09 Dec BLOCKCHAIN – THE DEATH OF A MIDDLEMAN
“Blockchain, is a form of distributed ledger in which a record of consensus is created with a cryptographic audit trail which is maintained and validated by several separate nodes. This cryptographically assured and synchronized data can be spread across multiple institutions. It can be either decentralized, granting equal rights within the protocol to all participants or centralized, designating certain users particular rights.”
If your curiosity has ever led you to google ‘What is Blockchain?’, you have probably run into an utterly impenetrable definition such as the one above. If it makes sense to you, then brilliant – there is no need to continue reading this article – indeed, I imagine with the time saved, you could solve a Rubik’s cube, blindfolded, while simultaneously unravelling the mysteries of time travel.
If on the other hand you find definitions such as these more perplexing than illuminating, then I hope that this article will go some way to helping shed light on what is sure to be a revolution inducing technology.
Blockchain is not Bitcoin
The first, and perhaps most useful, step in understanding Blockchain technology is, somewhat paradoxically, to understand what it is not – Blockchain and Bitcoin are not the same thing: Blockchain is a sophisticated form of technology used for maintaining ledgers (or registers), while Bitcoin, is a sort of made up form of money called a crypto-currency, that uses the Blockchain technology to work. That is to say, the Blockchain is the technology that underpins cryptocurrencies like Bitcoin but Blockchain can be used in multiple applications other than cryptocurrencies.
Moreover, while many people are circumspect about the usefulness of crypto-currencies as a means of exchange, there is consensus that Blockchain technology is going to play an ever increasing, and potentially revolutionary role, in how business is conducted in the future.
So…what is Blockchain?
Having established what Blockchain is not, we must now face the more vexing question of what it is.
The best way of approaching Blockchain is to not get bogged down in understanding the technology. Rather, we need to first step back and get a clear idea of the purpose of Blockchain technology. Armed with this knowledge, we can then peer in closer to examine the inner workings of the technology that achieves this purpose.
At its most fundamental, Blockchain is a mechanism for creating trust.
This is no simple task. Business, and indeed all other forms of human interaction, at their core are dependent on trust. It is what makes society work. However, as societies grow, expand and prosper, that very growth and prosperity make the establishment of trust more necessary and yet more difficult to achieve.
As a simple illustration, consider a farmer growing corn in a small village. To sell the corn, the farmer may set up a stall and sell the corn directly to other villagers –the farmer is paid immediately so she knows that she has received payment for the corn and the villager, who puts the corn directly into his basket, knows he has received the corn. There is little need for trust as the transaction is immediate both in time and in place.
If however, we change the variables of time and space slightly, then the need for trust grows – if the villager says he will pay the following week, the farmer must trust that the villager will pay later. Similarly, if the villager pays right away but asks the farmer to deliver the corn to his barn, the villager has to trust that the farmer will make the delivery.
As the sophistication of a transaction grows, so that the corn sale takes place in different countries, and now includes shippers, bailors…stevedores – the need for trust increases. Ironically, at the same time, as the need for trust increases, the natural presence of trust decreases – villagers living in one village who have known each other since birth are more likely to trust each other than strangers living in separate countries.
Faced with this problem, the solution that we have traditionally relied on is the trusted intermediary or middleman- I may not trust you and you may not trust me, but if we both trust a third person, we can use that shared trust in the intermediary to facilitate our transaction. Examples of such intermediaries include banks, international credit card companies and escrow agents.
What Blockchain does is augment and possibly even replace the role of the trusted intermediary by creating trust directly between individuals through the use of computer software.
How does the Technology work?
Blockchain acts as a giant ledger that is maintained across a network of computers which run the Blockchain software. This ledger keeps track of the different parts of the transaction – whether the corn has been shipped, where it’s being stored, if the money has been paid, and so on.
Therefore, to really understand Blockchain, it helps to start by looking at a traditional ledger.
If I wanted to transfer $10.00 from my bank account to my beloved favourite aunty, rather than actually sending the physical money to her by Fedex or another express courier company, I just give my bank instructions to transfer the money – my bank will make an entry in its ledger indicating that my account now has $10.00 less than before and my aunt’s bank would make a corresponding entry on its ledger indicating she has $10.00 more. The system works because we trust the banks to make the correct entries – one in my bank’s ledger and one in my aunt’s ledger.
There are however drawbacks with this system – in order for an intermediary to be trusted by persons all around the world, they tend to be large institutions, with history, gravitas and, most likely, corporate team-building weekends. Often, they will need to be regulated by a government authority of some type. The problem with all this is that large institutions of this sort are expensive to run, and the necessary bureaucracies needed to manage such an institution adds cost to a transaction.
