You can be forgiven for feeling terrified when you try to understand this mysterious thing called Blockchain technology. Before we dive into the details of a crytpocurrency and how it might change the world, let us first discuss what blockchain is. A blockchain is a digital ledger that records transactions. It is similar to the ledgers we use for hundreds of years to track sales and purchases. This digital ledger functions in the same way as a traditional one, recording debits and credit between people. This is the core concept of blockchain. The difference is in who holds the ledger, and who verifies transactions.

Traditional Transaction

Traditional transactions require some intermediary to facilitate a payment. Let’s say Rob wants Melanie to receive PS20. He can give Melanie cash in the form a PS20 note or use a banking app to transfer the money to her account. In both cases, the bank acts as an intermediary to verify the transaction. Rob’s funds can be taken out of a cash machine and verified, or they can be verified by the app when Rob makes the digital transfer. The bank decides whether the transaction should proceed. Rob also keeps a record of all transactions and the bank is responsible for updating it whenever Rob receives money or pays someone. The bank controls and maintains the ledger.

All transactions flow through the bank. Rob must feel confident in his bank. Otherwise, he will not trust them with his money. Rob must feel secure that his bank will not defraud, won’t lose his money, won’t be robbed, or disappear overnight. This trust is the foundation of almost every aspect of the monolithic financial industry. In fact, even during 2008’s financial crisis, it was discovered that banks were being reckless with our money. The government (another intermediary), chose to bail them out instead of risking destroying the last bits of trust by letting them fall.

Blockchains

Blockchains are completely decentralised, which is a key difference. There is no central clearinghouse like a bank and no central ledger. Instead, the ledger is distributed over a vast network, called nodes. Each node has a copy of the entire ledger stored on their own hard drives. These nodes can be connected to each other using a piece of software called a Peer-to-Peer (P2P), client. This client synchronizes data across the network and ensures that everyone has the same version at all times.

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A blockchain is used to store a transaction. It is encrypted using the most advanced cryptographic technology. Once the transaction has been encrypted, it is converted into a block. This is the term used to describe an encrypted group of transactions. The block is then broadcast (or sent) to the network of computer-nodes. Once verified, it is passed on through network so that the block can become part of the ledger on everyone’s computer. This is known as the chain and is why the tech is called a blockchain. Once the transaction is approved and recorded in the ledger, it can be completed. This is how cryptocurrencies such as Bitcoin work.

System Benefits

What are the benefits of this system over a central clearing or banking system? Why would Rob choose Bitcoin over normal currency? Trust is the answer. Trust is key. Rob must trust his bank to protect his funds and properly manage them. There are many regulatory systems in place to ensure that banks act responsibly and meet their requirements. The regulators are then regulated by the government, creating a system of checks that is geared towards preventing mistakes and bad behavior. In other words, organizations like the Financial Services Authority are created because banks cannot be trusted alone. We have seen too many instances of banks making mistakes and misbehaving.

Power can be misused or abused when there is only one source of authority. The trust relationship between people, banks and their customers is precarious and awkward. We don’t trust them, but we don’t believe there is any other option. Blockchain systems, however, don’t require you to trust them. All transactions (or blocks in a blockchain) are verified by nodes in the network before they are added to the ledger. This means that there is no single point for failure and no single approval channel.

Hacker

Hackers would need to hack millions of computers simultaneously to be able to successfully alter the blockchain’s ledger. This is almost impossible. Hackers would also not be able to bring down a blockchain network. They would need to be capable of shutting down every computer in the network. It is also important to understand the encryption process. Blockchains such as the Bitcoin one use complex verification procedures. Bitcoin blocks are verified by nodes that perform a series of complex and time-consuming calculations. This means that verification is not instantaneous nor accessible.

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Nodes that commit their resources to verify blocks are rewarded with a transaction charge and a bounty of newly-minted bitcoins. This serves two purposes: it incentivizes people to become nodes (because processing blocks such as these requires a lot of power computers and electricity), and it also handles the process of creating – or minting — units of the currency. This is called mining because it requires a lot of effort (by a computer in this case) in order to produce a new commodity.

This means transactions can be verified in a more independent manner than a government-regulated organization like the FSA. The decentralised, democratic, and highly secure nature blockchains allows them to function without regulation (they are self-regulating), government, or any other opaque intermediary. They work because people don’t trust each other rather than because of them.

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Once you understand the significance of this, the excitement surrounding blockchain begins to make sense. The applications of blockchain, beyond Bitcoin and other cryptocurrencies, are where things get really interesting. It’s easy to see how this system can be used in other ways than Bitcoin. Many of these applications are already in development or use, it’s not surprising. Smart contracts (Ethereum), the next most exciting blockchain development after Bitcoin. Smart contracts are blocks that contain code and must be executed for the contract’s fulfillment. It can be any code, as long as it can be executed by a computer. In simple terms, it means that blockchain technology can be used to create an escrow system for any type of transaction.

If you are a web designer, you could create a contract to verify if a client’s website has been launched and release funds to you when it is. No more invoicing or chasing. Smart contracts can also be used to prove ownership of assets such as property or artwork. This approach has the potential to reduce fraud. Cloud storage (Storj: cloud computing revolutionized the web and led to the emergence of Big Data, which in turn has sparked the new AI revolution.

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Most cloud-based systems run on servers located in single-location server farms that are owned by one entity (Amazon Rackspace, Google, etc). This is similar to the banking system in that your data is controlled and managed by one opaque organisation, which can lead to a single point for failure. The blockchain allows data to be distributed and removes trust issues. It also promises increased reliability, as it is much harder to shut down a blockchain network.

Digital Identification

Digital identification (ShoCard). Data protection and identity theft are two of the most pressing issues of our times. The potential for misuse of personal data is high with the vast amount of data held by centralised services like Facebook and the efforts made by many developed-world governments to store digital information on their citizens in a single database. Blockchain technology could be a solution. It encapsulates your key data into an encrypted block that can then be verified by the blockchain network whenever it is necessary to prove your identity. This technology has many applications, including the replacement of passports and I.D. It could be enormous.

Digital voting

This topic is hot in the wake the Russia investigation into the recent U.S. elections. Blockchain technology allows for verification that a voter’s vote has been sent successfully while keeping their anonymity. It promises to reduce fraud in elections and increase voter turnout by allowing people to vote from their phones. Blockchain technology is still in its infancy. Most of the applications are far from being widely used. Even Bitcoin, the most well-known blockchain platform, is still in its infancy and can experience extreme volatility, which is indicative of its relative newness. Blockchain’s potential to solve many of the major problems we are facing today makes it a fascinating and attractive technology to watch. I will be watching closely.