by Merlin Rothfeld, Online Trading Academy
Cryptocurrencies may be making all the waves in the financial world right now, but even greater potential exists in the underlying technology that powers them. Blockchain technology is set to revolutionize entire industries and professions, making the way we store data, purchase goods and conduct business much more secure, efficient and cost-effective. It’s about to revolutionize the way the world conducts business, much the same way Bitcoin has shaken up the financial markets.
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What is Blockchain Technology?
Blockchain is an entirely new technology and to understand it you must first take a look at the old way of doing things. The current, and most common, way of establishing and maintaining information is a database, a centralized system where all information is stored and controlled by one company or organization. That singular control is a liability with centralized databases; not only does one entity hold all the information, some of that information may be incorrect. Allowing singular control of a database also makes it much more vulnerable by providing hackers with an easy target that doesn’t move.
Stock Shock and Trust Issues
Databases are far from infallible. Here’s a real example of just how off a database can be. In 2013, Dole Food, the fruit company, was bought out. At the time of the buyout, Dole held 36.7 million shares of stock, but when it came time for shareholders to cash out, 49 million legal, legitimate claims of shares were presented. How could something like that happen?
It happened because people thought they owned stock, but they didn’t—and you don’t. Since 1973, all stocks purchased on eTrade, Tradestation or any other trading platform are held by the Depository Trust Company (DTC), a member of the Federal Reserve System. That’s right! The stocks in your 401(k) plan and all the stocks your neighbors and friends think they own are held by the DTC–to the tune of over $37 trillion. Like the money you assume you have in your bank account, all you really have is a piece of paper or a website you can access that says it’s yours, but in reality, it’s not.
The blame for the Dole boondoggle fell squarely on the DTC, which couldn’t keep track of all the shares they were holding. If this doesn’t make you nervous or distrustful of shadowy government entities, it should. They were off by 13 million shares – an error of 33 percent! And that’s just one example. When databases like this one can be so colossally off, how can this kind of error be prevented? Through a new technology called blockchain, that’s how.
Blockchain to the Rescue
Blockchain technology eliminates the ability to create fake or incorrect information by tracking every bit of data. It knows exactly how many bits of data there are and who owns each bit. Blockchain technology is the backbone of all cryptocurrencies. Without blockchain, none of them would exist. Blockchain stores all data in a decentralized, transparent and secure digital record called a ledger. The ledger is permanent and immutable – it can never be changed.
What is a Node in Blockchain Technology?
Copies of the ledger are distributed on a worldwide network of nodes. A cryptocurrency such as Bitcoin has thousands of nodes dispersed in many different countries, so there’s no chance of the network ever shutting down. Each node contains a complete copy of the ledger. The more nodes there are, the less chance of a false entry, since more than 50 percent of the nodes must agree on the transaction before it is verified. With a blockchain like Bitcoin’s, there is virtually no chance of false information ever being verified. The larger the network, the more secure and accurate it is.
How Does a Blockchain Work?
Let’s use a Bitcoin transaction between Mary and Ed to explain how blockchain works. Mary wants to send one bitcoin to Ed, and just like anyone accepting money from another person, Ed wants to make sure that the currency is real, it belongs to Mary and that she hasn’t already spent it. With blockchain, all those issues are eliminated. To transfer the Bitcoin to Ed, Mary will send three pieces of information to the network: her public address, a private key and Ed’s public address. Mary and Ed’s public addresses are long series of alphanumerical characters. A public address is like your home’s physical address – you provide it to businesses and friends, anyone can locate it, see it and even peer inside. It’s where the Bitcoin is stored. Mary’s private key is an even longer series of numbers and letters and controls her public address – it’s the only way to get in, and without that private key nothing can happen. Mary’s request is sent to the distributed network, which will validate all three elements of the transaction. The network will make sure the private key is associated with the public address and that Mary has enough Bitcoin for the transaction. Once the network has all three pieces of the transaction and they are agreed upon by consensus and validated, the Bitcoin is transferred to Ed.
