The fundamental principle of Blockchain is decentralised accounting, whereby network participants approve, validate and record transactions, rather than placing the onus on a single entity, such as a bank or trustee. The network participants, also known as miners, collectively time-stamp and validate entries, which prohibits unapproved changes to records.
First implemented in 2009, the technology consists of ‘blocks’ that hold batches of timestamped transactions, with each block linked to the previous one through cryptography, thus forming a chain.
As the name Blockchain suggests, transaction data is stored in blocks or data segments. Blocks are a set number of transaction records which are validated in a batch, then chained or tied together with other approved transactions. Blocks store, record and time-stamp transactions and then log them into the overall Blockchain. As the number of assets or transactions in a business network grows, the degree of trust and confidence in the ledger increases. Assets that could be tracked using this technology include tangibles like houses, cars, and land, or intangibles like patents, copyrights, and brands.
As the world becomes ever more smarter and inter-connected, cryptocurrencies have become an increasingly attractive proposition for growing markets that may not have traditional banking infrastructure. Several developing third-world nations have implemented blockchain-based national currencies, and the technology is also used by several major charity projects to help those without bank accounts.
A disruptive feature of Blockchain is that the technology facilitates peer-to-peer transfers or transactions without intermediaries like a bank or a governing body. In contrast to today’s intermediary-based transaction model, Blockchain technology requires validation via consensus among miners. This is commonly known as a proof-of-work consensus protocol. Miners must apply significant computing power to cryptographically synchronise and validate the database in real-time and, in return, earn fees or tokens from the underlying Blockchain.
However blockchain also offers the possibility of creating a fraud-proof system for transacting exchanges. This therefore gives it huge potential for use outside of the digital currency sphere, helping attract interest not just among traditional financial institutions, but in areas as diverse as manufacturing, food production and many more.
What is blockchain’s relationship with Bitcoin?
Blockchain and Bitcoin are linked in people’s minds because Bitcoin (a cryptocurrency, or unregulated digital currency that is thought to have value without the backing or authority of a government) was the first widely adopted Blockchain application.
Blockchain and Bitcoin aren’t the same thing, but they’re often thought of together because Bitcoin transactions are logged on an open-platform distributed ledger that exists on a peer-to-peer network; in other words, blockchain.
Bitcoin can also be the reward for sharing the workload of maintaining the blockchain. There needs to be an incentive for maintaining a computer that forms part of the network. With the Bitcoin network, the possible generation of new coin (so-called “mining”) is the incentive.
How does Blockchain work?
A blockchain system consists of two types of record, transactions and blocks. Transactions are simply the actions carried out in a particular period, these are stored together in a block.
What makes blockchain more unique is that each block contains the cryptographic hash of the previous one, thus forming a chain. What a cryptographic hash does is take the data from the previous block and transform it into a compact string. Since these strings are impossible to predict it means that any tampering with the chain is easily detected.
The linking of blocks isn’t the only thing that keeps the chain secure, however. It’s also decentralised, each computer with the software installed has a copy of the blockchain which is constantly updated with new blocks. There is no centralised server holding the transactions and because each new block must meet the requirements of the chain nobody is able to overwrite previous transactions.
Other transaction requirements can be added to define what constitutes a valid entry. In Bitcoin for example a valid transaction has to be digitally signed, it has to spend one or more unspent outputs of previous transactions, and the sum of transaction outputs cannot exceed the sum of input.
How does Cryptocurrencies Use The Blockchain?
In the case of bitcoin, a new block in its blockchain is created roughly every ten minutes. That block verifies and records, or “certifies” new transactions that have taken place. In order for that to happen, “miners” utilize powerful computing hardware to provide a proof-of-work — a calculation that effectively creates a number which verifies the block and the transactions it contains. Several of those confirmations must be received before a bitcoin transaction can be considered effectively complete, even if technically the actual bitcoin is transferred near-instantaneously.
This is where bitcoin has run into problems in recent months. As the number of bitcoin transactions increases, the relatively-hard 10-minute block creation time means that it can take longer to confirm all of the transactions and backlogs can occur.
