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What Is Blockchain? A Beginner’s Guide

The year 2017, for everything else it may or may not be, is already heralded as “The Year of Blockchain.” But what exactly is “blockchain” – and why is it slated to be the debutante of the ball across multiple industries?

Essentially blockchain is a way of connecting distributed databases to each other. In other words, it connects databases on machines that are not otherwise connected to each other in one firm or location. Further, it is also a way for these databases to “talk” to each other – to issue and receive commands and data in both encrypted and hashed form to accomplish functions or tasks. Blockchain is, in effect, a new kind of database, which writes “ledger entries” in different locations, but which can then be accessed by the network of computers to confirm that transactions did occur and reconcile these transactions.

It creates what is widely known as a “trustless” network – in other words, it removes the need for trusted third parties like banks or financial institutions to “enter” or reconcile entries, however this is a bit of a misnomer. The role that was formerly played by trusted third parties is now being played by the blockchain network itself. The “trust” that is implied is that the network is stable and the code – or protocols – of the network can in fact function as they are intended to. While blockchain may remove the need for trusted third party institutions, some of the newer blockchains (including Ripple) are based on the idea of “trusted” or “authorized” parties transferring data to one another. This allows a preselected group of “trusted parties” – in this case banks – to lower transactions costs, reduce the chance of fraud and remain competitive while creating in effect a private network.

The most revolutionary aspect of blockchain is that it moves the role of verification (of a task, payment or other action) from a single entity (such as a government or corporation) to multiple computers along its network. While a government or corporate entity (or even single person with enough wealth and power) could conceivably buy the majority of Bitcoins on the Bitcoin network and then hire programmers to change the rules of the network according to its own mandate, this is currently seen as a remote possibility.

The medium of exchange in the world of blockchain is cryptocurrency – tokens that have some value determined either by (a) direct market forces as in the case of Bitcoin or Ether, or (b) by the cost of the computing power required to produce them – in which case they is known as either a “tokens” or “altcoins”.

The workhorse of blockchain is the “smart contract” – which is just another way of saying that after a token has been “paid” for a particular purpose, then a certain action or transaction is triggered. For example, if Jane wants to send Bob five Bitcoins, she can utilize the Bitcoin network to do so (as long as she and Bob both have “wallets” connected to the network) and further, a record of that transaction will be recorded in all the computers in the network. If Jane is expecting to receive, in exchange for those five Bitcoins, ten shares of Bob’s company stock, he will be required to send her the digital token assuring her that the shares have been transferred to her before he can accept the five Bitcoins.

According to Nick Szabo, a cryptographer and “father” of smart contracts, an idea which he explored in a paper published in 1998, smart contracts are “a set of promises agreed to in a meeting of the minds [which] is the traditional way to formalize a relationship.”

Said another way, smart contracts work within the protocols (or algorithms) created to link the chain of databases together, to execute how such computers communicate with each other.

There are many different use cases for this kind of technology – although it has made its first impact in the world of finance. According to the Chamber of Digital Commerce, which has just published a report “Smart Contracts: 12 Use Cases for Business and Beyond” the industries (beyond finance) which are likely to see rapid deployment of the technology in the near future range from a further development of the concept in the financial industry to insurance and the healthcare industry.

What deployment of blockchain technology really means in the immediate future, is that the world will become more interconnected, that manual processes in many industries will be automated, and that the “costs” associated with these transactions will fall dramatically.

That said, it is far too early to predict what the adoption of blockchain will accomplish – just as it was essentially impossible to see where and how the Internet would change the nature of communication and community.

Suffice it to say, however, that by 2020, the world will already be a very different place because of blockchain’s deployment. By 2025, according to top consultants like Deloitte [pdf], the banking industry (at a minimum) will be profoundly disrupted.

Marguerite Arnold is an entrepreneur, author and third semester EMBA candidate at the Frankfurt School of Finance and Management.

(Image Source: Wall Street Journal)