Blockchain: a Comprenhensive Explanation
Blockchain: it has been called the most revolutionary technology since the Internet. It has the potential to drastically change our daily lives. It has the potential to turn the status quo completely upside down and replace all intermediaries and agencies. The only drawback? Nobody really understands it yet. Fortunately, after reading this post you will be able to explain to everyone in simple language what blockchain is and how to get others enthusiastic about it.
Let’s get started: So what is blockchain exactly?
The current form of money and transactions
To fully understand what blockchain is and what its benefits are, it is important to know how money and especially money transactions work today. Let’s start with some numbers. In 2009, 72% of all transactions in the were still done in the form of cash. In 2016, this number dropped to 45%. The remaining 55% of transactions are done digitally and this percentage seems to be increasing exponentially. The digital form of money is therefore on the rise, but it works in a completely different way to cash.
Let’s take the example of Laura and Juan to see how it differs. In this example, Laura gives a 10 euro bill to Juan. It is immediately clear that this 10-euro bill is no longer in the possession of Laura, but in the possession of Juan, because the bill has physically changed owner. With digital transactions it is different. Something or someone must keep track that Laura indeed transferred 10 euros to Juan. It is nothing more than numbers that are adjusted and tracked.
Currently, all banks do this for us. If Laura has a checking account at La Caixa and transfers 10 euros to Juan, then La Caixa ensures that the number of Laura’s account goes down by 10 and the number of Juan’s account goes up by 10. La Caixa keeps track of all this in their ledger (in the crypto world, this is also called a “ledger”). A ledger is “the record in debit and credit entries from all journals in order of category and within that category in order of time.” Or simply: a huge accounting work that keeps track of all transactions ever made (at the relevant institution).
If we just transfer 10 euros to someone, this seems like a heartbreakingly simple transaction. The average bank, however, does billions (!) of transactions per year and must therefore keep track of them all in its ledger. Much of this is done automatically, but at still countless employees are needed to keep track of it all. There are also additional costs for renting buildings, maintaining relationships, data centres, marketing et cetera.
These costs all come out of the pockets of customers and businesses. For example, as consumers we pay to have an account with the bank, while companies also have costs such as a small amount per transaction they make or are made with them. And banks want to have a profit as well of course, some of them have sky-rocketing profits. For example, in the second quarter of 2017, the largest US banks made a combined profit of 115 billion euros (!).
So, why am I telling you all of this? Because all these costs may soon be unnecessary thanks to blockchain technology.
So what exactly is blockchain?
“Blockchain technology provides a way for people or entities who do not trust each other to agree on a common digital history. A common digital history is important because, in theory, digital currencies and transactions are easy to copy. Blockchain technology solves this problem without the need for a trusted intermediary or agency.”
Perhaps far too abstract when you get this in front of you at once. Let’s go back to the example of Laura who wants to transfer 10 euros to Juan. Now this is all kept up to date by the banks because it would be chaos if we had to do this all ourselves and who is going to check that Laura doesn’t also secretly give the same 10 euros to someone else? It took years before a better solution than those expensive banks came along, but with blockchain technology it has finally arrived.
The blockchain ensures that the 10 euro transaction is automatically added to a global ledger in which all transactions are recorded. It also checks whether the transaction is valid. No intermediary (such as a bank) is needed to keep track of all this, it is all done automatically by the blockchain and the computers that keep it running (miners). But how exactly does this work?
Blockchain transaction: an example
We’ll stick with the same example, but this time Laura sends the 10 euros via the blockchain to Juan. This 10 euros is presented online as a “block”. This block contains all the information about the transaction, such as the value (10 Euros), the time it was sent, from whom it was sent, to whom it was sent, et cetera. This block is then checked by “miners”.
Miners are users who ensure that the blockchain remains secure and workable (read this post to learn some basic blockchain concepts). These are in fact computers that have the entire blockchain on their hard drive and can thus check whether Laura indeed has the 10 euros in her possession that she is trying to send. The miners who check this are randomly determined and are paid a small fee for the work they do to cover energy costs (plus a little extra).
If the miners in the network decide that it is indeed a valid transaction and Laura is not secretly giving money she does not have, then the block is approved and added to the blockchain, giving Juan his 10 euros. This block will then be checked again during a next transaction, so that Juan can spend the 10 euros again, while Laura can no longer can.
If you understand this, you already understand more than 99% of the world and can boast at birthdays that you understand what you are investing in! However, the benefits of blockchain are not only reflected in domestic transactions, but blockchain also has many additional advantages for international transactions.
The speed of blockchain
How is it that when you send an email to someone in Africa, it arrives completely free of charge within a few seconds, while when you want to send money to that same person, it takes a few days and you have to pay for it as well? In fact, you’re not doing much different. In both cases, it’s a kind of digital message that goes from one person to another. The reason why this is possible with emails is because the entire system behind all email clients (Gmail, Hotmail, et cetera) is the same. Basically, they all communicate in the same language.
This is a big disadvantage with centralized closed systems. They all communicate in their own separate language and this makes it difficult to connect them without compromising security. Virtually all banking systems suffer from this. Currently this is mainly solved by placing an intermediary between these different systems that provides enough trust and control to allow transactions to take place. However, this causes the current banking systems to be expensive, slow and prone to fraud.
Again, blockchain can be a solution to this. If everything and everyone uses the same system, the blockchain, a transaction from Laura in Spain, to Juan in the Congo, can be done within seconds. However, blockchain does not stop at keeping track of a simple transaction, but goes much further.
Blockchain: beyond money
Currently, Bitcoin is still by far the largest and most well-known blockchain application, but the number two (at the time of writing), Ethereum, is well on its way to overtaking that lead. Ethereum has become best known because it focuses not only on blockchain as a transaction tool, but also for creating smart contracts. This technology is what has enable for tokenization of assets to occur, being one of the most disruptive verticals of Blockchain, and which allowed Brickken to exist.
If you want to know what are smart contracts and how it has allowed blockchain to exist, read out post explaining them.