Unless you’ve been living under a digital rock, you would have heard about blockchain, and chances are someone has told you it will change the world and be the downfall of banks (or similar grandiose claims). Unless you are part of the 1% that understands what blockchains are and how they work you are probably at a loss as to what all the fuss is about (if you are part of that 1% then please forgive the brutal simplification of the concept that I’m about to provide). 


Having searched the Internet looking for a simple way to explain blockchain I came up empty handed, it seems there are two types of explanations: those that go into vast detail on distributed nodes, common ledgers, software architecture and cryptography; and those that are so simple they make no sense but proceed to foretell the end of the legal and financial industries as we know them.

So here is my attempt to answer some simple but vital questions on blockchain:

1.      What is blockchain?

2.      What is it used for / what could it be used for?

3.      I’ve heard it will [insert grandiose claim here], is that true?

What is Blockchain?

Having researched the topic for quite some time, this is the best explanation of blockchain I’ve found (thanks to Richard Bradley of Deloitte for this):

You (a ” node“) have a file of transactions on your computer (a “ledger”). Two government accountants (let’s call them “miners”) have the same file on theirs (so it’s “distributed”). As you make a transaction, your computer sends an e-mail to each accountant to inform them.

Each accountant rushes to be the first to check whether you can afford it (and be paid their salary “Bitcoins”). The first to check and validate hits “REPLY ALL”, attaching their logic for verifying the transaction ( “Proof of Work”). If the other accountant agrees, everyone updates their file…

This concept is enabled by “Blockchain”technology.

That’s the simplest explanation I could find, and yet unless you already had a base understanding of blockchain you’re probably not any wiser having read it.  I think the problem is that we are too focused on explaining how the technology works, rather than what it does. It would be like explaining an iPod by describing that it decodes compressed sound files called MP3s and converts them from digital format to analogue via a DAC, then transmits them via in-ear speakers to vibrate the air at specific frequencies to make sound. No one cares, all we need to know about iPods is that they let us listen to the music we chose wherever we are.

If you’ve watched Simon Sinek’s TED Talk you’ll see we’ve approached the concept of explaining blockchain completely wrong. We need to start with the why.

So why do we need blockchain? 

Blockchain allows us to trust strangers. That’s about as simple as I can get it, and it is pretty much the crux of the whole story. It allows us to trust strangers.

Based on that, you might be thinking that a blockchain is a large spiky block attached to a chain that you carry down dark alleyways and swing at threatening looking people (in the dark ages we called it a mace), and therefore you can trust strangers not to mug you. Not quite. Blockchain is a technology that means you can buy, sell, and transact with a stranger and know that you aren’t going to get ripped off.

Of course, we’ve been able to do this without blockchain for centuries.  By using a middle-man that we trust we can transact with strangers we don’t trust. For example, I can buy a house from a stranger knowing that the stranger does actually own the house, and the land it sits on, because the Government keeps a trusted record of all land ownership. I don’t trust the stranger, but I trust the Government and I can ask the Government if the land does belong to the stranger and if they have the right to sell it to me.

The most commonly used example of a traditional middle-man is a bank, we use banks as trusted middle-men when exchanging money. If I buy something from you, I’ll promise to put the money into your account, but how do you know I really will? If you are old enough to remember cheque books you’ll know that just because someone wrote you a cheque it didn’t mean it would actually clear. You could be left with nothing more than a worthless bounced cheque, that’s why we stopped using them. Today we make the transfer electronically, the bank verifies that I have the money, and that I have put it into your account. You don’t need to trust me, you can trust the bank.

The purpose of blockchain isn’t new, there are already systems and institutes (banks, Governments, escrow agents) that already allow us to trust strangers without getting ripped off. So what makes blockchain different, and why do we need it? I boil it down to two things: speed of transaction, and gaps in the market.

Speed of Transaction

Sticking with the example of buying a house, I don’t mind if it takes a day for my lawyer to check with the Government that the vendor does own it and can sell it, what’s 24 hours when you are buying a home that you’ll live in for 20 years? But if I was buying a diamond ring as a present for my wife I don’t want to wait a day to get the diamond certified (because as a typical guy I’ve left it to the last minute and I need that ring now). I need to know immediately that the person selling it does actually own it, the diamond is real, and it is of the quality claimed.

Today I’d have to wait for the vendor to send the diamond off to a lab and have it certified, then I’d have to trust that the certification I got back from the lab was real and hadn’t been tampered with by the vendor.  There goes a week, and I’ve missed my wife’s birthday.

What if there was a way to instantly lookup the ownership, history and quality of the diamond and to know that the answer I got back was 100% true? That’s what blockchain can provide, an instant way for me to trust the stranger I’m buying it from.

