Cryptocurrency is a hot topic these days, and tech-minded investors are quickly buying blockchain stocks, Bitcoin stocks, and Ethereum stocks. Even if one is not interested in putting real money into digital currency, the tech savvy investor at the very least keeps an eye on Blockchain news, Bitcoin news, and Ethereum news.
Cryptocurrency relies on blockchain technology.
Blockchains are not built from a new technology. They are built from a unique orchestration of three existing technologies. But what exactly can blockchain do?
A blockchain is comprised of three principal technologies, private key cryptography; a distributed network with a shared ledger; and an incentive to service the network’s transactions, record-keeping and security. None of these technologies is new, they have been combined in a novel way that supports cryptocurrency.
Cryptography allows users to conduct transactions securely online.
If two people want to conduct a transaction over the internet, in this system each of them holds a private key and a public key. Blockchain technology features this component, creating a secure digital identity reference. One’s online identity in this transaction is based on possession of a combination of both private and public cryptographic keys, and the combination of these keys can be seen as a dexterous form of consent. In turn, this system creates an extremely useful digital signature, which provides strong control of ownership, making the transaction even more secure.
While cryptography solves potential authentication issues, a strong control of ownership must be combined with a means of approving transactions and permissions–this is also known as authorization.
Blockchains achieve this through a distributed network, in which a large network of validators reach a consensus that they witnessed the same thing at the same time. The more validators on a distributed network, the more secure the network will be. A distributed network is most useful if it contains a number of computers, which increases the network’s aggregate computing power.
For public blockchains, “mining” entices other individuals to dedicate their computers’ processing power, which in turn helps make the entire platform more secure.
Bitcoins and their base units, called “satoshis,” must be unique to be owned and have value. To ensure uniqueness, the nodes serving the network must create and maintain a history of transactions for each individual bitcoin, achieved through computers solving proof-of-work mathematical problems. The increased computing power helps eliminate the possibility that the same bitcoin would be used in separate transactions at the same time. In turn, this allowing a bitcoin function like a more traditional commodity, such as gold or silver.
Data can be stored on blockchains in any combination of three ways.
One is as unencrypted data, which can be read by every blockchain participant in the blockchain and is fully transparent. Another is as encrypted data, which can be read by participants with a decryption key that provides access to the data on the blockchain, and that can prove who added the data and when it was added. Lastly, there is hashed data, which can be presented alongside the function that created it to show the data wasn’t tampered with.
Blockchain hashes are generally created in combination with the original data stored off-chain. For example, digital “fingerprints” are often hashed into the blockchain, while the main body of information can be stored offline. This type of a shared system of record can change the way disparate, or geographically distant, organizations coordinate their efforts.
This is how a blockchain works on a technical level. But how a blockchain works on a larger scale, with respect to its impact, or potential impact, on an economy, is also worth considering. Financial institutions have finances disruptions of numerous industries over the past three decades. However, financial institutions seem to be unaware of the sort of disruption that technology like blockchains can cause to their older, more static counterparts.
Where do banks stand with the development of blockchain technology?
In an attempt to not be left behind during a tech revolution, banks have proactively set up research and development labs, and have built testing centers and established partnerships with blockchain developers, all in an attempt to better understand the revolutionary potential of this new technology. Although financial institutions were the first to start researching applications of blockchain technology, academia, governments and consulting firms have also dedicated considerable time and effort to exploring blockchains and developing new ways to use the Bitcoin or Ethereum blockchains–or even create entirely new blockchains.
Cryptocurrencies were the first platform developed using blockchain technology, but the application of that technology has proliferated.
Blockchains have moved from a platform to exchange cryptocurrencies to a platform for smart contracts, a broad category encompassing three subtypes of contract. One category is “vending machine” smart contracts, in which machines engage after receiving an external input, such as a cryptocurrency, or send a signal that triggers a blockchain activity. Another category is smart legal contracts, also known as Ricardian contracts, which is based on the idea that a contract is a result of an agreement between consenting parties.
Ricardian contracts can be a combination of a verbal agreement, a written agreement, as well as aspects of blockchains such as timestamps, tokens, auditing, document coordination, or business logic. Lastly, the third category is Ethereum smart contracts, programs that control blockchain assets and that are executed over interactions on the Ethereum blockchain.
A blockchain database contains a history of itself.
As a result, blockchain databases are called immutable. It takes considerable effort to change an entry in the database, as it would necessitate changing all data that comes after this change, and on every node in the blockchain. Thus, blockchains are more a system of a record than a database.
Blockchains can do a lot. And their potential has yet to be fully understood or unveiled. Undoubtedly, as blockchains become more ubiquitous, both cryptocurrency platforms and brick and mortar financial institutions will continue to find new ways to employ the technology.