Blockchain Technology Explained

Everyone focuses on Bitcoin. But what’s really magical about Bitcoin is what makes it work – blockchain technology. And the startling truth is that blockchain technology has vastly more important uses than Bitcoin. It will fundamentally change the world around you in a myriad of ways that have nothing to do with Bitcoin or other cryptocurrencies like it.

Transactions could be instant. At the moment it can take days to transfer money internationally and the stock market runs on a T+3 basis, so settlement takes 3 whole days.

It could become impossible for fraudsters to sell the same thing to two people and make off with their money. You’ll be able to verify that the seller owns the item they’re selling, and that the ownership was transferred to one person only – you.

The blockchain’s unique combination of transparency and privacy allows you to open aspects of your life to others without them realising its you specifically. Your medical records could be instantly available to anyone you give permission to, as well as medical researchers getting access to all your information without linking it to you personally. Government regulation could track all market participants for what they’re up to, without linking any given wallet to a person until they establish a crime is committed.

Your business’ partners could automatically pay you the very instant you deliver the goods or services, without the payer lifting a finger. In fact, it’s possible to use blockchain technology to make an agreement that forces payment automatically when contract terms are met. No more chasing invoices.

These are just some examples of what blockchain technology will be able to do. The biggest gain is cost. Blockchain does most of the work currently done by back office bankers, lawyers, government administrators and accountants. Blockchain technology could sweep them out of our daily lives and replace them with something instant and free. It’s not small change.

What is a blockchain and how does it work?

The blockchain is a chain of blocks. I know, that doesn’t help much. The tricky thing about understanding blockchain technology is that it is defined by what it does, not what it is. After all, there’s nothing like it.

Think of a blockchain as an open ledger which is kept in many places at once – decentralised. These different places are constantly updating, agreeing and verifying the ledger using a consensus to establish what the latest ledger changes are.

Each change to the ledger — transaction – adds another block onto the chain of ledger records. The block is time stamped and records who moved what to whom.

Because the previous blocks aren’t changed in any way, they’re a record of what transactions occurred previously.

By having a record of transactions instead of a record of simple ownership, it becomes very difficult to falsify anything. You can’t just go into the government’s records office and change the name on an ownership document because the blockchain makes it obvious you didn’t get the ownership in the correct way in the first place. If you tried the same thing on a blockchain, the ledger would ignore your efforts because it clashes with all the other people’s version of the ledger.

People interact with the blockchain using a digital wallet. There are several ways to go about having a blockchain wallet, so much of what you’ll read about this is contradictory. For example, you can use your wallet in a way that links it to your actual identity, or you can remain hidden behind cryptography. But the idea is simply for the blockchain to identify and interact with the digital “you”.

You can build all sorts of other functions into the blockchain, but I’ve given you some of its basic essence. By making record keeping and transactions happen at the same time and verified by everyone continuously, the system works its magic.

What do we get out of it?

Advantages of blockchain technology

The biggest benefit of blockchain technology is that it’s effectively free. By using consensus to verify the ledger is correct, the task of keeping everyone honest is evenly distributed amongst users.

Anyone doing anything dodgy is simply ignored as their adjustment to the ledger doesn’t get accepted. They can’t corrupt the system.

No intermediaries are needed to make a transaction happen in blockchain. You don’t need visa, your bank, the other person’s bank, brokers or anyone else to be up and running.

There’s also no counterparty risk because the transaction is instant. You can’t be defrauded by someone who doesn’t pay in the end or doesn’t deliver you ownership of what you’ve bought. This is an especially exciting area called smart contracts. More on that in a second.

How to use the blockchain

The power of blockchain could be harnessed in many ways. Any system that needs secure ownership records and instant transfers of this ownership are set to be revolutionised by the blockchain.

The media gives all the attention to Bitcoin – a currency system. Instant transfers of money that are free and reliable certainly beats the modern banking system. Bitcoin and its currency cousins are keeping people in Venezuela alive these days while the government currency and bank system fails.

But crypto-currencies are just the beginning. Blockchain could be used by our own government currencies too. They’re mostly digital these days, afterall.

British banks and financial markets are set to be some of the earliest commercial adopters of blockchain technology. They’ve already invested in startups that will make the banking system outrageously efficient. A huge amount of back office staff work on transactions. They wouldn’t be needed any longer.

In fact, I’ve considered buying bank shares since realising that banks could see their cost of operation suddenly tumble.

Blockchain innovations so far

The list of blockchain entrepreneurial efforts is vast and growing.

The big four accounting firms are all investigating using blockchain technology. Ernst and Young issued all its Switzerland based employees with digital wallets and installed a bitcoin ATM in their offices.

Smart contracts are my favourite blockchain technology. They’re contracts designed to be enforced without human interaction. Once one side delivers on its side of the bargain, the payment is processed automatically. Because the contract is programmed into the very transaction process itself, the payment is tied into the agreement. It is not a separate thing like paying an invoice after the contract is complete. As soon as the programmed code which you agreed to with your business partner recognises you’ve done your bit, the payment is sent to your blockchain wallet. Etherium is the leader in this area.

As you might have guessed, the biggest area of blockchain innovation is the financial sector. That’s partly because it can still be such an arcane place. The R3 initiative is made up of 42 large financial institutions who are agreeing on standards to cooperate on potential blockchain solutions to their outdated problems like T+3 settlement. The Australian Stock Exchange awarded a deal to one blockchain initiative already. Silicon Valley is competing with the banks too.

Unlike Bitcoin, blockchain technology doesn’t necessarily require you to make an effort to understand it if you want to benefit. In coming years, if you find your bank fees tumbling, your broker getting very efficient and your business partners paying up instantly, you’ll realise what blockchain has achieved.

Category: Investing in Bitcoin

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