By Teodor Teofilov
One of the hot new topics in the past few years that has dominated the world of finance and technology is cryptocurrency. You might have heard the terms “bitcoin” and “blockchain” being thrown around, even if you aren’t particularly interested in it. Usually both of these are described in a complicated and confusing way. However, both of them can have immense consequences in the near future (bitcoin has already had a significant impact).
Even if they have a significant impact on our future, they should be explained in simple plain terms. So let’s do exactly that.
Before going into the details of blockchain technology let us first look at the history behind bitcoin.
Brief History of Bitcoin
As the writing of this article the price for one bitcoin currently stands at $11,703 and at its highest trading price it was at $20,000 at the end of 2017. But how did it get here?
Although bitcoin was the first cryptocurrency to be created, there were previous attempts with B-Money and Bit Gold. However they were never fully developed.
In 2008 a paper called Bitcoin – A peer to Peer Electronic Cash System was posted to a mailing list discussion on cryptography. A year later bitcoin was created by a mysterious person or group known only as Satoshi Nakamoto. The all-digital cryptocurrency doesn’t pay any attention to banks, governments or international borders. Inflation of bitcoin isn’t possible as there is a cap of only 21 million bitcoins to be mined, as the idea was for it to be similar to gold and be somewhat stable and predictable.
The cryptocurrency was created using blockchain in order to give it the ability to exist without regulatory oversight. We will examine the technology behind bitcoin later.
In 2010 was the first time that the cryptocurrency was trade, when an individual sold 10,000 bitcoins for two pizzas for the first time. At the current price, if they had held onto them, they would have been worth $117 million. A year later new cryptocurrencies emerged, with Litecoin and Namecoin being among the first.
In 2013, as the price for one bitcoin reached $1,000, it declined sharply and plummeted to around $300. Soon after, the cryptocurrency that was designed with anonymity and lack of control in mind, proved to be lucrative for criminals with Mt.Gox, the world’s largest bitcoin exchange at the time, going offline and filing for bankruptcy. It announced that 850,000 bitcoins were missing and likely stolen, which would be worth nearly $10 billion today.
New cryptocurrencies started growing and chasing after the crown of bitcoin in 2016, with Ethereum being closest. The same year saw the emergence of Initial Coin Offerings, fundraising platforms that offer investors the chance to trade what are often stocks and shares in startup ventures, in the same manner that they can invest and trade cryptocurrencies.
The following year would see the sharpest rise of the price of bitcoin, which reached $20,000, but it wouldn’t hold it for long, as later it fell below $6,000.
Bitcoin has had a lot of ups and downs over the years but it seems that it is here to stay. The future will most likely have a high usage of currencies such as bitcoin, but at the moment we are far away from them replacing existing currencies. The innovation that is making people more excited is blockchain — the technology behind bitcoin.
The technology that is blockchain allows people and companies to make instant and secure transaction without the need of a middleman, such as a bank. All transactions made on blockchain are kept as a record of what happened and it is often referred to as a digital ledger. But this doesn’t tell you how it actually works.
Blockchain is literally a chain of blocks, with each block representing data and everything is held in a specific order. Each data block is a transaction and blockchain is the record of all transactions and these transactions can be made and verified by both people and companies.
Let’s imagine that coffee shops in Chicago are all using blockchain to process transaction. Say Tom buys a coffee from Jenny’s coffee shop. On his copy of the blockchain, he marks that transaction down:
“Tom purchased a cup of coffee from Jenny for $3.”
His copy of this transaction gets spread around town to all coffee shops and to all of their customers, who put it down to their own copies. Before he is even done getting his coffee, the blockchain ledger of everyone will show that he bought a cup of coffee from Jenny for $3.
Blockchain allows companies and individuals to verify transactions. In Tom’s case, where he his blockchain copy was sent around town, everybody else wasn’t just adding his transaction. They were also verifying it. If his copy said “Tom purchased a cup of coffee from Olivia for $300,” then somebody would have automatically flagged the transaction. It might be that Olivia isn’t an accredited coffee seller, or everybody knew the price was ridiculous for a cup of coffee. No matter the reason, Tom’s copy of the blockchain ledger isn’t accepted by everyone as it doesn’t follow the rules of the blockchain network.
