Bitcoin, the most popular of crypto-currencies making headlines in the financial-technology world, is powered through a complex system known as a blockchain. This revolutionary technology is creating a buzz over its many possible applications in banking, accounting, law, and even the energy sector.
Blockchain technology can be tough to wrap your head around. It’s a decentralized, digital, distributed ledger. The “ledger” could be the record of transactions from a digital currency—or any other database—that’s distributed and can be viewed by all participants (if public and decentralized like Bitcoin) or by select participants (if private and not decentralized). Public blockchains have no central authority or single user that manages the system; a collective community keeps the ledger updated.
In the case of crypto-currencies such as Bitcoin, the blockchain is a network that verifies transactions through consensus, which is why The Economist has called it “the trust machine.” When you transfer money or buy something online, a bank or credit card company usually processes the transaction. Rather than security such as account numbers and passwords, Bitcoin transactions use the sender’s unique key to send an encrypted message to the blockchain to be verified.
Basically, users in the network with powerful computers, known as miners, must “solve the puzzle” based on a structure of rules to verify who the money belongs to and where it’s going.
This system prevents “double-spending,” where the same currency is sent or received twice. As a new “block” is created from the transaction, the miner is rewarded with a small amount of newly mined bitcoin.
It takes a ton of computing power and electricity to solve these complex math puzzles. This has implications on how environmentally friendly the technology is, but it also adds to its security, since it would take a prohibitive amount of money, processing power, and electricity for any one user to control the network.
Ethereum is another blockchain system—with its own popular currency, “ether”—that has shown promise as a useful platform for wide-reaching applications. Currently, Ethereum is used to execute smart contracts. Like the trust system with transactions in Bitcoin, smart contracts can use encryption to execute agreements between parties without an intermediary, based on “if-then” functions.
For example, you could agree to rent a place through Airbnb using this type of system and send a deposit. When the agreed-upon deposit reaches the owner’s account, the keycode to enter the apartment would automatically be sent to you, and the agreement could be set up so that if that keycode is not sent by a set date, a refund is automatically given to you.
This has limitless possibilities for applications in business, for executing complex purchases and deliveries, and for developing more secure voting systems and benefit disbursements in government systems.
This technology is exciting, complex, and not without its problems; the above is only a tidbit of the whole story. More next time on where this technology could be heading.