BLOCKCHAIN, A NEW TECHNOLOGY
“I don't consider myself preternaturally stupid but whenever someone tries to explain the principles of blockchains to me I begin to feel an overpowering need to bathe my temples in eau de cologne and go for a lie down.”@stephenfry | Twitter
So, what exactly is blockchain? Well I would agree with Stephen Fry, but in fact I think that although blockchain is difficult to explain, it’s not that difficult to understand. Let’s give it a go!
Let’s first imagine that a series of financial transactions, that are all linked together (such as your bank statements), are all represented by a train. Think of each carriage as a monthly statement (with the first carriage say being January) and the people sitting on seats as transactions within each statement.
Imagine that there are 12 carriages with seats in each carriage and that seat 1a in the first carriage is your monthly standing order on January 1st to pay say your mortgage, or whatever your first bank transaction of the month is.
Now think of these 12 carriages as a string of 12 blocks of data. But unlike your own personal statements (which could theoretically be altered by your bank since they control them), they are now locked and can’t be changed by anyone.
What’s more if anyone wants to add a new carriage, or a block, then it would require the agreement of a random number of computers anywhere in the world. And to make the alteration, each computer, known as a node, would need to agree that the new block was valid.
Since adding these blocks must be approved by random computers reaching a consensus and which race to add them by solving complex mathematical equations through a process known as mining, blockchains are essentially a public ledger of all transactions that have ever taken place and which cannot be hacked.
We’ve all heard of bitcoin which is a cryptocurrency built on its own blockchain. Anyone can buy bitcoin, so using it as an example, each time someone buys a bitcoin (or a satoshi which is the name for a unit of bitcoin) the transaction is approved by miners and added to the block or ledger.
I’ll explain more about mining in the next chapter but for the purposes of this book, it’s only the basics that you need to understand.
Are you with me so far? Now just think for a moment about the implication of a series of transactions which are publicly available and which cannot be tampered with by anyone. Who controls this?
The answer is simply no one, not your bank, not your stockbroker and not even the government nor you. This is why blockchains are what is known as “decentralized”.
At this point, I should add that there are different types of blockchain according to how decentralized they are.
A public blockchain such as bitcoin is available to all and anyone can participate in the consensus process.
A private blockchain can be set up by say a single company that just wishes to use it for its own internal operations, control being provided by pre-selected participants.
Finally, a consortium blockchain can be set up where there are several different entities involved (a supply chain for example), so this is really just another type of private blockchain.
As you start to get into all of this, you’ll come across a new word called “fiat”. Fiat is a legal tender like the US$ or UK£ which is issued by a government which also backs it with a promise to pay. The note that you take to the shops is accepted by the shopkeeper as he or she knows that its value is guaranteed by the government.
In the last century, most fiat currencies used to be backed by gold so that the total money supply’s value was equivalent to a country’s gold deposits. But when countries stopped this such as the UK coming off what was known as the Gold Standard, governments were free to print money, increasing the amount of currency in issue and theoretically reducing the value of each pound or dollar that you owned.
This is what has been happening since the great financial crash of 2008 through a printing process known as quantitative easing (or QE).
When a single party, such as a government or a central bank has control over a currency, then this is known as it being centralized. By contrast cryptocurrencies built on a blockchain are the opposite of this since they are decentralized, since they are not controlled by any one party.
In countries that have suffered rampant inflation, it is perhaps no surprise that many people have decided that their money is safer and will retain better value in a cryptocurrency such as bitcoin, rather than trusting their elected or unelected leaders. Cryptocurrencies are controlled by people like you and me and are owned by people like you and me.
When the Cypriot government raided people’s bank savings in 2013, it couldn’t touch their bitcoin.
But this book is not about bitcoin, it’s about giving you an understanding of the blockchain and cryptocurrency markets and the possibility of turning a small investment into hopefully something meaningful.