With certain alt-coins, that’s a little different. With Litecoin it’s more like two and a half minutes, while with Ethereum the block time is just 10-20 seconds, so confirmations tend to happen far faster. There are obvious benefits of such a change, though by having blocks generate at a faster rate there is a greater chance of errors occurring. If 51 percent of computers working on the blockchain record an error, it becomes near-permanent, and generating faster blocks means fewer systems working on them.
What Is a Blockchain Wallet?
A wallet is a piece of software or hardware that “holds” your cryptocurrency. But it doesn’t actually hold anything—it’s simply a place that your public and private keys are stored. That information allows you to access the currency that the public ledger says you own.
The wallet is the only record of your keys. So if you lose it, you’ll no longer have access to your cryptocurrency.
Blockchain’s five attributes
Blockchain has five attributes that create a sustainable network:
- Distributed ledger: The ledger is shared; it is not owned or controlled by any single entity. The longevity, veracity and security of a distributed ledger doesn’t depend on any single entity. Rather, a distributed ledger or database requires public consensus among accounting participants.
- Security and privacy: Security is maintained by network consensus and the continued reconciliation and connection to prior verified transactions. Blockchain values, in the form of tokens, are assigned to the electronic wallets of network participants. The network wallet has a unique identifier and is updated according to new transactions. While transactions and wallet electronic addresses are publically available, corresponding names and details of the owner remains private, unless the wallet exist on a regulated exchange that enacts “know-your-customer” procedures.
- Transparency and auditability: The concept of an open or shared ledger allows participants to validate transactions and verify ownership without intermediaries. At the same time, transactions are time-stamped and verified in real time without the need of third party audit.
- Consensus algorithm: Through the use of consensus algorithms, all network participants must agree that a transaction is valid. Transactions that do not meet the consensus protocol are dismissed as non-valid transactions.
- Flexibility: In addition to value and transaction accounting, Blockchain tokens can include custom rules such as contract terms and conditions. For example, a“smart lease contract” token would include information regarding lease terms such as initiation, termination as well as repossession. As business rules and protocols can be embedded into the network, Blockchain networks can adapt and evolve to support a wide range of activities.
What industries will blockchain impact?
The short answer to the above question is “Most of them,” but here’s a look at three specific industries:
Tax and Accounting
Tax and accounting may be the first industry to see the earliest significant changes as a result of blockchain. Since it automatically verifies transactions, blockchain will possibly mean the way we perform auditing today will become outmoded. If every transaction is publicly inspectable then the need for audit is diminished. It’s important to note, though, the advent of blockchain won’t necessarily mean auditing itself will become outmoded; just the way organizations perform it currently might. That’s an important distinction.
“For the near future, I think the answer to whether blockchain is going to largely replace decision processes, rather than supplement them, is probably ‘no’,” said Hella Hoffman, a data scientist with Thomson Reuters Labs. “Blockchain technology can increase transaction transparency and automate repetitive bookkeeping tasks, but it won’t replace the need for human guidance to answer complex questions about the transactions themselves.”
Blockchain will likely streamline and simplify the more mundane aspects of legal work, meaning attorneys will be able to concentrate on the kind of legal work that is more demanding and more profitable.
“You don’t need to contact a lawyer on every single contract you sign” Hoffmann said. “However, you do need a lawyer to help establish the basis of the contract in the first place. We’re not going to replace lawyers, but we’re going to need lawyers to understand technology more. We’re going to need professionals to understand what goes into the contract and what level of, say, proof of authority is needed. If a lawyer can work with technology and say ‘We need this to go in the contract’ or ‘This is vulnerable to exploitation in this way,’ that’s very valuable and necessary.”
While blockchain may make some things in finance easier (banks can use it to conduct transactions between each other quickly and cheaply, for example) it will first cause a period of great tumult. Smart financial contracts and tokenized investments, for example, both use blockchain as a launching pad and both are going to alter the way financial institutions do business. Finance’s era of disruption may not be as close as the tax and accounting industry’s, but it promises to be very eventful.