Continuing our series on using blockchains in business, let us see what are the general types of the blockchain, what are the advantages of the blockchain technology and why is blockchain so popular right now.
In the previous episode of this series, we looked at what a blockchain is and in a very simplified way, saw how it operated.
A blockchain network is a large number of interconnected nodes maintaining a synchronised digital ledger of encrypted digital transaction records.
Two of the most important aspects of the blockchain is who has control of the blockchain and who has access to the blockchain.
Types of Blockchain
Blockchains can be classified based on who has control of and who has access to the blockchain. There are three kinds of block chains:
Public blockchain: these type of Ledgers are public and accessible to all. They are fully decentralised which means no one party controls the blockchain. Anyone could become a member (node) in the blockchain.
An example of this would be the bitcoin blockchain, where nodes are distributed around the world and no one node or entity controls the bitcoin blockchain.
Consortium blockchain: these type of Ledgers are not fully public and are accessible to only a small group of members who operate the blockchain. They are partially centralised, which means a small group of members controls the blockchain.
For example, a number of banks can come together and have a blockchain running between them and only these banks’ customers had access to this blockchain.
Private blockchain: these type of Ledger are fully private and are usually controlled by a single party. Only this entity has access to the blockchain and it is fully centralised.
An example of a private blockchain would be security applications or internal transactions, such as payroll processing or performance appraisals or identity management, which are private to a single organisation.
Arguably, the whole idea of a private blockchain defeats the “no single control” definition of a blockchain. But under certain circumstances and for certain applications, a private blockchain might make more sense than a public one.
The advantages of a blockchain
By now you have a fair idea of how the blockchain system is set up, how it works and the major types of blockchain systems. The way blockchains are built and operated inherently creates a number of advantages. Considering that the blockchain is a continuous digital record of transactions within a system, let us see the various advantages that the blockchain offers over conventional transactions, using our friends, Bill, George and Jack:
The transactions in a blockchain are created, encrypted and stored digitally between the parties of the transaction directly. There is no intervention or requirement of a 3rd party to verify or ratify the transaction.
For example, if George transferred $100 to Jack through the blockchain system, this transaction is recorded automatically and encrypted as a block to the blockchain. This is then updated to every copy of the blockchain ledger with every member of the blockchain network. The trust is built into the system and there is no need for a bank or intermediary to keep a record or verify the transaction.
Every member of blockchain system has a copy of the blockchain transaction ledger. As a result, there is no danger of the record ever being destroyed or lost.
For example, if Jack loses his record book, he can take a copy from George and verify it from Bill and other members of the system. And as the record is digital and encrypted, its secure and easy to replicate and verify quickly.
One of the main advantages of the blockchain is that the transaction records are secured with very strong encryption, which is generated automatically.
Let’s consider the bitcoin blockchain, where transactions are encoded with randomly generated numbers (also called keys) made up of 78 digits. Like this:
The encryption calculation uses this randomly generated number to create a private key for each member on the bitcoin blockchain. The private key is used to access their bitcoin wallet account and transactions.
For someone to regenerate someone’s bitcoin private key, they will need to guess this random number. If one million hackers generated one million random numbers every second, it would take approximately 3,671,743,063,080,802,746,815,416,825,491,118,336,277,193,184,902,172 million years (on average) to generate the exact same private key.
The blockchain is a digital computer-based system. As a result, any transaction being recorded is almost instantaneously encrypted, recorded and updated across the blockchain network. As compared to a conventional transaction where any record creation can take hours, days or weeks depending upon the process involved, blockchain recording saves a lot of time and eliminates unnecessary processing.
The blockchain is a completely self-sufficient system without the need for any external party needing to get involved in its functioning. Recording of transactions is done automatically between the transacting nodes, securing the transaction records is done by encryption and verification of transactions is done by comparing ledgers internally. As a result, interference of any sort, either physically or via regulatory means is completely eliminated.
The blockchain, due to its distributed nature and high level of encryption, is very very difficult to modify, once a transaction has been recorded and updated. The result is an extremely high degree of accuracy in the ledger.
For example, if Jack wants to make a change to a transaction in a blockchain ledger, not only has he to decode the encryption, which is nearly impossible, and change every transaction after the one he wanted to make the change in (we’ll see why when we get a bit more technical about the blockchain). And now, he has to do all those changes in the ledger copies of Bill, George and every member of the blockchain system.
Transactions in the blockchain are completely between the parties involved. There is no need for middlemen, attorneys and other third parties usually involved in conventional transactions. This can lead to tremendous savings in service fees, irrespective of the value of the transaction.
So now you realize why the blockchain is so amazing in its possibilities as compared to existing ways of doing transactions. Almost every financial dispute in the world is because of breach of trust, something that the parties in a transaction are expected to honour. So if there was a way to eliminate the need for trust, there would be no disputes, no middlemen and no lawyers in a perfect world…
What about Bitcoin?
