How Bitcoin Uses Blockchain, a Basic Guide

How Bitcoin Uses Blockchain
Image by Pete Linforth from Pixabay

Before we look at how bitcoin uses blockchain, we need to answer this basic question; is Bitcoin the same as Blockchain?

Bitcoin and blockchain do not refer to the same thing. However, the two are closely interlinked. We can say they have a symbiotic relationship.

Bitcoin is a unit of digital currency—categorized as a cryptocurrency because of its use of cryptography for security and user labels (addresses). It exists only as bits and bytes on computers. 

And like with any other digital currency, its transactions have to be published on a ledger. 

It is the ledger on which Bitcoin transactions are published that is known as a blockchain. There is no bitcoin without blockchain. Bitcoins are just units written on the shared ledger and never independent pieces of data. 

Blockchain is a unique digital ledger. 

Before Bitcoin, nothing like a shared ledger (blockchain) had ever existed. The world had never seen a decentralized digital ledger whose content’s credibility was never in question. To appreciate the uniqueness of the blockchain as a digital ledger, you need to understand:

  1. How it is stored and 
  2. How it is updated. 

Indeed how these two functions are carried out is what makes blockchain revolutionary. 

It is easier to understand everything about blockchain, including where it resides and how it is updated when you compare it with what it seeks to replace.

Centralized digital ledgers

Bitcoin was the first cryptocurrency, but not the first digital (or electronic) currency. Ledgers that track and facilitate ownership and use of digital currencies have been around close to as long as computers have existed.

Financial institutions in particular banks were among the first entities to embrace computers, and the primary use they found for them is storing and updating customer transactions on dynamic ledgers.

It is now estimated that the bulk of the money in circulation exists only as electronic money on digital ledgers that banks and other financial institutions maintain. Countries like Sweden have seen digital currency adoption go up to 85% in recent years. The digital ledger, therefore, has turned out to be a central pillar and an asset in global finance. 

It is important to note that this type of digital ledger is stored on servers that the bank owns and controls. Also, all the edits are primarily done by the bank’s agents (tellers—human and machine).

The ledger is described as centralized, and that is because an authority in the form of the bank or a financial institution exists to oversee its use. The institution has full ownership and control of the ledger. It manages all its aspects, including access to it, data that can be added and its use by third parties.

A critical feature of a centralized ledger is that any edit can be done if one has the necessary access privileges. The records are not immutable. And this is why a lot of resources are put into preventing unauthorized access by hackers and other third parties.

According to a report by the global accounting firm Deloitte, banks spend as much as US$3000 per employee annually to prevent cyberhacking. That translates to hundreds of millions for a large bank. But still, billions are lost annually to cybercriminals who manage to access centralized ledgers and make unauthorized changes (transactions) on the digital ledger.

Decentralized digital ledger

On its part, the blockchain is a ledger that is stored on multiple computers that form a peer-to-peer network. All the nodes on the network keep identical copies of the ledger.

When a computer joins the Bitcoin network, one of the first things it has to do, especially if it needs to be a full node is to download the entire blockchain, right from the first transaction in January 2009. The size of the Bitcoin shared ledger is close to 250GB (by publishing time of this post) and increases at a monthly rate of about 5GB. 

But how the ledger is stored is not where the magic happens. The real magic happens when these multiple copies on different and independent computers on the network are updated. 

It is vital that all copies remain synchronized at all times. However, there is no authority to oversee the process and in particular, the addition of new transactions to the shared ledger. Instead, all the nodes have to form a consensus on the latest additions as well as the general status.

And that is where mining comes in. To understand how mining takes place, read an earlier blog post published here.

Those who help maintain the ledger need to be incentivized. And they are incentivized by being rewarded by the newly released bitcoins. Without bitcoin, it will be challenging for the public peer-to-peer network to maintain the ledger. 

Indeed, even blockchains whose primary application is not a digital currency have had to resort to having a native coin that miners receive as a reward for making their computer resources available for use to maintain a decentralized ledger.

How does Bitcoin work with Blockchain?

Indeed, the blockchain is used in more ways than just a ledger on which transactions are recorded and tracked. In addition to being a ledger on which data is stored, it is also used as a virtual machine that can execute code and thus run numerous applications.

Blockchain technology applications are referred to as decentralized applications (dApps). They range from digital assets, simple websites to complex information systems.

A blockchain is what its application makes it be. If it is used to keep and track ownership of a digital currency like Bitcoin, then it is a ledger. But if it is used to run an app and store its data, then it is a virtual machine on a peer-to-peer network.

