Amid the financial crisis of 2007 and 2008, a pseudonymous author using the moniker, Satoshi Nakamoto, released a white paper titled Bitcoin: A Peer to Peer Electronic Cash System. Nakamoto described Bitcoin as a “purely peer-to-peer version of electronic cash.” The white paper imagined the development of an electronic currency that would be free from a central banks’ monetary policies. While Bitcoin instantly garnered fans, its real contribution—seemingly unknown at that time—was not restricted to its use as an alternative to fiat currency. Rather, its primary contribution was the potential of its underlying technology: blockchain.
A blockchain is a decentralized, distributed, and often-public digital ledger. It is comprised of records, known as “blocks,” that serve to document transactions. In other words, the blockchain operates as a verification mechanism, validating transactions while at the same time making it difficult, if not impossible, to alter those records. This characteristic is why the technology has gained attention across industries.
But blockchain technology wasn’t entirely a new concept. For example, cryptographer David Chaum proposed a blockchain-like protocol in his 1982 dissertation, Computer Systems Established, Maintained, and Trusted by Mutually Suspicious Groups. In fact, this work formed the bedrock for the current blockchain technology, although the notion of a blockchain as a form of cryptography traces back to the 1970s. Over the years, further improvements were introduced to Chaum’s concepts. These changes were later encapsulated in Satoshi Nakamoto’s Bitcoin white paper. Below is a list of key improvements to Chaum’s original protocol.
A timeline of selected discoveries in cryptography and blockchain technology.
But how exactly does blockchain relate to Bitcoin? The link between the two can be summarized through an analogy shared by Sally Davies, a Financial Times Technology reporter. She aptly wrote: “Blockchain is to bitcoin, what the internet is to email. A big electronic system, on top of which you can build applications. Currency is just one.” Even today, it is a common misconception that the blockchain and Bitcoin are one and the same. Bitcoin is a by-product of, and built upon, the blockchain, although it can accurately be said to be the first significant blockchain innovation. Since its introduction, Bitcoin’s market capitalization has grown remarkably, and millions of people use the cryptocurrency in their transactions. However, Bitcoin is just one of the numerous digital currencies (in, technical jargon “altcoins”) that use the blockchain as their foundational framework.
The second blockchain innovation is less technical and more philosophical, revealing the technology’s potential impact on the economy and society at large. As Bitcoin soared in popularity, blockchain technology also rose to prominence. This rise led many to recognize that the blockchain infrastructure has many potential applications. More than 400 banks and financial institutions are currently using the blockchain in some form, and this count is rising rapidly in the financial sector and beyond. Indeed, blockchain has transitioned from being synonymous with Bitcoin to representing a revolutionary technology in itself.
Blockchain also gave rise to the era of “smart contracts,” embodied as a derivation of Ethereum (another kind of altcoin). Vitalik Buterin, the co-founder of Ethereum, was an initial contributor to the Bitcoin codebase. However, he soon became concerned with Bitcoin’s programming limitations. Unable to convince the Bitcoin community to modify the technology’s codebase, Buterin set out to build a separate platform known as “Ethereum.”
The primary difference between Bitcoin and Ethereum lies in their intended purposes. While Bitcoin aims to function as an alternative to fiat currency, Ethereum endeavors to serve as a platform to facilitate programming contracts and applications through its currency, Ether. These programmatic contracts were dubbed “smart contracts” since they function as computer protocols that digitally facilitate, verify, and enforce the terms of agreements without third-party oversight. Similarly, applications built with smart contracts are called “decentralized applications” (in technical jargon, “dApps”). They are increasingly used to develop “decentralized finance” (DeFi)—an umbrella term for dApps geared toward eliminating financial intermediaries.
The fourth major blockchain innovation (which is currently under development) is known as “proof-of-stake” (PoS). When Bitcoin was made available to the public as a digital currency, a key debate centered on how to establish a transaction’s authenticity. To solve any authenticity problems, the Bitcoin community established that transactions would be secured by undertaking energy-intensive calculations to validate each block. These calculations, in turn, would form part of a bigger proof-of-work (PoW) problem—an exceedingly difficult mathematical puzzle that takes enormous amounts of computing energy—that must be solved in order to validate a transaction. Unsurprisingly, the PoW concept was besieged with energy and scalability concerns. In 2015, estimates suggested that a single Bitcoin transaction consumed the electricity required to power 1.57 American households each day.
To overcome the incumbent energy-heavy models, a PoS model was formulated. It shared the same transaction validation objective but differed in approach. Instead of solving complex PoW puzzles, the PoS concept suggested that transactions be validated in proportion to respective altcoins’ holdings. In other words, a person (in technical jargon, a “miner”) who owns 5% of an altcoin could theoretically validate only 5% of the altcoin’s transactions. Thus, the PoS framework puts the onus on the stakeholder to maintain a stable network, disincentivizing malicious intent. Plus, since the PoS concept involves no computation-intensive calculations, it offers time and cost synergies.
Blockchain technology is slowly acknowledging its own potential. Arguably, Bitcoin made “blockchain” a popular term, leading to the development of numerous altcoins harnessing the technology’s potential. As altcoins proliferated, the blockchain’s scalability and energy problems were revealed. Soon afterward, an improved blockchain platform was introduced. But even today, blockchain technology is still realizing its potential. And given the technology’s dynamic nature, just how far it will reach remains to be seen.