A coffee shop might be a simple way to explain it but it illustrates the point that adding a new transaction to the blockchain requires it to be verified. It really doesn’t matter what the network is, be it coffee shops or banks, everyone will have to agree to rules that determine the validity of transactions.
This security system of blockchain is one of the reasons why a lot of people and companies are interested in the technology. Records cannot be changed by anyone, so it is a trustworthy and fair source of information that can be verified by everyone.
Another reason is its speed. Although the example above makes it sound like everyone has to copy everything that happens on the chain, transactions on blockchain get processed and verified much more quickly — computers process them in milliseconds. Blockchain is faster than the alternatives because it is also decentralized.
Blockchain technology operates without a central authority. It lets people and companies add and verify the transactions with no governing body making sure everything is normal. But what does this mean exactly? A good and simple example would be if we take a look at paying your grocery bill at the supermarket.
You might think that when you enter your pin or sign, you are paying. In reality you are not. When you do that you are starting a very complex process. You are giving the merchant permission to take payment from your account, with the request going through several intermediaries. Here are the simple steps it goes through:
- You use your credit card at the terminal.
- The POS (point of sale) terminal sends the credit card details to the bank via internet or phone line.
- Bank sends credit card details to credit card network.
- Credit card network clears payment and requests payment authorization from issuing bank.
- Issuing bank receives request and validates credit card number, checks available funds, matches billing address and validates CCV number.
- Issuing bank approves transaction, sends back response to the merchant through the same channels.
- Once this is done the issuing bank places a hold in the amount requested in your account and you get a receipt from the merchant.
There is even more that happens, with the merchant in reality getting the money from the transaction within 24 to 48 hours with a fee attached.
Now the same scenario for using blockchain is as follows:
- You pay the merchant.
That’s it. The transaction between you and the supermarket gets recorded on your blockchain, the supermarkets blockchain verifies it and everything is done. It pretty much gets rid of the middleman.
With more participants, when one copy of the blockchain gets changed, all of them verify the transaction before adding it to their own ledgers. It is faster because everybody doesn’t have to wait one the middleman as it all happens simultaneously.
Blockchain isn’t too complicated, even though it might sound a bit complex.
If you want to get into more detail about blockchain you can find links to more information at the bottom of the article.
Before we conclude this quick look into the workings of blockchain let’s look at the possible advantages and disadvantages of the technology.
The Good And The Bad of Blockchain
The biggest advantages that blockchain has are transparency, security, instant transactions, not central authority and the solution to the double-spend problem.
As everybody has access to the ledger and rules of the blockchain in the network, they can see who owned, paid, gave or did what, whenever they want or need to. And since everyone has a copy of all the transactions and needs to verify them, the system is secured with no one single entity having the power — everyone is in charge of the network equally.
The transaction are also instantaneous because there isn’t a middleman and are self-validating through the network. The lack of central authority can be considered a good thing as a middleman usually slows things down and charges a fee and late penalties.
One of the main advantages of blockchain is that it solves the double-spend problem — as digital currency is just a computer file, the information can be reproduced with relative ease. Banks currently keep track of everyone’s money to avoid the same money being spent twice. Blockchain solves this more efficiently than banks as it makes all transactions and accounts public so that it is obvious when money is counted twice.
However there are a few challenges with blockchain.
For it to work it needs everybody to cooperate. This means that to be a part of a blockchain network every participant needs to be upfront and forthcoming about their security protocols. Transactions need to be transparent to everybody else so that it can be verified.
The lack of regulation can also be a problem. The government is bound to come up with rules and regulations governing the use of blockchain sooner or later but the uncertainty is an issue. Blockchain is pretty secure in making sure fraud doesn’t happen, but it isn’t completely safe from hackers. If a bank is hacked it loses its own money but if a blockchain is hacked a lot more damage can be done, especially if there are multiple banks on the network.
There is still much that needs to be done, but the technology is here to stay and the kinks will be figured out sooner rather than later. There are currently 40 central banks worldwide that are considering experimenting with blockchain and only the future will show us how much it catches one or if something new comes around that makes it obsolete.