Blockchain is the new hip kid on the block in digital circles. It is responsible for many heated debates stemming all the way from developers to even social scientists. It challenges so much of what we take for granted today it can quickly get a little abstract. Yet, billionaires are being made and lost every minute in the booming and volatile trading of Bitcoin. The average punter could be forgiven for standing on the sidelines wondering if this is something to actually tune into or just a passing, somewhat nerdy fad.
As someone interested in digital technology, blockchain has been slowly gnawing away at me inviting me in to understand it better. I finally got to spend some time recently to digest what blockchain, cryptocurrency, miners and a whole bunch of other new words actually mean. In an attempt to compose my thoughts, I’ve written this article.
I am not a developer, nor am I a social scientist. I hold no cryptocurrency nor have any involvement in the blockchain technology as yet. So what better person to provide a completely neutral write up! I like to personally see potential in new ideas for the betterment of business and life in general. My aim is only to try and make a complex concept simple to understand for as many people as possible, including myself.
If you can’t explain it to a six year old, you don’t understand it yourself. – Albert Einstein
Why Should Someone Learn About Blockchain?
Before investing time in learning a new and complex topic I get that you may want a little prompting. So here goes.
Blockchain has the potential to replace almost everything you’ve come to accept as normal. From transferring money, listening to music, watching a movie, getting a taxi, casting a vote, trading shares, buying a house or simply buying a loaf of bread.
As an end consumer, you may not notice much difference in transacting over blockchain compared to conventional methods. I mean do you know what happens today when you tap your VISA card for payment? No, not many people do, you just trust that it works. But, if you are involved in any business that verifies transactions, or acts as a middleman or agent in either a financial or non-financial transaction, blockchain has the potential to disrupt or remove that business from the equation altogether.
This is of course if blockchain is everything it is cracked up to be. Questions remain on whether it can scale effectively or if the fear of the unknown by the masses means it is never fully adopted. But, at the moment, everything and everyone is fair game.
Convinced? I hope so. Let’s move on. You can either read this end to end or jump to a question that grabs your attention:
Skip to what you want to learn…
> What is blockchain?
> Why was blockchain created and what problem does it try to solve?
> What is the double-spend problem?
> How does blockchain solve the double-spend problem?
> How does a transaction take place on blockchain?
> What does a miner in a blockchain do?
> How does mining transactions into blocks make them legitimate?
> What does the ‘chain’ in blockchain actually mean?
> So what would it take to commit fraud within a blockchain?
> How does blockchain work in reality?
> What are the main problems with blockchain?
> What will blockchain replace?
> Should I invest in Bitcoin?
What is blockchain?
Blockchain is a list of records or transactions (called blocks) linked together and secured in date order (called a chain). The information is secured using cryptography which means it can’t ever be changed. However, everyone has their own copy of the blockchain and helps make sure everything is legit.
A core part of a blockchain is the tokens that represent a unit of value within a blockchain system. These tokens are known as digital currencies or more commonly, cryptocurrencies. Each blockchain will have its own unique cryptocurrency. A cryptocurrency is the only accepted payment within the blockchain it belongs to.
For example, the most widely known (and also the first) blockchain is the Bitcoin blockchain on which the Bitcoin currency is traded. Although there are many blockchains in the world today (over 1,500 at time of writing) each with their own cryptocurrency.
The ‘transactions’ that occur within blockchain most obviously are monetary transactions of the relevant cryptocurrency. However, other transactions (or agreements) can also occur which are referred to as smart contracts. We’ll explore smart contracts at the end but to begin with, we’ll focus just on the monetary based transactions to make life easier.
Why was Blockchain created and what problem does it try to solve?
If blockchain was pitched to you as an idea it might sound a little something like this:
You know how when you transfer money to someone online it needs to be authorised by a bank? Well, what blockchain does is allow transactions to be made peer-to-peer, removing the bank completely. In fact, the most popular blockchain, Bitcoin has over 30 million users and performs over 200,000 transactions per day.
It may seem a trivial problem to solve, cutting out the bank as the middleman. What about PayPal? However, even PayPal uses the same old method for transferring money electronically. As mentioned in the intro, you might not even know what happens after you tap your VISA card or send money via internet banking. You just trust that the system works. Unless you’ve been seriously defrauded in the past you will probably go on using this system right? I mean if it’s not broke, no need to fix it!
However, if you transfer money overseas you might start to run into issues. Hefty fees, long IBAN or SWIFT numbers to obtain depending on the bank and country involved. You also have exchange rates to consider. Then there are the days of nervous delays waiting for your money arrive. Also, if you live in (or are dealing with) a country with corrupt governments and unregulated financial systems you are less confident your so-called ‘trusted’ middleman will do as they are told.