Gaps in the Market

There are many things that are currently tracked in registers that we can trust, such as land ownership, money (via banks), and car ownership. For each of these there is already a middle-man that we can trust that tracks and records changes in ownership. However, there are millions of things that aren’t tracked by central trusted registers, so there is clearly a gap in the market for a way to track other items.

However, the barriers to entry for creating a centralised register are huge.  Let’s say (based on the example above) I wanted to create a register of diamonds so that there was a way to quickly verify their ownership, authenticity and quality. What barriers would you face? Firstly, why would you trust me to hold that register, I’m a stranger and for all you know I’m part of a diamond stealing cartel. How would I gather the information about the diamonds and their ownership? How could you be sure that what I tell you is correct and hasn’t been tampered with? Creating a new, trusted registry isn’t something that happens overnight, we trust banks and Government because they have been around for centuries.

Blockchain removes the barriers to the creation of new trust registries. Blockchain distributes the registry across a number of people, all of whom have an exact copy of the same registry, so even if one of those holders can’t be trusted, the collection of all of them can be. Blockchain ensures that all transactions and answers are 100% correct and verified, so no one can tamper with them. Blockchain removes the need to trust an individual, it allows you to trust a system, a wide collection of individuals that must all agree on the truth.

So now if I wanted to create a register of diamonds I could set up a blockchain that contained the ownership, quality and authenticity of diamonds. In fact, someone already has:

Everledger provides an immutable ledger for diamond ownership and related transaction history verification for insurance companies, owners, claimants, and law enforcement agencies. This immediately addresses one of the major issues of document tampering. With Everledger, the record is tamper-free; it’s immutable and can therefore be trusted! Everledger has established relationships with the major certificate houses in the US, Israel, India, and Antwerp. These houses grade and certify each diamond for the market. Everledger takes this data and creates a digital ‘DNA’ record comprising the 4Cs , 14 metadata reference points and the unique identification code for each stone.

With this information, Everledger knows who owns which diamond and where it is. It can even trace the movement of diamonds on platforms such as eBay and Amazon as they are bought and sold. Everledger works with insurance companies when diamonds are reported stolen, and alongside Interpol and Europol where diamonds are crossing borders and entering black markets. Everledger has recently constructed a consumer app that enables users to add their own diamonds (and other valuable items) to the Everledger blockchain.

Stop! Don’t ask how it works.

So now we know that blockchain is a technology that enables us to trust strangers. The next question really should be “what could we use it for?”, but unfortunately most people will jump to “how does it work?”. It’s like being shown a microwave oven for the first time, don’t ask “how does it work?”, ask “what can I cook with it?”. Because if you try to explain to someone how a microwave oven works you’ll completely loose the point of why they exist, which is to help us cook food faster.

Perhaps the best analogy is the Internet itself. How many business leaders understand hyper-text-transfer-protocol and hyper-text-markup-language? Not many, if any. Yet how many can imagine and describe how the Web can be used to transform their business.

The second we start explaining how universal resource locators (URLs) direct us over an IP network to files stored on hyper-text-transfer-protocol servers (HTTP webservers) that are encoded in hyper-text-markup-language (HTML) and are secured by Transport Layer Security (TLS) we’ve completely lost the plot. Now expect someone to grasp that explaination of the web and leap to the idea that they could use it to sell things, engage with clients, or watch videos of cats.

The same applies to blockchain, we’ve spent so much time trying to explain how it works that we’re almost unable to imagine how it could be used.

If you really want to understand how blockchain works there are some great articles to help explain it, here are some I’d recommend:

https://www2.deloitte.com/ch/en/pages/strategy-operations/articles/blockchain-explained.html

https://medium.com/the-intrepid-review/how-does-the-blockchain-work-for-dummies-explained-simply-9f94d386e093

What could blockchain be used for?

Blockchain’s key purpose is providing trust in transactions, so that you can trust the thing you are buying is legit, the person paying really has the funds, and the ownership of the item is clear.  It does all this almost instantly, and it can scale to huge volumes of transactions. So what could this be used for?

Banking

Replacing the banking system with peer to peer money transfer is the most commonly used example of blockchain. Ever since the invention of paper-currency money exchange has used a middle-man. Even when paying in cash we still use a middle-man, with cash it’s the central Government bank that guarantees the $10 note you hand over can be redeemed for $10, we all inherently trust that a certain bit of paper with $10 written on it is worth $10 and we have that trust because there is a middle-man that says so. With electronic payments we rely on the middle-man (a bank or credit card company) to confirm that the payer has the funds available.

Blockchain can remove the need for this, it can enable two individuals to transact and exchange money directly without the need for a middle-man. The transaction is checked by the blockchain, certified by the blockchain, and permanently recorded in the blockchain.