Many of the blockchains that have been launched after that of Bitcoin have many capabilities that go beyond supporting the use of digital currency. The Ethereum blockchain, in particular, can support multiple applications, the most revolutionary of which being smart contracts, agreements written in code that self execute once specific predefined conditions are met.

So how does bitcoin use blockchain?

Bitcoin is the first ever blockchain application (or dApp). While bitcoin without blockchain is not possible, the blockchain can, and has, existed without the bitcoin. And this is proven by the thousands of other blockchains that have been created.

Bitcoin, as a digital currency, uses blockchain in the following 5 ways:

  1. As a ledger on which Bitcoin spends and receipts are recorded.

The blockchain is the reference point when there is the need to prove who owns what bitcoin and at what time. 

It is the shared truth of all those who use Bitcoin, and in case of any dispute, the blockchain is consulted as the final arbiter.

The blockchain is the ledger on which ownership of bitcoin units is recorded but, more importantly, tracked. When Jane sends Bob bitcoins, the ledger has to reflect this transaction as well as their new balances.

When Jane sends a Bitcoin to Bob, the Bitcoin peer-to-peer network of independent computers through consensus (mining) reduces the amount attached to her address on the blockchain by that amount and increases what is written next to Bob’s address by the same margin. 

Of course, how the system works is more complex than this description.

2. As a source of security for transactions

By its design, blockchain secures digital records in a way others systems do not. Unlike digital ledgers in centralized systems, blockchain doesn’t rely on controlling access for security. The Bitcoin blockchain is public, and everyone is welcome to help maintain it through mining.

Each transaction on the bitcoin blockchain is time-stamped. This makes it immutable, meaning no one can arbitrarily change it or erase it from the records.

Given that all participants have to agree at every point the status of the ledger, it is almost impossible for an individual or single entity to make changes on the ledger. Also, the transactions are stored in batches known as blocks, which are interlinked through hashed IDs.

This makes the blockchain an immutable ledger. Once a record is made, it can not be altered. An attempt to change records requires one to change the ID of every block on every copy of the shared ledger. This is impossible as it requires non-existent computer power, and even if it was possible, the rest of the network could easily ignore the altered copy.

It is the reason why bitcoin transactions are irreversible. Immutability of the blockchain makes the transactions it carries credible.

Besides, the public-private key cryptography used on the blockchain ensures that everyone’s private funds are adequately protected. Every user can generate a private key known only to them, and through it, they can spend what is sent to them.

3. As an address system

The first step for anyone who wants to use the cryptocurrency is to create a public key (an address) on the blockchain. This is a pseudonym identity through which others can send you bitcoins and from which you send others bitcoins. 

Indeed, an address system is fundamental to any blockchain app.

It is the basis on which others interact with you on the blockchain. The address is created using a wallet application on your mobile phone or desktop.

Every public key has a corresponding private key through which one can control ownership of bitcoins. A public key could be thought of like an email address and a private key a corresponding password. 

To receive email messages, you share the address with others. To read messages sent to you, the password gives you access. To receive bitcoins, you share your public key. To spend those bitcoins, you need the corresponding private key.

The public key address on the blockchain is a genius use of the public-private key cryptography, whose primary function is the security of user funds on the shared ledger.

The blockchain system is robust enough that there is no risk that two users can generate an identical address for receiving bitcoins. And one can create as many addresses as they want. Indeed, it is advisable to use a new address for every single transaction. 

Meaning, you should share a new address every time you need to receive bitcoins from someone. That secures your privacy as well as that of the sender. It makes it a little harder for a third party to track and figure out identities and their spending habits.

4. The blockchain offers privacy to bitcoin users

The blockchain creates the possibility that someone can create an account they control to which they receive and send funds without the need for them to share personally identifying information. 

Before Bitcoin, it was almost always necessary for one to give their real-world identity to use a digital or electronic currency. This was primarily necessary to ensure the money went to the right person.

On the blockchain, users generate their own addresses and share them with others. This removes the responsibility of making sure money is sent to the right person from a third person. There is no need to verify identities. 

Through pseudo-anonymous identities ( in the form of public addresses) bitcoin affords users a cash experience on the Internet. That means, one can spend money on the internet without necessarily leaving a trail that leads to their doorstep.

5. Blockchain is a source of sustainability for the currency.

Users are assured that as long as the Internet exists in some corner of the globe, bitcoin will continue to exist given that the blockchain exists in multiple copies on thousands of nodes around the world.

Due to the nature of blockchain’s decentralization, Bitcoin can survive all kinds of attacks including censorship, internet failure, hacking attempts and even major natural disasters.

In short, Bitcoin relies on blockchain to give its users all the benefits that matter to them, including security, privacy and reliability. It also relies on the blockchain for its existence and long term survival.

 

Thoughts?

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: