Ever since Satoshi Nakamoto first described Bitcoin in a paper in 2008, Blockchain, the technology behind Bitcoin has captured the imaginations of many the world over. Years later and the outlook of blockchain remains extremely positive. In fact, a majority of people who have been closely following its advancement believe that blockchain represents the future of financial transactions. In their minds, there is little doubt that in the near future, blockchain will have impinged on every aspect of life, for practically everyone on the planet. Therefore, for such a disruptive technological force, it is imperative that we seek to understand it. Consider this as a “blockchain explained for dummies” article. In it, we will seek to, among other things, answer the following questions:
To answer the question, “what is a blockchain?”, we first need to define a ledger. In accounting, a ledger is a computer file or a book where you can find a complete record of a company’s financial transactions throughout its life. Using this record, accounting officers can prepare the company’s financial statements. The ledger record financial information on liabilities, assets, expenses, revenues and owners’ equity.
With the above information in mind, blockchain simple explanation would be a public or distributed ledger, meaning, the records it contains can be verified autonomously without the need to have a central entity. Accordingly, it is quite easy to discover without anyone else’s involvement, whether any tampering with your copy of the ledger has taken place. This essentially makes blockchain a public ledger that everybody can verify.
A simple explanation of blockchain should include the fact that it is not just a public ledger, but a real-time public ledger that records practically anything that can be put on record, including contracts, financial transactions, information on supply chain, physical assets, etc. One major idea behind blockchain technology is that there is no one organization or person who is in charge of keeping this ledger. Instead, the ledger is open for everyone in the chain to see every detail of every record. Each of the records in this chain of records is referred to as a block.
So, what does blockchain mean and how does the blockchain work? Think of blockchain as a long chain of records (financial transactions or otherwise) made up of blocks, with each block being each of the records that make up the long chain. Each block is encrypted and has a time stamp. The “owner” of each block is the only one who can edit it. Each owner has a private key which they can use to access their block. With every change that occurs to one block within a blockchain, the information on the change is distributed in real time to the rest of the blockchain.
While the blockchain technology can be applied in many sectors, none has been as widely discussed, perhaps because of the far-reaching implications of its implementation, like the financial and banking industries. Therefore, any “blockchain for dummies” introduction to understanding blockchain technology should include explanations using the financial and banking industries. Blockchain explained through financial transactions might be easier to understand for the majority of people.
In the traditional way of carrying out financial transactions, any payment from one entity to another always involves an intermediary. For example, if Martin intends to pay Joseph $50, he has two options: either give Joseph the $50 in cash or use a banking app to move the money from his account to Joseph’s bank account.
In either of these scenarios, a bank is the third party and an intermediary between the two men and serves to verify that the transaction has indeed taken place. When paying in cash, Martin’s money is verified when he withdraws it from an ATM. When transferring from his bank account through a banking application, the app verifies the transaction the moment he initiates a digital transfer.
This essentially means that his bank decides whether or not the transaction should move forward. Additionally, his bank has the records of all the transactions that Martin makes and is tasked with the responsibility of updating this record every time Martin receives funds into his account or pays someone. Therefore, Martin’s bank has the ledger and controls it.
As you can clearly see, the bank has a ton of responsibility. Therefore, it goes without saying that Martin needs to trust the bank if he is to risk keeping his money there. Martin must be persuaded that the bank has his best interests at heart, will not swindle him of his hard-earned cash, will not lose the money by robbery or otherwise and will always be there. This scenario captures the intricacies of the traditional financial transactions.
Now, what makes blockchain technology so revolutionary is the fact that it is entirely decentralized. It eliminates the need for an intermediary or a central ledger that only one entity holds and controls. Central to understanding blockchain is comprehending this major difference. It answers the question: where is the blockchain stored?
Instead of a third party holding and controlling the ledger, blockchain makes it possible for the ledger to be distributed across a massive computer network, with each computer in the network (called node) holding a copy of the complete ledger.