Lastly, in a digital age, using the internet for transferring money has one fundamental problem that has prevented this from happening. This issue is known as the double-spend problem. This is the core problem attempting to be overcome by blockchain technology.
What is the double-spend problem?
When you send an email with an attached file, like a Word document, you are not sending the actual document, you are sending a digital copy. It is exactly the same in every way but still, it’s a copy. No big deal for most attachments but when it comes to more valuable items, like money, you run into the issue of devaluing the item each time a copy is made.
For example, if I gave you $100 note but I still kept an exact copy of that same $100 it would be considered counterfeit. In the physical world, creating this $100 counterfeit copy is extremely difficult and the risk and effort often outweigh the reward. However, in the digital world, the digital copy is not only super easy to create it’s actually how the whole system works!
This is the basis of the double-spend problem. Prior to blockchain, this double-spend problem is overcome by having a trusted third party (e.g. a bank) to ensure that the money is withdrawn from my account and deposited into yours. This is the accounting practice of debits and credits which a bank controls and manages on its general ledger. Apart from keeping our money secure, we mostly rely on banks these days to authorise the movement of money from one account to another so that no one is shortchanged and the nation’s currency isn’t devalued by being duplicated.
How does Blockchain solve the double-spend problem?
There are three main unique features of blockchain that contribute to this.
Firstly, the number of tokens (the amount of cryptocurrency) in the system is 100% known down to the last coin. This is because the cryptocurrency can only be created through a digital process called mining. More on mining shortly. With the currency being 100% digital it is 100% traceable and unlike regular currency, it can’t get lost or damaged or go out of circulation. So double-spending can’t occur as the system would notice an increase in the total amount of currency and reject the transaction.
Secondly, when a transaction in blockchain takes place, the person making the payment can’t spend more than they have in their digital wallet. There is no credit advance possible in blockchain.
Lastly, the way blockchain works is that every transaction that occurs is broadcast to all of the blockchain users via the distributed public ledger. This means that instead of one central authority managing the ledger (like a bank) in blockchain every user holds a copy. This means that every transaction that has occurred is visible for everyone to see and every last dollar can be traced by anyone from when it was first created (mined) to where it is today.
How does a transaction take place on Blockchain?
Each person on the blockchain has a public key and a private key. The <public key is the persons assumed (anonymous) identity on the blockchain which everyone can see. The private key is what only the individual user knows. Using the public key and the private key together you create your digital signature. When a transaction in blockchain takes place, the two people involved in the transaction each use their two unique digital keys to create their own digital signature to sign and approve the transaction.
By using the digital signature, the blockchain system can then identify that each person in the transaction is a valid user and that they have enough money in their wallet to support the transaction. Once this transaction occurs it is broadcast as an unverified transaction to the entire network of users in the blockchain system. Now enter the blockchain miners…
What does a miner in a Blockchain do?
A miner is an ordinary user within the blockchain system that decides to participate as a miner. This involves keeping an ear out for unverified transactions that are made and competing with other miners for the opportunity to verify these transactions into officially sealed blocks.
For each block they create, they receive a portion of system generated cryptocurrency. At last count, for the Bitcoin blockchain, this was 12.5 Bitcoins per block mined. In the true sense of the word these ‘miners’ create new value within the blockchain through the ‘mining’ of unverified transactions into verified blocks. These sealed blocks are then rebroadcast to all users in the blockchain who add the block to their version of the blockchain, safe in knowing that the transactions are legitimate. But wait, there’s more…
How does mining transactions into blocks make them legitimate?
As we’ve seen, much like a real-life miner, a miner in a blockchain earns their money from verifying transactions in fierce competition with other miners. The purpose of this competition generally is to make sure the miner who verifies a transaction is completely random, and also to make it somewhat difficult to be eligible to be a miner.
To verify a transaction (and create the next block) in the blockchain a miner must solve a very complex mathematical puzzle until it gets the right result. The first miner to get the correct result to this puzzle is allowed to verify any currently unverified transactions into a new block. The miner in reality simply provides the processing power using the blockchain technology to verify that no conflicts arise with the transactions.
The blockchain rules determine how long on average a block is created, this is based on the complexity of the puzzle. For instance, the Bitcoin blockchain is around 10 minutes per block.
These mathematical puzzles have over a trillion possible results and require a huge amount of computer processing power to get a correct result within this limited amount of time. The random nature that a miner is awarded the job of verifying a transaction and the effort required to solve the puzzle is a key security feature of blockchain.
What does the ‘chain’ in Blockchain actually mean?
