With all that hype around blockchain, crypto-currencies and Bitcoin, the “common man” gets lost somewhere in between. What is blockchain? How are crypto-currencies related to it? And what is Bitcoin? We explain all this in the simplest manner possible to give you a clear idea about what people are talking about. Read on to find out.
What is Blockchain Technology?
Blockchain can be simply defined as a distributed ledger, which records time stamped data in an immutable, permanent and transparent way.
Primarily devised for the digital currency Bitcoin, the brain child of Satoshi Nakamoto blockchain has now gained new potential users in the tech community.
The three most important aspects of blockchain that make it a fascinating prospect are
Data is Not Owned by a Single Entity, It is Distrubuted among Users.
The centralised system is one where control of a database lies with a single entity.
A centralised system is the definition of what exactly blockchain is not.
A good example to understand the centralised system is the bank. The bank stores all your money and transaction details. So if you want to to pay someone, the only way is through the bank. Here bank is the central authority which has control over your money and how you transact with another person.
Wikipedia serves as a fine example of a client-server model which too is based on a centralised system. A client (user) with permissions associated with his account is able to change Wikipedia entries which are stored on a centralised server. Whenever a user accesses the Wikipedia page, they will get the updated version of the “master copy” of the entry. But, control of the database remains with Wikipedia administrators allowing for access and permissions to be maintained by a central authority.
Though centralised systems have served us well for so long, they have always had some inherent issues.
- Because all the data is centralised, it increases their susceptibility to access and manipulation by hackers
- In case of a software upgrade in a centralised system, the entire system will be brought to a halt.
- A probable shutdown of a centralised system will block off all the data it possesses from its users.
- If the centralised entity were to become malicious, this too can compromise the database.
Now unlike a centralised system data is not owned by a single entity, rather it is distributed among the users where all the respective users enjoy equal privileges; democratisation in the true sense.
In simple terms, you alone are in charge of your money. So, if you wanted to pay one of your friends, you can do so directly without going to the bank.
The Blockchain Technology is based on a Decentralised System
Decentralisation removes any third party within the transaction, thus eliminating any transaction costs.
The absence of a third party in a transactions such implications that blockchain can replace all processes and business models which rely on charging a small fee for a transaction.
Consider a railway ticketing service where a credit card company charges a cut for processing the transaction while buying a ticket. Blockchain can replace the entire ticketing system where the two parties will be the railway company and the passenger, removing the role of the credit card company all the while saving the railway company the processing fee.
Records selling can begin to be profitable again for artists by using blockchain, this will eliminate the role of music companies and distributors like Apple Music, Google Play Music, Gaana, etc. The music that is bought can be encrypted into blockchain, making it a cloud archive for any song purchased. The amounts charged can be so small that they will cause subscription and streaming services to become irrelevant.
Similarly Ebooks can be encoded in blockchain and circulated in an encoded form, and in case of a successful blockchain transaction all the money will be transferred to the author instead of meagre royalties.
The applications of blockchain in the financial world are more obvious and the revolutionary changes it will bring are more imminent. Blockchains will potentially transform the way stock exchanges work, loans are bundled, and insurances contracted. They will eliminate bank accounts and practically all services offered by banks. Almost every financial institution will go bankrupt or be forced to change fundamentally, once the advantages of a safe ledger without any transaction fees is widely understood and implemented. After all, the financial system is built on taking a small cut of your money for the privilege of facilitating a transaction. Bankers will become mere advisers, not gatekeepers of money. Stock brokers will no longer be able to earn commissions and the buy/sell culture will disappear.
Data Once Entered Cannot be Tampered With
In the context of blockchain, immutability implies that once a data block has been entered in a blockchain it cannot be tampered with.
This can root out cases of embezzlement, as there will be no more fiddling around with company accounts.
Blockchain uses cryptographic hash function to encode data, which gives an output of fixed length(called hash) for any input of any length. This becomes critical when dealing with large amounts of data as instead of having to remember hordes of data one can remember just the hash code of the particular data to track it.
One important property that needs a particular mention is termed “the Avalanche Effect“.
It means that if there is a small change in the input, it will be reflected as a large change in the output.