This is where Blockchain comes in – Blockchain replaces the separate ledgers held by my bank and my aunt’s bank, with one ledger that is shared by all parties to the network. A great analogy (which I have borrowed from an article by William Mougayar) would be to think of the traditional ledger as being a Microsoft document that you email back and forth between someone each making their changes, while the Blockchain is like Google Docs where both parties simultaneously have access to the same document, and the single version of that document is always visible to both of them.
The question then becomes, if the ledger is shared by all the persons accessing it, and it is not controlled by a large trusted institution, how on earth can we trust the ledger? Won’t all the people who have access to the ledger try to change it for their benefit, for example by increasing the balance in their account in the example above?
This is where the brilliance of Blockchain comes in.
At its core, Blockchain turns the classical method of creating trust on its head – instead of creating trust by centralising the process in one large institution, it creates trust by a process of decentralisation – so many people with such different and competing interests are required to approve a transaction using Blockchain that it is theoretically not possible for them to get together to rig the system.
Each time there is a proposed change to the ledger, the network works together to ensure that the change is legitimate. If the network agrees that the change is legitimate, only then is this change broadcast across the network and the ledger updated accordingly.
This process of validation is done through something called a consensus algorithm. There are many different types of consensus algorithms with arcane names like Delegated Byzantine Fault Tolerance, Directed Acyclic Graphs, Proof of Work and Proof of Stake. What consensus algorithms generally have in common though is that:
- they consist of a complex mathematical problem that is difficult to solve, but once it has been solved, it is easy to verify that the solution is correct (at this point I find it is best to have faith that the mathematicians have found a way to do this); and
- solving this consensus algorithm has some cost, in one form or another, associated with it. For example, in the case of proof of work consensus algorithms, a considerable amount of computer technology (and the associated cost of electricity) is required to solve the consensus algorithm.
That’s all a bit abstract though; let’s take a look at an example of the consensus algorithm in practice.
Let’s say that the Blockchain ledger indicates that I currently have $100.00 in my account (probably accurate unfortunately), and that my aunt has $50.00 in her account. I would like to transfer $10.00 from my account to my aunt. I therefore give instructions for the ledger to be updated to reflect that $10.00 has been transferred from my account to my Aunt’s account. In giving these instructions, a consensus algorithm is sent out to all the computers on the network.
Before the ledger can be updated, all the computers forming the network have to agree on a solution to the consensus algorithm. When one computer solves it (which is hard to do), all the other computers on the network can easily verify that the solution is correct (as this is easy to do). Once the consensus algorithm is solved and verified by the network, the ledger is updated so that my account will now decrease by $10.00 and my aunt’s account will increase by $10.00.
If someone were trying to steal my money, he would have to have falsely verify a solution to the consensus algorithm that was not correct. To do that we would have to have more computing power than 50% of the persons on the network who were also trying to solve the consensus algorithm. The cost of dedicating that much computing power to stealing my money would be much greater than the $100.00 in my account, so it simply is not worth it.
That in a nutshell is Blockchain. Of course, the Blockchain ledger isn’t relegated to keeping track of money. It can keep track of any information – whether a contract has been signed, whether the corn has been delivered or who owns valuable intellectual property.
What can Blockchain be used for?
The truth is we are only now discovering what Blockchain can be used for.
The primary benefit of Blockchain is that if facilitates trust between disparate parties without the need for an intermediary. By removing the intermediary, the speed of transactions is increased, and the cost lowered. Consequently, any transaction which involves reliance on an intermediary may potentially benefit from the use of Blockchain.
Some of the fields in which Blockchain solutions are being considered include:
- in real property, to effortlessly keep track of land titles;
- in the management of medical information, allowing teams of doctor to seamlessly work together to care for a patient;
- in the financial industry to facilitate instantaneous commercial payments, using fiat currency such as US Dollars (as opposed to a cryptocurrency) – indeed, in December 2018, the New York Department of Financial Services authorised the use of a new Blockchain-based platform called Signet for commercial payments; and
- in supply chain management, allowing the global food supply chain to be monitored and tracked in an entirely transparent manner.
Now that you hopefully have a better idea of what Blockchain is (and what it is not), you can get busy coming up with the next brilliant use for Blockchain that will change the world – what are you waiting for?
Disclaimer: This Document Provides General Guidance Only And Nothing In This Document Constitutes Legal Advice. Should You Require Specific Assistance, Please Contact Your Attorney-At-Law.
This Article was authored by Luke Hamel-Smith, Partner at M. Hamel-Smith & Co.