What is crypto?
If you’ve tried diving into this mysterious thing called blockchain, you’d be forgiven for recoiling in awe at the sheer obscurity 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, not unlike what we’ve been using to record sales and purchases for hundreds of years. The functionality of this digital ledger is, in fact, almost identical to a traditional ledger in that it records debits and credits between people. This is the basic idea behind blockchain; The difference is who keeps the books and who verifies the transactions.
With traditional transactions, payments from one person to another involve some sort 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 sort of banking app to transfer the money directly to her bank account. In both cases, a bank is the intermediary to verify the transaction: Rob’s funds are verified when he withdraws money from a cash machine, or they are verified through the app when he makes a digital transfer. The bank decides whether to proceed with the transaction. The bank also has a record of all transactions made by Rob and is solely responsible for updating it whenever 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.
That’s a lot of responsibility, so it’s important that Rob feels he can trust his bank otherwise he won’t be risking his money with them. He needs to feel confident that the bank will not cheat him, lose his money, rob him and disappear overnight. This need for trust has largely influenced every major behavior and aspect of the monopolistic financial industry, even when it was discovered that banks were irresponsible with our money during the 2008 financial crisis, the government (another intermediary) chose to destroy the last shreds of trust by collapsing them. Bail them out rather than risk.
Blockchains work differently in one key respect: they are completely decentralized. There is no central clearing house like a bank, and no central ledger held by an entity. Instead, the ledger is distributed across a vast network of computers, called nodes, each of which holds 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 time. .
When a new transaction is entered into a blockchain, it is first encrypted using sophisticated 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. That block is then sent (or broadcast) to the network of computer nodes, where it is verified by the nodes and, once verified, passed through the network so that the block can be added to the end of the ledger on everyone’s computer, under the list of all previous blocks. This is called a chain, hence the technology is referred to as blockchain.
Once approved and recorded in the ledger, the transaction can be completed. This is how cryptocurrencies like Bitcoin work.
Removal of accountability and trust
What are the advantages of this system compared to a banking or central clearing system? Why would Rob use Bitcoin instead of normal currency?
The answer is faith. As mentioned earlier, with the banking system it is important that Rob trusts his bank to protect and manage his money properly. To ensure this, extensive regulatory mechanisms exist to scrutinize the operations of banks and ensure they are fit for purpose. The government then controls regulators, creating a sort of tiered system of checks whose sole purpose is to help prevent wrongdoing and bad behavior. In other words, bodies like the Financial Services Authority exist precisely because banks cannot be trusted on their own. And banks often make mistakes and misbehave, as we’ve seen so many times. When you have a single source of authority, abuse or misuse of power tends to happen. The trust relationship between people and banks is awkward and uncertain: we don’t really trust them but we don’t think there’s much choice.
Blockchain systems, on the other hand, don’t need to trust them. 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 and no single approval channel. If a hacker wanted to successfully tamper with the ledger on a blockchain, they would have to hack millions of computers simultaneously, which is nearly impossible. A hacker would also be largely unable to bring down a blockchain network, because again, they would need to be able to shut down every computer in a network of computers distributed around the world.
The encryption process itself is a key factor. Blockchains like Bitcoin use deliberately difficult mechanisms for their verification methods. In the case of Bitcoin, blocks are verified by nodes performing an intentionally processor- and time-intensive series of calculations, often in the form of puzzles or complex mathematical problems, which means that verification is neither instantaneous nor accessible. Nodes that commit resources to the verification of blocks are rewarded with a transaction fee and a grant of new bitcoins. Both have the task of incentivizing people to become nodes (since processing such blocks requires quite powerful computers and a lot of electricity), while also managing the process of creating – or minting – currency units. This is referred to as mining, because it involves a considerable amount of effort (by a computer, in this case) to produce a new product. This means that transactions are verified in the most independent way possible, rather than by government-controlled bodies such as the FSA.
This decentralized, democratic and highly secure nature of blockchains means that they can operate without the need for regulation (they are self-regulating), governments or other opaque intermediaries. They work not because people trust each other, but in spite of it.
Let that significance sink in for a while and begin to understand the excitement around blockchain.
This is where blockchain’s applications get really interesting outside of cryptocurrencies like Bitcoin. As one of the underlying principles of blockchain systems is the secure, independent verification of a transaction, it is easy to imagine other ways in which such a process could be valuable. Surprisingly, many such applications are already in use or in development. Some of the best are:
- Smart Contracts (Ethereum): Perhaps the most exciting blockchain development after Bitcoin, smart contracts are blocks that contain code that must be executed to fulfill the contract. 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 type of transaction. . For example, if you’re a web designer, you can create a contract that checks whether a new client’s website is up and running, and then automatically releases the funds to you when it does. No more chasing or running. Smart contracts are also being used to prove ownership of assets such as property or industry. The potential to reduce fraud is enormous with this approach.
- Cloud Storage (Storz): Cloud computing has revolutionized the web and ushered in the emergence of Big Data, leading to a 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 presents the same problems as the banking system, in that 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 promises to increase reliability as the blockchain network is much harder to bring down.
- Digital Identification (ShoCard): Two of the biggest issues of our time are identity theft and data security. With vastly centralized services like Facebook containing so much data about us, and efforts by various developed-world governments 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 possible solution to this by wrapping your key data in an encrypted block that can be verified by the blockchain network whenever you need to prove your identity. Applications range from obvious replacements for passports and ID cards to other areas such as password replacement. It can be huge.
- Digital Voting: Highly relevant given the investigation into Russian influence in the recent US election, digital voting is suspected to be both unreliable and highly vulnerable to tampering. Blockchain technology offers a way to verify that a voter’s vote has been successfully cast while keeping their identity private. It promises to not only reduce election fraud but also increase general 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 massive volatility indicative of its relative novice status. However, the problems we face today in solving some of the major potential problems with blockchain make it an incredibly exciting and enticing technology to pursue. I will definitely keep an eye out.