Now considering that blockchains are essentially linked-lists, containing data and a hash pointer. The hash pointer not only points to the address of the previous block but also to the data inside it.
So if a hacker attempts to change data in a particular block, it would completely change the hash code of the previous code and so on until the entire chain is changed, which is impossible, thus imparting the said immutability to blockchain.
There has been much confusion and skepticism regarding this aspect of blockchain. Whether blockchain offers the privacy one requires or puts everything on the table for everyone to see?
Well, the answer is both. A person is represented by his public address where his identity is hidden behind complex cryptography. This means, “David sent 1 BTC” will instead appear as “1MF1bhsFLkBzzz9vpFYEmvwT2TbyCt7NZJ sent 1 BTC”. Consequenty, the person’s identity remains secure, while the transactions made by his public address can be easily tracked and held acccountable. This imparts a never before level of transparency to blockchain based systems.
Even though companies would not necessarily transact in crypto-currencies, supply chains integrated with blockchain will create a transparency that will force companies to be honest and accountable of all their transactions. This indeed can be very helpful in the finance industry.
How Blockchain Technology Works?
The blockchain implements three technologies to function the way it does
- Cryptographic keys
- Distributed network with a shared ledger
- Network servicing protocol – An incentive to service the network’s transactions, record keeping and security
Cryptographic keys serve the purpose of authentication in blockchain.
Each of the two persons who wish to transact through a blockchain network must possess a pair of keys, one of which is private and the other is public.
The combination of keys is perceived as a form of consent, creating a unique digital signature respective to the person holding the set of keys. This digital signature provides strong control of ownership.
But strong control of ownership constitutes only a part of a secure digital relationships, not the entire thing.
While authentication has been served by the use of cryptographic keys, it must be combined with a means of approving transactions and permissions i.e. authorisation.
Blockchains implement this using a distributed network.
How blockchain utilises a distributed network for authorisation can be understood by a simple thought experiment.
“If a tree falls in a forest, with cameras to record its fall, we can be pretty certain that the tree fell. We have visual evidence, even if the particulars (why or how) may be unclear.”
In blockchain too there is a large network of validators, not unlike the cameras in the analogy, who reach a consensus that they witnessed the same thing at the same time. But instead of cameras, they use mathematical verification.
So, larger the network, more secure it is.
Why use a Distributed or Peer-to-Peer Network?
Client-server models used for downloading are extremely slow and are solely dependent on the health of the server. Also it is prone to censorship.
But, a file sharing based on peer-to-peer system has no central authority, where all the peers have the same privileges and exist in a flat topology. Even if one of the peer leaves the network, there still are more peers to download from. Moreover, a peer-to-peer distributed system is not subject to the idealistic standards of a centralised system, hence it is not prone to censorship.
This is one of the Bitcoin blockchain’s most lucrative qualities – it is so large and has amassed so much computing power. Bitcoin is secured by more than 3,500,000 tera-hashes/second(tera-hashes/second or hash-rate are a measure of how much computing power is being thrown at the network by users all over the world), which is more than the 10,000 largest banks in the world combined.
When cryptographic keys are combined with this distributed network, a very useful form of digital transactions emerges.
The transaction process begins with the sender taking their private key, making an announcement of some sort e.g. sending a sum of crypto-currency – and attach it to the receiver’s public key. Following this, a block consisting of the digital signature, time stamp and relevant information is broadcast to the peers in the network.
Network Servicing Protocol
On returning to our thought experiment, we are faced with a glaring question, “Why would there be a million computers with cameras waiting to record whether a tree fell?” We could rephrase these words, how do you attract computing power to service the network to make it secure?
Mining is built off a unique approach to an ancient question of economics – “The tragedy of the commons”.
It utilises a person’s self interest to service the public need. There is a reward system for the computers offering their processing power to service the network in blockchain.
The goal of this protocol is to eliminate the possibility that the same crypto-currency is used in separate transactions at the same time, in such a way that it would be difficult to detect.
Crypto-currencies and their base units must be unique to be owned and have value. The nodes serving the network create and maintain a history of transactions for each bitcoin by working to solve proof-of work mathematical problems.
