It all started in late 2008, a mysterious whitepaper emerged by an unknown entity called itself Satoshi Nakamoto. The paper proposed a new peer-to-peer financial system based on a digital cryptocurrency called Bitcoin.
Probably the word blockchain sounds familiar to you and I am sure many have heard of it, thanks also to the media and the buzzing around the rising value of Bitcoin near the end of 2017.
But, have you ever tried to understand a little bit more about how does it work and what is it?
If this is your purpose, you stumbled into the right article because in the next paragraph I will try to explain what blockchain is and talk about cryptocurrencies and other potential applications of this technology.
What is Blockchain
To provide a simple definition, a Blockchain is a public register of data that is distributed between thousands of computers around the world all connected to a network.
In other words, it is a continuously updated register of “who holds what”, an open decentralized database of any transaction occurred on the network.
The blockchain works as a worldwide computer but it is not owned by a single entity, it is formed by lots of independent computers talking to each other on the network.
Whenever someone makes a transaction, the information is broadcasted to the network. This and other transaction are verified by nodes of the network by running complex cryptography algorithms. Once the transactions are confirmed they are sealed into a block, that is added to the previous ones forming the blockchain.
When a block becomes part of the blockchain, the information is stored permanently across the network of computers and anyone on the network is sure about the authenticity of the records because were verified by the entire community, building automated trust.
Each block has a time stamp and a reference to previous blocks, forming a chronological chain. Users can add new information (new transaction) but can’t change the information that is already there (previous transactions).
Since the blockchain is distributed and decentralized between millions of users, is nearly impossible for anyone to influence or take down the network, that offers high levels of security and transparency.
I will enter the details of how it works in another article. For now, just remember that blockchain is a technology, there are many blockchain projects whose functioning is based on different principles.
What they all have in common is the use of cryptography to authenticate transaction and a consensus mechanism to agree upon their validity.
Blockchain and money
Money exists to facilitate trade, through the years trade has become increasingly complex and the solution we developed is to rely on trusted third parties and middlemen for bookkeeping and approval of transactions (think about governments, banks, accountants and notaries).
To understand how and why blockchain can be used for cryptocurrencies, imagine the following situation:
I want to transfer $1000 to my friend John for a project we started to develop together, what do I do? I go on my online banking app and enter the following order: “Please (bank), take $1000 from my account and transfer them to John’s account”.
The bank opens its register and checks if I have the amount of $1000 on my balance, if so, it proceeds to write an entry in the register that records -$1000 on my account and transfers +$1000 to John’s account using the banking system.
Without taking into account the costs and the time needed for this operation (typically 1–3 days depending on the situation), what I want to highlight is that:
- There wasn’t a real movement of money, there were entries in my and John’s accounts
- To make the transaction we trusted the bank (a third party) to manage our money
- We didn’t have direct control over our funds
Is it possible to perform the same transaction and have the same outcome without recurring to a trusted third party? Here is where blockchain comes into play because the transfer of money is nothing more than an entry in a register.
When a sufficiently large number of people agree on using a blockchain-based register, like the case of Bitcoin, a third party is no longer needed and the bookkeeping of transactions can be maintained via the internet between the participants of the network. This register is not closed and is not in control of a single party, it is public and the blockchain is available to everyone.
If I own a certain amount of cryptocurrency, to make a transaction there is no need for a third party to check if I have funds on my balance because the records on the blockchain prove that I have that amount of cryptocurrency in my wallet. I can directly send the funds to my friend, after the transaction is approved and sealed into a block using cryptography; the funds are taken from my account and definitively transferred to my friend John wallet.
Cryptocurrencies are a new form of currency, that can be used to make purchases and perform transaction like the ones that we normally do everyday. It is still a new thing but progress are being made very fast and chances are that we’ll soon be able to make a wider use of cryptocurrencies in our everyday life.
Although the use of cryptocurrencies may be similar to standard currencies, there are substantial differences. While both are means of exchange, cryptocurrencies are not issued by a central bank and there isn’t any central control, they are created from computers and are decentralized (not controlled by a single entity). They have a limited supply, they are exchanged digitally and their value is not determined by regulation (there is no “legal-tender”).
Why Blockchain is important
While the social perception of blockchain is strongly related to Bitcoin and other cryptocurrencies, the monetary aspect is just the tip of the iceberg, one of the possible uses.
This new technology is very promising with implications that go far beyond cryptocurrencies, it is potentially disruptive for dozens of industries and it has already attracted millions of dollars of investment with numerous projects under development.
Let’s start from the example of cryptocurrencies: there is a blockchain that works as a distributed ledger of transactions and a token, called Bitcoin, that is divisible and serves as unit of account and mean of exchange. In the case of the Bitcoin network, the general perception of tokens is mainly related to currency, we naturally tend to assign a monetary value to each Bitcoin.
The key point is that a token on the blockchain can represent anything: it is possible to develop blockchain-based systems where tokens represent any piece of information, like a digital certificate of ownership (such as a house or a share in a company), a certificate of credit, a Kilowatt of energy, a vote during the elections, patents, information about the origin of products, instructions for an algorithm, the identity for an IoT device, etc.
The programmable and open features of the blockchain allow to innovate and completely rebuild systems in many fields, dramatically reducing the level of bureaucracy and making the whole processes significantly more efficient and transparent. Blockchain could be used to prevent fraud, to avoid using intermediaries, for land registry, for stock exchange and asset management (record the trading orders and property of securities), for insurance claims, digital payments and many others. Major banks have already invested millions to develop platforms to clear transactions using blockchain systems.
Blockchain is so important because opens a new world of possibilities, with numerous application and a high disruption potential.
Take a look at this chart:
As you can see there are multiple applications for this technology across very different sectors.
The Internet of Things is an area where the blockchain technology will surely have a huge impact. With millions of devices connected, the security of the information and the identity of every device become real issues. Blockchain can be a solution to manage the massive amount of data coming from these devices protecting ownership and privacy of the data and the base to develop new services, like an automatic supply chain service (maybe one where also the payments are made using cryptocurrencies).
Smart Contracts are an innovative way to automatically execute a pre-defined action when a specific condition is met or a specific situation occurs. The aim of smart contracts is to provide a higher level of security compared to traditional law contracts, improve the speed of execution and reduce transaction costs. They can be used for all sort of agreements or situations like intellectual property rights and royalty distribution, rent and payments, access to personal information such as identity and healthcare data, voting systems, supply chain management, etc.
Their execution on the blockchain makes them safe using cryptography, builds trust and allow a high flexibility of usage.
To take the discussion one step further, smart contracts allow the development of Decentralized Autonomous Organizations (DAOs), real entities that create value acting with no human intervention.
They are decentralized, which means they are on the blockchain, and autonomous because there is no central management. The code runs the transactions and makes decisions instead of a management team and executes smart contracts when needed.
Blockchain and cryptocurrencies have caused a paradigm shift, the introduction of this technology paves the way for a new revolution that will be pervasive in almost every sectors.
The possible uses of this technology seem to be endless. Right know everything is still new, we could relate to the early days of the internet (who could have imagined back in 1993 the impact of the internet on our lives and the world of business), but in a few year is possible that it will change how we record, organize and run things in our everyday life.
There is a lot of potential and this is only the beginning.
This article is for informational purposes only, it should not be considered financial advice.
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