The computers are interconnected via a peer-to-peer (P2P) client software program. This program synchronizes all data across the network of computers in real time, making sure that everyone within the network has an exact copy of the updated ledger at all times. This is blockchain technology explained.
Whenever there is a new transaction in a blockchain, the first thing that happens is encryption. The transaction is encrypted and then added to a group of new transactions to form a block. This block is broadcast across the entire network of computers within the blockchain. Verification of the transaction takes place within each node, after which a record of the verified group of transactions can be added to everybody’s computer at the bottom of the ledger, further elongating this chain of records.
Many books have been written in the last decade or so to explain the workings of blockchain technology. A recurrent theme in all “blockchain technology for dummies” type of books is the fact that the technology, when used in to facilitate financial transactions eliminates financial institutions like banks and credit card companies. This brings up the question: how is blockchain technology able to eliminate these third parties and retain trust in the integrity of each transaction?
It accomplishes this by providing strong ownership control and double spending prevention. To provide strong ownership control, blockchain technology uses digital signatures. Similar to the approach used in signed PDFs and secure emails, digital signatures are considered secure and robust. A user in the blockchain creates two different cryptography keys, keeps one key private and the other public. He uses the private key to sign his transactions. The public uses the second key to verify this transaction.
In double-spending prevention, the blockchain technology makes it virtually impossible for users to spend their digital cash more than once. To do this, it makes every transaction that takes place within the blockchain irreversible. Every new transaction entry is linked (chained) to those that came before it as recorded in the ledger. This is done using complex math calculations that while difficult to repeat are quite easy to validate.
Once there’s a new transaction added to the blockchain, undoing it would require an inordinate volume of computer resources to alter, essentially making that transaction permanent. As the ledger adds up more transactions, it becomes almost certainly impossible to change older transactions.
For most of us, any mention of blockchain immediately takes our minds to cryptocurrencies. While cryptocurrencies make up for the majority uses of blockchain technology, there are other areas where blockchain can be applied. Top among these other applications is the Ethereum network. First described by Vitalik Buterin in a 2013 white paper, the Ethereum network uses a Turing-complete language of computer programming that has the capacity to support all the essential operations needed to implement a particular algorithm. This makes it possible to manipulate that Ethereum blockchain with ease.
Nevertheless, the use of blockchain is not limited to the Ethereum network. The following are other major uses and underlying potential of the blockchain as an innovative technology with the potential to disrupt the existing world system in many different industries.
Bitcoin leads the way in this front and there is every indication that the next few years will still see more use of the blockchain in payment systems and digital currencies. The introduction of Ethereum and such other better blockchains will boost the uptake of the technology as digital payments become faster, cheaper and easier. Using the blockchain, businesses will be in a position to eliminate transaction fees, which often eat into their profit margins as well as force them to sell their products a little more than they would if there were no transaction fees.
One big 21st century problem is online privacy concerns. This problem is so devastating and has contributed immensely to the slow adoption of new technology. This is because individuals and businesses fear passing on too much control to third parties that they have very little or no control over. By embracing the blockchain, people can comfortably and confidently use new technologies like cloud storage of personal information without fear that hackers or governments will get access to this information.
Smart contracts have been touted as the true building blocks of blockchain applications for the modern times. At the core of smart contracts is self-execution, code write-ups and blockchain enforcement. This means that a smart contract is designed using lines of code, executes itself without the intervention of a third party and after fulfillment of certain laid out conditions. Using smart contracts, you eliminate both enforcement costs and ambiguity, making all business transactions instantaneous.
Blockchain-based solutions are gaining prominence in other industries, including real estate, government, healthcare, identity management, the automobile industry, etc. Investors and entrepreneurs are moving into this space and multinationals are exploring and testing this technology. While there is no telling how the world will be transformed when the blockchain goes mainstream, there is little doubt that we will soon see a brand new generation of digital services and products as well as mind boggling applications designed using the Blockchain technology.