Amid the financial crisis of 2007–08, a pseudonymous author called 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 caused a sensation—especially in the investing community—since it imagined the development of a currency with universal applicability, free from central banks’ monetary policies. While Bitcoin instantly garnered fans, its real contribution—seemingly unknown at that time—was not as an alternative to fiat currency. Rather, its main offering was the limitless potential of its underlying technology: the blockchain.
A blockchain is a decentralized, distributed, and often-public digital ledger. It comprises records known as “blocks” that document transactions across many terminals. In other words, the blockchain operates as a verification mechanism, progressively validating transactions and making retroactive alterations to transactions nearly impossible since any alteration would require changing all subsequent blocks in the chain. This characteristic is why the technology has gained attention across industries.
We should also mention that blockchain technology isn’t exactly a new concept. Cryptographer David Chaum proposed a blockchain-like protocol in his 1982 dissertation, Computer Systems Established, Maintained, and Trusted by Mutually Suspicious Groups. This work formed the bedrock of the current blockchain technology, but the notion of a blockchain as a form of cryptography traces back to the 1970s. Over the years, further improvements were introduced to the original idea that Chaum proposed. 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 does blockchain tie in with Bitcoin? The link between the two can be aptly summarized through an analogy shared by Sally Davies, a Financial Times Technology reporter. She 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, a common misconception holds that the blockchain and Bitcoin are one and the same. Though they differ, Bitcoin is a by-product of the blockchain, and it can accurately be touted as the first significant blockchain innovation. Bitcoin’s market capitalization is currently over $28 billion (and it’s increasing), 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. As Bitcoin soared in popularity, blockchain technology also rose to prominence. This rise led to many ideas for how the blockchain could experiment with industries’ value chains. 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. This stage is widely considered to be pivotal for the blockchain, which has transitioned from being synonymous with Bitcoin to representing a revolutionary technology in itself.
The third blockchain innovation was known as 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 is their intended purposes. While Bitcoin aims to function as an alternative to fiat currency, Ethereum endeavors to serve as a platform facilitating programming contracts and applications via its currency, Ether. These programmatic contracts became known as “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. Ethereum-powered smart contracts are viewed as a gamechanger across industries since they could eliminate various financial intermediaries across verticals.
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 argument involved 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.For now, Ethereum is tentatively scheduled to move from PoW to PoS by late 2020 or early 2021.
Blockchain technology is slowly acknowledging its own potential. In this respect, the space is akin to Clark Kent discovering that he’s Superman and gradually transitioning from an ordinary journalist to an Earth-saving superhero. 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.