A brief introduction to blockchain – for normal people
If you’ve tried to immerse yourself in this mysterious thing called blockchain, you’d be forgiven for recoiling in horror at the sheer opacity of the technical jargon that’s 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, blockchain is a digital ledger of transactions, not unlike the ledgers we’ve used for hundreds of years to record sales and purchases. The function of this digital ledger is actually almost identical to a traditional ledger as it records debits and credits between people. This is the basic concept behind blockchain; the difference is who keeps the ledger and who verifies the transactions.
In traditional transactions, payment from one person to another involves some kind of intermediary 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 note, or he can use some banking app to transfer the money directly into her bank account. In both cases, the bank is the intermediary that verifies the transaction: Rob’s funds are verified when he withdraws the money from an ATM, or verified by the app when he makes the 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 when Rob pays someone or receives money in his 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, otherwise he wouldn’t be risking his money with them. He must feel confident that the bank will not cheat him, will not lose his money, will not be robbed and will not disappear overnight. This need for trust underlies almost every basic behavior and aspect of the monolithic financial industry, so much so that even when banks were discovered to have been irresponsible with our money during the 2008 financial crisis, the government (another intermediary) chose to save them rather than risk destroying the last fragments of trust, leaving them to crumble.
Blockchains work differently in one key respect: they are completely decentralized. There is no central clearing house like a bank and no central ledger kept by one person. Instead, the ledger is distributed across a vast network of computers called nodes, each holding 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 ledger at any given moment in 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 converted into something called a block, which is basically 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 verified by the nodes and, once confirmed, transmitted over the network so that the block can be added to the end of anyone’s computer’s ledger, under 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.
Accountability and de-trust
What are the advantages of this system over a bank or central clearing system? Why would Rob use Bitcoin instead of normal currency?
The answer is trust. As mentioned earlier, with the banking system it is extremely important that Rob trusts his bank to protect his money and handle it properly. To ensure that this happens, there are massive regulatory systems in place that scrutinize the actions of banks and ensure that they are fit for purpose. Governments then regulate regulators, creating a sort 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, as we have seen too many times. When you have one source of power, power tends to be misused or abused. The trust relationship between people and banks is uncomfortable and uncertain: we don’t really trust them, but we don’t think 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 a blockchain are verified by nodes in the network before being added to the ledger, meaning there is no single point of failure, no single approval channel. If a hacker wants to successfully tamper with the blockchain ledger, he would have to hack millions of computers simultaneously, which is nearly impossible. A hacker would also be nearly unable to take down a blockchain network, as they would again need to be able to shut down every single computer in a network of computers spread across the globe.
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 deliberately performing a CPU- and time-intensive series of calculations, often in the form of puzzles or complex mathematical problems, meaning that verification is neither immediate nor accessible. Nodes that commit the resource to verify blocks are rewarded with a transaction fee and a reward of newly minted bitcoins. This has the function of both incentivizing people to become nodes (since processing blocks like this requires quite powerful computers and a lot of electricity) while managing the process of generating or minting units of the currency. This is called mining because it involves 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 possible, more independent than 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 any other opaque intermediary. They work because people don’t trust each other, not in spite of.
Let the significance of this sink in for a while and the excitement around blockchain starts to make sense.
Where things get really interesting is blockchain applications beyond cryptocurrencies like Bitcoin. Given that one of the core principles of the 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 are:
- Smart Contracts (Ethereum): Probably the most exciting blockchain development since Bitcoin, smart contracts are blocks that contain 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 this means that you can use blockchain technology (with its independent verification, trust architecture and security) to create a kind of escrow system for anything transactions. As an example, if you’re a web designer, you can create a contract that checks whether or not a new client’s website has been launched, and then automatically release the funds to you once it has. No more chasing 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 huge.
- Cloud Storage (Storj): Cloud computing revolutionized the web and led to the emergence of Big Data, which in turn ushered in the new AI revolution. But most cloud-based systems run on servers stored in single-location server farms owned by a single entity (Amazon, Rackspace, Google, etc.). This creates 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 a blockchain removes the trust issue entirely and also promises to increase reliability as it is much harder to bring down a blockchain network.
- Digital ID (ShoCard): two of the biggest issues of our time are identity theft and data protection. With huge 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 misuse of our personal data is terrifying. Blockchain technology offers a potential solution to this by packaging 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: Hot on the heels of 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 sent successfully, while preserving their anonymity. It promises not only to reduce fraud during elections, 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 of the applications are far from mainstream use. Even Bitcoin, the most established blockchain platform, is subject to massive volatility, indicative of its relative newcomer status. However, blockchain’s potential to solve some of the major problems we face today makes it an extremely exciting and enticing technology to pursue. I’ll certainly keep an eye out.
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