Blockchain has been in the news a lot this past year, with the tech press eager to explain how it’s the ‘real innovation’ behind Bitcoin. This revelation won’t come as a surprise to anyone who has been following the money, though. The litmus test for any upcoming technology is to look at the private equity flowing into it, and VC investment has been pouring into the blockchain ecosystem recently.
In this article, we’re going to look at the reasons behind the increasing popularity of blockchain technology. But before that, I want to explain how the technology works, and how it differs from Bitcoin. It’s an important distinction because, while Bitcoin is limited to the financial sector, blockchain technology can be programmed to record virtually anything of value. Which means it has potential applications across a much wider range of industries.
First things first: Bitcoin ≠ blockchain
Our current financial system relies on ‘trusted’ third-parties to manage transactions. These intermediaries protect us from problems such as the ‘double spending’ issue. This is the risk that any digital money can be spent multiple times. It’s a problem that is unique to digital currencies because they are so easy to duplicate. After all, you don’t need a third party with cash transactions. If you want to buy a coffee, simply give $4 to your barista and grab your coffee!
When Satoshi Nakamoto wrote his infamous 2008 Bitcoin white-paper, he was writing at the height of a financial crisis. Public confidence in financial institutions was extremely low at the time. Bitcoin advocates were saying that it was the intermediaries making the whole system insecure. Every time a credit card is used online, they said, it divulges sensitive personal information to multiple parties. That information is then at risk of being accessed, stolen and misused.
Bitcoin positioned itself as an alternative to this existing system, by suggesting a cryptographic solution to managing transactions. One that replaced the need to ‘trust’ these intermediaries with the logic of math.
But while the two terms are often used interchangeably, blockchain and Bitcoin are not the same. The confusion is understandable; it stems from the fact that the public was introduced to both of these radically new concepts at the same time. The difference is that Bitcoin is a digital currency, whereas blockchain is the technology under the hood. Think of Bitcoin as the Ford Model T, the first mass-produced car. The Model T changed the way society thought about transportation. But this societal shift was made possible by drastic cost savings from another innovation: the production line. And while this production line was initially just used to create Model Ts, it would go onto to revolutionize the way we create all consumer products. You can think of Blockchain as the production line for Bitcoin. It’s the true innovation here, and will likely outlive Bitcoin itself.
OK, so what exactly is a blockchain?
Here is a fairly typical definition you will find on the internet:
“A blockchain is software protocol for a distributed ledger, managed by a consensus algorithm, that is designed to maintain a permanent and tamper-proof record of transactional data.”
Phew. You can see why so many people walk away confused but don’t worry, let’s unpack this definition bit by bit:
A protocol is a set of rules. The software aspect means every blockchain is governed by a digital set of rules. These rules are built into the code and so, are both binding and automatic.
Ledgers have been used to store transactional data as far back as the Phoenicians. All these ledgers had something in common, they were managed by an authority figure (like a bank, for example). What makes distributed ledgers so revolutionary, is that they do not rely on a central authority to manage themselves.
To better understand this concept, let’s take a look at 3 database systems: centralized, decentralized and distributed.
Traditional databases are centralized. All their data is stored and processed on one server. In order to access information, individuals (or nodes) have to connect directly to the server. This control over information makes it a central point of authority. Our current financial system is an example of a centralized system. To transfer money we have to use a bank’s server and abide by whatever rules and costs they put in place. We have to ‘trust’ they are operating with our best interests in mind.
A database becomes decentralized when the storing and processing of data is shared across multiple servers. This means that users (or nodes as they are called) can access information from multiple servers. If one server goes down the information is not lost and remains available. In the case of our ledger, this means it is no longer in one place where it could be lost or deleted. It becomes permanent.
A distributed database goes a step further. Not only is storage shared, but the concept of a server is dissolved. And with it, the idea of central authority. Each node in the database has equal authority. So, by virtue of being distributed, our ledger is permanent and no longer controlled by a central authority.
Let’s take a look at how decisions are made without central authority.
Consensus is another word for an agreement. In this case, it’s an agreement between a majority of the nodes on the network that information being added to the network is valid. Consensus is vital to the blockchain model because it replaces the ‘trusted’ third parties in our current financial model. In the case of the Bitcoin Blockchain, if all nodes agree that a transaction occurred – it occurred. In other words, you’re putting your trust in math – not companies or people.