Basically they vote with their CPU power, expressing their agreement about new blocks or rejecting invalid blocks. When a majority of the miners arrive at the same solution, they add a new block to the chain. This block is time-stamped, and can also contain data or messages.
You can read about the potential applications of blockchain in this article by Blockgeeks.
What is Crypto-currency?
Crypto-currency is a medium of exchange, which is created and stored electronically in the blockchain, using encryption techniques to control the creation of monetary units and verify the transfer of funds.
There are three inherent characteristics of crypto-currency which make it a unique medium of exchange
- It has no intrinsic value. A crypto-currency unit is not redeemable for another commodity such as gold.
- It has no physical form. A unit of crypto-currency exists only in the network.
- Its supply is not determined by a central bank. No central authority interferes or dictates a whimsical value and supply of the crypto-currency units, and the network is completely decentralised.
Crypto-currencies offer consumers faster and cheaper peer-to-peer payment options than those offered by traditional money services businesses, without the need to provide personal details.
While crypto-currencies continue to gain acceptance as a method of payment, price volatility and the opportunity for speculative investments encourage consumers not to use crypto-currency to purchase goods and services but rather trade it.
Crypto-currency represents the beginning of a new phase of technology-driven markets that have the potential to disrupt conventional market strategies, longstanding business practices and established regulatory perspectives – all to the benefit of consumers and broader macroeconomic efficiency.
Crypto-currencies carry groundbreaking potential to allow consumers access to global payment system – anytime, anywhere in which participation is restricted only by access to technology, rather than by factors such as having a credit history or a bank account.
What is Bitcoin?
Bitcoin in 2008 was proposed as an electronic payment system based on mathematical proof by a software developer going by the pseudonym Satoshi Nakamoto. The basis was an idea to create a means of exchange, independent of central authority, that could be transferred electronically in a secure, verifiable and immutable way.
Bitcoin can be used to pay for things electronically, with consent of both parties. In this sense, it is similar to conventional currencies which too are traded digitally.
But it differs from conventional digital currencies in some ways:
- Limited supply
Decentralisation is inherent to Bitcoin as it is based on the blockchain technology. No single institution controls the Bitcoin network, instead it is maintained by a group of volunteer coders and maintained by an open network of computers spread across the globe.
Bitcoin essentially solves the “double spending problem” of electronic currencies in which digital currencies can be copied and re-used. This it does through an ingenious system of cryptography and economic incentives.
In conventional digital currencies this function is fulfilled by the banks, which gives them control over the traditional system. But with Bitcoin, the integrity of the transactions is maintained by a distributed and open network, owned by no one.
Central banks can issue as many units of currency as they want and even attempt to manipulate a currency’s value relative to others, while those who hold the currency without choice a have to bear the cost. In other words conventional currencies are virtually unlimited in supply.
On the other hand supply of Bitcoins is tightly controlled by an underlying algorithm. Only a small number of new Bitcoins trickle out every hour, and will continue to do so at a diminishing rate till the maximum of 21 million has been reached. This makes bitcoin more attractive as an asset. Theoretically, if demand grows and supply remains same, the value will increase.
Traditional electronic payments are required to identify the sender for the purpose of verification to comply with anti money laundering and other legislation. However, users of Bitcoins operate with semi-anonymity.
The system does not need to know the identity of the sender. The protocol only checks previous transactions to confirm that the sender has the necessary number of bitcoins along with the authority to send them.
In practice, each user is identified by the public address of their wallet. Furthermore, most exchanges are required by law to perform identity checks on their customers before they are allowed to buy or sell bitcoin, facilitating another way that Bitcoin usage can be tracked. Since the network is transparent, the progress of a particular transaction is visible.
This makes bitcoin not an ideal currency for criminals, terrorists and money-launderers.
Bitcoin transactions cannot be reversed unlike conventional digital currency transactions. If a transaction is recorded on the network and an hour has passed, it is impossible to modify.
This does not mean that any transaction on the Bitcoin network cannot be tampered with.
The smallest unit of a bitcoin is called a satoshi. It is one hundred millionth of a bitcoin (1 Bitcoin is currently USD 9241.42). This could conceivably enable micro-transactions that traditional electronic money cannot.