If you tried to immerse yourself in this mysterious thing called a blockchain, you would be forgiven for the horror of deviating from the opacity of the technical jargon often used to create it. So before we understand what a cryptocurrency is and how blockchain technology can change the world, let’s discuss what a blockchain really is.
Simply put, a blockchain is a digital transaction book, unlike the books we have used for hundreds of years to record sales and purchases. The function of this digital book is actually pretty much identical to a traditional book in that it records debits and credits between people. This is the basic concept of a blockchain; the difference is who keeps the book and who checks the transactions.
In traditional transactions, payment from one person to another is linked to some intermediary to facilitate the transaction. Let’s say Rob wants to transfer Melanie 20 pounds. He can transfer cash to her in the form of a £ 20 bill, or he can use some bank application to transfer the money directly to her bank account. In both cases, the intermediary who checks the transaction is the bank: Rob’s funds are checked when he takes money from an ATM, or the application checks them when digitally transferred. The bank decides whether to carry out the operation. The bank also keeps track of all transactions made by Rob, and is solely responsible for its renewal if Rob pays anyone or receives money into his account. In other words, the bank holds and controls the book, and everything flows through the bank.
This is a big responsibility, so it’s important that Rob feels he can trust his bank, otherwise he wouldn’t risk his money with them. He must be sure that the bank will not deceive him, will not lose money, will not be robbed and will not disappear overnight. This need for trust underpinned virtually all major behaviors and aspects of the monolithic financial industry, and even when banks were found to be irresponsible with our money during the 2008 financial crisis, the government (another intermediary) chose to bail them out rather than take risks destroy the ultimate fragments of trust by allowing them to collapse.
In one key aspect, blockchains work differently: they are completely decentralized. There is no central settlement institution like a bank, and there is no central ledger kept by a single entity. Instead, the book is distributed over a wide network of computers called nodes, each of which contains a copy of the entire book on the appropriate hard drives. These nodes are connected to each other using software called peer-to-peer (P2P) software, which synchronizes data across a network of nodes and ensures that everyone has the same version of the book at all times.
When a new transaction is entered into a transaction, it is first encrypted using state-of-the-art cryptographic technology. Once encrypted, a transaction is converted into what is called a block, which is basically a term used for an encrypted group of new transactions. This block is then sent (or broadcast) to a network of computer nodes, where it is checked by the nodes and, after verification, transmitted over the network so that the block can be added to the end of the book on each computer, under a list of all previous blocks. This is called a chain, so the technology is called a blockchain.
After approval and entry in the book the transaction can be completed. This is how cryptocurrencies like bitcoin work.
Accountability and withdrawal of trust
What are the advantages of this system over a banking or central clearing system? Why does Rob use bitcoin instead of regular currency?
The answer is trust. As mentioned earlier, it is very important for the banking system that Rob trusts his bank to protect his money and handles it properly. For this to happen, there are a huge number of regulatory systems to verify the actions of banks and ensure their compliance with the purpose. Governments then regulate regulators, creating a kind of multi-tiered system of inspections, the sole purpose of which is to prevent errors 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, as we have seen too many times. If you have one source of power, power is usually abused or abused. Trusting relationships between people and banks is awkward and shaky: we don’t really trust them, but we don’t feel there is a great alternative.
On the other hand, blockchain systems do not need to trust them at all. All transactions (or blocks) in the blockchain are checked by nodes on the network before being added to the book, which means that there is no single point of failure and a single acknowledgment channel. If a hacker wanted to successfully tweak a book in a blockchain, they would have to hack millions of computers at once, which is virtually impossible. A hacker would also be largely unable to disable a blockchain network because, again, they would need to be able to shut down every computer on a computer network distributed around the world.
The encryption process itself is also a key factor. Blockchains, such as bitcoin, use deliberately complex processes for the verification procedure. In the case of bitcoins, blocks are scanned by nodes that perform intentionally processor and time-consuming series of calculations, often in the form of puzzles or complex mathematical problems, meaning that the scan is neither instantaneous nor accessible. The nodes that make the resource for checking the blocks are rewarded with a transaction fee and a reward for the recently minted bitcoins. It has the function of both encouraging people to become nodes (because processing such units requires quite powerful computers and a lot of electricity), as well as handling the process of generating – or minting – currency units. This is called mining because it requires considerable effort (in this case a computer) to produce a new product. It also means that transactions are verified in the most independent way, more independent than a government organization such as 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, and other non-transparent intermediaries. They work because people don’t trust each other, not the other way around.
Let the value of this subside for a while, and the hype around the blockchain starts to make sense.
Things get really interesting – it’s the application of a blockchain outside of cryptocurrencies like bitcoin. Given that one of the basic tenets of the blockchain system 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 under development. Some of the best:
- Smart Contracts (Ethereum): Probably the most exciting blockchain development after bitcoin, smart contracts are the blocks that contain the code that needs to be executed in order for the contract to be executed. The code can be any as long as it can be executed by a computer, but in simple words, it means you can use blockchain technology (with its independent verification, distrustful architecture and security) to create a kind of deposit system for any transaction. For example, if you are a web designer, you can create a contract that checks whether a new client’s website is running or not, and then automatically releases you money. No more chasing or billing. Smart contracts are also used to confirm ownership of an asset such as property or art. The potential for reducing fraud with this approach is huge.
- Cloud storage (Storj): Cloud computing revolutionized the Internet and led to big data, which in turn marked the beginning of a new AI revolution. But most cloud systems run on servers stored on single-site servers that belong to the same entity (Amazon, Rackspace, Google, etc.). This creates the same problems as the banking system because your data is managed by a single opaque organization that is the only point of failure. Dissemination of data on the blockchain completely removes the problem of trust, and also promises to increase reliability, as to remove the network of blockchains is much more difficult.
- Digital Identification (ShoCard): The two most important issues of our time are data theft and data protection. With extensive centralized services such as Facebook storing so much data about us, and the efforts of various governments in developed countries to keep digital information about their citizens in a central database, the potential for misuse of our personal data is appalling. Blockchain technology offers a potential solution to this by wrapping key data in an encrypted block that can be verified by a blockchain network whenever you need to verify your identity. Scope – from explicit replacement of passports and identity cards to other areas, such as replacement of passwords. It can be huge.
- Digital voting: Extremely relevant as a result of the investigation into Russia’s influence in the recent US elections, digital voting has long been suspected of being unreliable and highly vulnerable to fraud. Blockchain technology offers a way to verify the success of voter voting while maintaining anonymity. He promises not only to reduce election fraud, but also to increase 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 common. Even bitcoin, the most established blockchain platform, undergoes tremendous variability, indicating its relative novice status. However, the potential of the blockchain to address some of the major challenges we face today makes it an extremely exciting and enticing technology to follow. I will definitely be watching.