Why should I trust blockchain technology?
Blockchain is aptly named. At its core, it’s composed of a chain of blocks that contain transaction data. The question I now want to answer is: “how is this distributed public ledger actually safer than a centralized one where only ‘trusted’ users have access”?
Well, for one, it’s anonymous. A transaction on the Bitcoin blockchain, for example, does not collect any personal information (email, name, address, ID, etc.). If no one knows who you are on the blockchain your privacy is assured. Many other coins, such as Monero, take anonymity even more seriously by building much more security into their technology.
Today’s centralized transactions, as I keep reminding you, are far from private. You are required to provide large amounts of personal data as part of every transaction. This means you don’t just risk the funds specific to a transaction, but also of that data being captured and used maliciously.
To understand how blockchain technology is so secure, let’s start with a simple blockchain diagram:
Each block in a blockchain is summarised by a ‘hash’. A hash is a one-way mathematical formula. It is irreversible, so a hash can never be decoded. A good way to understand hashing is to consider an online banking scenario. If you forget your password, your bank won’t tell you what it is. The reason may surprise you: it’s because they don’t know it; nobody does. The bank only knows you are entering the correct password because the first time you created that password, the system ran a hashing algorithm which generated a code (a.k.a. the hash). This was then stored in the bank’s database. Now, every time, you type your password, the bank uses a hashing algorithm to generate the hash in memory and compare it to the hash already saved. If they match, you can log in.
As I was saying, the transactions in each block are converted into a hash, which is unique to that block. If you’re a hacker reading this, you might be thinking, “I can tamper with this system.” Which is why the hash in ‘Block 1’ is then referenced in ‘Block 2’, and every block after it. This way, a hacker cannot just change the contents of one block, as it’s hash does not change and no longer matches the following block’s hash. For example, if you were to add a $28 transaction to ‘Block 1’, then it’s hash would change to 34868829 and would no longer match the previous hash on ‘Block 2’.
The chain would be broken.
This is where consensus comes into play. Once a mismatch is spotted, the blockchain will look at all other copies of these blocks on the network and choose the most common chain. So if someone tampers with a version (or many versions) of the blockchain, the network will consider what the majority say is correct. This makes tampering effectively impossible on large blockchains.
I say ‘effectively impossible’ because the only way to feasibly change a string of blocks would be to control the majority of the network. When you consider the sheer size of say, the Bitcoin network, you can see how this is essentially impossible. Any attempt would be spotted way ahead of the 51% majority of nodes ownership needed to do any damage.
And hashing is not the only security measure in place here. Most blockchains, including Bitcoin, use cryptographic digital signatures to verify transactions. They are called ‘signatures’ because they provide validation and authentication – in the same way a hand-signed document used to.
Cryptography is the method of disguising and revealing (or encrypting and decrypting) information through mathematics. And while explaining it is way beyond the word-count of this article, suffice to say that it is safer than scribbling your name on a piece of paper. The encryption method used by most blockchains, AES, has been studied in excruciating detail and, to date, no vulnerabilities have been discovered with it.
Our financial institutions charge a fee for their services. And those fees add up to $140 billion a year! They also drive up transaction costs, which constrains innovation across the financial industry. Micropayments are a great example of what we’re missing out on. Small payments (transactions of less than 25 cents) are just not economically viable in our current financial system. Yet, it’s precisely this type of innovation that could help sustain investigative journalism. Few people buy newspapers, and paywalls are unpopular. Micropayments, via the blockchain, could be the solution that helps sustain our free press.
Bitcoin’s blockchain has a poor reputation for transaction speeds, something the media loves to dwell on. But this is not an inherent limitation of blockchain technology, it’s more a case of ‘growing pains’… This is new technology, don’t forget. Remember how slow the internet used to be? Blockchain technology is maturing fast. Users of Bitcoin’s lightning network (essentially a plugin for Bitcoin) can take advantage of instant transactions right now. In the words of Alex Bosworth, the creator of this new functionality, “Speed: Instant. Fee: Zero. Future: Almost Here.”
Clear as mud?
Hopefully, blockchains are sounding more approachable now.
Remember that the real innovation here is how blockchain technology creates a trusted transactive system that relies on maths. Eliminating the need for centralized banks, governments and basically any third party trying to skim from a transaction. This is the reason many are calling blockchain ‘the trust protocol’.
If you are looking to hire blockchain developers, get in touch!