If you try to dive into this mysterious thing called blockchain, you will be forgiven for retreating in horror at the sheer ambiguity of the technical terms so often used to frame it. So before we dive into what crytpocurrency is and how blockchain technology can change the world, let’s discuss what a blockchain actually is.
In simpler terms, the blockchain is a digital transactional ledger, not unlike the ledgers we have used for hundreds of years to record sales and purchases. The functionality of this digital ledger is, in fact, broadly identical to the traditional ledger in that it records interpersonal debts and credits. This is the basic concept behind blockchain. The difference is who keeps the ledger and who checks the transactions.
In traditional transactions, payment from one person to another involves some type of middleman to facilitate the transaction. Let’s say Rob wants to transfer £ 20 to Melanie. He can either give her cash in the form of a £ 20 cash note, or he can use some kind of banking app to transfer the money directly to her bank account. Either way, the bank is the intermediary that verifies the transaction: Rob’s money is verified when he takes money from a cash machine, or it is verified by the app when he digits the transfer. The bank decides whether to go ahead with the transaction. The bank also keeps a record of all transactions made by Rob and is solely responsible for updating it when Rob pays someone or receives funds in their account. In other words, the bank maintains and controls the ledger, and everything flows through the bank.
This is a huge responsibility, so it is important for Rob to feel he can trust his bank or else he won’t be risking his money with them. He must feel confident that the bank will not cheat him, not lose his money, not be robbed, and not disappear overnight. This need for trust has greatly supported every major behavior and aspect of the monolithic finance industry, to the point that even when it was discovered that banks were irresponsible for our money during the 2008 financial crisis, the government chose (another middleman) to bail them out rather than risk destroying the last bits of Confidence in letting them collapse.
Blockchains work differently in one major aspect: they are completely decentralized. There is no central clearinghouse like a bank, nor is there a central ledger maintained by a single entity. Instead, the ledger is distributed across an extensive network of computers, called nodes, each of which loads a copy of the entire ledger onto their respective hard drives. These nodes are linked to each other via software called a peer-to-peer (P2P) client, which synchronizes data across the network of nodes and ensures that everyone has the same version of the ledger at any given point in time.
When a new transaction is entered into the blockchain, it is first encrypted using the latest cryptographic technology. Once the transaction is encrypted, it’s converted into something called a block, which is the term originally used for an encrypted set of new transactions. This block is then sent (or broadcast) to the network of computer nodes, where it is verified by the nodes, and once verified, it is passed through the network so that the block can be added to the end of the ledger on everyone’s computer, under the list of all previous blocks. This is called the chain, and then the technology is referred to as the blockchain.
Once approved and recorded in the ledger, the transaction can be completed. This is how cryptocurrencies like Bitcoin work.
Accountability and the demise of trust
What are the advantages of this system over the banking or central clearing system? Why does Rob use bitcoin instead of regular currency?
The answer is confidence. As mentioned earlier, with the banking system, it is crucial that Rob trust his bank to protect and handle his money properly. To ensure this happens, massive regulatory systems are in place to check the actions of banks and ensure they are fit for purpose. Governments then regulate the regulatory agencies, creating a kind of tiered system of controls whose sole purpose is to help prevent errors and bad behavior. In other words, institutions like the Financial Services Authority exist precisely because banks cannot be trusted on their own. Banks often make mistakes and misbehave, as we have seen many times. When you have one source of power, power tends to be misused or abused. The trust relationship between people and banks is embarrassing and risky: We don’t really trust them but we don’t feel like there are many alternatives.
On the other hand, Blockchain systems do not need to be trusted at all. All transactions (or blocks) in the blockchain are verified by the nodes in the network before they are added to the ledger, which means that there is not a single point of failure nor a single approval channel. If a hacker wanted to successfully tamper with the ledger on the blockchain, they would have to hack millions of computers at once, which is almost impossible. The hacker would also be largely incapable of disabling the blockchain network, as he would need, once again, to be able to lock down every computer in a network of computers distributed around the world.
The encryption process itself is also a major factor. Blockchains like Bitcoin one use intentionally difficult operations to perform verification. In the case of Bitcoin, blocks are verified by nodes that intentionally perform a series of time-consuming and manipulative calculations, often in the form of complex puzzles or mathematical problems, which means that verification is not instantaneous and inaccessible. A contract requiring a supplier to verify blocks is rewarded with transaction fees and a bonus of newly minted bitcoins. This has the function of motivating people to become nodes (because processing blocks like this require very powerful computers and a lot of electricity), while also dealing with the process of generating – or minting – units of currency. This is referred to as mining, because it requires a large amount of effort (by computer, in this case) to produce a new commodity. It also means that transactions are verified in the most independent, and independent manner, of a government organization such as the Financial Services Authority.
This decentralized, democratic, and highly secure nature of blockchain networks means that they can operate without the need for a regulation (they are self-regulating), government, or other opaque medium. They work because people do not trust each other, not in spite of it.
Let the significance of that sink for a while and the excitement around the blockchain begin to make sense.
Where things get really interesting are blockchain applications other than cryptocurrencies like Bitcoin. Given that one of the fundamental tenets of the blockchain system is the secure and independent verification of a transaction, it is easy to imagine other ways in which this type of operation could be of value. Not surprisingly, many of these applications are already in use or development. Some of the best ones:
- Smart Contracts (Ethereum): Probably the most exciting blockchain development after Bitcoin, smart contracts are blocks containing code that must be executed in order to fulfill the contract. The code can be anything, as long as the computer can execute it, but in simple terms, it means you can use blockchain technology (with independent verification, unreliable architecture and security) to create some kind of security system for any type of transaction. For example, if you are a web designer, you can create a contract that checks whether or not a new customer site is launched and then automatically release the funds for you once it is launched. No more stalking or billing. Smart contracts are also used to prove ownership of an asset such as property or art. The potential to reduce fraud with this approach is enormous.
- Cloud storage (Storj): Cloud computing revolutionized the web and led to the emergence of big data which in turn launched the new artificial intelligence revolution. But most cloud-based systems run on servers stored in single-site server farms, owned by a single entity (Amazon, Rackspace, Google, etc.). This represents all the same issues that the banking system faces, where your data is controlled by one opaque institution that represents one point of failure. Distributing data on the blockchain completely removes the trust issue and also promises to increase reliability since it is very difficult to disrupt the blockchain network.
- Digital Identification (ShoCard): Two of the biggest issues of our time are identity theft and data protection. With vast central services like Facebook containing a lot of data about us, and the efforts of various governments of the developed world to store digital information about their citizens in a central database, the potential for misuse of our personal data is terrifying. Blockchain technology offers a potential solution to this by encapsulating your main data into an encrypted block that can be verified by the blockchain network whenever you need to prove your identity. Applications for this range from the apparent replacement of passports and ID cards to other areas such as password substitution. It can be huge.
- Digital voting: In the wake of the investigation into Russia’s influence over the recent US elections, digital voting has long been suspected of being unreliable and prone to manipulation. Blockchain technology provides a way to verify that a voter vote has been sent successfully while remaining anonymous. It promises not only to reduce electoral fraud but also to increase the general voter turnout as people will be able to vote on their cell phones.
Blockchain technology is still in its infancy, and most applications are still very far from general use. Even Bitcoin, the more established blockchain platform, is subject to large fluctuations indicating the status of a relatively newcomer. However, the ability of the blockchain to solve some of the major problems we face today makes it an unusually exciting and alluring technology to pursue. I will definitely watch.