So let’s recap briefly before getting deep into the security features of blockchain. So all transactions in blockchain are made public for everyone to see. Miners listen for unverified transactions and then compete at solving complex puzzles against other miners to win the right to verify transactions into new blocks, roughly every 10 minutes. Miners then get paid in newly issued cryptocurrency. Sounds like a computer game doesn’t it? Interestingly, this is all based on what is called game theory.
Now, when a miner creates a new block they attach it to the previous block that was created. They create an unbreakable link, a chain, using cryptography so that the chain cannot be broken. In blockchain, this process continues indefinitely, each new block gets connected to the last block in an ever-growing chain.
Should you want to amend an already verified block of transactions you would need to unlock it. To unlock a block takes as much processing work as it was to create. However, you not only have to unlock the block you want to amend but also every block that was created after it. And, you need to do this before another block is added to the chain (i.e. within 10 minutes). So the older a block is the more protected it is from being altered. Much like a growing number of security doors being added to the entire system each time a block is created.
So what would it take to commit fraud within a blockchain?
We’ve skimmed over security features briefly, but let’s test it. How would you try and attempt fraud in blockchain?
Let’s say you only have 10 Bitcoins. You make a payment to me for 10 Bitcoins and then try to also send the same 10 Bitcoins to yourself at the same time. Once these transactions get picked up by a regular miner for verification they will be rejected. The only way this might get through is if you just happen to be the actual miner for verifying these two transactions. If that happened, you could, in theory, create two versions of the blockchain ledger. One version for me and another version for everyone else. Much like creating a parallel universe just for me.
From my perspective, I see the transaction in the block that is broadcast to me and I see the transaction is processed successfully. However, in reality, in everyone else’s version of the blockchain, it says I don’t have these 10 Bitcoins, they think you still do! Sneaky! If I went to go and spend any of those 10 Bitcoins it would be rejected as no one will believe that I have them!
However, I will most likely find out what you are up to 10 minutes later when the next block is added by the next miner. The next miner will, of course, be working off the main version of the blockchain you sent them. When they add the next block they will broadcast the updated version of the blockchain to me and I will see that the two versions in plain sight, revealing your scam. The only way I won’t find out is if you somehow you become the miner again. The odds of this happening though are very low.
Suppose you did manage to be the miner twice in a row, to keep up the scam, you would have to continue to be the miner over and over and keep sending me the alternate version of the blockchain, forever. The odds of doing this over and over get so small that it becomes impossible. The only way to pull this off is if you have over half the processing power of all the other miners put together to be guaranteed to win the mining contest. The cost of doing this in hardware and running costs would be way too high to justify the reward.
To overcome this risk, a rule of thumb in blockchain, therefore, is to always trust the version of the public ledger (the chain) that is the longest. In the case above, I might choose to wait for a few extra blocks to be created after your transaction is made to ensure it is legit. As I know that after a period of about 6 blocks (1 hour) I’m pretty confident any fraudulent versions of the blockchain will be revealed. So if none appear after 6 blocks are added after my transaction I can reliably trust the version I have.
Of course, we are not checking and updating this blockchain ledger manually, your digital wallet software will be constantly monitoring blocks, updating your ledger and ensuring your transactions are legit by accepting the longest version of the blockchain should a discrepancy be detected.
Confused? How would Blockchain work in reality?
There is a lot to absorb with blockchain and often I too walk away with more questions than answers.
As mentioned in the intro, many people would not be aware nor care about the inner workings of any complex system so long as it worked time and time again until it was trusted. So how is a simple payment be made using the Bitcoin blockchain today?
Scenario: Tom is wanting to transfer 1 Bitcoin to Sue.
- Tom obtains Sue’s bitcoin address (her public key)
- Tom uses a digital wallet app (such as Coinbase) on his mobile phone to create a transfer to Sue for 1 Bitcoin.
- Tom presses ‘Send’.
- 10 minutes later Sue would get the first confirmation on her digital wallet app that the transaction has occurred. Meaning the block containing her transaction has been created (mined).
- An hour later Sue would be guaranteed that the transaction is legitimate (i.e. 6 blocks have been created on top of hers). Or, whatever setting she has in her digital wallet to guarantee payment.
What are the main problems with blockchain?
While the blockchain technology might sound OK in theory, there are some recognised flaws:
Blockchain is unregulated by design. If something goes wrong within a blockchain like Bitcoin, there is no one to ask for help or indeed take to court. It’s hard to trust something you don’t understand and even harder when there is no safety net should it all go peat tong.
No one single blockchain
While the Bitcoin blockchain is well known, there are over 1500 blockchains each with their own cryptocurrency. This makes it hard to know where to start or invest and being able to actually use the currency for anything other than just trading with other cryptocurrencies.
Point of sale payments are not viable
While transactions happen relatively quickly (every 10 minutes) this is a long time to wait to pay for a cup of coffee! Blockchain transactions do occur quickly when compared with online or overseas transactions but not compared to cash or credit cards at the point of sale.
