A Beginner's Guide To Blockchain
You may have heard the term ‘blockchain’ and dismissed it as a fad, a buzzword, or even technical jargon. But I believe blockchain is a technological advance that will have wide-reaching implications that will not just transform the financial services but many other businesses and industries.
A blockchain is a distributed database, meaning that the storage devices for the database are not all connected to a common processor. It maintains a growing list of ordered records, called blocks. Each block has a timestamp and a link to a previous block.
Users can only edit the parts of the blockchain that they “own” by possessing the private keys necessary to write to the file. Cryptography ensures that everyone’s copy of the distributed blockchain is kept in synch.
Blockchains are secure databases by design. The concept was introduced in 2008 by Satoshi Nakamoto, and then implemented for the first time in 2009 as part of the digital bitcoin currency; the blockchain serves as the public ledger for all bitcoin transactions. By using a blockchain system, bitcoin was the first digital currency to solve the double spending problem (unlike physical coins or tokens, electronic files can be duplicated and spent twice) without the use of an authoritative body or central server.
The security is built into a blockchain system through the distributed timestamping server and peer-to-peer network, and the result is a database that is managed autonomously in a decentralized way. This makes blockchains excellent for recording events — like medical records — transactions, identity management, and proving provenance. It is, essentially, offering the potential of mass disintermediation of trade and transaction processing.
How does blockchain really work?
Some people have called blockchain the “internet of value” which I think is a good metaphor.
On the internet, anyone can publish information and then others can access it anywhere in the world. A blockchain allows anyone to send value anywhere in the world where the blockchain file can be accessed. But you must have a private, cryptographically created key to edit only the blocks you “own.”
Using your private key and someone else's public key you can transfer the value of whatever is stored in that section of the blockchain.
So, to use the bitcoin example, keys are used to transfer blocks, which contain units of currency that have financial value. This fills the role of recording the transfer, which is traditionally carried out by banks.
It also fills a second role, establishing trust and identity, because no one can edit a blockchain without having the corresponding keys. Edits not verified by those keys are rejected by the network. Of course, the keys — like a physical currency — could theoretically be stolen, but a few lines of computer code can generally be kept secure at very little expense. (Unlike, say, the expense of storing a cache of gold in a proverbial Fort Knox.)
This means that the major functions carried out by banks — verifying identities to prevent fraud and then recording legitimate transactions — can be carried out by a blockchain more quickly and accurately.
Why is blockchain important?
We are all now used to sharing information through a decentralized online platform: the internet. But when it comes to transferring value – e.g. money, ownership rights, intellectual property, etc. – we are usually forced to fall back on old-fashioned, centralized institutions or establishments like banks or government agencies. Even online payment methods which have sprung into existence since the birth of the internet – PayPal being the most obvious example – generally require integration with a bank account or credit card to be useful.
Blockchain technology offers the intriguing possibility of eliminating this “middleman”. It does this by filling three important roles – recording transactions, establishing identity and establishing contracts – traditionally carried out by the financial services sector.
This has huge implications because, worldwide, the financial services market is the largest sector of industry by market capitalization. Replacing even a fraction of this with a blockchain system would result in a huge disruption of the financial services industry, but also a massive increase in efficiencies.
The third role, establishing contracts, opens up a treasure trove of opportunities. Apart from a unit of value (like a bitcoin), blockchain can be used to store any kind of digital information, including computer code.
That snippet of code could be programmed to execute whenever certain parties enter their keys, thereby agreeing to a contract. The same code could read from external data feeds — stock prices, weather reports, news headlines, or anything that can be parsed by a computer, really — to create contracts that are automatically filed when certain conditions are met.
These are known as “smart contracts,” and the possibilities for their use are practically endless.
For example, your smart thermostat might communicate energy usage to a smart grid; when a certain number of wattage hours has been reached, another blockchain automatically transfers value from your account to the electric company, effectively automating the meter reader and the billing process.
Or, smart contracts might be put to use in the regulation of intellectual property, controlling how many times a user can access, share, or copy something. It could be used to create fraud-proof voting systems, censorship-resistant information distribution, and much more.
The point is that the potential uses for this technology are vast, and I predict that more and more industries will find ways to put it to good use in the very near future.