If you’ve tried diving into this mysterious thing called blockchain, you’d be forgiven for jumping back 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 can change the world, let’s discuss what blockchain actually is.
Simply put, a blockchain is a digital ledger of transactions, similar to the ledgers we’ve used for hundreds of years to record sales and purchases. The functions of this digital accounting are essentially largely identical to traditional accounting in that it records debits and credits between people. This is the basic concept of 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 intermediary who facilitates the transaction. Let’s say Rob wants to transfer Melanie £20. He can either give her cash in the form of a £20 note or use a banking app to transfer the money directly to her bank account. In both cases, the bank is the intermediary that verifies the transaction: Rob’s funds are verified when he withdraws money from the ATM, or they are verified by the app when he makes a digital transfer. The bank decides whether to proceed with the transaction. The bank also keeps a record of all transactions made by Rob and is solely responsible for updating it whenever Rob pays someone or receives money into his account. In other words, the bank keeps and controls the ledger and everything goes through the bank.
It’s a big responsibility, so it’s important that Rob feels he can trust his bank, otherwise he wouldn’t be risking his money with them. He needs to be sure that the bank will not cheat him, lose his money, rob him, or disappear overnight. This need for trust underlies almost every major behavior and aspect of the monolithic financial industry, to the point that even when the banks were found to be irresponsible with our money during the 2008 financial crisis, the government (yet another intermediary) chose to bail them out. rather than risk destroying the last shreds of trust by letting them crumble.
Blockchains work differently in one key aspect: they are completely decentralized. There is no central clearinghouse like a bank, and no central ledger maintained by a single entity. Instead, the ledger is distributed across a wide network of computers called nodes, each of which stores a copy of the entire ledger on their respective hard drives. These nodes are connected to each other through a piece of 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 registry at any given time. .
When a new transaction is entered into the blockchain, it is first encrypted using the most advanced cryptographic technology. Once encrypted, the transaction is converted into something 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 verified by the nodes and, after verification, transmitted across the network so that the block can be added to the end of the registry on all computers, below the list of all previous blocks. This is called a chain, which is why the technology is called blockchain.
Once approved and posted to the ledger, 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 bank or central clearing system? Why would Rob use Bitcoin instead of regular currency?
The answer is trust. As mentioned earlier, in the banking system it is very important that Rob trusts his bank to protect his money and handle it properly. To ensure this, there are huge regulatory systems that scrutinize the actions of banks and ensure that they are fit for purpose. Governments then regulate regulators, creating a sort of multi-layered system of checks and balances whose sole purpose is to help prevent mistakes and bad behavior. In other words, organizations like the Financial Services Authority exist precisely because banks cannot be trusted on their own. And banks often get it wrong and misbehave, as we’ve seen too many times. When you have a single source of power, power tends to be misused or abused. The relationship of trust between people and banks is awkward and fragile: we don’t really trust them, but we don’t think there is an alternative.
On the other hand, blockchain systems don’t need you to trust them at all. All transactions (or blocks) on 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 channel of approval. If a hacker wanted to successfully forge a blockchain ledger, he would have to hack millions of computers at once, which is nearly impossible. It would also be virtually impossible for a hacker to take down a blockchain network because, again, he would need 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 such as Bitcoin use intentionally complex processes for their verification procedures. In the case of Bitcoin, blocks are verified by nodes that deliberately perform a series of time- and CPU-intensive calculations, often in the form of puzzles or complex math problems, meaning that verification is neither instantaneous nor accessible. Nodes that allocate a resource to validate blocks are rewarded with a transaction fee and a reward in the form of newly minted bitcoins. This has the function of incentivizing people to become nodes (because processing such blocks requires quite powerful computers and a lot of electricity), as well as handling the process of generating – or minting – units of the currency. This is called mining because it requires considerable effort (in this case by a computer) to produce a new commodity. It also means that transactions are verified in the most independent way, more independent than a government regulated body 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 or other opaque intermediary. They work because people don’t trust each other, not against each other.
Let that be understood for a while and the excitement around blockchain starts to make sense.
Where things get really interesting is the application of blockchain outside of cryptocurrencies like Bitcoin. Given that one of the core principles of a blockchain system is the secure, independent verification of a transaction, it’s easy to imagine other ways in which this type of process could be valuable. Not surprisingly, many such applications are already in use or in development. Some of the best:
- Smart Contracts (Ethereum): Probably the most exciting blockchain development since Bitcoin. Smart contracts are blocks of code that must be executed in order for the contract to be executed. The code can be anything as long as a computer can execute it, but in simple terms it means that you can use blockchain technology (with its independent verification, architecture and security) to create a kind of escrow system for any transactions. . As an example, if you’re a web designer, you can set up a contract that checks whether a new client’s website is up and running and then automatically allocates funds to you as soon as it does. No more chasing and billing. 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 Internet and led to the emergence of big data, which in turn ushered in a new revolution in artificial intelligence. But most cloud systems run on servers stored in co-located server farms owned by a single organization (Amazon, Rackspace, Google, etc.). This creates all the same problems as the banking system, in that your data is controlled by a single, opaque entity that represents a single point of failure. The distribution of data in the blockchain completely removes the problem of trust, and also promises to increase reliability, since it is much more difficult to destroy the blockchain network.
- Digital Identification (ShoCard): Identity theft and data protection are two of the most pressing issues of our time. With vast, centralized services like Facebook storing so much data about us, and efforts by various governments in developed countries to store digital information about their citizens in a central database, the potential for our personal data to be misused is dire. Blockchain technology offers a potential solution to this problem by wrapping your key data in an encrypted block that can be verified by the blockchain network every time you need to verify your identity. Applications for this range from the obvious replacement of passports and IDs to other areas such as password replacement. It can be huge.
- Digital Voting: Highly relevant after the investigation into Russia’s influence on the recent US election, digital voting has long been suspected of being unreliable and highly vulnerable to tampering. Blockchain technology offers a way to verify that a voter’s vote has been successfully submitted while maintaining their anonymity. It promises not only to reduce electoral fraud, but also to increase overall voter turnout as people can vote from their mobile phones.
Blockchain technology is still in its infancy, and most applications are far from mainstream. Even Bitcoin, the most recognized blockchain platform, is subject to enormous volatility, a testament to its relatively new status. However, blockchain’s potential to solve some of the major problems we face today makes it an extraordinarily exciting and enticing technology. I will certainly be watching.