Cryptocurrencies are perhaps one of the trendiest technological developments of recent years. But behind every Bitcoin or Ether token is a blockchain, a secure and foolproof technology that positions itself as a counterpoint to the flimsy “real-world” financial system. By now, it seems every country in the world is focused on building their blockchain industry; gold bullion is being purchased and sold on a blockchain platform; and governments are considering the technology for combating illegal immigration. Though the breathless coverage of the blockchain sparks eyerolls in some circles, the impact that it might have merits going back to its building blocks.
The basics of blockchain
At its core, blockchain is a secure, anonymous, and immutable ledger, or transaction record (financial or not). Unlike records held by banks or government agencies, for example, a blockchain is a public record stored in a digital “chain” containing blocks of data that record all made transactions. A blockchain is not stored in one place but rather across every device (or “node”) in a network and is thus “decentralized,” making it virtually impermeable to theft and corruption.
When a transaction is requested, every node uses known algorithms to validate it and the status of the user requesting it. The exact process of validating transactions is complicated and can take different forms depending on the blockchain. Bitcoin mining is one example of the validation process — more on what the mining process looks like can be found here.
Next, the validated transaction is added to the ledger stored on each node — but not immediately. Rather, transactions are bundled into series of “blocks,” each of which holds a couple thousand transactions. The length of time it takes to confirm each block—and add all of its transactions to the ledger—depends on the network; bitcoin blocks take around 10 minutes, while Ethereum aims for a confirmation time of about 12 seconds.
Once transactions are committed to the ledger, they’re immutable — which is part of what makes blockchain technology stand out from other systems of record keeping. As we’ll discuss below, most ledgers today require some sort of trust in a third party, whereas the blockchain was built to provide an alternative to that exact issue.
Intermediaries and regulations, or the origins of blockchain
Blockchain is appealing because it makes unauthorized transactions and record alteration nearly impossible. In that sense, the technology plays the role of a trustworthy third party—something that many people felt was lacking in the wake of the 2008 financial crisis.
Long ago, before the advent of businesses, formal governments, or even currency as we think of it today, there was a world without transactional third parties. Direct trades happened based on the inherent value of an item, rather than a token representing the item’s generally accepted value (a currency).
However, as we added more and more layers to the value exchange—from currencies to bank accounts to electronic payments—intermediaries became necessary to guarantee that each requested value transfer actually occurred. When a buyer attempts to make a purchase with a debit card, for example, the seller needs to know he or she will receive payment, meaning that an external party has to validate the buyer’s funds to actually complete the payment. We now have a complex multi-party system in place to complete this verification—and this holds true for not only value, but also for information exchange, such as documentation that proves a consumer owns a tangible asset, such as a house or car.
These third-party systems, which typically involve governments, businesses, and banks, work without incident so long as the intermediaries remain trustworthy. Things get trickier, however, as soon as the users of the system start to question whether the intermediaries holding their money or recording ownership records are doing so with complete honesty. In 2008, consumer trust in the financial system eroded quickly, opening up space for an alternative: blockchain.
How we use blockchain
An obvious application of blockchain has to do with the movement of money. With today’s financial infrastructure, a significant number of wire transfers fail, the cost of sending money can equal the amount being sent, and international transfers take days to complete. Bitcoin, a decentralized public blockchain network that enables peer-to-peer, digital value exchange, is perhaps the best-known application of blockchain technology, and it eliminates the problems listed above. By using Bitcoin, users are granted instant settlement of transferred funds, a permanent and public record of what’s been transferred, and free value exchange (no transaction fees!).
But finance isn’t the only industry that can benefit from blockchain technology. In fact, it can be applied to any system that requires a transaction record, and new players have started to think about how to use blockchain rails to develop software for other use cases.
The second most prominent cryptocurrency, Ethereum (more on that here), provides developers with a coding language that can be used to build apps on top of the Ethereum blockchain, using ether (the equivalent of Bitcoin) to pay fees on the network—but not for value exchange for its own sake. Current applications of Ethereum range from betting platforms to decentralized crowdfunding.
Some large organizations have started evaluating the use of a private blockchain to facilitate real-time information sharing across the business. For these applications, the technology is less about mistrust of third parties, and more about lowering costs and speeding up current processes.
In today’s world, trusted third parties are increasingly rare. This growing mistrust combined with technological advances has made blockchain research and innovation an obvious hot topic. As we continue to discover new applications of the technology, both in and outside of finance, it will be interesting to see where else blockchain can take us—and how big of an impact it will ultimately have.
A version of article was originally published on Fin, the online magazine that illuminates the complexities of finance, the technology that powers it, and what the future holds.