Recent months reveal a growing fascination with Bitcoin and blockchain technology in general. The meteoric rise in dollar value of Bitcoin and other “crypto-currencies” contribute to this increase in exposure. In this post, we examine Bitcoin, the idea behind blockchain technology and its potential.
What is Bitcoin?
Bitcoin is the name of a particular type of “cyber-currency”. It operates worldwide and is also known as a digital payment system. The currency was invented in 2009 by Satoshi Nakamoto, who is/are either an individual or a group of individual computer coding professionals. The purpose of the technology was to facilitate entity to entity payments internationally and without an intermediary. In other words, people all over the world can transact business in Bitcoin without a bank acting as an intermediary to verify the transaction. With Bitcoin, the transaction is authenticated the block chain technology.
Some of the important characteristics of Bitcoin and other cryptocurrencies are:
- Each unit has no inherent value – Unlike commodity currency (i.e. backed by gold or silver) or fiat currency (i.e. backed by a governement’s power to tax its population), cryptocurrency has no value outside its role as a medium of exchange.
- Each unit is without physical form – Likewise, the unit of cryptocurrency exists only within the network (i.e. you cannot hold a bitcoin in your hand).
- The supply of the currency is stable (in theory) – Because new bitcoins are “mined” by computers in the network and are payment for the authenticating processes they run, the amount of the currency is relatively stable. Contrast this to modern currencies wherein a government can create literally trillions of dollars from a few key strokes. Stable currency is an economic panacea according to some economists because it encourages thrift and investment.
How Blockchain Works.
The use of Bitcoin (and other block chain digital currencies) begins when someone requests to transact business using the cryptocurrency as payment. The request is then broadcast to a network of independent computers (peer to peer network or P2P network). The network then validates the transaction using certain algorithms which confirm the currency is available. Once confirmed, the transaction is combined with other transactions in order to create a new block of data for the currency ledger. This new data block is then added to the existing blockchain. This addition completes the transaction. Further, the new data is permanent and cannot be altered causing a permanent record of the transaction. Every unit of currency has the history of transactions in its chain.
By developing blockchain, which stores blocks of information on independent computer networks, the currency cannot be controlled by any single computer in the network. It is therefore decentralized because the process is a function of the entire network of blockchain nodes (independent computers). These computers conduct the verification process for profit (i.e. the opportunity to earn (“mine”) bitcoin).
Why is Bitcoin Important?
Finance is the main application for Bitcoin so far. International transactions are a primary example in which decentralization alleviates the need for the contracting parties to buy/sell different currencies to transact business across geographic borders. Instead, the parties can just transact in Bitcoin and cut out the middleman.
Enhanced security is another byproduct of blockchain technology. Because data is stored on multiple nodes within the network, there is no centralized point hackers can target. Blockchain security uses “public” and “private” keys for security. The public key is a random set of numbers which act essentially as ownership identification on the blockchain. The private key is similar to a password that give the owner access to the Bitcoin. The data point is as secure as possible, but it is important to note that the owner must NOT lose the private key or else the ownership cannot be authenticated.
These types of safeguards can give rise to a new variety of transactions and the validation of same.
What Blockchain Technology Means for the Rest of Us.
The implications of a global network acting to decentralize money have only scratched the surface. Some new technologies have already emerged, such as:
- Smart Contracts – Imagine a contract which can be programmed to execute automatically once certain conditions are met. For example, a smart contract can automate payment once a product delivery is made, or an options contract can automatically execute once it reaches another predetermined price level. The blockchain technology authenticates the transaction and automates the process.
- Peer to Peer Trade – Blockchain facilitates direct transactions between parties. Consider a vacation rental portal such as VRBO.com where “renters” can shop existing units and contact “landlords” for vacation properties. Currently, users have to go through VRBO.com as an intermediary. Through the use of blockchain, peer to peer payments are made directly, without paying transaction fees.
- Document Recording – Blockchain can make the recording of documents much more efficient. Court documents such as real estate titles, which historically have problems with fraud, can be authenticated and transferred in minutes, and without the need for title insurance or other authentication process.
Again, blockchain technology promotes efficiency. Only time will tell what industries will be impacted. What we do know is that this technology is gaining rapid acceptance and the dramatic rise in Bitcoin pricing over the last year increases its exposure to the masses. Who knows what ideas people will come up with? We are limited only by our imaginations.
Thanks for listening.