Why is blockchain getting people excited today? One major factor for the buzz is bitcoin, a digital currency built on blockchain technology as its underlying platform.
Bitcoins actually are digital “units” which get transferred from one person to another, very similar to cash. The amount of bitcoin that each person has (balance) and any transfer of bitcoins from one person to another (transaction) is encrypted and stored on the bitcoin blockchain, a digital copy of which is maintained at every member of this blockchain, in an application file called a bitcoin wallet.
How do you print a digital currency?
Bitcoins are generated by computers continuously and collectively solving complex calculations. These computers are usually owned and operated by the members of the bitcoin network. Very simply, an application on your computer continuously solves mathematical problems and you are given bitcoins in return. This is called bitcoin mining.
As the bitcoin network has grown, the mathematical calculations have become more complex and need longer times to solve, as a way to control the number of bitcoins in circulation.
What is its value?
Now because Bitcoin is a digital currency (or cryptocurrency, a term used to emphasize the encryption used in the system), it is naturally compared to existing currencies like the US Dollar, GB Pound, Euro etc. And this has exposed bitcoin to speculation and trading, much like stocks or commodities.
Another aspect of bitcoin is that it does not have an inherent value by itself. It is not pegged to the value of a commodity like gold, so it also does not have a relative value. The only thing that would set its relative value is its demand.
The demand for bitcoin
The smart part about the bitcoin blockchain is that, while everyone has a complete copy of the bitcoin ledger, one can only read the transactions in which one is involved. If you need to see the transactions of another, they have to permit you to see them. This permission is unbreakable and immutable, hence law enforcement authorities, governments, banks etc. Cannot override this permission. This makes the bitcoin blockchain a really confidential and secure storage of financial value.
While this confidentiality is great for a financial instrument, this level of secrecy is now making bitcoin really lucrative for people who want to hide their money and financial transactions. Some of these are:
- People with unaccounted money (black money)
- People who want to avoid paying tax
- People engaged in illegal or antisocial activities
- People engaged in terrorist activities
All of the people on the list above have huge sums of physical money that they need to hide or transfer secretly.One well publicised example was the WannaCry Ransomware attack, which demanded its ransom in bitcoin.
As a result, they end up buying large amounts of bitcoin, creating a demand for bitcoin which cannot be matched by the rate at which bitcoin is mined. This drives up the relative value of bitcoin (the value of bitcoin in terms of other currencies). As a result, the trading of bitcoin like any other commodity like gold or crude oil has taken precedence over using bitcoin as a means of exchange.
The future for bitcoin
As stated earlier, there are two schools of thought about bitcoin. On the one hand, there is a lot of excitement about the cryptocurrency and its potential to be independent of any controlling authority.
In a perfect world, a bitcoin will become the standard means of exchange and will determine the true price of everything.
So a loaf of bread in New York would cost 1 bitcoin and in Delhi and in Tokyo and in Capetown. This will be the end of inflation as we know (and hate) it. And because every transaction is recorded by default, no one will be able to hoard or steal bitcoin because what is yours will be yours, verified by everybody else’s ledger.
However, this is not liked by the traditional controllers of currency, viz. Governments, central banks and financial institutions. The fact that they lose control over the supply of currency and the complete inability to impose transaction fees and taxes turns out to be a massive loss for these entities. As a result, all these agencies will not favour bitcoin and other cryptocurrencies without having a measure of control over it. And that fundamentally goes against the very nature of a cryptocurrency.
Moreover, the volatility in bitcoin trading (buying and selling bitcoin like a commodity) and the huge spurt in its relative price is also troubling for many smaller and developing economies, which are worried about their own value will be severely eroded with a new global currency taking over. At the time of this writing, the price of one bitcoin had moved from $1808 in May 2017 to hit its record high of $19213 in December 2017 only to fall to $6100 in Jan 2018. Given this kind of volatility, the bitcoin has become a very expensive speculative commodity.
So it is my personal opinion that cryptocurrency, in its current form, will be strongly opposed by the governments and central banks, with greed and ignorance driving their opposition. Cryptocurrency across the world will be subjected to heavy regulation, varying from mandatory declaration at the least, to absolute bans at its worst. Add to that, the reduction of bitcoin to a mere commodity will result in its real value as an economic equalizer being completely overlooked.
As of today, bitcoin is probably a very risky investment as its future is very uncertain. Unless there is some consensus about the validity and acceptability of bitcoin across the world, this uncertainty will continue to play out.
That is all for Part 2 of this series. If you’ve just joined in, you can also read Blockchain: More than Bitcoin – Part 1 .
As always, I await your feedback and comments.
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