How do blockchain and bitcoin really work?

How do blockchain and bitcoin really work?

Blockchain is going to conquer the world, not bitcoin. The blockchain technology will probably even have a future usefulness in your company. To understand why, you first need to understand how the blockchain chain works.

Everything revolves around so-called hash functions. These are mathematical calculations in which data is converted into a series of hexadecimal characters with a specific length (256 bit for example). It is very easy to obtain a hash of data, such as a bitcoin transaction. Anyone who has the original data can immediately calculate the hash of it. It will always be the same, and is more or less unique for the data contained in it.

Acting the other way around is virtually impossible. You can't come up with data in advance in an attempt to find a specific hash. The hash calculation only works in one direction. The blockchain is a digital logbook in which data such as transactions are kept in the form of a hash.

Transaction log

Let us start a hypothetical blockchain together. If A gives money to B, that transaction is hashed and stored as Hash1: this is the start of our chain. B now gives money to C. That transaction is taken together with Hash1, and the whole thing goes through a hash function. The result, Hash2 has the data of the second transaction in it, along with the hash of the first transaction.

For the third transaction the same thing happens: Hash3 is the result of transaction 3 together with Hash2. That's how the chain goes on. As soon as someone wants to change data somewhere in the chain, the hash changes with that data. Imagine that you want to trick B and change the transaction from the previous paragraph so that B does not give money to C, but gets money from C. Since the data has changed, then Hash2 also changes. Hash3 is the combination of the third transaction combined with the now changed Hash2, so that hacking B also affects Hash3. When someone changes something from data into a blockchain, the whole chain falls apart.

How exactly such a hash works is not important. It is interesting to know that this is a very transparent mathematical function, which has the property that it only works in one direction. It is not that blockchain is protected by a mysterious technology that you only have to trust it is safe. The safety of the chain is based on a very clear mathematical principle that everyone can see and is safe in its simplicity.

' Proof of work

For Bitcoin there is one more difficulty: the person who adds a transaction to the chain can theoretically adjust it before the hash is carried out. The solution will come in the form of proof of work. Anyone can try to sew a new transaction (or' block') on the blockchain, but only anyone who delivers a proof of work first can do so effectively.  Proof of work is the source for a hash function whose result is smaller than a given maximum.

As mentioned above, it is only possible to start from data and calculate a hash and you can't start with a hash and vice versa calculate which data is the basis. You can make calculations and carry out hash functions in the wild, however, in the hope that one has a result that is smaller than the given maximum. If a lot of computers do a lot of calculations, sooner or later one almost accidentally delivers a proof of work that meets the requirements. The winner of that contest stitches the transactions to the chain, and in return receives a bitcoin. Mining' is called that, and it is how bitcoins are made.

Mining and proof of work are an essential part of the digital currency. They make it impossible for you to predict in advance who will add a transaction to the chain, so that you cannot bribe anyone in advance to adjust the details of the transaction to your advantage, for example.

Indirect limitations

Mining is necessarily difficult. If it were simple, then the body with the most computer power would win the contest for the proof of work. In the long run, that authority would be to sew most of the transactions on the chain and serve again as a kind of bank, while bitcoin has just been made to work in a decentralised way with miners from all over the world.

Therefore, what makes bitcoin safe without a bank being involved makes the currency slow. When too many people jump on bitcoin, minting is not fast enough and transactions are only added to the blockchain with a delay. It is therefore unlikely that bitcoin can ever become a truly common payment method.

Blockchain technology is much more interesting in a business environment. A limited number of parties that have to manage a limited amount of transactions are not subject to speed limits. Think hypothetically of a notarial-blockchain shared by all Belgians. Whoever buys a house puts an acte in the blockchain. It is coded in a perfectly secure way, just like a bitcoin transaction. In this way, you can prove at all times that you have bought the house, without having to call in an additional body (the notary) which, as a third party, draws up an official and unalterable document.

Blockchain and you

Maersk uses a blockchain to trace containers. A lot of official paperwork went hand in hand with this, too. However, the security of the blockchain eliminates the need for complicated documents and stamps. In theory, companies can trade with each other with the help of a private block chain, while banks can base their mutual transaction system on the chain.

The most imaginative application is perhaps that of the smart contrasts. Imagine an energy blockchain in which energy providers are drawn, just like you, along with your smart refrigerator and your smart washing machine. If the washing machine jumps on at night, it will use the internet to find energy for the next minute. She buys that energy from the cheapest supplier, after which the transaction is put into the energy blockchain. The same thing happens for the next minute, so that your washing machine has always run at the lowest possible price. Payment can be made retrospectively via an invoice that you cannot dispute, or automatically, and can be made perfectly in euros. The blockchain serves here as an extremely reliable digital transaction book to make such microtransactions possible.

The possibilities of blockchain technology are far-reaching, as long as you keep the limitations in mind. Bitcoin is currently a fantastic experiment and an exciting investment opportunity, but a worthy competitor for dollars and euros, Visa and Maestro, will never be the digital currency. The blockchain, on the other hand, has endless potential: everything that is kept in a logbook today by people or authorities can theoretically be done more efficiently and safely with a digital chain. This means that your company can probably also find applications of blockchain technology. This can range from the automatic processing of invoices with customers to a simple internal system for recording leave.