New Kid on the BLOCK

Blockchain Technology - Road to Revolution or Financial Fairytale?

11 Oct 2016, Fanny Siltberg

New Kid on the BLOCK

In the wake of the digital currency Bitcoin’s failure, the world has instead turned its eyes to blockchain, the underlying technology behind bitcoin. Where some hail it as the next technology revolution - a means to a new democratic and transparent world order where banks are rendered obsolete - others scoff at the mere thought of the blockchain becoming anything more than a feverish fantasy for coders and cryptocurrency enthusiasts. Is there a future for “The Internet of Value”? The LINK tries to find out what is what in the world of blockchain.

In late 2008, as the world was trying to come to terms with the financial crisis, a certain Satoshi Nakamoto published a paper called “Bitcoin P2P e-cash paper”. It came to be the foundation of Bitcoin, a so called cryptocurrency that not only caught the attention of the whole world, but promised a revolution of the monetary system. However, the years that followed didn’t fall out as expected, and today it is quite clear that Bitcoin wasn’t all that it promised to be. But in recent years, the technology behind it, blockchain, has increasingly come into focus. And it is gathering up a storm of attention within the fintech industries. But why, you may venture to ask.

Before answering that question, let’s look at the basics of how a blockchain actually works. In the same way that internet is a transmitter of information and data, blockchain is a way of transmitting assets. For the bitcoin, it was used to trade and transfer currency, but it can also be used for sending money, carrying out transactions, and for foreign exchange trading.

For those of us less enlightened in the backend of digital solutions, it is not the most straightforward process to understand. The short explanation is this: blockchain is a publically shared, transparent ledger of transaction records that enables secure peer to peer transactions without the interference of middlemen.

Let’s look at an example of a simple purchase process and how it would work on a blockchain. As the name suggests, it is a chain of blocks. Each block contains 10 minutes of transaction history, and is connected in chronological order to all blocks before and after it in the chain. It is, in other words, a ledger of transactions. This is a function that our banks provide today, together with a number of other actors who are involved each time we make a purchase. But unlike a traditional bank, whose ledgers are centralised, the blockchain ledger is distributed on thousands of specialised computers around the world, so called mining computers.

But why do we have intermediaries such as banks in the first place? Simple, it is all down to trust. In order for us to want to give away our money, we need some kind of entity that can validate and manage transactions. We trust them to guarantee that our money end up where it should, to the right person and without being corrupted in some way.

So, if blockchain works without any intermediates or middlemen, how can we trust it? The answer is “mining”. The mining computers, or miners, collect the transaction history into blocks and once a block is finished, transform them into a mathematical puzzle. Then the “mining” begins. To validate the block and the transactions it contains, all miners compete to solve these mathematical puzzles. The first one to solve it, notifies the rest of the miners, who control that the calculation is true. Once this is done, the block is approved and is added to the chain. In this way, a chronological chain of blocks is created, where each block is time stamped and validated individually.

The process continues and the chain grows as miners direct their attention to the next block of transaction that has aggregated in the meantime. This process continues to form an ever growing ledger of transactions - the blockchain, and the transactions are carried out and validated without passing any kind of centralised middleman. It is instead the mathematical puzzle solving, the miners, that protect the blockchain network. In order to hack a transaction, a hacker would need to hack not only all the blocks leading back to the transaction in question, i.e the entire history of commerce, but also do it on more than 50% of the connected mining computers simultaneously, since the ledger is distributed on thousands of computers across the world. No mean feat to say the least.

Given the above, it is easier to see why the arrival of blockchain has put the financial industry on the edge of their seats. It has the potential of opening up a world of possibilities in terms of time saving, participation and personal integrity.

The fact that the middleman is cut out has several positive implications according to blockchain proponents. Don Tapscott, author of the book “Blockchain Revolution: How the Technology Behind Bitcoin Is Changing Money, Business and the World” calls Blockchain The internet of Value and is one of the more prominent enthusiasts of blockchain. He argues that blockchain can bring prosperity through a truly shared economy and personal data control among other things. He describes how, in his view, shared economy celebrities like Uber, AirBnb and Lyft, aren’t successful because they share and spread the profit as the term “sharing economy” suggests, but rather because they have aggregated services together and then sell them. The capitalisation is still centralised.

“What if, rather than Airbnb being a $25 billion corporation, there was a distributed application on a blockchain that was essentially owned by all of the people who have a room to rent? And when someone wants to rent a room, they go onto the blockchain database and it helps them find the right room, and then the blockchain helps with the contracting, it identifies the party, it handles the payments just through digital payments -- they’re built into the system. So, the big sharing-economy disruptors in Silicon Valley could be disrupted, and this would be good for prosperity”, he said in his TED Talk from June this year.

The financial industry hasn’t been slow to jump on the bandwagon either. Goldman Sachs recently filed a patent in the hope of being able to facilitating foreign exchange trade via blockchain. The transaction process of today is a rather cumbersome one, where a party’s funds are held up in an intermediary’s transit until the counterpart has provided theirs. This can take up to a day, which means that the foreign exchange market is not as efficient as it could be.

“But to me, the blockchain, the underlying technology, is the biggest innovation in computer science - the idea of a distributed database where trust is established through mass collaboration and clever code rather than through a powerful institution that does the authentication and the settlement”, Don Tapscott writes in a report for McKinsey.

Of course, even a rose has its thorns and the blockchain technology has by no means gone uncriticised. Ian Harper and Peter Evans-Greenwood work for The Centre of the Edge, a Deloitte department focusing on digital trends. They shed some balance to what they call the blockchain hype.

“The challenge is that blockchain is a limited technology. Bitcoin – the genesis of the technology – can only process a few transactions a second and is already struggling with performance limitations. This problem is compounded by enthusiastic marketing where the term ‘blockchain’ is being stretched so thin it has become nebulous”, they state in a report published earlier in 2016.

An even bigger issue perhaps, is the fact that blockchain lacks a governing body. As the internet was established round the world, several organisation revolved it that made sure that there were some sort of guidelines in place, for example The Internet Corporation for Numbers and Names who controls web domains. The problem with blockchain, being open source and distributed worldwide, is that it lacks that stability and direction. Tapscott himself sees this as one of the biggest issues and describes it as being a complete Wild West. Many associate Bitcoin with illegal activity, something that contributes to the scepticism.

An even bigger issue perhaps, is the fact that blockchain lacks a governing body. As the internet was established round the world, several organisation revolved it that made sure that there were some sort of guidelines in place, for example The Internet Corporation for Numbers and Names who controls web domains. The problem with blockchain, being open source and distributed worldwide, is that it lacks that stability and direction. Tapscott himself sees this as one of the biggest issues and describes it as being a complete Wild West. Many associate Bitcoin with illegal activity, something that contributes to the scepticism."

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