Introduction to Blockchain
Bitcoin. Cryptocurrency. Ethereum. Hashing. Mining. Dogecoins. You may have heard these terms tossed about in the past year or two and wondered what they are all about and why there is so much fuss about them. Well, you are in luck, this series of articles is meant to demystify the technology related to all of these buzzwords: blockchain.
While the technology behind blockchain can take a little effort to wrap your head around, the general concepts are easy to grasp. As you read this series of articles, do your best to go with the flow without attempting to understand everything at once for if you do that, you are likely to end up frustrated and still out-of-the-loop.
Let’s begin our journey to understanding blockchain technology by first looking at some problems that it solves:
- Wiring money to other people, especially in other countries, is slow, requires one or more third parties, and is expensive.
- In traditional financial transactions, double spending is possible: I promise to pay you my only $10 at the same time as promising to pay someone else that $10. Some one will not get paid.
- Centralized authorities. You rely on your bank to facilitate the transfer of funds into or out of your account, but what if they refuse to do so quickly? What if they make a mistake with your balance? What if they simply raise their transaction fees to an intolerable level?
- You get into a car accident and, rather than paying to help you cover the damage, your insurance company battles you to attempt to pay as little as possible.
- Your bank is hacked and your social security number and credit info is released to thousands of black-hat hackers.
These are just a few of the problems solved by blockchains. They have no central authority so there is no single entity in control of your finances, healthcare, insurance claims, etc. They maintain a very limited body of information about you, essentially just your blockchain ID and your account balance. They can contain “smart contracts” which are contract conditions written in code that automate fulfillment of the contract (I total my car, the fair market value is automatically released to my account from the insurance company without argument). Wire transfers do not require a third party and are near-instant.
Blockchains indeed do a lot of great things but if you are like most people, you are probably already thinking ahead, with a dubious expression on your face, as to how all of this could be possible. After all, the idea is incredibly disruptive. We’ll get you there.
Have you ever used one of those nifty shared Google sheets that allow you to share the spreadsheet with a coworker and view that coworker’s updates to the sheet in real time? Blockchains are kind of like that except the data in them is not stored on Google’s, or anyone else’s, database. Instead, everyone who participates in the blockchain keeps a complete copy of the spreadsheet on their own machine.
When one person, let’s call her “Jane” makes a change to the spreadsheet, the blockchain software running on her machine broadcasts out a message about that change to all other peer-to-peer blockchain users so that their spreadsheets are updated as well. There is no central database and no central authority controlling the information flowing in and out of the spreadsheet. Of course in the real world, blockchains are a bit more complicated than this, but let’s continue with the spreadsheet analogy as it makes the general concept clear.
Suppose that Jane wants to send some money to another peer on the blockchain named “John” in order to pay for a piece of decorative art he sold her. You can’t actually send fiat currency (like US dollars) through a shared spreadsheet so Jane purchases 100 units of the blockchain’s cryptocurrency--let’s call it Polycoin--from a currency exchange such as Coinbase.com. Once Jane pays her fiat currency to Coinbase, they transfer 100 Polycoins to her account directly on the blockchain and the shared spreadsheet is updated so that it now shows that Jane has a Polycoin balance of 100.
Note that John, who just joined the blockchain, has an initial balance of 0 Polycoins. Jane now sends John the 25 Polycoins she owes him and the shared spreadsheet is once again updated.
Now John has a balance of 25 Polycoins and Jane has a balance of 75 Polycoins.
John has no use for Polycoins so he exchanges them with Coinbase for fiat currency. Assuming that 1 Polycoin is worth $1 US dollar (less a small transaction fee), John now has about $25 US dollars in his pocket and a balance of 0 Polycoins:
Also note that the balance on the Coinbase account is 25 Polycoins higher since John exchanged his 25 Polycoins with Coinbase for fiat currency. Once again, the shared spreadsheet is updated for everyone.
Now Bob enters the blockchain with a balance of 0 Polycoins. He wants to get rich quick so he takes the liberty of changing his balance to 1,000,000 Polycoins. After all, it’s a shared spreadsheet on which anyone can make changes so why not just change it to any value you want?
The thing is, there is no historical record of a transaction that led to Bob’s account balance going from 0 Polycoins to 1,000,000 Polycoins. When the other participants in the blockchain (Jane, John, and Coinbase) see this, they reach a consensus that Bob’s wishful thinking does not reflect reality and Bob’s change is tossed out, resetting his balance to zero and restoring order to the galaxy.
No authorities had to be called and no banks had to be involved. A simple consensus was reached that Bob’s transaction was phony and it was thereby tossed from the system. Sorry Bob.
In the real world, no one is literally monitoring every transaction in a blockchain. Instead, each participating node in a blockchain checks to make sure that advanced cryptographic evidence proves that all transactions are genuine. This check occurs every time a new block of transactions is added to the blockchain. Unless a majority of nodes reach the same cryptographic conclusion (math stuff) as to the authenticity of a submitted block of transactions, the transactions will not be allowed to enter the chain.
Eruption of Disruption
Assuming that you can accept on faith for the moment that blockchains are as this article describes them: identical copies of software and data distributed across a network of thousands of nodes that offer a hack-proof method of transferring money from one peer on the network to another, then you are probably starting to realize just how potentially disruptive this technology might be.
Obviously, you no longer would need banks to transfer funds on your behalf. In fact you wouldn’t need them at all. But, as you will see in the other articles for this series, the disruption goes further. “Smart Contracts” could replace the need for notaries and escrow companies while completely upending the business of managing deeds and titles to real property.
Given the odds of significant disruption in the financial industry, it isn’t surprising to see that major financial institutions are scrambling to either embrace blockchain technology on their own terms, run smear campaigns against it, or lobby legislative bodies to put in place regulations that restrict the legal use of blockchain technology. In fact, it is said that blockchain technology will do to the finance industry what the Internet did to the Media: it will change it completely.
Throughout this series of articles we hope to help you achieve a better grasp on how blockchain actually works and how it can be used so that your enterprise is not left in the dust as yet another game-changing technology shakes us to the core.