It’s a solution looking for a problem to solve
True, blockchain was designed to overcome the double-spend problem and avoid middlemen and have a currency not managed by any one government. But it is debatable if this is ever going to be a mainstream problem, particularly in most developed economies with strong regulation. Blockchain was born out of the 2008 Global Financial Crisis when trust of the establishment was at an all-time low. It would need a continued drop in confidence for blockchain to emerge as an acceptable replacement. The thinking is it will be more suited for developing countries where trust of financial systems is extremely poor.
Security of private keys
For all it’s high tech security features, the main cases of fraud that have occurred in blockchain to date have been a result of the user having had their private key stolen or lost. A chain, as they say, is only as strong as it’s weakest link. A private key is the only way anyone will know you exist in blockchain. If you lose it, all your money and identity goes with it. There is no forget password function. And, if someone obtains your private key, they can clean out your account and you’ll never know who did it. This is a definite weak point in all that blockchain stands for.
The mining process is not sustainable
The practice of mining is crucial to the security of blockchain. Yet it relies on incentives for miners to participate and also do the right thing. Bitcoin, for example, is finite, meaning it will eventually stop producing more Bitcoins, i.e. the mine will run dry. This is intentional, but what happens then? Transaction fees will either skyrocket and make the system cost prohibitive for users; or miners will just leave, making it more open to mining monopolies and fraud. Either way, the value of the system (and its cryptocurrency) plummets.
So what will blockchain replace?
If I knew that, I’d be building it instead of writing this!
If you put aside for a minute the current trend of speculative investment in cryptocurrency, there are a few areas where blockchain looks to be viable:
One easy way to think about smart contracts is gambling. Today you place a bet with an agency but really you are betting against all the people who think the outcome will be different to yours. However, you could create an agreement (a ‘smart contract’) in a blockchain with someone directly that states what the bet is for and how much money changes hands as a result. It would be signed and sealed in a mined block and when the result is known the relevant payments are automatically distributed by blockchain.
Use cases for smart contracts are far-reaching. Any form of agreement, from a vote to buying a house and selling music or movies online and truly cutting out the middlemen like Spotify and Netflix, as much as we love their service! Ethereum is a blockchain designed with smart contracts in mind.
Gold, apart from jewellery, is mainly used as a stable store of value in areas of the world where the nation’s currency is too volatile to keep large amounts. A cryptocurrency could, in theory, possess the same qualities as gold and be easier to transport and also access across borders than heavy, easily stolen gold bars.
The dark web is a version of the internet that is completely anonymous. All manner of illegal transactions can occur from drugs to firearms. To date, cryptocurrencies have been the currency of choice for criminals and terrorists and this is likely to continue whether we like it or not.
As we saw earlier, making an international transaction is very messy today. Using a cryptocurrency that is widely accepted internationally, like Bitcoin, may provide a growing way to make those overseas payments easier.
So, cut to the chase, should I invest in Bitcoin?
Hopefully, this is not the only reason you are reading this! The answer to that is not straightforward and also a personal choice! Yes, you might be lucky and make a quick buck, or lose it, depending on when and where you invest. But the practice of putting in a traditional currency to invest in cryptocurrency to then extract it into that same traditional currency simply goes toward devaluing that cryptocurrency eventually. To hold real value long term it has to have a use or purpose, other than speculation, that makes it valuable.
Initial coin Offerings (ICO’s) is also becoming a way people are getting involved. But again highly speculative. It’s like a Kickstarter campaign where you believe the blockchain being created will be the next big thing and invest today’s currency in return for a share of the new, supposedly bargain basement cryptocurrency.
I’d say invest time in blockchain development or look to offer a service that works within the blockchain ecosystem. Developers of blockchain technology, for example, are highly sought after. Otherwise look to see what problems can be solved by cutting out middlemen and allowing people to transact directly with each other. Each blockchain is trying to achieve something slightly different and I think that is the best way to decide on whether its cryptocurrency is likely to be something of use to people once all the speculation goes away.
I hope this now quite lengthy article helps you understand blockchain a little more. It’s an interesting area and twenty years from now we’ll either question or kick ourselves about whether we should have got less or more involved, at least now you can say you made an informed decision at the time. Thanks for reading and of course get in touch with any digitally related questions or just post in the comments.
Sling Digital Difference
Sling Digital offers Australian small businesses a ‘tier 1’ digital service at a reasonable cost. We will never work with your competitors. Our goal is to build great relationships with a few trusted clients, working with them as an extension of their business, helping their business to grow.
If you are a small business needing help with anything digital related, we can help get you on a clear path to ongoing measurable success.