain can be used for, but blockchain is not bitcoin.
Blockchain is to bitcoin as an egg is to a soufflé. You can’t make a soufflé without eggs, but you can do much more with an egg than just making soufflé, and if you happen to not be a big fan of soufflé, don’t let that put you off eggs.
This is key, as bitcoin gets a fair bit of bad press, which people often associate with blockchain, but burning a soufflé doesn’t mean we should stop eating eggs.
Let’s have a quick chat about bitcoin, then we can talk about why much of what bitcoin is has nothing to do with blockchain.
Bitcoin is a currency, just like the US dollar, the Pound Sterling or the Euro. You can buy things with it, earn it, spend it, have it stolen, lose it. In every respect it’s just another form of money. The thing that makes it special is that there’s no central Government body that controls it. Currencies like the US dollar have a central bank that controls the release of new money into the economy, the central bank uses the amount of currency in circulation as a lever to control inflation and interest rates.
The more money in circulation, the faster inflation rises and the higher interest rates go. The central banks print new money as the need arises (“printing” could be just releasing more currency electronically but it helps to think about it as printing a physical note). If there isn’t enough currency in circulation the value of the currency can skyrocket, and/or the economy can slow as it becomes harder to get access to funds. So there is a lot of science that goes into managing the amount of available currency, this is the main function of central banks (also called Reserve Banks).
Bitcoin doesn’t have a central bank to control how much currency is in the market, no one group controls bitcoin, no one decides when to “print” more bitcoins. So how do more bitcoins get released into the market as the demand for bitcoins grows? If you could just make your own bitcoins we would end up with hyper-inflation of bitcoin and the value of them would plummet to the point that they would be worthless. If no new bit coins were created the market would become stifled and bitcoins would become hyper-expensive. Both situations are bad, so a way to add new bitcoins to the market in a fair and controlled manner was needed.
The solution was to let people generate their own bitcoins, but to make it incrementally harder each time to do so. At first it was easy to create new bitcoins, which was okay as they weren’t worth very much, so generating a hundred bitcoins wouldn’t make you rich. As each bitcoin was generated it became harder and harder. Now generating just one bitcoin is a very expensive and time consuming task, which is fair as they are now worth a lot of money. The cost of generating one has been kept in balance with the value of the currency. A very clever model.
Generating bitcoins is called “mining”, and it is done by using computers to solve highly complex mathematical problems. Each time you solve the problem you earn (mine) a new bitcoin, and the next problem is that much harder to solve. It has now reached the point that it takes a vast amount of computing power to generate just one new coin, but in return you get a coin worth thousands of dollars.
What does mining bitcoins have to do with blockchain? Nothing. Mining and blockchain have nothing in common, if someone tells you that you need to mine new blocks, they are either confused or plain wrong.
Where bitcoin and blockchain do interact is in the record keeping of who holds the coins. With a physical currency like the US dollar, there are two ways to track who holds the money, you either have the physical cash, or you have a bank that can confirm you have the funds in your account. We trust the banks and we trust the cash. With bitcoin there is no physical cash, and there are no banks.
No banks? Yes, one of the goals of bitcoin was to create a currency that could be exchanged independently of any third party (read banks and governments), so that peer to peer transactions could happen in complete privacy and anonymity.
If I wanted to pay you in a normal currency for that charming garden gnome you just sold me on eBay, I’d tell my bank to move the money from my account to yours. The bank would confirm that I had the money available in my account, then they would move it to yours and record the transaction. We would trust the bank, even though we never saw any physical money move. But if I didn’t want anyone to know that I’d just brought a garden gnome from you, I would not want the bank involved, as that would leave a transaction history. I could post you some physical cash (which is rather slow and not that safe) or I could use bitcoin and pay you directly without any need for a bank to be in the middle.
This is where blockchain comes in. If I’m going to pay you money you will want to know that I actually have the money. Today we do that via giving you the physical cash, or by getting my bank to confirm I have the money in my account. With bitcoin there is no option for physical cash (it’s a virtual currency), and there is no bank to confirm I have the funds in my account. So who can you ask to check that the virtual funds I’m sending you are real? Ask the bitcoin blockchain.
A blockchain is a shared database that keeps a permanent record of transactions. Being shared it means that there are multiple copies of the database stored by different parties. All copies must match, so this way it can remain accurate even though there is no central point of authority. If someone tries to change part of the database, the change must be confirmed by all other copies, otherwise it’s rejected. This makes it a good way to keep track of bitcoins, every exchange of bitcoins is permanently recorded in a blockchain, so the blockchain provides a shared verification that I do own the bitcoins I’m giving you.
Bitcoin uses blockchain technology to keep track of who has the bitcoins. That’s the relationship between bitcoin and blockchain. Hopefully you can now see that blockchain is not bitcoin, and bitcoin is not just blockchain.
Just to clear up one last point, adding a new block to the blockchain is just like adding a new record to a normal database. You don’t need to mine for blocks, mining has nothing to do with blockchain, mining is how new bitcoins are released into the market.