What is Blockchain technology?
Is it “the next big thing”?
Are you missing out on a once in a lifetime opportunity
when some startup wants you to invest in thier blockchain
based venture?
Well stick around,
In this article we’ll answer these questions and more.
Today’s topic is the Blockchain and the exciting world of
blockchain technology.
Hopefully by the end of this article you’ll understand
exactly what blockchain technology is and why it’s really hard to separate it
from Bitcoin.
Before we understand how Blockchain technology works, we
need to understand what problems it was designed to solve, so let’s take a step
back and let me ask you a question...
How do we tell if something is fake or real in today’s
world?
For example, each dollar bill has a serial number that is
recorded by the bank.
Your driver’s license number is recorded by the DMV and voting records are used to track who voted and who didn’t, so the same person won’t be able to vote twice.
Whenever you want to verify that a document is legit, you just look it up with the relevant authority.
We even have Notaries, people who are licensed by the
government to act as witnesses to attest and record the validity of pieces of
information or identities.
You’ll notice there’s one thing that all of these mechanisms have in common - they are all centralized, which means there’s a central authority, whether it’s a bank, state office, or person that has the power to issue and validate information. These central authorities have a lot of power, and as you know power may sometimes corrupt.
So what happens if one of these authorities wants to change
the facts or even maybe change history a little bit?
This my sound far-fetched, but even our world history is
just a record kept by historians in a centralized manner.
The phrase “History is written by the victors” tells us that
facts can sometimes be distorted by those in power.
If you don’t think that’s possible, here’s a real life
example.
Today, most money is just a record of who owes what to whom.
Due to the subprime crisis in 2008, almost a thousand
companies in the US received over 63 billion dollars that never existed before.
Other companies had debts completely removed.
Some would argue this bailout was justified, but you can’t
deny that someone decided to change the records of how much money was owned and
owed.
This is why Bitcoin was born. It was the first form of money
that removes the need for a central authority. Its records are kept by
everyone, not just by central banks.
And when everyone is keeping track and verifying the facts,
well, that means that you can no longer change the ledger of transactions
whenever something doesn’t add up or because it’s more convenient.
Decentralization reduces the risk for corruption, fraud and
manipulation.
Blockchain technology is a new and innovative way to
implement decentralization.
In a nutshell, Blockchain technology is a solution for the
problem of centralization.
It’s a system for keeping records by everybody, without any
need for a central authority - a decentralized way of maintaining a ledger that
is practically impossible to falsify.
I mean, when so many eyes are watching and verifying
everything that’s being done, it’s really hard to break the rules unnoticed.
You might be wondering why is it called Blockchain?
So the pages are actually linked, or chained together.
Many people think that Satoshi Nakamoto, the mysterious
inventor of Bitcoin, created Blockchain technology.
Technically he only created the first real life
implementation of it - Bitcoin. In fact, that word blockchain is never even
mentioned in Satoshi’s original whitepaper. The closest he comes to saying
Blockchain is “chain of blocks”.
- How does it work
- Is blockchain going to change our future?
Let’s start with the first question.
Another way to ask this question would be - how do I create
a system that allows the creation, verification and updating of records by
everybody?
Well, there are four elements a blockchain needs to have a
life of its own.
1-
peer-to-peer network
The first thing required to support a blockchain is a peer-to-peer
network - A network of computers, also known as nodes, that are equally
privileged. It is open to anyone and everyone.
This is basically what we already have today with the
Internet. We need this network so that we will be able to communicate and share
with each other remotely.
2-
cryptography
The second ingredient is cryptography. Cryptography is the
art of secure communication in a hostile environment.
Remember, I said anyone can participate in this network - including bad actors.
3-
consensus algorithm
The third element is a consensus algorithm.
You can switch the technical word “algorithm” with the word
“rule”. This means we need to agree about rules on how we add a new page, also
known as a block, to our records.
There are many types of consensus rules, in Bitcoin’s case
we use a consensus algorithm known as Proof of Work.
This algorithm states that in order for someone to earn the
right to add a new page to our ledger they need to find a solution to a math
problem, which requires computational power to solve.
Computers around the network run calculations to solve the
math problem and in doing so, consume a lot of energy.
In other words they do a lot of work.
That’s why when one of them finds the number that solves the
problem and displays it to the network, they’re basically displaying a “proof
of work”.
Think of it as the node’s way of saying:
There are pros and cons to different algorithms, but in
order to run a decentralized ledger you’ll need to choose one, otherwise it
will be really hard to reach a consensus with so many people in the network.
