Bitcoin was the start,
but as a wise man once said, you ain't seen nothing yet.
Last year, Ripple Labs, creator of the virtual
currency XRP, was fined $0.7 million
(~£540,000) by
the US Financial Crimes Enforcement Network for violating regulations
concerning money laundering.
Some observers cite this
as the moment cryptocurrencies shaved off their startup hipster beards, put on
a tie, and went mainstream. Being fined by a regulator means that you’re part
of the financial services industry at last.
Given that the first and
most famous cryptocurrency, Bitcoin, was launched back in 2009, it has taken
the wider industry a relatively long time to warm to it. But now suddenly
everyone is talking about Bitcoin’s underlying blockchain technology as a
disruptor of potentially massive proportions: Sweden is trialling a
new land registry that uses a blockchain, dozens of startups
spanning numerous sectors are poking around at possible uses, and
importantly policy makers such as the European Parliament have voted in
favour of a more hands-off approach towards blockchain tech
regulation.
So, what’s the
connection between Bitcoins and blockchains? And why the renewed interest in
the latter?
It's kinda
like a database
A blockchain is a ledger of records
arranged in data batches called blocks that use cryptographic validation to
link themselves together. Put simply, each block references and identifies the
previous block by a hashing function, forming an unbroken chain, hence the
name.
Put
like this, a blockchain just sounds like a kind of database with built-in validation—which
it is. However, the clever bit is that the ledger is not stored in a master
location or managed by any particular body. Instead, it is said to be distributed,
existing on multiple computers at the same time in such a way that anybody with
an interest can maintain a copy of it.
Better still, the block validation system
ensures that nobody can tamper with the records. Rather, old transactions are
preserved forever and new transactions are added to the ledger irreversibly.
Anyone on the network can check the ledger and see the same transaction history
as everyone else.
Effectively a blockchain is a kind of
independent, transparent, and permanent database coexisting in multiple
locations and shared by a community. This is why it’s sometimes referred to as
a mutual distributed ledger (MDL).
There’s nothing new about MDLs, their
origins traceable to the seminal 1976 Diffie–Hellman research paper New Directions
In Cryptography. But for a long time they were
regarded as complicated and not altogether safe.
It took the simpler blockchain
implementation within Bitcoin to turn things around. The permanence, security,
and distributed nature of Bitcoin ensured it was a currency maintained by a
growing community but controlled by absolutely nobody and unable to be
manipulated.
Following
the launch of Bitcoin, dozens of vigorous tech startups have vied with each
other to produce the Next Big Thing in blockchain-based cryptocurrency, from
the relatively-well-regarded Ethereum to the frankly
ludicrous Coinye West.
A
notable drawback of blockchains is that their distributed nature demands
constant computational power in many multiple locations, and all the on-going
accumulated (electrical) power that entails.
“You may have heard a myth that Bitcoin
consumes the energy consumption of Ireland,” says Michael Mainelli, executive
chairman of financial tech think tank Z/Yen. “That’s absolutely wrong. It’s
only half the energy consumption of Ireland.”
So when one large bank recently announced
that it planned to bring out 400 different kinds of virtual currency, they risk
consuming 200 Irelands’ worth of power just to keep them running.
In fact, the renewed interest in
blockchains has less to do with inventing yet more currencies to spend at
hipster cafes than with realising the benefits of an MDL in cutting costs and
reducing the power of monopolies elsewhere in the financial services industry.
“Financial services are based on
mistrust,” explains Mainelli. “So what do we do? We set up a registry and get
someone to handle the transactions. If I register my sailing boat and then sell
it, the transaction is safeguarded. If something then goes wrong with the boat,
we can go back to the registry and look at the records.”
This in turn produces a monopoly of
third-party services to manage exchange and settlement in the financial
industry, which can be expensive and is not without risk of manipulation—the Libor scandal being just one recent example.
Blockchains:
For when everyone distrusts each other
But if the registry was not owned by a
central third party but sitting on multiple machines and everybody had copies,
it would have resilience and looking up transactions would be quick. And with
the data being immutable once entered in the ledger, it would provide a
permanent record that financial regulators and auditors could quickly fall in
love with.
In principle, MDLs have a much wider
potential beyond financial services. Solving the issue of trust and ensuring
non-malleable permanence of the data could make it invaluable for managing the
provenance of assets, date-stamping events, geo-stamping those events in a
specific location, establishing identity, and so on.
In other words, it’s a souped-up audit
trail for anything you like, not just a cryptocurrency. It’s not just one
system. Indeed, the situation can be compared of the database revolution of the
1970s: there wasn’t just one type or structure for a database, you created the
specific database you wanted for your own purposes.
The
current resurgence in interest in
blockchains, therefore, could be a welcome sign that
sanity is breaking out in the financial technology (fintech) investment arena,
as those working in financial services and other sectors begin to recognise the
practical benefits beyond the Bitcoin hype.
Indeed, one day we may look back on this time as a transitional period when everything changed. Blockchains could become the norm for data records sooner than we think. Mainelli offers an example: “Imagine I showed you an app on my phone that showed all the ski resorts around the world. You wouldn’t say ‘Wow, does that use a database?’ Well, duh, what else?
“In about three or four years, you’re
going to be looking at an identity app and perhaps you’ll be saying ‘Wow, does
that use a distributed ledger?’"
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