Virtual Currencies

Bitcoin is a virtual currency that uses blockchain technology to provide trusted transactions without any involvement from banks or Governments.  Bitcoin and blockchain are often confused as being the same thing, but the best way of relating them is to compare their relationship to email and the internet. In the same way that email is an application that exists because the internet made it possible, Bitcoin is a service that exists because blockchain made it possible.

Bitcoin isn’t the only virtual currency, its simply the most well-known, with blockchain there’s nothing stopping more virtual currencies being formed.

Asset Exchange

Any asset that we care about the authenticity, ownership or history of is a contender for a blockchain based exchange.

These assets don’t need to be of high value. We probably wouldn’t use blockchain to exchange a cup of coffee, as we can see right in front of us that the coffee was brewed in the café by the barista, so we know who owned it and where it came from. However, we might use blockchain to exchange bulk milk powder, it may be a commodity but we do want to know its history to ensure it came from disease-free cows, feed on GM-free grass, and was produced by a reputable manufacturer.

Other obvious candidates for blockchain exchange are houses, land, precious items, artwork, stocks/shares, and any other item for which authenticity and history are vital.

Smart Contracts

Smart contracts are computer protocols that facilitate, verify, or enforce the negotiation or performance of a contract, or that make a contractual clause unnecessary. Smart contracts often emulate the logic of contractual clauses. Smart contracts allow many kinds of contractual clauses to be self-executing, self-enforcing, or both. Smart contracts aim to provide superior security to traditional contract law and to reduce transaction costs (thanks Wikipedia).

Smart contracts have been misunderstood by some to be a full replacement for commercial contracts. They aren’t that at present, they are snippets of code that can run when certain transactions take place. These snippets can execute a process agreed in a contractual clause. Let’s find an example as that’s not a simple thing to understand.

A simple example might be a contracted delivery timeframe, when an item is ordered and paid for it must be delivered within 2 days. When the item is ordered (via a blockchain exchange) it triggers a smart contract (code snippet) that records the order time. When the item is delivered and recorded as delivered in the blockchain, the same smart contract runs and checks the time it took to deliver. If it is outside of the contracted 2 day period the smart contract will execute an automatic 10% refund on the product to make up for the delay, as per the agreed contract terms.

Privacy Control

Blockchains can record and transact both physical and digital items, so there is a role for blockchains in the protection of personal data. By using a blockchain to transfer personal data between parties, the blockchain can identify who owns the data, and can then run a smart contract to test if the recipient is allowed access to that data. The owner of the data can control who gets access to the data, and just as importantly the blockchain ensures the data is authentic and hasn’t been tampered with.

 

There are dozens of other examples, with more appearing every day, as with the invention of the world wide web, I don’t think anyone could have predicted how widely it would be used when it was first launched.

I’ve heard it will [insert grandiose claim here], is that true?

These are just my own opinion, not those of my employer, and are not sponsored by anyone, they are simply my observations (well informed observations I’d hope to think):

“Blockchain will remove the need for banks.”

Blockchain may be a very disruptive technology, but it’s not going to be the end of banking as we know it. Banks do a lot more than just act as a middle-man for financial transactions, the most important role banks play is a lender of funds. Banks, particularly Australasian banks, also have vast amounts of money to spend on using blockchain technology themselves. Blockchain will have an impact on banking, but in my view that impact will be embraced by banks and used to make them better, not to make banking obsolete.

“Blockchain will take away thousands of jobs.”

Unlikely, it may impact some sectors but if anything it will create new industries and jobs. New companies will be created to offer services using blockchain, banks will adjust and embrace blockchain, and the demand for blockchain skilled developers will far outweigh the few jobs that are lost.

“If it’s on a blockchain its 100% true and you can absolutely count of it.”

No. Blockchain provides assurance that all parties (nodes) on the chain agree, but they could all be in agreement about the wrong thing. This is a key point, blockchains can be hacked, not by altering the information already contained in a blockchain, but by socially hacking the wrong information into a blockchain. Just like any technology, it can be used for nefarious reasons, there’s nothing to stop a group of organized criminals creating a blockchain that claims to verify an asset exchange that contains manipulated information.  As with anything, pay more attention to the company providing the service than to the technology they use.

“Blockchains can’t be hacked.”

Tell that to the DAO, an early player in the smart contract market that provided venture capital funding, they were hacked for US$50m in May 2016. Yes, the concept of a blockchain is one that means the information can’t be tampered with, but the very nature of a blockchain is that information in the chain is public – and it’s that fact that created the weakness leading to the $50m hack.

More to Come

I’ve barely scratched the surface on blockchain, I could write a book on it, but of course it would be out of date before it was published. So I’ll aim to write a few more articles to dive a bit deeper into the uses and benefits of blockchain over the next month or so.

Posted by Mike Bullock

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s