If you’ve tried to dive into this mysterious thing called blockchain, you’d be forgiven for recoiling in horror at the sheer opacity of the technical jargon often used to frame it. So before we get into what cryptocurrency is and how blockchain technology could change the world, let’s discuss what blockchain actually is.
In its simplest terms, blockchain is a digital ledger of transactions, unlike the ledgers we’ve used for hundreds of years to record sales and purchases. The function of this digital ledger is, in fact, quite identical to a traditional ledger in that it records debts and credits between people. That’s the basic concept behind blockchain; the difference is who keeps the ledger and who verifies the transactions.
In traditional transactions, a payment from one person to another involves some sort of intermediary to facilitate the transaction. Let’s say Rob wants to transfer £20 to Melanie. He can give her cash in the form of a £20 note or he can use some sort of banking app to transfer the money directly to her bank account. In both cases, the bank is the intermediary that verifies the transaction: The slave’s funds are verified when he withdraws money from the ATM, or verified by the application when he makes a digital transfer. The bank decides whether the transaction will continue. The Bank also keeps a record of all transactions made by the Slave and is solely responsible for updating whenever the Slave pays someone or receives money into their account. In other words, the bank holds and controls the ledger, and everything flows through the bank.
It’s a big responsibility, so it’s important that Rob feels he can trust his bank or he wouldn’t be risking his money with them. He needs to be sure that the bank will not cheat him, that he will not lose money, that he will not be robbed and that he will not disappear overnight. This need for trust has underpinned almost every major behavior and aspect of the monolithic financial industry, to the point that even when banks were found to be irresponsible with our money during the 2008 financial crisis, the government (the second intermediary) chose to bail them out instead rather than risk destroying the final fragments of trust by letting them crumble.
Blockchains work differently in one key respect: 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 book is distributed through a vast network of computers, called nodes, each holding a copy of the entire book on their hard drives. These nodes are connected to each other through 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 book at any given time.
When a new transaction is entered into the blockchain, it is first encrypted using state-of-the-art cryptographic technology. Once encrypted, the transaction is turned into something called a block, which is basically a term used for an encrypted group of new transactions. That block is then sent (or broadcast) to a network of computer nodes, where the nodes verify it 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, below the list of all previous blocks. This is called a chain, hence the technology is called blockchain.
Once approved and recorded in the ledger, the transaction can be completed. This is how cryptocurrencies like Bitcoin work.
Liability and removal of trust
What are the advantages of this system compared to the banking or central clearing system? Why would Rob use Bitcoin instead of normal currency?
The answer is trust. As mentioned above, it is critical to the banking system that Rob trusts his bank to protect his money and handle it properly. For this to happen, there are huge regulatory systems that verify the actions of banks and ensure that they are fit for purpose. Governments then regulate regulators, creating a kind of multi-tiered system of checks whose sole purpose is to help prevent mistakes and misconduct. In other words, organizations like the Financial Services Authority exist precisely because banks cannot be trusted on their own. And banks often make mistakes and behave badly, which we have seen too many times. When you have only one source of authority, power is often misused or abused. The trust relationship between people and banks is awkward and precarious: we don’t really trust them, but we don’t feel there’s much of an alternative.
Blockchain systems, on the other hand, don’t need you to trust them at all. All transactions (or blocks) in the blockchain are verified by nodes in the network before being added to the ledger, meaning there is no single point of failure and no single approval channel. If a hacker wanted to successfully break into a ledger on the blockchain, he would have to hack millions of computers at the same time, which is almost impossible. A hacker would also not be able to crash the blockchain network, because, again, they would have to be able to shut down every single computer in a network of computers distributed around the world.
The encryption process itself is also a key factor. Blockchains like Bitcoin use deliberately difficult processes for their verification procedure. In the case of Bitcoin, blocks are verified by nodes that perform a deliberately processor- and time-intensive series of calculations, often in the form of puzzles or complex mathematical problems, meaning that verification is neither instantaneous nor available. Nodes that establish block verification resources are rewarded with a transaction fee and an abundance of newly created Bitcoins. This has the function of both encouraging people to become nodes (since processing such blocks requires quite powerful computers and a lot of electricity), while also managing the process of generating – or minting – units of currency. This is called mining because it involves a considerable amount of effort (in this case computers) to produce new goods. It also means that transactions are verified in the most independent way possible, more independent of a government-regulated organization like the FSA.
This decentralized, democratic and highly secure nature of blockchains means that they can function without the need for regulation (they are self-regulating), government or other opaque intermediary. They work because people don’t trust each other, not in spite of it.
Let the significance of that sink in for a while and the hype around blockchain starts to make sense.
Where things get really interesting is the application of blockchain beyond cryptocurrencies like Bitcoin. Given that one of the core principles of blockchain systems is secure, independent transaction verification, it’s easy to imagine other ways in which this type of process can be valuable. Not surprisingly, many such applications are already in use or in development. Some of the best are:
- Smart Contracts (Ethereum): Arguably the most exciting blockchain development after Bitcoin, smart contracts are blocks that contain code that must be executed in order for the contract to be fulfilled. The code can be anything, as long as a computer can execute it, but in simple terms this means that you can use blockchain technology (with its independent verification, trustless architecture and security) to create a kind of escrow system for any kind of transaction. For example, if you’re a web designer, you can create a contract that checks whether or not a new client’s website is up and then automatically releases funds to you once it is. No more chasing or invoicing. Smart contracts are also used to prove ownership of assets such as property or art. The potential to reduce fraud with this approach is huge.
- Cloud Storage (Storj): Cloud computing revolutionized the web and led to the emergence of big data, which in turn launched a new AI revolution. But most cloud-based systems run on servers stored in server farms in a single location, owned by a single entity (Amazon, Rackspace, Google, etc.). This presents all the same problems as the banking system, as your data is controlled by a single, opaque organization that represents a single point of failure. Distributing data on the blockchain completely removes the trust issue and also promises to increase reliability as it is much harder to crash the blockchain network.
- Digital identification (ShoCard): two of the biggest problems of our time are identity theft and data protection. With huge centralized services like Facebook holding so much data about us, and efforts by various governments in 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 wrapping your key data in an encrypted block that the blockchain network can check whenever you need to prove your identity. Applications of this range from the obvious replacement of passports and ID cards to other areas such as password replacement. It could be huge.
- Digital voting: very topical in light of the investigation into Russia’s influence on the recent US election, digital voting has long been suspected to be unreliable and highly vulnerable to tampering. Blockchain technology offers a way to verify whether a voter’s vote was successfully sent while maintaining their anonymity. It promises not only to reduce electoral fraud, but also to increase overall voter turnout as people will be able to vote on their mobile phones.
Blockchain technology is still in its infancy and most applications are far from general use. Even Bitcoin, the most trusted blockchain platform, is subject to massive volatility indicative of its relatively new status. However, blockchain’s potential to solve some of the major problems we face today makes it an extremely exciting and seductive technology to pursue. I’ll definitely keep an eye out.