If you have tried to immerse yourself in this mysterious thing called a blockchain, you will be forgiven for stepping back in horror at the absolute opacity of the technical jargon often used to shape it. So before we get into what 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 log, unlike the registries we have used for hundreds of years to record sales and purchases. The function of this digital book is actually almost identical to the traditional book, as it records debits and credits between people. This is the basic concept behind blockchain; the difference is who holds the book and who checks the transactions.
In traditional transactions, payment from one person to another involves some intermediary to facilitate the transaction. Suppose Rob wants to transfer £ 20 to Melanie. He can either give her cash in the form of a £ 20 banknote, or he can use a banking application to transfer the money directly to her bank account. In both cases, the bank is an intermediary that checks the transaction: Rob’s funds are checked when he withdraws the money from an ATM, or they are checked by the application when he performs the digital transfer. The bank decides whether to continue the transaction. The bank also keeps records of all transactions made by Rob and is solely responsible for updating them each time Rob pays someone or receives money in 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 for Rob to feel that he can trust his bank, otherwise he won’t risk his money with them. He must feel confident that the bank will not deceive him, will not lose his money, will not be robbed and will not disappear overnight. This need for trust is at the heart of almost every major behavior and aspect of the monolithic financial industry, to the extent that even when it was discovered that banks were irresponsible with our money during the 2008 financial crisis, the government (another intermediary ) chose to save them instead of risking destroying the last fragments of trust, leaving them to collapse.
Blockchains work differently in one key respect: they are completely decentralized. There is no central clearing house like the bank and no central book held by one person. Instead, the book is distributed in a vast network of computers called nodes, each of which holds a copy of the entire book on their respective hard drives. These nodes are connected to each other through software called a peer-to-peer (P2P) client, which synchronizes data on a network of nodes and ensures that everyone has the same version of the registry at any given time. .
When a new blockchain transaction is introduced, it is first encrypted using state-of-the-art cryptographic technology. Once encrypted, the transaction is transformed into something called a block, which is essentially the term used for an encrypted group of new transactions. This block is then sent (or broadcast) to the network of computer nodes, where it is checked by the nodes and, after being checked, transmitted over the network so that the block can be added at the end of the computer register to anyone under the list of all previous blocks. This is called a chain, so the technology is called a blockchain.
Once approved and recorded in the book, the transaction can be completed. This is how cryptocurrencies like bitcoin work.
Responsibility and removal of trust
What are the advantages of this system over the banking or central clearing system? Why would Rob use bitcoin instead of normal currency?
The answer is trust. As mentioned above, it is crucial for the banking system that Rob trusts his bank to protect his money and handle it properly. To ensure that this happens, there are huge regulatory systems that check the actions of banks and ensure that they are appropriate for the purpose. Governments then regulate regulators, creating a sort of system of levels of inspections whose sole purpose is to help 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 misbehave, as we have seen too many times. When you have a single source of power, power tends to be abused or abused. The relationship of trust between people and banks is uncomfortable and uncertain: we don’t really trust them, but we don’t think there is much alternative.
Blockchain systems, on the other hand, do not need to be trusted at all. All transactions (or blocks) in a blockchain are checked by the nodes in the network before they are added to the book, which means that there is no single point of failure and no channel for approval. If a hacker wants to successfully forge a blockchain registry, he will have to hack millions of computers at once, which is almost impossible. The hacker would also be virtually unable to download a blockchain network, as he would again have to be able to disconnect any computer on a network from computers distributed around the world.
The encryption process itself is also a key factor. Blockchains like bitcoin deliberately use difficult processes for their verification procedure. In the case of bitcoin, blocks are checked by nodes that intentionally perform CPU and time-consuming series of calculations, often in the form of puzzles or complex mathematical problems, which means that the check is neither instantaneous nor accessible. The nodes that commit the block verification resource are rewarded with a transaction fee and a number of newly minted bitcoins. This has the function of stimulating people to become nodes (because processing blocks like this requires quite powerful computers and a lot of electricity), while dealing with the process of generating – or cutting – currency units. This is called digging because it involves a significant amount of effort (in this case from a computer) to produce a new product. This also means that transactions are verified in the most independent way possible, independent of a government-regulated organization such as the FSA.
This decentralized, democratic and highly secure nature of the blockchain means that they can operate without the need for regulation (they are self-regulating), government or another non-transparent intermediary. They work because people don’t trust each other, not in spite of themselves.
Let the meaning sink in for a while and the excitement around the blockchain begins to make sense.
Where things get really interesting are blockchain applications beyond cryptocurrencies like bitcoin. Given that one of the basic principles of the blockchain system is secure, independent transaction verification, it is 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 are:
- Smart contracts (Ethereum): perhaps the most exciting development of the blockchain after bitcoin, smart contracts are blocks that contain code that must be executed in order for the contract to be executed. The code can be any, as long as the computer can execute it, but in simple words it means that you can use blockchain technology (with its independent verification, unreliable architecture and security) to create a kind of escrow system for any kind transaction. As an example, if you are a web designer, you can create a contract that checks whether a new client’s website is up and running, and then automatically release your funds once that happens. No more harassment or invoicing. Smart contracts are also used to prove ownership of an asset such as property or art. The potential for reducing fraud with this approach is huge.
- Cloud storage (Storj): Cloud computing has revolutionized the web and led to big data, which in turn has launched a new revolution with artificial intelligence. But most cloud-based systems run on servers stored on single-location server farms owned by a single entity (Amazon, Rackspace, Google, etc.). This poses the same problems as the banking system, as your data is controlled by a single, non-transparent organization that is a point of failure. Dissemination of data in a blockchain completely eliminates the problem of trust and also promises to increase reliability, as it is much more difficult to eliminate a 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 storing so much data about us, and the efforts of various governments in developed countries to store 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 your key data in an encrypted block that can be verified by the blockchain network when 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 can be huge.
- Digital voting: Very relevant after the investigation into Russia’s influence on the recent US elections, digital voting has long been suspected of being both unreliable and highly vulnerable to counterfeiting. Blockchain technology offers a way to verify that a voter’s vote has been sent successfully while maintaining their anonymity. He promises not only to reduce election 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 common use. Even bitcoin, the most established blockchain platform, is subject to huge volatility, which is indicative of its relative status as a newcomer. However, the potential of the blockchain to solve some of the major problems we face today makes it an extremely exciting and enticing technology to follow. I will certainly be careful.