Building Data Blocks
Now that Ed has his Bitcoin, let’s follow that transaction into the blockchain. Once it’s validated by the network, it’s combined with other transactions based on time or conditions into a block of data. This data block not only contains transactions, but also mining rewards, fees, timestamps, previous block information and a reference code for the block, called a nonce. Once the block is complete, it goes into a chain and is linked with other blocks, creating an unalterable, immutable and permanent record – a blockchain. The network validates all transactions and will reject any modifications to the blocks of data or to the chain.
In the block of data before Mary sent one Bitcoin to Ed, Mary had 10 Bitcoins and Ed had zero. In the new block, Mary now has nine Bitcoins and Ed has one. From this point on, anyone can search and see that Mary’s private address now has nine Bitcoins. There’s no argument or mistake. Any future transactions will go back through this chain–the ledger–to find the most recent transactions and balances at Mary and Ed’s addresses.
What Are the Types of Blockchains?
There are various types of blockchains. A public blockchain is the kind used by Bitcoin and other cryptocurrencies. It’s a distributed, open source ledger that anyone can make changes to and works with a consensus algorithm, meaning that the network as a whole must agree on all transactions. It’s a better, more secure system because it can’t be manipulated. A federated or consortium blockchain is internally run by a select group, such as banks and financial institutions. The public has no access, but because the blockchain is immutable, it’s a much more efficient, transparent and even trustworthy way of doing business. A third type of ledger is a private blockchain, controlled by one organization, usually a corporation. Smaller blockchains make it easier to control more than 50 percent of the network, so they are much less secure than a ledger with thousands and thousands of nodes dispersed all over the world.
The implications for the commercial use of blockchain technology are staggering. In a test run of a federated blockchain by Walmart, two mangoes were tracked every step of the way from harvest to store – in two seconds! Imagine being able to track a package and know exactly where it is anytime, anywhere. Or using a private key to verify your identity and have a driver’s license mailed to you instead of standing around all day at the DMV. Blockchain is much more than just a database–it’s a whole new way to perform and record transactions on many different levels, with a massive potential for world commerce.
What Potential Does Blockchain Technology Offer?
What are the Strengths of Blockchain?
When it comes to the benefits of blockchain technology, it’s mostly good news. Blockchain inherently promotes disintermediation, the removal of intermediaries and middlemen from a transaction. That makes the process much more efficient and cost-effective. It’s is also a very transparent system, allowing everyone to see every step in the process. Blockchain is durable, reliable and unless every node of the blockchain disappears off the earth, all transactions are permanent. There’s also a built-in integrity to the process, thanks to all the trust mechanisms in the blockchain network working together to ensure accuracy. A blockchain transaction is also immutable – once it’s made, it can never be changed. Blockchain also eliminates the conflicts that can plague a standard database, creating a more simplified ecosystem. And, of course, transactions are just much faster and more cost effective.
…followed by a bit of caution
Remember that blockchain is fledgling technology–it’s new, so hiccups are to be expected. Thankfully, there’s a massive support community dedicated to quashing any unforeseeable kinks. There is also the issue of uncertain regulatory status. Right now, it’s safe from government regulation, with initiatives proposed to protect the technology. Some countries are fearful of such a powerful technology without some sort of government control, especially when it comes to cryptocurrencies. It also takes a huge amount of energy to run the computer nodes and miners the network requires. And with the reward of cryptocurrency for mining blocks of data, more and more powerful computers will need to run 24/7. Control, security and privacy are a concern, especially with integrated and private networks. It’s also going to be very expensive for companies to upgrade to a new database technology despite long-term savings. And finally, blockchain needs to be understood, accepted and trusted by not only businesses, but the public. New technology tends to make people wary, but as more and more people are educated about the benefits of blockchain, the easier it will be adopted in more and more places.
The Future is Already Here
Blockchain technology is set to revolutionize entire industries with a faster, more efficient, more secure and less expensive way of storing data and conducting business online. Cryptocurrencies are just the beginning – blockchain is the framework of the future, with endless potential just waiting to be tapped.
Previous Articles in this Series
Cryptocurrencies 101 – Simple Answers To The Questions You’re Too Embarrassed To Ask
Cryptocurrencies 102 – How To Build A Fort Knox For Your Assets
