If you haven’t been living under a rock for the past decade, you must have heard about blockchain. Why do people talk about blockchain so much? Can this technology change the world?
As Bitcoin saw a parabolic rise in its price in 2017, many people started using the word blockchain which now became a part of our everyday vocabulary. However, it cannot be said that the general understanding of blockchain technologies increases proportionally.
So, how powerful is this blockchain database? And which areas of our lives can it revolutionize?
Blockchain: the Public Database
In short, blockchain is a very specific form of database (or better yet, public ledger, or public book of accounts). It is distributed (stored on multiple computers), does not have a central administrator, can be accessed by anyone, but can only be written to by consensus. It is created through the voting of financially motivated network participants (at least in the case of a public blockchain, because there are other concepts). This makes it possible to store data or transactions securely and permanently without the need for a central supervisory authority (and thus without a single point of failure).
The validation is taken care of by the network itself. Users who participate in the validation of transactions by voting are rewarded for their activity in the form of network coins and tokens of the blockchain (for example, by Bitcoin, Litecoin, etc.). Today, you can easily exchange these coins and tokens on specialized crypto exchanges for government-issued fiat money (e.g. for USD, Euro, etc.). The important aspects of the blockchain are stability, simplicity of specification and immutability (permanent nature over time since it is extremely difficult to falsify it).
A successful public decentralized blockchain is not vulnerable to misuse (tampering) of records or loss of data. In addition, it allows two or more parties to make transactions with each other without having to know and trust each other. Blockchain transactions cannot be challenged through censorship or the exclusion of one of the parties (as was the case in 2010, when MasterCard, Visa, and PayPal began blocking donations to Wikileaks accounts).
But how does such a blockchain actually work? Let’s try to explain it without unnecessary technicalities.
Blockchain: How (Not) to Have Pizza for Free
Take an example of a simple transaction: I bought a whole pizza, I met you, and because you looked hungry, I offered you a half. You had a half, and I had a half at the end of this transaction. Neither you nor I needed an intermediary for the transaction to oversee the honesty of the entire process and possibly regulate it somehow.
Now, let us move on to the digital world. Say, you can buy pizza vouchers from a Pizza Factory website and you can exchange your voucher for a pizza in many places. Such a voucher is in a digital format. If this voucher is to retain its transaction value, it must not be easily copyable. In other words, we must somehow ensure that there will always be only one copy of it – one voucher for one physical pizza. Otherwise, you could multiply this voucher and give or sell it to many people. No one, including the pizza factory, might find out as long as you would keep this “voucher copying” within some limits.
In the example above, we have touched on the so-called problem of double spending – someone could pay twice with the same asset (e.g. with a copy of a voucher). If you know just the general principles of how computers and computer networks work, you can see how big a problem we are facing. This is because data is usually moved by copying. For example, a photo (a picture file) or a document (a document file) can be copied and sent out very easily. Thus, you can have the same photo or the same document in multiple locations.
Absolutely Reliable Accountant
But let’s go back to our pizza transaction. What if we had a ledger that contained all the transactions made with the issued vouchers (“digital pizzas”) and someone who would oversee the accuracy of the records? Any transfer of ownership of such a pizza or part of it would be easy to trace and verify, and our accountant would be responsible for the accuracy. Problem solved?
Unfortunately, not quite, since we need to trust the integrity and accuracy of our accountant. Suppose he is careful at first, but later on he will start slacking. Once he realizes his mistake and finds out that no one but him has noticed it, or at least no one minds yet, he might later be vulnerable to bribery – to allow double spending. He might also take advantage of the system and edit older records. Another problem can arise when our accountant starts to play the censor and arbitrarily excludes someone he doesn’t like from the transaction process. What is the solution?
Public Ledger for Everyone
What if we made the ledger, or its current copy, available to everyone and also left the entry of transactions to users? They will verify transactions until one page of the accounting book is completely filled. Then, it will be sealed with a unique key that all the accountants in the group agree on, ensuring that no one can tamper with its contents in the future. This key will also ensure continuity, as each subsequent page will need to contain the fingerprint of the previous one. If a whole series of pages connected in this way is created in this manner, it will be practically impossible to fake pages with false transactions into older records, since the seals/keys would not match.
When you imagine our page as a separate block which is linked to the entire transaction history through the key of the previous block, you get a rough idea of why we are talking about a blockchain – a chain of blocks. Now, you can no longer sell the same “digital pizza” (voucher) for the second time, because an attempt to make such a record does not synchronize with the database copies of all the other members of the network. The deeper the record of the sold “digital pizza” is in the history of the public ledger, the more difficult and less likely such tampering with the record is. In addition, the system is overseen by all the participants – not just by a single central authority that could decide who will be able to participate in the transaction, or, contrary to the rules, has enriched itself with a few extra pizzas.
Blockchain: Verifying and Updating the Records
But how to ensure that network members are sufficiently motivated to become active accountants of the system to check and update records?
When it comes to checking, it is a little easier, because in order to confirm the validity of older records, we only need to own a valid copy of our digital ledger.
Regarding the verification of new transactions, some work will be needed. For such work, a small reward in the form of, say, a little slice of digital pizza could be distributed to each accountant for each completed and sealed page of the public ledger. And at the same time, this would also be the only way to add more pizza to the system. The accountant can keep this reward or sell it.
This will not only ensure a willingness to create records, but could also reduce the number of attempts at fraud, as few will want to devalue their own wealth.
But how else to ensure that one super-efficient accountant does not collect and sign most transactions? That would circle back to the problem of having a central authority. So how about involving some randomness in the whole process? For example, accountants could draw lots to see who can sign the page with the completed transactions. No one would be sure in advance that it would be him.
Of course, in order for such a system to work, a few technicalities remain to be solved. Fortunately, we don’t have to do this from the beginning, because such a system already exists. It is called the Bitcoin protocol and instead of pizza it uses a digital coin known as Bitcoin. The total number of digital coins in the Bitcoin protocol is limited to 21 million, which makes it a highly deflationary asset in the long run. Otherwise, everything works similarly to our simplified pizza accounting described above.
Advantages of the Blockchain
Let’s sum up what such a system has allowed us to do and what the advantages of the blockchain are:
- The blockchain preserves the scarcity of an asset in the digital world.
- Any transaction is permanent and very well documented. For example, the “pizza” is no longer yours, or at least not whole, and everyone knows it. All transactions are permanent and immutable.
- No third party is needed to oversee the process.
But that’s not all. Many other benefits stem from the very digital nature of our asset. Now, we are not bound at all by the physical limitations of our world. For example, we can combine and divide our pizza almost at will and send only a part, equivalent to 0.00000001 of a pizza to someone. Or we can create other digital goods over our pizza (for example, a pizza base with all kinds of toppings) and use the pizza only as a base layer.
We can also attach a message to the pizza. Speaking of attaching text, why not attach some more useful code to pizza right away? For example, a certificate of ownership of one share (or a fraction of a share) of a pizza factory, a digital ID, or perhaps a code with a smart contract that will be executed only after all the proposed conditions have been met (you cannot have pizza until…)?
Hopefully, it’s clear why people talk about the blockchain so much. It is definitely not because of pizza as per our example. It is mainly because the blockchain preserves the scarcity of assets and keeps the transactions permanent and immutable. This is something that can really change our world.