Bitcoin, Ethereum, mining — distributed ledger technology decoded
These are some of the key concepts and terms to understand when talking about blockchain technologies.
After the 2008 financial crisis, technologists wanted to create a financial system that existed without banks; a way for people to send a new type of money to one another, without any company or authority getting involved. That money became known as cryptocurrency, after the cryptographic maths that made it possible.
The grandfather of the cryptocurrencies is bitcoin, which was envisaged by its pseudonymous creator (or creators) Satoshi Nakamoto as a “peer-to-peer electronic cash system”. Although bitcoin is the best known digital coin, more than 1,600 are on the market with more being created all the time. Ether, Ripple and Litecoin are among the better known of the growing list.
■ Distributed ledger
The technique that bitcoin’s creators settled on to create decentralised digital money was a huge, public record-keeping system. Rather than being controlled by a single entity, the distributed ledger is spread across thousands of computers that work together to verify transactions.
Blockchain is one type of distributed ledger, where hundreds of computers create a growing list, or chain, of time-stamped transactions that cannot be altered. Each new transaction is added as a “block” to the chain. Blockchain is attractive to many users because it offers a verifiable, immutable and public record.
A network of connected computers work together to agree on a transaction history, crunching through cryptographic calculations to verify the transactions. This process of confirming the record is known as mining. In return for maintaining the record, or chain of blocks, miners are rewarded with new bitcoin, a system known as proof of work. The code underlying bitcoin determines that no more than 21m bitcoins can ever be created — 17m have so far been mined. There is about $15m worth of bitcoin available as a reward every day, which miners compete for.
■ Energy use
Blockchain’s proof-of-work system requires vast amounts of computing energy, so it is energy-intensive and slow. When bitcoin demand is at its highest, once-speedy bitcoin transactions start to take days rather than minutes to complete and incur high transaction fees from the miners.
The more computational power that the miners can dedicate to verifying transactions, the greater their likelihood of being rewarded.
Miners in countries with low electricity prices, such as Russia, China and Canada typically had an edge over the competition, although the Chinese crackdown on cryptocurrencies has damped activity in that country.
Technologists are experimenting with alternative ways to achieve the same consensus between the computers that power bitcoin, a protocol called proof of stake. There are various techniques being tried, including voting systems, which should use less power.
■ Bitcoin cash
A faction within the online bitcoin community believed bitcoin should still act as cash, moving more freely between users rather than becoming an asset that people expected would gain in value. They split off the bitcoin blockchain, creating a new digital currency called bitcoin cash. It is important to note that even though blockchains are designed so that transactions are impossible to duplicate, the protocol which underlies the chain can be replicated so that two chains with the same structure run in parallel.
The most important evolution of blockchain after bitcoin came from a then 19-year-old Canadian-Russian computer science student, Vitalik Buterin. He proposed a way to make a blockchain system more useful than simply moving value from one place to another. Mr Buterin showed that programmers could code functions into the blocks, often referred to as smart contracts. That meant you could build decentralised applications, or “dapps”, opening up the blockchain to a host of other possibilities. Games have become popular dapps. CryptoKitties, a game that allows you to collect, breed and trade virtual cats, is the most famous.
However, there are relatively few applications that actually work yet and, like bitcoin, Ethereum’s blockchain is also liable to getting clogged up with transactions. Ethereum underpins many of the blockchain projects that sprung up last year. It allowed hundreds of new digital tokens to be produced — EOS, for example, has just raised $4bn in a token sale — creating a proliferation of cryptocurrencies that some traders have used as vehicles for speculation.
■ Not so anonymous
Bitcoin gained a cult following of people who wanted to transfer cash to each other outside of the traditional money systems — sometimes because they valued privacy, at other times for illegal activities, such as buying drugs. While bitcoin is often referred to as anonymous because IP addresses are not connected to names, law enforcement bodies have identified drugs traffickers and other sellers of illegal goods by uncovering their bitcoin wallets and using the public record to track their transactions.
■ Public or private?
Until recently, decentralized blockchain projects were generally open source, with developers collaborating on the public blockchains without necessarily being backed by a company. Now enterprises, which are by their nature centralised organisations, are increasingly interested in using blockchains.
In contrast to the rebellious, decentralised spirit behind bitcoin, with these new blockchains companies are in control and reap most of the profits.
■ Living up to the hype
But as businesses from banking to shipping are experimenting with their own purpose-built blockchains, there is deep scepticism over whether the technology can live up to the hype. Blockchain has proved difficult to scale and its use by corporations contains an inherent contradiction: blockchain was developed to be decentralised — without that, it becomes simply a less efficient database.