4-
punishment and
reward
Finally, our last element is punishment and reward.
This element is actually derived from game theory and it
makes sure that it will be in people’s best interest to always follow the
rules.
So far, we’ve set up a network that has a way to communicate
securely, and follows a set of rules for reaching consensus.
Now we’ll glue these elements together by giving a reward to
people that help us maintain our records and add new pages.
This reward is a token, or coin, that is awarded each time a
consensus has been reached and a new block is added to our chain.
On the other hand, bad actors who try to trick or manipulate
the system will end up losing the money they spent on computational power or
their coins can be taken away from them.
In the end, the important thing to remember is that the punishment and reward system works on psychological behavior.
It turns the rules of the system from something you need to follow into something you’ll want to follow, since it will be in your best interest to do so. This was just a very high level explanation of what a blockchain consists of.
So there you have it, the four elements for creating blockchain technology - a peer to peer network, cryptography, a consensus algorithm and punishment and reward.
However, there is a fifth element, that can’t really be
synthesized...
market adoption.
I mean, we can have a group of five people sharing a ledger
with a consensus algorithm but it doesn’t really make it decentralized, since
not enough people are a part of the system.
Moreover, if there’s no adoption, there’s not really any
value to our coin and the fourth element of punishment and reward isn’t very
effective.
Only once you achieve critical mass in the number of users, does a blockchain become truly decentralized and therefore immutable.
And at that point, the coin of that blockchain usually
begins to appreciate in value.
Up until today there are only a handful of blockchains that have over 1,000 truly independent participants, and as such can be considered as decentralized - Bitcoin, Ethereum and Monero to name a few.
If you’re thinking that it sounds like a lot of hard work to put a blockchain in motion, you’re absolutely right.
But this is where Ethereum comes in.
Ethereum is a Do It Yourself blockchain where all of these five elements are already in motion. All you need to do is build the right solution on top of it. But that’s a whole different whiteboard episode you can check out later on.
Now let’s move on to another term you may have heard - a
private, or closed blockchain.
This term refers to companies that screen and limit the
players who can participate in their blockchain.
It’s a bit like how the Internet, which is open to everybody
and anybody, is different from an Intranet -an internal network of company
computers.
While I assume some companies will find value in running
private blockchains to improve their internal processes, it’s far from anything
exciting inasmuch as it has nothing to do with decentralization.
To emphasize this a bit more let’s compare open, public
blockchains to closed, private ones.
A public blockchain is
-
Open to everybody
-
It’s transnational and borderless.
-
It’s censorship resistant,
-
It doesn’t require any 3rd
party.
-
It’s also neutral - there’s
no such thing as a “good”, “bad”, “illegal” or “legal” transaction, there’s
only a “valid” or “invalid” one.
A private blockchain on the other hand,
-
Is limited to authorized participants only,
-
It's governed by a handful of entities.
In the words of Andreas Antonopoulos, in most cases of
private blockchains you don’t really need a blockchain, you can just share a
spreadsheet between the participants.
And finally, it’s censorship resistant so you can’t really
remove a record or stop it from getting published - as long as it follows the
consensus rules.
Is blockchain technology the next big thing?
I assume you may have heard of different startups that are
using blockchain technology to solve some sort of a problem. In most cases when
I hear of such a company I ask two questions:
Second, do they even need a blockchain?
For example, the queue to the pharmacy is managed in a
centralized manner but I don’t really care since there’s not a lot at stake and
it’s actually more efficient that way.
Blockchain technology is very good at decentralizing, but it’s also very inefficient, slow and energy consuming.
For example,
Bitcoin’s network takes 10 minutes on average to confirm a
transaction. Not the ideal waiting time for buying a cup of coffee at a 7-11.
The only reason to choose Blockchain technology as your
solution is if your problem is actually centralization. If you don’t need to
decentralize something, you probably don’t need to use blockchain technology and
are better off with some centralized solution. In fact it will probably work
better.
Summary
To sum it up,
So the real question is this at the current moment, is our
world ready for more complex blockchain implementation than what Bitcoin
already offers?
In the early 2000s, there were a lot of Amazons, Googles and Facebooks that never caught on for the changes they presented...
Today, many of these blockchain startups face the same fate.
It’s a solution to the problems centralization presents. I
also hope that whenever you hear the term “blockchain technology” in the future
you’ll know to take it with a grain of salt and ask the right questions.
1 Comments
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